Analysis of Otec Corp (1736:TYO)

This is my 3rd review of Otec (2nd update), a very small Japanese company that I acquired two years ago. Otec has been active since 1948 in the sale of pipes, joints, valves, sanitary appliances and environmental equipment. It also handles instrumentation work, electrical work and maintenance work for new and existing buildings.

Valuation & dividend

Even if since the last analysis the title gained 15%, it remains quite attractive in terms of its valuation. Indeed, the price is trading at:

• 10.11 times current recurring earnings
• 11.89 times average recurring earnings
• 0.84 times tangible assets and 0.83 times book value
• 0.49 times sales
• 11.37 times current free cash flow
• 11.26 times the average free cash flow

The enterprise value also represents only 6 times the FCF while the EBIT (as well as the EBITDA) climb to 26.5% of the enterprise value. These ratios confirm the very attractive valuation of the stock.

In terms of dividends, it is quite interesting, with a yield of 2.9%. It should be noted that distributions have been growing every year for quite some time, at a very sustained average annual rate of 26.58% (over the last five years). Even better, the dividend paid only represents a small part of the Japanese company's results, since it amounts to:

• 29.29% of current recurring profit
• 34.46% of average recurring profit
• 32.94% of current free cash flow
• 32.63% of average free cash flow

Otec still has plenty of room to not only continue paying its dividend, but more importantly to grow it further in the future.

Balance sheet & result

Just like the dividend, the profit, the value of assets and cash reserves are growing over the long term, which proves the solidity of the Tokyo SME's business model. Otec is clearly managing to create value for its shareholders and this is reflected in the stock which has tripled over the last five years.

Liquidity is comfortable, with a current ratio of 1.97 (up slightly) and a quick ratio of 1.72. No worries about paying bills. The gross margin, although down very slightly, is correct, with 20.4%, for a net margin that is admittedly a little low, at 4.89% and a free cash flow margin that is almost identical, at 4.34%. We are in a similar configuration in terms of profitability, with fairly average ratios, i.e. an ROA of 4.69% (up), an ROE of 8.26% and a CFROA of 4.71%. Nothing transcendental, then, but nothing catastrophic either (and let's remember that this was already the case in the past, which did not prevent the price from progressing well).

The long-term debt ratio to assets is very low, with only 1.74% (note that it is increasing). The company would only need a year and a half to repay all of its debt (which represents only 0.11 times equity) using its free cash flow. This low use of debt explains why the valuation ratios compared to the enterprise value are even more interesting than compared to the capitalization. It should also be noted that, despite the increase in debt over the last financial year, the company tends to reduce its net debt over the long term, which represents an additional return for the shareholder of 1.54% per year on average. On the other hand, it should be noted that Otec has increased the number of shares outstanding once in the last five years, causing an average annual return for the shareholder of -0.39% during this period.

Conclusion

Between the dividend yield, the repayment of debt and the issuance of a few shares, Otec achieves an average annual return of more than 3% for the shareholder, which is appreciable. Above all, this generosity remains very prudent, since it only represents a third of the free cash flow. We have also seen that in the long term the SME tends to generate increasing liquidity. The fact that Otec's capital expenditures only represent 11% of the profit is certainly not unrelated to this. All the lights are therefore green for the Japanese company to continue to reward its owners in the future, either by increasing its dividend, or by repaying its debt, or by buying back shares, or a little of all of these at the same time.

It's true that margins and profitability aren't very sexy, like its business (although the pipes...). The stock is also largely shunned by analysts and institutional investors. As usual, only Fidelity is present, at 10%. For contrarians, it's obviously a godsend.

It should also be noted that despite its small size, the company is financially solid, in particular thanks to very low debt, which is confirmed by a Z-Score (Altman) of 3.03 (green zone). Piotroski's score is also correct with 6 out of 9.

Despite the strong rise in recent years, I believe that the stock should at least gain 50% to reflect its intrinsic value, and that the dividend should do the same. I have therefore decided exceptionally, even though I have already made a gain of 56% in just two years with it, to further strengthen my position on this great company.