Yodogawa Steel Works (JP:5451): A J- Net Beauty with Loads of Hidden Assets

Company overview

Yodogawa Steel Works, Ltd. is an independent Japanese steelmaker located in Osaka. It mainly provides surface treated steel sheet. It is particularly strong in color steel sheet.

The Company operates in four business segments. The Steel Sheets-related segment manufactures and sells coated steel sheets, galvanized steel sheets and cold-rolled steel products. The Roll segment is engaged in the manufacture and sale of steel rolls, non-ferrous rolls, etc. The grating segment is engaged in the manufacture and sale of gratings. The Real Estate segment is engaged in the leasing and sale of real estate.

Most of its products are provided to corporate customers, such as building contractors and consumer electronics maker, but the company also handles household use storerooms, carports, and photovoltaic power generation, among other things, for general consumers.

It runs plants in Osaka, Kure, Ichikawa, Fukai and Izumiotsu. It started steel sheet sales through own sales offices. It also has a large overseas plant in Taiwan. The joint venture subsidiary, which operates the Taiwanese plant, is listed on the Taiwan Stock exchange. The company also set up local firms in Taiwan and China to produce and sell surface treated steel sheet.

General Valuation

Apart from price metrics in relation to book value and sales, Yodogawa does not appear being a deep value investment.

EPS for FY ended March 2020 came in at 132 Yen leading to an actual P/E ratio of 15.

Average EPS for the last 21 Years was 96 Yen leading to an average P/E ratio of 20.

The P/E ratios do not appear really compelling for such a low margin business like Yodogawa. But P/E ratios in general are very flawed metrics. Especially in corporate Japan with its high cash balances, big investment portfolios and low financial gearing.

 

To adjust for the overly conservative financing of the company EV/ Ebit and EV/ Ebitda ratios are used. The enterprise value (EV) of the company stands at 15’070 Mios. of Yen. If Yodogawa’s investment portfolio is excluded, which consists of highly liquid assets, which are marked to market, the EV turns highly negative (- 19’ 700 Mios. Of Yen).

An Ebit of 4'360 Mios. of Yen and Ebitda of 8’148 Mios. of Yen the EV/Ebit and EV/ Ebitda ratio (incl. Investments) is only 3,5 and 1,9 respectively.

Overview of Operations

Sales suffered significantly during the great financial crisis (GFC) and have never recovered to pre- crisis levels. Stated operating margins and net income margins have been low and volatile for a long time. For the FY ended March 2020 a meager 3.5% and 2.5% were reported.

 

Stated return metrics and EPS are highly volatile, and the company reported three loss years in the last 21 Years. Stated ROE and ROA for the latest FY came in at a poor 2% and have been poor historically.

Interesting to note is the fact that the company is showing quite significant aberration between stated and adjusted operating and return metrics, which are brought forth by extremely conservative accounting procedures. In addition, adjusted return metrics are significantly less volatile.

Analysis of Cash Flow

Not only with its stated vs. adjusted margins Yodogawa exhibiting discrepancies, but more importantly so in relation of earnings to generated operating and free cash flow.

At a current market price of 1’930 Yen and stated average earnings per share of 96 yen for the last 21 years, the stock is trading at an average P/E ratio of 20. Whereas the average P/OCF ratio stands at only 7. Furthermore, FCF generation appears much more stable than the volatility of stated operating, earning and return metrics would suggest.

In addition, although average stated ROE is only around 2%, the average FCF yield is almost four times higher (roughly 8%).

Interim Conclusion: A well-established Japanese steel company that has been showing low operational and return metrics over an extended period. By scrutinizing stated metrics, discrepancies emerge. It appears that the company is misrepresenting its operational efficiency for the worse and underreporting its true earning power.

Analysis of Balance Sheet

Yodogawa does not carry any interest-bearing debt on its balance sheet, which is astounding. I think I have never come across a steel manufacturer that has no financial leverage at all.

Stated overall book value per share has been increasing moderately by approximately 3% p.a. The equity ratio for FY 2020 stands at a staggering 83%. The decrease around the GFC is attributable to losses on valuation of investment securities and impairment on PP&E.

 

Cash and investment holdings have increased significantly since the GFC, but lately expansion has stalled.

Asset composition has been seeing a significant transformation over time, away from fixed assets towards more liquid assets. As for the latest FY asset composition is highly favorable. Cash, receivables, and the investment portfolio make up for roughly 60% of total assets. Goodwill and intangibles are negligible.

Yodogawa’s investment portfolio is highly valuable and mainly composed of the biggest two coating manufactures within Japan. Other relevant holdings are a well-established Japanese building material company and an elevator manufacturer. 

Yodogawa’s NCAV is roughly 2’800 Yen per share.  At a share price of 1’900 Yen the stock is trading at a discount of roughly 33%. If the highly valuable investment portfolio were included (1’185 Yen per share) the discount would widen significantly to 52 % per share.

The stock is even trading at a discount to liquidation value (incl. Investments), which is quite remarkable for a dividend paying and cash generative business. The discount to liquidation value is roughly 37%.

Thus, according to the Graham and Dodd philosophy the minimum upside potential should be the liquidation value including investment portfolio (approx. 60%). Maximum upside should be the NCAV incl. investment portfolio (roughly 110%).

The trend of NCAV is favorable.

The same holds true for the liquidation value.

 

 PP&E Account

Yodogawa’s PP&E account is quite remarkable, as it contains significant hidden assets. It contains a golf course, warehouses, a guest house and several other buildings and land, mainly located in the Hyogo prefecture. Till 2017 the difference between carrying value and fair value of the real estate portfolio was published and showed a significant amount of hidden asset value.

The crown jewel in Yodoko’s property portfolio is the Yodoko Guest house, which was designed by the fabulous and renowned star architect Frank Lloyd Wright. It is the only still existing Wright building in Japan and has been designated as an important cultural property by the Japanese government. Valuing it as priceless is no exaggeration.

Interim Conclusion:

Debt- free Company with a severely overcapitalized balance sheet. Overall business is cash generative and adjusted EV in unchartered negative territory. Company is hiding true earning power through extremely conservative accounting policy. Fair value of the real estate portfolio is significantly higher than the carrying value on the balance sheet.

Analysis of Shareholder Returns

For FY 2020 the company paid a dividend of 70 Yen per share. At current market price the dividend yield is 3,7 %. The interim dividend for FY 2021 was 35 Yen.  Due to Covid 19 a year end dividend has not been declared so far. The stated average payout ratio over the last 21 years was 44%. The real ratio was 27%, significantly lower.

The company is engaged in share repurchases on a continuous basis. The company has been buying back shares in 17 out of 21 years. The share count over time has decreased by roughly 30%.

Share buy backs were executed at extremely value accretive terms for the remaining shareholders. All of them were executed below stated book value and the majority even below NCAV and liquidation value.

Corporate Governance

The fundamental analysis of the company conducted so far, begs the question what makes Mr. Market valuing the company as if it is heading for bankruptcy. The fundamentals presented in this post do not indicate any distress the company might be facing. Quite to the contrary. It reveals a company that is delivering decent adjusted owners’ earnings, has a vast amount of net liquid assets and a severely understated PP&E account.  

The only sensible explanation for Yodogawa’s extreme undervaluation is Mr. Market applying a massive corporate governance discount to this company. But is he rightly doing so?

As far as I know the company has never been approached by any activist fund and the current shareholder register does not indicate any activist involvement momentarily.

Although, the company has been having a take-over defense mechanism implemented, I personally see it as a plus. An abolition would result in immediate corporate activism with the danger of shareholder been taken out at unfavorable terms. Should the share price recover to a fair value basis abolition should be on the agenda at coming AGM’s.

Apparently, management does not act against the best interest to shareholders in hostile manner like it was the case with Kawasumi (see shareholder return policy). But a more aggressive approach regarding matters concerning capital efficiency and a renunciation of extremely conservative accounting policies is urgent.

Given the severe overcapitalization of the balance sheet, the best measure management could take to mend the severe undervaluation in a timely manner is adopting a shareholder return policy based on dividend on equity (DOE). Basically, paying out a certain rate on equity.

Conclusion

Yodogawa is an ok business, that is misrepresenting its operational performance for the worse and hiding assets over an extended period. Why it is doing so remains a mystery!

For a long time, the company has had a balance sheet that has been overcapitalized. A valuation only based on the net liquid position indicates a hugely undervalued security. If hidden assets are included in the analysis the undervaluation becomes insane, seldom seen in my career as a security analyst.

On an asset basis the company has been undervalued for a long time, but the discount between intrinsic value and the market price has been steepening significantly in the last 3 years.

The main culprit for this steep undervaluation is not to be found in extremely poor decisions concerning capital allocation by management, but rather in total ignorance of market participants within Japan and abroad.

Due to the existence of a poison pill a certain corporate governance discount is warranted. But at Yodogawa Steel Works this discount is hilarious.

 

Disclaimer: Long Yodogawa Steelworks