3rd Jan 2012

DEEP VALUE IN JAPAN:

A Basket of 5 Profitable net –net stocks
By
Gurpreet Narang
narang.gp@gmail.com

Benjamin Graham, The father of value investing wrote in The Intelligent

Investor:
It always seemed, and still seems, ridiculously simple to say that if one can acquire a diversified
group of common stocks at a price less than the applicable net current assets alone—after
deducting all prior claims, and counting as zero the fixed and other assets—the results should be
quite satisfactory. They were so, in our experience, for more than 30 years.

A Net- net stock or Net Current asset value stock means a stock trading below the value of its
Current assets minus all liabilities. That means if you liquidate the company it is worth more dead
than alive.

Current assets include cash and securities, receivables, inventory. And all Liabilities include short
and long term debt. So basically you are getting its plant and machinery and its other assets for
free.

The 5 net-nets listed here are all have 10- straight years of positive EBIT (Earnings Before Interest &
Taxes) which I demanded as the first requirement in filtering Japanese net nets.

They are not money losing businesses. Sometimes what appears as a value stock becomes a value
trap because the terrible underlying business that burns cash. So some businesses do deserve to be
net -nets. Forever.

Which is a better Bath tub?

One which perpetually drains its water. Or the one that sports a fancy faucet which keeps on
flushing the liquid into the tub.

I prefer the latter.

Therefore I also looked for ample free cash flow that ensures plenty of ‘supply’ of cash into the
company from its operations.

So let’s go where the value is right now. Simple.

The meanings of the terms that have used in the analysis are as follows-

• Market cap: stands for market capitalization of the company which is share price x total
number of shares outstanding. It’s basically what the stock market is assigning the value to
the whole company.

• EV means Enterprise value and is calculated as market cap + (long term debt –cash)
 This is theoretical takeover value of the company that adjusts for excess cash and debt.

• EV/EBIT is Enterprise value /10 year average Earnings before Interest and Taxes. We use 10
year average EBIT rather than recent EBIT to get ‘normal’ earning power of the business.
EV/EBIT ratio is better than P/E ratio and the lower it is the cheaper the stock relative to its
earnings. P/E ignores cash and debt. EV/EBIT ratio includes these balance sheet items and
gives a better picture. And Japanese companies hold tons of cash on their balance sheets.

• Price /FCF: This is the ratio of stock price to its 5 year average free cash flow per share (which
is operating cash flow –capital expenditures/no. of shares outstanding).

• Price/NCAV: Is like price to book value ratio .The lower it is the cheaper the stock is relative to
its assets. But in this case the denominator is Net current asset value which is calculated as
Current Assets-Total liabilities
----------------------------------------
No. of shares outstanding

So it is far more stringent than price to book ratio.

• Price/ NQAV means stock price divided by net quick assets value. Quick assets are cash and
receivables and do NOT include Inventories. So
Net Quick asset value = (Cash + Securities + Accounts receivables)-Total liabilities
------------------------------------------------------------------------------
No. of shares outstanding
Therefore Price/NQAV is even more stringent than price/NCAV ratio because it’s a ratio of
stock price to the company’s most liquid assets (that can be turned into cash easily) minus all
liabilities. And the lower this ratio is the cheaper the stock relative to its assets.

• Sales Growth: means the 10 year compounded annual growth rate of revenue of the
company. The higher the percentage the better it is.

• EBIT margin: means Earnings before interest and taxes divided by sales. The figure is
expressed as percentage. High margins are good but one needs to look at its consistency to
gauge the pricing power of the business. The more consistent the margins, the better its
pricing power.

• Free cash flow margin: is free cash flow (operating cash flow –capital expenditures) / net
sales One of the best indicators of business quality. It shows how efficiently a company
translates its sales to cash. The higher and more consistent it is the more efficient the
business.
 • Dividend yield: on a company stock is the company's total annual dividend payments divided
by its market capitalization, or the dividend per share, divided by the price per share
expressed as a percentage.

Here is the list:

# 1 Excel Co Ltd ( 7591)

Share price: ¥ 767 EV/EBIT: -0.69 Price/NCAV: 0.36

Market Cap: ¥ 6840 million Price/FCF : 1.88 Price/NQAV: 0.56
EV: ¥ -1610 million Dividend yield: 3.80 % Sales growth:11.19 %

YEAR 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
SALES 28368 66837 69965 103483 141746 150549 131747 90147 72119 81945
EBIT 658 2221 2415 3120 3784 4109 3153 622 1750 1495
EBIT margin 2.32% 3.32% 3.45% 3.01% 2.67% 2.73% 2.39% 0.69% 2.43% 1.82%
sales growth 11.19%

(in million ¥)

Business: Manufactures and sells integrated circuits, semiconductor devices, LCD devices, and other electronic
components and equipment. In addition, the company manufactures and sells systems and software related to
electric machines, appliances, and materials related to these products.

Website: http://www.excelweb.co.jp/

CASH FLOW ( in million ¥)

YEAR 2007 2008 2009 2010 2011
CFFO 4715 3324 6470 2637 1356
CAP-EX 49 20 36 29 88
FREE CASH FLOW 4666 3304 6434 2608 1268
Free cash flow margin 16.45% 4.94% 9.20% 2.52% 0.89%

#2 Natoco Co Ltd. (4627)

Share Price: ¥ 590 EV/EBIT: -1.30 Price/NCAV: 0.65

Market Cap: ¥4220 million Price/FCF: 8 Price/NQAV: 0.78
EV: ¥ :-975 million Dividend Yield:2.54% Sales Growth:0.62%

YEAR 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
SALES 11249 10058 10212 10852 10743 12120 13435 13004 10137 11965
EBIT 854 296 538 818 475 1101 1376 849 94 1097
EBIT margin 7.59% 2.94% 5.27% 7.54% 4.42% 9.08% 10.24% 6.53% 0.93% 9.17%
sales growth 0.62%
Business: It offers synthetic resin paints and inks. The company provides coatings for metal,
building, and other functional materials, as well as related equipment. It also engages in the
transportation of the industrial waste.

Website: http://www.natoco.co.jp/

Cash Flows:
YEAR 2006 2007 2008 2009 2010
CFFO 1237 1654 1035 401 1661
CAP-EX 295 1117 712 598 617
FREE CASH FLOW 942 537 323 197 1044
free cash flow margin 8.37% 5.34% 3.16% -1.82% 9.72%

#3 Otec Corp (1736)

Share price :¥ 485 EV/EBIT: -1.66 Price /NCAV: 0.60

Market Cap: ¥ 2760 million Price/FCF: 4 Price/ NQAV: 1.03
EV: ¥-1276 million Dividend yield: 2.72% Sales Growth:0.32%

YEAR 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
SALES 16356 16861 15951 17417 17557 18859 20238 18217 17185 16892
EBIT 555 658 544 741 727 1054 1274 974 714 450
EBIT margin 3.39% 3.90% 3.41% 4.25% 4.14% 5.59% 6.30% 5.35% 4.15% 2.66%
sales growth 0.32%

Business: Otec Corporation sells pipe equipment and materials in Japan. It operates in three
segments: Pipe Material and Equipment, Construction, and Environment-Related Equipment. The
Pipe Material and Equipment segment involves in the sale of steel pipes, joints, valves, sanitary
ware, and housing equipment. The Construction segment engages in the electrical installation
and construction, instrumentation works, and maintenance of new and existing buildings.

Website: http://www.o-tec.co.jp/

Cash flows:
YEAR 2007 2008 2009 2010 2011
CFFO 756 757 744 810 640
CAP-EX 24 52 54 72 48
FREE CASH FLOW 732 705 690 738 592
free cash flow margin 4.48% 4.18% 4.33% 4.24% 3.37%

#4 Daiichi Kensetsu Corp (1799)

Share price: ¥ 665 EV/EBIT:0.19 Price/NCAV:0.80

Market Cap: ¥13870 million Price/FCF: 9.75 Price/NQAV:0.86
EV: ¥ 595 million Dividend yield: 2.60% Sales Growth:1.24%
YEAR 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
SALES 37496 45746 38998 38816 42929 38694 43073 45735 40776 42409
EBIT 1490 2042 2499 3175 3516 3507 4046 3017 3872 4017
EBIT margin 3.97% 4.46% 6.41% 8.18% 8.19% 9.06% 9.39% 6.60% 9.50% 9.47%

Business: Provider of construction services. The company engages in pavement construction,

road construction, and water and sewerage works in Akita, Sendai, Niigata, Nagano, and Tokyo
and also offers survey, design, planning, and construction supervision services, as well as real
estate services.

Website: http://www.daiichi-kensetsu.co.jp/

Cash flows:
YEAR 2007 2008 2009 2010 2011
CFFO 4478 2309 5615 4489 2309
CAP-EX 1020 2052 5443 2112 1453
FREE CASH FLOW 3458 257 172 2377 856
free cash flow margin 9.22% 0.56% 0.44% 6.12% 1.99%
price/fcf 9.74

#5 Fuji Oozx (7299)

Share price: ¥ 330 EV/EBIT:0.42 Price/NCAV:0.62

Market Cap : ¥ 6780 million Price/FCF: 5 Price/NQAV: 0.71
EV: ¥ 725 million Dividend Yield: 3% Sales Growth:-0.70%

YEAR 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
SALES 17231 17943 17961 19718 22055 21614 21768 17380 13597 16063
EBIT 1035 1105 1778 2878 3434 2012 1885 568 784 1636
EBIT margin 6.01% 6.16% 9.90% 14.60% 15.57% 9.31% 8.66% 3.27% 5.77% 10.18%

Business: Fuji Oozx manufactures and sells engine valves, valve seats, cotter, rotator, aluminium
retainers, aluminium tappet etc.

Website: http://www.oozx.co.jp/

Cash Flows:
YEAR 2007 2008 2009 2010 2011
CFFO 1642 1930 2261 1979 2342
CAP-EX 1429 631 472 180 605
FREE CASH FLOW 213 1299 1789 1799 1737
free cash flow margin 1.24% 7.24% 9.96% 9.12% 7.88%

And Now let’s rank them on the basis of assets and earnings .
 CHEAPEST

ASSETS EARNINGS

Company name Price/NQAV Company name EV/EBIT

Excel Corp (7591) 0.56 Otec Corp (1736) -1.66

Fuji Oozx (7299) 0.71 Natoco (4627) -1.30
Natoco (4627) 0.78 Excel Corp (7591) -0.69
Daiichi Kensetsu Corp 0.86 Daiichi Kensetsu Corp 0.19
(1799) (1799)
Otec Corp (1736) 1.03 Fuji Oozx (7299) 0.42

Best Overall

# 1 Excel Corp
# 2 Otec Corp
#3 Fuji Oozx
#4 Daiichi Kensetsu Corp
#5 Natoco

Disclosure
The views and opinions expressed in this report are purely the author's own. Any product claim, statistic, quote or
other representation about a topic, company, product or service should be verified with the company, provider or
party in question.
The author is not an investment advisory service, nor a registered investment advisor or broker-dealer and does not
purport to tell or suggest which securities you should buy or sell. The author of this report may hold positions in the
stocks or industries discussed here. You understand and acknowledge that there is a very high degree of risk
involved in trading securities.
The author, the publisher, and all affiliates of this report assume no responsibility or liability for your trading and
investment results. Factual statements contained in this report are made as of the publishing date and are subject to
change without notice.
The indicators, strategies, columns, articles and all other features of this report (collectively, the "Information") are
provided for informational and educational purposes only and should not be construed as investment advice.
Such set-ups are not solicitations of any order to buy or sell. Accordingly, you should not rely solely on the
Information in making any investment. Rather, you should use the Information only as a starting point for doing
additional independent research in order to allow you to form your own opinion regarding investments. You should
always check with your licensed financial advisor and tax advisor to determine the suitability of any investment.