´´ Ryoyo Electro (jp:8068) - japanese net-net

Saturday, March 31, 2012

Ryoyo Electro (jp:8068) - japanese net-net

The first individual company I would like to present is Ryoyo Electro Corporation, a classic Graham and Dodd net-net investment .

A Graham and Dodd net- net stock is a company, where the current assets minus all liabilities of a stock is worth more than the total business is valued on the stockmarket. Therefore an investor pays a significant discount on the most liquide assets of a company and gets the business for free (the typical paying 50 cents on the dollar). Those situations are very rare, but they do happen from time to time. Especially in circumstances where the economy of a country is in a depression. Benjamin Graham, the father of value investing and mentor of Warren Buffett, found many net- nets during the great depression of the 1930`s. He followed the theory, that an investment in a portfolio of those businesses, where the intrinsic value is significantly higher than the current market capitalisation, represents a sound investment. It offers a so called "margin of safety", because in case of theoretical liquidation the investor gets more cash paid out than his inital investment was. Usually net- net stocks are moneylosing businesses and one is speculating on a turn- around of the company. Graham therefore advised people to buy a basket of net- net stocks to minimise the risk that an individual company keeps on losing money, hence depleting its cash and finally going bancrupt.

I will refrain from going into more details regarding Benjamin Grahams investing princicples as there is plenty of resource to be found on the internet.

Ryoyo Electro Corporation engages in the distribution of semiconductors, computer systems and peripherals, and electronic devices mainly in Japan but also internationally. Therfore Ryoyo Electro is a classical trading company, that is not engaged in the production of electronic devices. It was founded in 1961, is headquartered in Tokyo, Japan and the stock is listed on the First Section of the Tokyo Stock Exchange (TSE).

The price of the stock as of today is 944 Yen and the market cap stands at 25.1 bln Yen. Ryoyo engages in a segement of the japaneses economy which is characterised by fierce competition, resulting in a wave of consolidation. Also Ryoyo wasn't able to isolate from this harsh business environment, which is reflected in a decline in net sales in the last several years.From 2003 til today sales at Ryoyo declined by a whooping 28%. Surpirsingly Ryoyo was able to isolate shareholder's equity from a significant decline. This is mainly attributable to a quite impressive control of the company's cost base and the avoidance of net losses, with only one losing year (2009) in the last decade.

Ryoyo has been consistantly paying a dividend in the last 10 years and is currently paying a dividend of 30 yen and therefore offering a 3 percent dividend yield, which is pretty good giving that the 10 year government bond in Japan (JGB) is yielding just a paltry 1%. Futhermore Ryoyo is engaging in treasury stock buy backs in a flexible manner and has so far bought back around 10% of its outstanding shares.

The average price- earning ratio (pe-ratio) of the last 9 years is 25, which is quite high. This is due to the fact that Ryoyo's operatinal and net margins are annoyingly low, consistantly hoovering around 1 percent.

Operating cash-flow is extremly volatile, given that Ryoyo is debt free and finances its working capital needs internally. Build- up and cut backs in working capital therefore has a big impact in operating cash- flow metrics. Also cash- flow of investing activities is volatile, as Ryoyo tends to invest and divest a lot in long term assets.

Hence it doesn't make really sence to make an analysis of the price cash flow ratio (pcf-ratio) or free cash flow yield.

What really strikes me at Ryoyo is its balance sheet, which is impressively strong. Actually one has to say that Ryoyo is extremely overcapitalized, which is quite common with japanese corporations.

Ryoyo's equity ratio is 86% and Book value per share (BPS) stands at 2300 yen, that leads us to a price to book ratio (P/B) of 0,4. But more impressive is the composition of the book value. It is rock hard with 915 yen in cash and cash equivalents per share, current assets at 2145 yen per share and an astonishing net-current asset value per share (NCAV = Net current assets - all liabilities) of 1798 yen. Given the stock price of 944 yen per share this gives us an impressive 47 % discount to NCAV and represents a extremely nice margin of safety.

Even the most stingent margin of safety analysis, the liquidation value, where I weight cash and cash equivalent by a factor of 1, accounts receivables by a factor of 0,7 and inventories by a factor of 0,5 and hence, more or less, simulate a fire sale of Ryoyo's assets, leaves us with a liquidation value of 1341 yen per share.

click to enlarge

Not included in the intrinsic value analysis is Ryoyo's investment portfolio. Investment portfolios in Japan are marked to market and in the majority of cases investments are marketable and liquid.  Ryoyo has got an investment portfolio which represents around 45% of its market cap, hence investments in long term assets are valued on the books at 442 yen per share. If I included it in the value analysis the margin of safety would rise significantly.

Given all the aforementioned  financial ratios I believe Ryoyo is extremely undervalued and offers good opportunity for the risk averse investor.

Disclosure: Long 8068 Ryoyo electro company


  1. Muy bueno, O-tone
    Desde estas latitudes voy a seguir tus muy interesantes analisis

  2. Gracias Guillermo,

    es muy interesante la situacion en japon. Si se lee la prensa internacional se podría pensar que es igual a la
    de la argentina de 2001/2002. Pero no lo creo.
    En mi opionion los inversores subvaloran Japon.
    Vamos a ver. El futuro decirá.


    1. En realidad, Argentina 2012 está muy cercana a Argentina 2001/2002.
      Volviendo a Japón, comparto tu opinión y creo que hay posibilidades allá

  3. Yo tambien estoy seriamente preocupado por mi querida argentina. Ni siquira tratan de controlar la inflacion.
    Y ahora tenemos los comienzos de controles del capital y
    un banco central bajo del regimen del gobierno. A donde quiere ir Christina? Escuchaste que dijo Mercedes Marcó del Pont sobre inflacion? Imprimir billetes no crea Inflacion! Donde vive esa muchacha?

    No vas a creer que dice la prensa aqui sobre las politicas de los Kirchners despues de la crisis.
    Que es un milagro y podría ser un modelo para grecia.

    Pero es otro tema y merecería un blog propio.


  4. O-tone,

    Nice post.

    This stock is challenging to value. I don't genearally look at this kind of company, but it is an interesting problem.

    The volatile cash flow means that it need to keep a solid balance sheet - it is a prerequisite for it continuing operations, a bit like an insurer, except the difference is that it does not use its float for anything.

    And, it is not like the company will be broken up in pieces and sold off - there are no corporate raiders in Japan - their visas must be rejected or something.

    So you need a catalyst, or a sign that they will eventually change. In the case of this company, it seems they are trying to grow overseas. You should also check out the company's shift from a consumer electronics to more industry-focused electronics (higher margins), and also their restructuring their agency arrangements - I haven't looked into this in detail, but assume that these are contributing to the forecast growth in earnings for next year - you need a handle on these things to get an idea of the future prospects.

    One more point - I am not sure how important the margins are for this kinds of companies, which typically get involved in all kinds of reselling, so they have a large pass-through component of sales.


  5. Hi Jan,

    a pleasure having you comment on my blog.

    Volatile cash-flow stems from financing working capital. For sure
    they need a healthy balance sheet. But that healthy? I mean have you had a look into current asset composition? I'm pretty sure they would have access to external, short- term financing if they wished to. Banks in Japan are eager to finance good borrowers, as they are drowning in cash.

    There has been fierce competition in Japan among this kind of trading companies and consolidation in this sector has run rampant.

    Ryoyo is trying to diversify there product portfolio into higher margin businesses. One has to see how this is playing out.

    Regarding corporate raiders in Japan; hopefully we'll see some coming out of theire rabbit hole, that don't need a visa and can't get deported, when they're starting to shake things up a little. It's not going to work with foreigners, as 2003-2008 showed.