I stumbled across Fuji Furukawa E&C whilst combing through a lengthy screen of very average Japanese net-nets. The company stood out from the pack for its surprisingly high-quality characteristics.
So many of these Japanese net-nets are static companies with wafer thin or non-existent profit margins, low returns on capital and balance sheets stuffed full of non-productive assets. This doesn’t rule them out as investments of course (if the price is low enough) but one is really just betting that at some point they will trade closer to asset value. Fuji Furukawa E&C looks like a different animal… it is a quality business that is growing and available at a bargain price.
To be fair, it only just made it onto the original screen trading as it does at a slender 5% discount to Net Current Asset Value. It does however sport an average 14% return on capital over the last 8 years (figures from Koyfin) with steadily rising revenues and operating margins. It trades at a paltry 5 times earnings, 70% of Tangible Book Value, has no debt, and comes with a 3.38% dividend yield. Over this 8 year period the share price has steadily risen, compounding at an annual rate of 12.63% while Tangible Book Value per share grew at approx 17.5% a year (the share count remained steady at 9M with a small buyback taking place in 2016). In short, Fuji Furukawa E&C doesn’t look like a typical Japanese deep value play.
Company Profile
Fuji Furukawa E&C is a construction and engineering company whose operations include Power and Manufacturing facilities, IT infrastructure such as data centres and server rooms, Industrial Air Conditioning, Renewable Energy projects and more general Building Works. Most of their operations are in Japan however they also have various overseas subsidiaries across SE Asia. In 2018 Overseas Sales accounted for 8.2% of revenue and they are targeting 12% overseas sales by 2023. The company has a market cap of Y20.33B (approx $195M) however 65% of the shares are held by the former parent companies Fuji Electric (45%) and Furukawa Electric (20%) resulting in a rather constrained free float.
A look at the company history page on their website shows how this came about. The original company was 100% acquired in 1944 by Fuji Electric and then spun out in 1996 through a listing on the second section of the Tokyo Stock Exchange, with Fuji Electric presumably maintaining a large stake from this point onwards. Then in 2009 they merged with Furukawa E&C (formerly part of Furukawa Electric) resulting in the entity and ownership structure we find today.
Valuation and Analysis
The company has a fairly simple balance sheet. As of Dec 2020 two thirds of the current assets were receivables with the rest being mostly cash and short term investments and a smaller inventory position. PPE is also small, and current assets make up 90% of total assets. Most of the liabilities are in trade payables and there is a small pension liability and no long term debt. The company trades at 0.7x Tangible Book Value and has traded as high as 1.2x in the recent past (2015). So clearly we are looking at a strong balance sheet which can be purchased at a reasonable, albeit not spectacular, discount to where it has traded historically. However this is a company with good earnings and a history of revenue growth and margin expansion. Looking at it through the lens of an Earnings Power Valuation is likely to be more illuminating when assessing intrinsic value.
For this I look at two scenarios. Scenario 1, which is the most conservative, normalizes the previous 8 years of revenue and operating margins. Scenario 2 uses 2020 revenue and operating margins. Neither of these scenarios assume any growth, which is perhaps unfair as the company has shown consistent growth and has some exposure to long term secular trends in Emerging Market growth. For the calculation I use a 9% cost of capital, which may be too conservative considering the lack of leverage and low valuation. I also make no adjustments to depreciation and amortization, although it does in fact look like the company has been over-depreciating for the last few years (the numbers are fairly trivial and I prefer to err on the side of caution here). I then add back 80% of net cash (6536M Yen) on the loose assumption that 20% of net cash is necessary for operations and subtract the pension liability (2096M Yen).
| SCENARIO 1, NORMALIZED REVENUE AND OPERATING MARGIN | YEN MILLIONS |
| REVENUE | 75,883.50 |
| OPERATING MARGIN | 4.95% |
| NORMALIZED EBIT | 3756 |
| AVERAGE TAX RATE | 37.79% |
| NORMALIZED OPERATING INCOME AFTER TAX | 2337 |
| EPV OF OPERATIONS AT 9% COST OF CAPITAL | 25964 |
| ADD 80% OF NET CASH (6536) MINUS PENSION LIABILITY (2096) | 30404 |
| UPSIDE FROM CURRENT MARKET VALUE (20.33B Yen) | 50% |
| SCENARIO 2, 2020 REVENUE AND 2020 OPERATING MARGIN | YEN MILLIONS |
| REVENUE | 81,986 |
| OPERATING MARGIN | 7.23% |
| NORMALIZED EBIT | 5928 |
| AVERAGE TAX RATE | 37.79% |
| NORMALIZED OPERATING INCOME AFTER TAX | 3688 |
| EPV OF OPERATIONS AT 9% COST OF CAPITAL | 40973 |
| ADD 80% OF NET CASH (6536) MINUS PENSION LIABILITY (2096) | 45413 |
| UPSIDE FROM CURRENT MARKET VALUE (20.33B) | 123% |
As we can see the company is considerably undervalued based on its earnings power, which also assumes no future growth. In both cases the EPV comes in higher than the current book value of the equity (27B Yen as of Dec 2020) which suggests that either the book value understates the true value of the assets or perhaps that the company has some kind of sustainable competitive advantage, which would be unusual indeed for such a cheaply valued business.
Looking at it from a more qualitative point of view it seems likely that the ownership and partnership advantages the company enjoys from its association with Fuji Electric and Furukawa Electric are considerable. Both these companies are large manufacturers of diverse electrical equipment and industrial components of the type that Fuji Furukawa E&C would use in their construction projects. The CEO of Fuji Furukawa E&C is a former executive of Fuji Electric. The ties between these two companies appear to be deep and synergetic and one can assume that Fuji Electric’s large ownership stake in Fuji Furukawa E&C incentivises them to offer favourable terms for their products and improves the efficiency of their supply chain. It’s likely that a similar dynamic is at work with their other former parent and stakeholder Furukawa Electric.
Of course, these large ownership stakes and the fact that Fuji Electric were able to appoint a CEO from their own organization shows that they are pretty much in control of the company and running it for their own benefit. This isn’t really an issue though as there is no need for an activist to shake things up (I am not expecting excess cash to be distributed to shareholders as part of the investment thesis). As minority shareholders we are simply hoping to ride along on the coattails of the majority owners and enjoy the same solid returns on capital and profit margins that they are benefiting from.
Whilst not necessarily a clear barrier to entry, having the backing of two large electrical manufacturers and suppliers is a big advantage and it would likely be hard for other firms without similar advantages to show the same type of returns on capital in what must otherwise be a competitive industry. I suspect that their 14% return on capital is likely to be an outlier in the industry and is comfortably above their cost of capital.
What kind of returns can investors expect going forward? EPS growth over the period 2014-2020 averaged roughly 19%, an impressive trajectory. I have no idea if this growth is sustainable, but one could cut it all the way back to 4% and still achieve returns similar to the current 12.5% CAGR return when factoring in the dividend of 3.3% and some fairly modest multiple expansion from the current 5x Earnings to an approximate historical average of 7.5x.
| EPS GROWTH | CURRENT DIVIDEND YIELD | MARGIN EXPANSION. 5x > 7.5x OVER 10 YEARS | ESTIMATED ANNUAL RETURN |
| 4% | 3.30% | 5% | 12.30% |
Conclusion
All in all there does seem to be a pretty wide margin of safety here, and a very general look at the company’s link with its two larger partners/shareholders provides reason to believe that these returns are probably sustainable. For a company with such a low valuation and no financial risk this is an attractive setup. My base case is simply that shareholders will continue to benefit from the approx 12.5% CAGR going forwards. However there is always the possibility that growth could continue at the steady clip of the last few years, and as shareholders we might get the double whammy of EPS and Dividend growth along with the market recognizing that a company with fundamentals such as these should probably be worth at least 10x earnings, and not the measly 5x that it sits on now.