Takamatsu Machinery Co. Ltd.

Takamatsu Machinery engages in manufacturing: a) machine tools (88% of revenues), b) equipment related to liquid crystal substrates and semiconductors (8%), and c) automobile parts (4%). It generates 2/3^rd of its sales within Japan, 12% in China, 10% in North America, 10% in the rest of Asia, and the balance in Europe.

The company primarily manufactures CNC lathes (computer-controlled NC lathes), which are used as ‘mother’ machines for making metal processing machines. They are primarily sold to the automobile industry, which makes up over 50% of sales – and therefore, the company’s fortunes are largely tied to the capital investment cycle of the automobile industry.

Its semiconductor segment operates under a different demand cycle pertaining to that industry. And the auto parts business is marginally loss-making.

The coronavirus pandemic has gutted capital investment, and the company’s machine tools orders fell a whopping 68% in the six months to September 2020. Though semiconductor demand held up, sales still declined 9%. Auto parts sales declined 30%.

The company reported TTM sales (to September 2020) of 17.8b yen (FY19: 22.7b yen), ebitda of 1.4b yen (FY19: 2.7b), and net profits of 723m yen (FY19: 1.7b). Earnings have averaged 1.1b yen over the last five years.

The balance sheet is strong with net cash of 4.6b yen. However, 3.5b yen has been earmarked for building out a new factory.

Net current assets (including securities at market and investment properties) amounted to 9.6b yen.

The stock is currently selling for 7.3b yen – at a 24% discount from liquid asset value, and under 7x average earnings.

Average returns on tangible assets (net of cash) are just over 10%; if the new factory can deliver such returns, the incremental earnings would be a valuable bonus.

Recent dividend payouts are pathetic – averaging just 170m yen – and yielding just 2% at market.

The most concerning aspect of this management is the institution of takeover defense mechanisms – initially brought in 2008 and again passed by a 99.42% vote in 2020. Considering that the public holds 52% of the shares, we urge shareholders to make the effort to vote against such proposals that appear to be against their interests.

There’s no reason to believe automobile demand won’t recover to near former levels – and sales should be aided by additional capacity from the new factory.

In our view, the market appears to be over-pessimistic pricing the shares at this subnormal level.