Jeffrey Au
September 26, 2019
Nichirin (Tokyo stock exchange: 5184)
Quick Summary:
Nichirin is an automobile
hose manufacturer with a focus on motorcycle hoses and steering hoses. 90% of sales
are automobile hoses, while 10% are hoses for Japanese residential and hoses for
compressed gasses in Thailand. 56% of sales are overseas. While Nichirin’s main
customers are Japanese companies like Suzuki, Nissan, and Honda; it also has
foreign brands such as General Motors, Volkswagen, etc.
Trading at the Japanese stock
exchange at 20 billion yen (USD185M), Nichirin has 14 billion yen (USD130M)
in cash, cash equiv. & securities, and earns 3.5 billion yen (USD32M) on
61 billion yen (USD566M) of sales. Working capital is 18B yen (USD170M),debt
of 2 billion yen (USD18.5M), LT debt is 1.2B(USD11M), Nichirin is selling at
approximately 1.6-1.7x ev/ebit, with a dividend yield of 2.7% -- 716 million yen
paid out in 2018 (USD6.63million)
Tangible Book: ¥31-34 billion
(USD280 to 320M)
Tangible Book: USD320M = 150M
(fixed assets/PPE) + 170M (working capital)
Working Capital: ¥18,500,000,000
(USD170M)
Working Capital – Cash: ¥4,500,000,000
(41.7M)
Number of consolidated
subsidiaries— 15 companies
Nichirin Co., Ltd. is one of the biggest domestic automobile
hose manufacturers with close ties to Honda, and other Japanese motorcycle
manufacturers. 90% of Nichirin sales are in automobile hoses; in particular,
they enjoy a near monopoly status for motorcycle brake hoses and automobile
steering hoses with Japanese manufacturers.
Nichirin Co., Ltd. was founded in 1914 through a spin-off of
a rubber department of the trading company Suzuki Shoten and is headquartered
in Kobe, Japan. As a result of its historical relationship with Suzuki Shoten,
it has retained 2 big shareholders Taiyo Koko Co. (now Taiyo Mining) (22.3%),
Ltd. and Sojitz Corporation (7.9%).
Although there are many types of hoses for automobiles
depending on its application, Nichirin’s products specialize in
high-performance hoses for automobiles, such as brake hoses, car air
conditioning hoses, and power steering hoses and automatic transmission fluid,
air brake, clutch, ESC, hydraulic, CNG, oil cooler, suspension, urea SCR,
vacuum brake hoses, as well as EF-TUBEs and oil cooler units for automotive
applications.
Nichirin’s main products are steering hoses and brake hoses.
New products such as heat exchangers are being ventured into. For Motorcycle
applications, Nichirin provides brake, fuel, clutch, and oil cushion and cooler
hoses. Customers include the biggest Japanese motorcycle manufacturers Honda,
Suzuki, Mitsubishi, and Nissan. Sales for air conditioning hoses have been dropping in the
recent years and the electrification of vehicles is a concern which is
mentioned later in this article.
The R & D expenses for Nichirin for 2018 was ¥ 1.13 billion
yen (11M USD) (¥1.08B for 2017). This amount is minimal and sustainable in the
long term. Hydraulic brake hoses for
motorcycles are installed on disk brake vehicles. Disc brakes requires subtle
and quick responsiveness, and Nichirin has been focusing their R &D efforts
in this area. Nichirin prepares a series of hoses with different inflation
rates and has an assortment/wide variety of mouthpiece fittings to cater to
minute calibration. Nichirin has also developed new hydraulic brake hoses and
has been supplying them to General Motors and Daihatsu.
For hydraulic brake hoses, environmentally friendly new vulcanization
method such as continuous steam vulcanization— is currently in mass production due
to increasing demand. Vulcanization is the process of adding sulfur and other
impurities to strengthen and change the properties of rubber. In fuel hoses,
fuel permeation regulations are becoming stricter. In order to meet this
demand, development of hoses and plastic parts are being promoted.
Nichirin has a production base in North America, China, and
Europe. Other operating plants are located in Thailand, Vietnam, India, and
other locations. Overseas/foreign sales were 56%, domestic (Japan) sales were 43%.
Nichirin has had a consistent return on capital of 9-11% and
its operating margins have grown from 9.5% in 2014 to 12-13% in 2019. Debt to
equity has shrunk from 16.3% in 2014 to 5.5% in 2019. In the past five years,
day inventory outstanding has been pretty consistent at 58-62 days.
(millions yen)
The bulk of Nichirin’s operating cashflow and profit comes
from Japan, China, and Asia. Nichrin has been doing poorly in Europe and has
not been profitable in the recent years. South East Asia, such as Indonesia,
Thailand, and Vietnam has the greatest number of motorcycle users which require
brake and other hoses. This comprises the bulk of operating profits and has the
highest margins at 25%.
North America has the greatest potential for improvement
with a measly 4% operating margin (¥450-550 million) when they have a third of
the sales of Japan. Net sales were ¥12.9 billion in 2018 due to a decrease in
demand for power steering hoses. Sales of car air-conditioning hoses are
increasing both in Japan and overseas except for North America. North America
has a relatively stable economic trend in automobile purchases, but the demand
for sedan cars is decreasing and there is a growing tendency for light-duty
trucks and SUVs.
Nichirin has experienced steady domestic sales (Japan).
Almost half of its sales ¥33 billion (USD305M)
were from Japan. Operating income increased to ¥2.3 billion (USD21.3M) due to
an increase in labor costs associated with increased orders.
In the Chinese market, there was an end to tax reductions
for small cars, and there was a decline in sales volume. As a result, operating
income was ¥1.8 billion (USD17M) in 2018. The new SuZhou factory should boost
capacity, but may not reach full capacity as some equipment is being
transferred from the Shanghai base.
In Asia, where the demand for motorcycles is crucial to
Nichirin, there were some countries that grew and some that declined. In addition
to increased sales of brake hoses for motorcycles due to the introduction of
ABS(anti-lock braking system / device that reduces sliding caused by wheel lock
during brake operation), sales of newly introduced fuel hoses were steady. Net
sales in 2018 were 15.7 billion yen(USD146M), and operating income was ¥ 3.7 billion
(USD35M). In Indonesia, motorcycle sales were flat, but models equipped with
ABS performed well, and the Indian motorcycle market grew (J.V with Indian
company explained later). As a result, sales of brake hoses increased.
Net sales in Europe were ¥ 5.8 billion (USD54.3M), but there
were upfront costs related to new orders. Operating loss was ¥ 20 million (USD
186,915). Overall sales of automobiles are slowing down, and it was impossible
to expect a significant increase or turn around in the next five years. Nichirin
held a consolidated subsidiary Nichirin UK ltd. On August 9, 2019 the board of
Directors held a meeting and decided to stop production due to poor sales in
Europe, the fear of Brexit, and political uncertainty. In addition to this, impairment
loss on fixed assets was due to the closing of the former factory in Vietnam and
a replaced with a new one.
Recently opened factories for Nichirin include SuZhou Nichirin Co Ltd. in May 2019 in
ChangSu, which is in the JiangSu province of China, where ¥2.1B (20M USD)was
invested; and Nichirin Vietnam Co Ltd.
in April 2019 in the Bac Giang province of Vietnam where ¥698M (USD6.4M) was
invested in the factory and ¥302M (USD2.8M) was invested in automobile hosing
equipment.
Suzhou Nichirin (SZN), which is under construction in
Changshu City, China, is proceeding with construction for completion in May
2019 and operation in July of 2019. When SZN is completed, the total floor area
will be 31,030m2, the largest overseas subsidiary; equivalent to 1.5
times the original location of the original Shanghai Sun Ring (SNA). After
completion, Nichirin will gradually transfer production facilities from SNA,
aiming for a full transfer with an adequate utilization by June 2020
The construction of the new factory in Vietnam (NVC) has
been completed and has a production area of 7,955m2. At the new
plant, one brake hose production line for motorcycles will be added to increase
production capacity to 1.1 million m / month, which is twice the previous
production capacity. Nichirin expects sales of approximately ¥6.2 billion (USD58M) (up 10% year on year) for the fiscal year ending December 2019.
In 2015 and 2016, capital expenditures for Nichirin was
around ¥2B (USD18M), which matches current depreciation, serving as a rough
and imprecise proxy for maintenance capital expenditures. For the fiscal year
of 2018, ¥5.06B (USD46M) was spent on capital expenditures. From March 2018 to
March 2019 ¥6.2B (USD 56M) was spent on capital expenditures to meet
management’s goal of ¥6.6B (USD 60M). We can assume ¥4- 4.6B (USD40M), are
capital expenditures on new factories, R&D, and further investments in
existing foreign subsidiaries.
New plants in Vietnam and China are only part of the plan
for Nichirin to respond to the increasing motorcycle market in Southeast Asia, by
expanding capacity. Previously Nichirin has also increased shares in its
Indonesian subsidiary, and formed strategic business alliances with South
Korean listed Hwaseung R&A by licensing out technology for AC hoses,
steering hoses, and brake hoses.
As India is a large and growing market, Nichirin formed a
J.V with an Indian company, Imperial Ltd, to increase its distribution and
reach. The joint venture will sell Imperial's rubber brake hose for motorcycles
in India. The right is purchased and the product is manufactured and sold. Imperial
will undertake a third-party allotment of 40% investment based on Nichirin
India’s net assets. Imperial's sales network to domestic Indian manufacturers
and labor management know-how for local employees is exchanged for Nichirin’s
capital investment. Nichirin Co., Ltd. will own 60%, while Imperial Corporation
will own 40%.
Automobile-parts suppliers such as Nichirin are particularly
sticky with their customers. While the electrification of cars will affect the
sales of hoses, certain components will be decreased, while new hosing components
will be required for EVs. Though some of the electric vehicles under
development are electric brake systems (hoses are not used); currently, most electric
vehicles are installed with hydraulic brake hoses. In the future, electric
brakes may be applied in some vehicle models, but the impact is expected to be
limited because hydraulic brakes are expected to continue in the mainstream.
For air conditioning hoses— even electric vehicles are equipped with old air conditioning systems, will slowly be replaced. It is expected that the heat pump/heat exchange system will become mainstream for air conditioners since there will be no heat source from an internal combustion engine in the future to generate AC.
One area in which Nichirin would lose sales in due to the electrification of vehicles would be power steering hoses. Regardless of the EV system, hydraulic power steering is progressing with electric power steering (not equipped with hoses) in order to increase fuel efficiency. By 2022, Nichirin expects the sales of power steering hoses to almost disappear. Automation will bring driverless vehicles in the future, and Nichirin has developed hoses for automatic cruise systems.
This is why Nichirin has developed a heat exchange system
IHX, and is marketing it to its current customers. The number of models equipped
with internal heat exchangers is increasing as a result of the change in
refrigerants. Nichirin is pioneering the development of IHX and is working to
expand sales. In addition to expanding sales of conventional products such as
brake hoses and air conditioner hoses, sales of IHX and air conditioner curved
tube hoses are expected to be complementary and growing.
For the minority of Nichirin’s sales (10%), the
non-automotive field, -- Nichirin has hoses for special uses and residential
uses. Nichirin supplies hoses
specifically for compressed natural gas in Thailand. These hoses have to be
highly resistant to impurities. For residential uses, which comprises of a
minority of Nichirin’s sales— Nichirin provides a mixing faucet, metal
fittings, and cold/hot water supply piping related items, including toilet
hoses. Nichirin is working to expand the specifications of resin joints used
for toilet hoses and start mass production of new parts. In the future, resin
joint specifications will be expanded to customizable types.
We know that hoses will not be obsolete in the near future
for automobiles, but there are many parts which will be replaced such as some
hydraulic breaks and air conditioning hoses due to the declining demand for the
internal combustion engine. Automated and electric cars will require a new
demand for different types of hoses. This is a risk which cannot be ignored. I
can predict that hoses will still be used in the next 5 years, but not far
enough for a decade or more.
The question is, how fast can Nichirin grow and how much
market share can it capture at a profitable rate? Motorcycles are growing at
4-5% in India, while cars are growing at 8-10%. South East Asia is growing at
6%, while China took a hit and sales fell 9-12% for the first few quarters of
2019.
Nichirin’s management will continue to increase dividends
with the goal of a consolidated payout ratio of 30%. In their Japanese annual
report, they have considered buybacks. So far they have set goals of increasing
gross margins and enriching shareholders and they have met most of their
targets for phase I. Now they are on phase II, and their targets are ¥6.6B (USD61M) of capital investment in 2019.
Nichirin may reach their 2020 goal by 3rd or 4th
quarter, but that depends on the average sales price of new products now that
heat exchangers and new hose components are introduced and if utilization rates
of factories are ramped up to satisfactory rates. Nichirin has grown its book
value from ¥19B (¥15.9B w/o minority interest) or USD 17M in 2013 to ¥37.8B (¥32.8B
w/o minority interest) or USD 34M in 2019. If Nichirin can continue their past
results of increasing retained earnings by the same rate, book value should be
growing at about 12% annually.
Nichirin is sell at a deep discount at a multiple of
1.5-1.8x. Its working capital is US USD175M, and as of September 27, 2019, its
market capitalization is 185M. There is a considerable margin of safety, and I
am assuming earnings power will revert back to 2017-2018 levels of ¥ 8.2-8.5B (USD77M),
when 2019 was only ¥6.5B (USD60M). There may be a possibility earnings will
reach USD 85-90M, but this may take 2 years.
Competitor Teito Rubber is also focused on automobile hoses
but went private in 2011. Other companies are diversified into industrial
rubber and do not focus on automobile hoses like Nichirin. These companies are
selling at significantly higher multiples while lacking foreign sales which may
hamper its growth.
Sumitomo Riko
Company Limited (TSE:5191) is selling at ev/ebit 23x,
NOK Corporation (TSE:7240) ev/ebit at 18x,
Fukoku Co.,Ltd. (TSE:5185) at 10x.
While the automobile industry may fluctuate due to many
external factors, the growth of automobiles and motorcycles in South East Asia
and India will not remain stagnant. At a market capitalization of 185M with
working capital of 170M, and debt of only 18M, there is significant upside and
margin of safety. This stock is traded on the Tokyo Stock Exchange.
References:
Japanese Company Manual 2018,
MarkLines,
Nichirin Annual Report, and Company Website
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