Analysis of Honshu Chemical Industry Co Ltd (4115:TYO)

Honshu Chemical Industry Co. is a fine chemical company based in Japan, founded in 1914 and having 361 employees.

Valuation & dividend

The stock is trading at a very attractive price of:

• 7.38 times recurring earnings
• 9.48 times average earnings
• 0.71 times book value and tangible assets
• 0.62 times sales
• 23.82 times current free cash flow
• 6.45 times the average free cash flow.

All ratios are therefore attractive, except that in relation to current FCF. We know the inconsistent nature of the latter and if we rely on the average FCF we see that we are perfectly on target. EBIT and EBITDA represent a trifle of 32.10% of the enterprise value, which confirms the very attractive valuation of Honshu Chemical.

The dividend is rather disappointing in appearance, with a yield of 2.38%. This relative weakness is nevertheless misleading since this very small company is very cautious in this matter. The distributions only represent:

• 17,58% of current recurring profit
• 22.56% of average recurring profit
• 56.72% of current free cash flow
• 15.35% of average free cash flow.

The company therefore has substantial room to continue paying and increasing its dividend in the future. It has done so regularly in the past, at an average annual rate of nearly 5% (over the last five years).

Balance sheet & result

Just like the dividend, the profit, cash reserves and asset values are growing over the long term, which proves the solidity of the Tokyo chemist's business model. Honshu is clearly succeeding in creating wealth for its owners and this is reflected in the share price which has more than tripled over the last ten years.

Cash reserves are very comfortable, if not almost excessive, with a current ratio of 3.38 (up) and a quick ratio of 2.48. The gross margin is correct, with 25.2% (down), for a net margin of 8.42%, but a fairly modest free cash flow margin of 2.61%. We are in fairly similar trends from a profitability point of view, with an ROA of 6.09% (down), a CFROA of 5% and an ROE of 9.6%. General expenses are also well controlled (30.5% on average).

Debt is well under control, with a long-term debt-to-asset ratio of 2,64% (increasing). The entire debt could be wiped out in less than a year using average free cash flow, as debt represents only 10% of equity.

It should also be noted that the number of shares in circulation is stable over the long term, which avoids any dilution of shareholders' assets.

Conclusion

Honshu Chemical Industry is a very small company that is very little followed by institutions. Only Fidelity (them again) is present there, with a 9% stake in the capital. It has a long history and solid fundamentals, although it has lost a very slight amount of momentum over the last year, based on the F-Score (Piotroski) of 4 out of 9. This score may raise some questions, but if we look more closely we see that three points are lost for a few tenths of a percentage point difference (gross margin, asset turnover and ROA). Sometimes Mr. Piotroski, despite all his qualities, has a Manichean and arbitrary side... Furthermore, the company can be considered safe based on the Z-Score (Altman) of 3.12 (green zone).

Another quality, always good to take in these times: the title is not too volatile (18%) and relatively insensitive to market variations (beta of 0.89).

In short, to conclude, the only "weak" point that I could detect in Honshu is paradoxically a small excess of liquidity. It is not monstrous and catastrophic, but there is still a bit of waste in keeping all this cash uselessly. It would be more useful if it were invested in the company or distributed to shareholders.

I figure the stock should earn at least $35% and the dividend should do at least as well. So I decided to buy a slice.