Nakayama Steel Works, Ltd.

Nakayama Steel (‘company’) manufactures and sells steel products – in the form of crude, rolled, and processed steel – primarily to the construction, automobile, and industrial machinery industries. It also has small engineering, and real estate leasing/brokerage operations.

The company sells its output within Japan with significant sales to Hanwa and Nippon Steel – both major shareholders. One competitive advantage it has is in securing low-cost raw materials via its scrap iron facilities.

The steel industry suffered during the pandemic with a drop in steel prices and volumes. Beyond that, the Japanese steel industry suffers from a sluggish demand outlook with a declining population. Further, competition is expected to intensify with excess capacity of Chinese steel mills set up in South East Asia. Moreover, it suffers from increasing labor, transport, and electricity costs.

The company reported TTM sales (to September 2020) of 115.7b yen, down from a 2019 high of 153.7b yen; ebitda of 5.2b yen, down from a 2018 high of 8b yen, and net profits of 1.7b yen, down from a 2017 high of 5.8b yen. Past average earning power has exceeded 3.5b yen/year.

The balance sheet is strong with net cash of 14.1b yen, and net current assets of 35.8b yen. The current and liquid asset ratios are strong.

Adding in investment securities of 2b yen and investment properties 12.4b yen - at market - to the net current asset value, totals 50.2b yen without including steel manufacturing assets.

The stock is selling for 20.4b yen – at a 60% discount to this minimum realizable asset value, and under 6x average earnings.

Management, however, appears to be mediocre. They’ve been unreasonably stingy with dividend payouts – paying 540m yen last year that supposedly included a 100^th anniversary bump of 2 yen/share. This yields under 3% at market, and is a fraction of earnings and cash resources.

In addition, returns on tangible assets are pathetic at below 5%/year.

These are publicly known facts, however, and likely priced in by the market. Therefore, what price is too low for this security? If investors shut down this business, they could more than double their money. Even without liquidation, there is inherent earning power, which provides a safety margin.

This appears to be a case of a distressed company selling at a distressed price promising safety of principal and a satisfactory return – an apt stock to include as part of a widely diversified portfolio.