Analysis of Fenwal Controls of Japan Ltd (6870:TYO)

Fenwal Controls of Japan, Ltd. is a Japanese company that designs, develops, manufactures and sells fire prevention equipment, temperature control equipment and medical equipment. Fenwal Controls of Japan was founded in 1961, has 188 employees and is headquartered in Tokyo.

Valuation & dividend

This very small company is trading at a very attractive price. The share price is:

• 7.69 times current recurring earnings
• 8.12 times average recurring earnings
• 0.76 times book value
• 0.77 times tangible assets
• 0.72 times sales
• 44.97 times current free cash flow
• 10.35 times average free cash flow

The price to current free cash flow seems out of line with the other indicators, but it is linked to a one-off drop in cash flows due to the repayment of a short-term liability (debt, as we will see later, is very far from being a concern for Fenwal Controls of Japan). The price to average FCF also shows us that the valuation remains cheap, even compared to cash flows. EBIT and EBITDA represent a whopping 32,92% of enterprise value, which is to say how cheap the stock is.

From a dividend point of view, we are in the same register, with an appreciable yield of 3.8%. This is all the more remarkable since the distributions only represent:

• 29.20% current recurring profits
• 30.83% average recurring profits
• 170.81 % of current free cash flow (for the reasons explained above)
• 39.33% of average free cash flow.

The small Japanese company therefore has a lot of room to continue paying and even increasing its dividends in the future. In the past, it has done so at a sustained average annual rate of 14,09% (over the last five years).

Balance sheet & result

Just like the dividend, earnings, FCF and asset values are growing over the long term, which proves the strength of Fenwal Controls of Japan's business model. The company is clearly succeeding in creating value for its owners and this is reflected in the share price which has tripled over the last ten years.

Cash reserves are huge, with a current ratio of 3.48 (a very sharp increase - also linked to the repayment of the short-term debt mentioned above) and a quick ratio of 2.78. At the risk of being picky, I paradoxically find that this mountain of cash is counterproductive, because it borders on wasting resources and could be better used. A current ratio above 3 is very often a false friend.

The gross margin is good, with 26.8% (up), for an equally appreciable net margin of 9.33%. The FCF margin, as one might expect, is affected by this repayment of current liabilities and therefore shows a modest 1.59%. In terms of profitability, it is correct, with an ROA of 7.04% (up), an ROE of 9.9% and a CFROA of only 2.74% (once again because of the repayment).

Long-term debt is only 2.71% of assets (decreasing). Debt has been falling continuously for several years and Fenwal Controls of Japan would be able to wipe it out in a single year using its average FCF. Debt is only 0.08 times equity!

With all this liquidity and this near absence of debt, it is not surprising to note that this pretty little Japanese company has not had the need to increase its number of shares in circulation for several years, which is obviously a good point for its shareholders who keep a stable share of the pie over time.

Conclusion

Fenwal Controls of Japan is small in size, but is a giant in terms of its cash reserves and overall financial strength. Margins are good, overheads are well controlled and capital expenditure requirements are very low (19.9% of profits). The Z-Score (Altman), with 3.56, confirms to us, if it were still necessary, that this company has very little chance of going bankrupt. The F-Score, with 7 out of 9, further proves the strength of Fenwals Controls of Japan.

The title is also very little volatile (8.43%) and not very sensitive to market variations (beta of only 0.62), which is always good to take in these times.

The current price, with 1527 JPY seems to me to be very far from the real value of the company. 2500 yen would not seem exaggerated to me. I have owned Fenwals since last year and for the moment I am suffering a slight loss of 8%. The current current ratio, above 3, prevents me for the moment, despite all the qualities of this beautiful company, from still considering it as a buying opportunity.

Certainly this ratio has climbed a little artificially because of the amortization of short-term debt, but on the other hand it was already at 2.74 in 2017, so there are still some unknowns regarding this excess of liquidity. So I think it is a stock to watch until next year, to see how this situation evolves.