| | | Thank you PaulSenior, Spekulatius and Jurgis Bekepuris for useful comments on Kobayashi (TSE: 4967). I apologize in the delay in responding and appreciate the opportunity to share ideas with you and the group. Please see below response to your comments in order posted.
Comment from Jurgis Bekepuris: "TSE page lists ROE 11%, PE 18, PB 1.9. MSN agrees. MSN claims that future PE is 11, but personally I don't use future PEs and I would doubt that number if only single analyst covers the company"
Response: Thanks Jurgis. Looking at the headline multiples on investment databases might often not give you the full story. Getting to a normalized multiple after one-time events and excess cash is important to value the operating business.
In Kobayashi's case, the historical P/E (excluding cash and short term investments of $483) is 13.0x ($2.1bn market cap - $483mm / $124 in FY2013 net income). There are two one off charges, that need to be added back to net income - i) $5mm cost incurred related specifically to share transfer of their medical devices subsidiary (Kobayashi is divesting this fully by FY2014 which is a lower margin business) and ii) $3.5mm goodwill amortization as under Japanese GAAP, Kobayashi is required to amortize goodwill for 20 years which reduces net profit (under US GAAP no amortization is required, its just an impairment test annually). This gets us to a 12x P/E. While obviously I would like the multiple to be 5-6, the free cash flow yield is about 8% and EV/EBITDA multiple less maintenance capex less than 8.0x (company has no debt, predictable and low capital intensity, etc).
Comment from Paul Senior: "For me to buy shares, for a "stockholder-friendly" company, especially one from the Japanese culture, I'd like to see a higher yield, if funds are available."
Response: Thanks Paul Senior and for having me on the board. In my mind, there are a few things the company can do with excess cash:
- reinvest in the company
- acquire other companies
- repurchase shares
- pay dividends
Given management's ability to have generated returns on capital of the business of above 50% for a long period of time (indication of a significant competitive advantage), I would borrow from Mr. Buffett and prefer management deploy this capital (and compound cash) through 1, 2, 3 before they increased the current 1.5% dividend yield. While the payout ratio of ~30-40% could be higher and certainly should be close to 100% in cases where returns on capital are very low, however in this case, given the sustained high ROC, it is best management deploy excess cash in projects with similar returns on capital and let cash compound.
Comment from Paul Senior: For me though, if the primary way that I have to view the undervalued nature of Kobayasi is by something called "high returns on unlevered tangible equity" where "Returns on tangible invested capital defined as normalized operating income divided by (non cash working capital (i.e. less interest bearing short term debt, current capital leases, short term cash, etc) plus tangible fixed asset)" -- well that is just too much of a stretch for me.
Response: Buffett discusses at length in his letters the concept of returns on unlevered equity excluding goodwill & intangibles in his Sees Candy investment and indeed does focus on returns on capital. Greenblatt defines ROIC as EBIT/Net PPE + Net Working Capital and focuses on ROIC and Earnings yield for the "Magic Formula". While there isn't such a thing as a magic formula, clearly evidence of a company's ability to plow less capital but earn more than its peers is powerful. Apologies though for over complicating this and let me know if I can be clearer in this point.
Comment from Spekulatius: My main issue is that it's not cheap enough with an ~18PE. I can buy well managed consumer good companies in the US or Europe for a similar PE. Their near term outlook appears to be muted with slightly declining earnings. The company has not much of an export business (<10% of revenues) and the Japanese consumer goods market has way below average growth.
Response: Good point, as per my response to Jurgis, P/E excluding cash and adjusted for non operating items (goodwill amortization and the cost incurred for share transfer of a divestment) get you to a reasonable 12x P/E. For valuation, I have used EV/EBITDA less maintenance capex of under 8x (company has a debt-free balance sheet and D&A/Capex is predictable and low.) You bring up a good point - that the export business is <10% of revenues - this is a "free" call option in my view as they expand to HK, South Asia, China, etc. The products are time tested and the major stores in HK carry their products. I've spoken to sales reps who mentioned that Kobayashi pain relievers are best selling amongst the others. I do not think this stock is a double in 12 months, however I think this is a "long term" core holding in Japan, where most companies have very low returns on equity and capital. You have to look no closer than the company's KOVA method (adopted from the Economic Value Added method by Stern Stuart) - management is very focused on allocating capital wisely and that is very rare in Japan. This is an exception in my humble view.
Thanks for the comments, and will post other Asian ideas shortly!
Good investing,
AsianValueInvestor |
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