Analysis of Wakachiku Construction Co Ltd (1888:TYO)

Here is an update of my analysis of last summer concernant  Wakachiku Construction, une toute petite entreprise japonaise active depuis déjà 1890, dans la construction et l'real estate.

Valuation & dividend

Wakachiku is trading at an extremely cheap price in several respects. Its price is:

• 5.63 times current recurring earnings
• 7.09 times average recurring earnings
• 0.65 times book value and tangible assets
• 0.18 times sales
• 178.52 times current free cash flow
• 18.51 times the average free cash flow

As we can see, the company's valuation is particularly cheap compared to all criteria, except for the FCF. We note in particular that it is the last published free cash flow that poses a problem, since the average of the last five years remains quite correct, despite this latest increase. If we compare the enterprise value in relation to the FCF, we find ourselves in similar proportions, but a little more interesting, with a current EV/FCF ratio of 96.88 and an average EV/FCF of 10.04. It is quite normal for the free cash flow to undergo quite marked variations from one year to the next and that is why it is important to take the average into account. What is disturbing here is the extent of this variation, since last year the price was trading at only 5 times the current FCF. We will see a little later what explains these significant jumps.

That being said, the title nevertheless remains extremely accessible overall from a price point of view, which is confirmed by the EBIT which amounts to the trifle of 46% of the enterprise value (idem for the EBITDA).

Le dividende de Wakachiku est intéressant, avec un rendement de 4%, toujours bon à prendre par les temps qui courent. Il est de plus particulièrement bien couvert par rapport aux bénéfices, avec un distribution ratio courant de 22.32% et un ratio moyen de 28.10%. Par contre, la situation est évidemment moins bonne par rapport au free cash flow, avec un ratio de distribution courant de 707.92% et un ratio moyen de 73.99%. Comme nous l'avons déjà vu ci-dessus, la moyenne est plus significative que les données courantes, vu la variation normale du FCF. Le dividende n'est donc pas directement menacé, par contre il est fort probable qu'il ne puisse plus progresser aussi vite que par le passé (22.42% par an en moyenne ces cinq dernières années).

Balance sheet & result

Just like the dividend, profits, asset values and cash reserves are growing over the long term, which proves the solidity of the business model of this Tom Thumb of construction. Wakachiku manages to create value for its shareholders, even if this has difficulty translating into stock market performance. The price has in fact "only" doubled in ten years. This is certainly not bad for ordinary mortals, but quite far from what one might expect from this type of stock. It must be said that the company is off the radar of most analysts and institutions (even Fidelity is not there). It should also be noted that the stock has underperformed over the past twelve months, with a loss of 17%, even more than other Japanese stocks. FCF's recent difficulties are part of the explanation, but we will see a little further down that it is not the only one.

Despite recently declining available cash, Wakachiku has still managed to increase its current ratio to 1.5, for a quick ratio of 1.37. This is certainly not huge, but no problem in any case for paying the bills. What is more problematic, however, are the margins. The gross margin is in fact only 10%, the net margin 3.21% and the free cash flow margin... 0.10%. That explains a lot! The company has difficulty transforming its sales into available cash, which means that despite a constantly growing turnover, the slightest variation in cash flow or equipment expenditure is immediately and significantly noticeable. The same phenomenon can be seen in Wakachiku's profitability, which is nevertheless correct. While the ROA is 3.92% (up) and the ROE is 11.52%, the cash flow return on assets (CFROA) only amounts to 0.41%.

The Tokyo-based manufacturer has a good handle on borrowing, with a long-term debt-to-asset ratio of only 1,38% (a notable decrease). The total debt represents only 0.2 times equity. Despite these more than correct figures, Wakachiku would still need a little over five years to repay all of its debt, given its low FCF. This is certainly not dramatic, but not ideal either. It should also be noted that despite a decrease in long-term debt over the last five years, net debt has paradoxically increased due to an increase in current liabilities. This represents a negative impact of 7,92% per year on average on shareholder returns, which is not insignificant. Fortunately, however, the number of shares outstanding has been stable for several years, which avoids any dilution of the company's owners' equity.

Conclusion

Il y a indéniablement du bon chez cette toute petite entreprise, mais aussi du moins bon. Le FCF est à la peine, avec une marge très faible et des variations importantes d'une année à l'autre. L'autre point noir, qui explique, avec la faiblesse de FCF, pourquoi le titre a de la peine à décoller, c'est comme nous l'avons vu ci-dessus l'augmentation de la dette nette ces dernières années, malgré une baisse de l'endettement à long terme. Cela a un impact défavorable sur le rendement moyen des actionnaires (Shareholder Yield), qui est négatif (-5.15%) malgré un dividende de près de 4% et un nombre stable d'actions en circulation.

Cela étant dit, il ne faut pas non plus peindre le diable sur la muraille. Les besoins en dépenses d'équipement ne représentent en moyenne que 26.4% des bénéfices. Cela signifie que l'entreprise peut convertir une grosse partie de son flux de trésorerie en liquidités disponibles. Donc, tant que le Cash Flow est assuré, le FCF l'est aussi, et certaines années comme 2016 et 2018 c'est particulièrement évident. De plus, les variations importantes des flux d'argent, n'ont pas empêché 'entreprise à continuer à faire croître son dividende, la valeur de ses actifs, son bénéfice et même ses réserves de cash ces dernières années. Il faut dire que Wakachiku n'est pas née de la dernière pluie, ses origines remontant au 19e siècle et son business pouvant être considéré de nature plutôt défensive, en particulier pour la partie immobilière. Ceci se traduit par un beta de 0.77, malgré une volatility assez marquée, à 25.47%.

The negative return to shareholders due to the increase in net debt must also be put into perspective by the fact that the company's total debt remains at very prudent levels. The Z-Score (Altman), with 2.15, places Wakachiku in the gray zone, i.e. not absolutely safe, but also not at imminent risk of going bankrupt. The F-Score (Piotroski) is also very high, with eight out of nine possible points. It tells us that the company is financially solid and that its fundamentals are improving. This score is a fairly reliable indicator of the future performance of a stock.

At the current price, I believe the stock should nearly double to reflect its intrinsic value. The dividend should theoretically follow the same progression, although it may be slowed in the short term due to the FCF. Since I like to put things in historical perspective, in the late 90s, Wakachiku was trading at over 27 times its current price. If the pendulum had clearly swung too far in one direction at the time, it would seem that today it has swung too far in the other direction.

Is this Japanese SME therefore a buying opportunity, given its very attractive valuation? Since my acquisition last year, the price has fallen by 17% and the Japanese market has returned to a negative trend. For the moment, I therefore consider Wakachiku as a stock to watch because the momentum is clearly not going in the right direction. It is also possible that I will have to part with it, to remain faithful to my procedure stop loss. Yet another paradox linked to this very cheap company but whose share price is definitely not taking off, quite the contrary...