Nippon Gear Co. Ltd.

Nippon Gear (‘company’) is a small operator that manufactures, sells, and maintains gears and jacks, valves and actuators, other acceleration/deceleration machines, etc. - for use in power plants, automobiles, industrial machinery, construction machinery, machine tools, railways, shipping, and water and sewage - among other industries.

The company operates entirely in Japan and has a diversified customer base (including some exports to machine tool manufacturers in China).

The business is largely dependent on the capital investment cycle and the frequency of inspections/maintenance of plant and machinery. It is also exposed to severe price competition and rising raw material costs of iron and copper.

The coronavirus pandemic resulted in orders declining by 11% (though revenues were up 6% to September).

The company reported TTM revenues (to September) of 7.8b yen (FY20: 7.6b), ebitda of 998m (FY20: 842m), and net profits of 504m (FY20: 396m). Earnings averaged 432m yen over the last five years.

There was excess net cash of 2.3b yen and an undrawn credit line of 1.6b yen should business conditions deteriorate. The net current assets plus securities at market and overfunded pension assets amounted to 6.4b yen.

The stock is selling for 4.2b yen – at 2/3^rd of net current asset value and under 10x average earnings.

Dividends are meagre and yield less than 2% at market, and returns on tangible assets were weak at 7%.

Management have indicated efforts to: develop new products and sales to the water/sewage sector, cater to overseas markets, generate orders from prime contractors for power plants, and expand diagnostic services.

However, at the current market price, the investor needn’t bring any significant judgment to bear on the business due to the significant discount from liquidation value and sufficient earnings yield – both of which provide an adequate safety margin to take his/her chances on the future of this business.