Elite Client Idea #25

Nakano Corporation (TSE Ticker: 1827; Price: ¥318)

Nakano (‘company’) is a long-established operator in the Japanese construction industry catering mostly to the private sector (90% of sales). It engages in the construction of factories, offices, university facilities, hotels, etc. It generated 74% of sales in Japan and the rest in South-East Asia - where it operates in Singapore, Malaysia, Thailand, Vietnam, and Indonesia.

The construction industry contracted severely in FY22 (year-ended March 31st) due to the coronavirus pandemic and included government orders to close operations temporarily in Malaysia and Singapore. In addition, prices of major materials rose sharply.

The company recorded its first operating loss in two decades in FY22 due to provision for losses on construction contracts. This was mitigated to a certain extent in the six months to September 30th with revenues and profits bouncing back – but orders in Japan declined 22% and near-term headwinds are expected.

Further, there were issues of inappropriate accounting in its Thailand subsidiary totaling ~¥392m since FY19 – but this appears to be isolated and resolved.

The company reported TTM revenues of ¥112.3b (FY22: ¥96.4b), ebitda of ¥3.4b (FY22: loss of ¥0.4b), and net profits of ¥1.9b (FY22: loss of ¥1.7b).

Average profits appear to exceed ¥2.3b/year and these are backed by cash flows over past business cycles.

It paid down debt considerably over FY22 and current sports a strong net cash position of ¥14.3b. Net current asset value (including ¥2.1b of liquid securities) stood at ¥14.5b and net tangible equity was ¥35.4b.

Apart from cash, the primary net current asset component is receivables and contract assets (conditional right to receive revenue), which amounted to ¥23.3b. Relative to sales, this is lower than the average of the recent past and has been considerably reduced since FY21 – and therefore doesn’t appear to pose a problem.

The equity currently sells for ¥10.9b at market, which is 75% of minimum realizable liquid asset value, and under 5x average earnings.

Management estimates business to continue as before over the next few years. Dividends payouts aren’t high but yield close to 4% at market.

The shares have sold at least 50% higher in the last three years – though not a market darling, there is scope for a re-rating of the stock.

Regardless, the attractive underlying earnings yield and liquid asset protection would qualify this stock as among the better values in the market today.