Best idea for 2023. Tokuden Co (JP:3437): cheap Japanese microcap with a good quality business
Tokuden Co (stock code 3437 in Japan and Edinet code E01464, see also KaijiNet/JapanExpress) provides “welding work, welding consumables, steel plates with special welding, welding equipment, welding methods, and applied products derived from these technologies.”
Currently the share price is about 2150 JPY and therefore the market cap is about 26 million USD. At the current market value the stock is extremely cheap based on EV/EBIT and EV/Revenue. Moreover NCAV/Market cap is slightly above 1. I estimate the stock trades slightly below liquidation value, also because of 1.0 billion JPY of land holdings.
More positives: the dividend yield is 1.7%. Trading is very illiquid and volatility of the stock price is extremely low.
Usually I find such cheap stocks at companies with low quality business or bad management. But this seems to be a good business. That is, multi-year metrics for judging earnings quality and asset allocation are very good. Furthermore, during the last 5 fully reported years the company spent 186 million JPY on research and development.
Disclosure is in Japanese. My analysis depends on the accuracy and readability of software translations. I was able to use Google Translate on the annual report (year ending on 31 March 2022) and the recent quarterly report (30 September 2022).
In the annual report the auditor mentioned the following key audit matter: “Construction sales for which revenue is recognized when performance obligations are fully satisfied”.
The 4 main business segments are 1. Construction (focused on welding for equipment maintenance, 2. Welding materials (mainly flux-cored wire and 3. Environmental equipment (forced cooling equipment cooling rough materials for automotive, mold heating equipment), 4. Others (own manufactured and imported aluminum die casting machine parts).
About 70% of the revenue is from actual welding (construction work) and the rest is mainly from manufacturing and reselling welding materials. A large part of the revenue comes from other steel companies and the automobile industry. Last financial year and the year before the largest customer was Nippon Steel (15% of revenue last financial year).
Though the company also has a factory in China and an office in Thailand almost all assets are in Japan.
Although the dividend is small the company is a very reliable dividend payer. The payout ratio is low. Every year the dividend is only 50-60 million JPY. I estimate net earnings plus depreciation minus capex not related to business growth at 300 million JPY, at least. Over the years the cash balance has slowly increased. I think there is room for a dividend increase.
There are 1,602,000 shares including 20,900 treasury shares (1.3% of total share count).
The balance sheet is strong with moderate leverage, a high current ratio, lots of cash and low debts. Between 1 April 2022 and 30 September 2022 the company spent nearly 800 million JPY on its factories. The company seems to have financed this mainly though long term debt, while it has so much cash. If the company plans to increase the dividend much that is a good move, otherwise it is a red flag.
Substantial shareholders (page 5 quarterly report): UH Partners Co 15.99%, Hikari Tsushin Co 8.48%, “Special Electrode Employee Shareholding Association” 7.53%. Six individuals owns stakes of about 2% each. The largest 10 shareholder own 48.18% in total. Members of management also own some shares but not substantial wealth.
Note the company does not hold significant wealth in stocks of other companies. I suppose the 6 individuals and the 3 main shareholders will follow management recommendations at shareholders meetings. Therefore, I think it will be difficult to acquire this company without permission from management.
Related party transactions: In the related party section of the annual report it says “Not applicable”.
Last financial year 7 directors earned together 48.7 million JPY and 2 outsider directors earned together 19.4 million JPY. Their remuneration consisted of fixed pay only.
My take: Good quality Japanese steel business trading at low earnings multiples. Strong balance sheet. Reliable dividend payer with room for a dividend increase. I also like the low volatility of the stock price. I think this is a very good stock to own, on a statistical basis.
Disclosure: Long Tokuden Co.
Best idea for 2023
This is the best idea available now. So, I call it my best idea for 2023! Since I pick stocks that are good on a statistical basis this “best idea” mark does not guarantee great returns. But on average I think ideas like this one generate 20-50% annualized return.
A general problem I see with Japan is the shrinking, aging population. This leads to a decline in demand. There is also hardly any immigration, since Japan is already isolated in terms of language and immigration is rejected. It is difficult for a company to increase its sales, for example, if the population is shrinking and aging. For a global (often larger) company, however, this is less of a problem. Perhaps that is why these small companies are favorably valued.
Interesting find. Any clue what the massive capex program is for (FY19 & TTM spend look more than double that of next largest program). And any communication on dividend policy? Payout looks very low even for Japan..