Wednesday, June 18, 2008 4 comments ++[ CLICK TO COMMENT ]++

Added to Watch List: Toyota Industries

I feel that Japan is one of the most undervalued markets out there, and have been looking for an investment in some Japanese company. I kept getting dissapointed with the low ROE of Japanese companies. For example, why even consider Makita (6586) when Black & Decker (BDK) has consistently had substantially higher ROE? If you do look at Japan, do note that a lot of companies are cyclical industrial companies (P/Es may look low near the top.)

A couple of companies that seem attractive are Fanuc (6954) and Yaskawa (6506), two world-class industrial companies producing motors, factory robots, and the like. I decided to concentrate on Toyota Industries (TSE: 6201). I decided to look at it after seeing its stock price fall quite a bit over the year.

Toyota Industries is a long-term Martin Whitman pick. I just started going through his shareholder report history and he first bought it in 1998. He has been adding to it lately and I figured I should study this company further. Here are some preliminary thoughts:


Toyota Industries, which primarily manufacturers car parts and material handling equipment, was once the parent of Toyota Motors, the world-famous car company. The child has outgrown the parent so Toyota Industries is tiny compared to Toyota Motors. Both of them belong to the Toyota Group keiretsu. All the members of the group own portions of each other through cross-shareholdings. During good times, this strengthens the group but this is also what makes Japanese companies inefficient during bad times (can't do anything independently). Toyota Industries is the largest "individual" shareholder of Toyota Motors (owns something like 7%(?)), while Toyota Motors owns 20%+ of Toyota Industries. Martin Whitman's Third Avenue is the 3rd large shareholder with about 5% of Toyota Industries (Second largest is another member of the Toyota Group, DENSO Corporation.) One should always keep this group structure in mind and realize that these companies are limited somewhat. For example, it would be difficult for one of these companies to sell their products to a competitor or a third party that may compete with one of the members. However, since I am bullish on Toyota Motors (going to be the #1 auto manufacturer for a while), I'm not too concerned with this.

The structure of Toyota Industries is captured in the diagram below:



Automotive equipment and materials handling equipment are its two main operating businesses.


You can see from the long-term chart below that the stock price has dropped almost 40% from the peak in 2007 (source: bigcharts.com).



Assuming extra-ordinary events such as stock dividends, spin-offs, or similar activity, did not take place, this is quite a big drop. I think the price can drop a lot further but timing, as usual is tough, given the world economic outlook, fluctuating Yen, and so forth.

I haven't looked too deeply at the valuation metrics to see what the numbers are. Management expects earnings to drop significantly so I have to double-check the reported numbers. Cyclical companies trade at low P/E near a peak and a lot of the low P/Es are higher than they seem. In any case, this is more of an asset play (that's mostly what Martin Whitman invests in). In his latest shareholder letter, Martin Whitman was saying that Toyota Industries is trading at 6x flow-through earnings.

Current Price: Y 3760
Ticker Symbol: 6201 (Tokyo Stock Exchange)

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4 Response to Added to Watch List: Toyota Industries

June 18, 2008 at 11:45 PM

Great stuff. The fact that Whitman has owned the company for a decade, and has recently added to his position certainly speaks well for it.

See what percentage of TAVF assets it is -- Whitman holds a large number of stocks in his fund's portfolio. So if he has 2% (for example) of TAVF in Toyota Industries, you might be careful about making it a huge chunk of your own.

I have no idea how much accounts for TAVF. Just some food for thought. If you take the plunge, good luck. Being a fellow traveller with Whitman, well, you could do worse!

June 19, 2008 at 4:43 AM

I think you need to consider a number of things when considering ROE in Japan. Firstly, balance sheets tend to be bloated - if you strip out cash and other daft things like golf courses that some companies have on their books and look at the underlying business the returns are often much better. Secondly, from very low levels ROE is improving and firms are slimming down balance sheets - via divvies and buybacks.
Japan is a still a very, very low interest rate environment despite moves at the long-end of the JGB yield curve. That means your hurdle rate is considerably lower to create value.
Granted there are a ton of hideously run Japanese companies out there but the picture is improving. The WSJ had a piece on Industries a while back in their Heard in Asia column and VIC has a Toyota Industries write-up as well

June 19, 2008 at 10:30 AM

Thanks for the comments John and Eddie Bravo. Let me throw in my thoughts on some items Eddie is saying:

Eddie Bravo: "I think you need to consider a number of things when considering ROE in Japan. Firstly, balance sheets tend to be bloated - if you strip out cash and other daft things like golf courses that some companies have on their books and look at the underlying business the returns are often much better. "

You are right in what you are describing but I don't think a passive investor (i.e. no influence on the company) should strip out the excess cash/etc. Yes these companies are becoming more shareholder-friendly but even if they have respectable ROE on their core business, the return to shareholders is still the depressed number. Why should I pick one of those companies instead of, say, an American one? If you invest in these companies, it's like typing up your money at a lower return at a bank.


"Secondly, from very low levels ROE is improving and firms are slimming down balance sheets - via divvies and buybacks. "

Yep... that's one reason I'm attracted to Japan. Things are indeed getting better. But they are still quite poor.


"Japan is a still a very, very low interest rate environment despite moves at the long-end of the JGB yield curve. That means your hurdle rate is considerably lower to create value."

Agreed... but I, as a global investor, don't care about that. If a business elsewhere has higher prevailing interest rates but is able to create greater returns, then why look at Japan? Perhaps this is why Japan is doing so poorly. Japanese bond yields are so low that Japanese investors may be satisfied with low stock returns. For foreigners like me, what matters is the final return. I remember Buffett was joking (I think back around 2000) that he would be almost in heaven (or something like that) if his businesses could borrow at 1% and you simply had to beat that, but he still didn't see any value in Japan (back then).


Anyway, I agree with most of what you are saying Eddie Bravo. It's just that they still need to post good returns in the end because we are all comparing those companies to global companies...

Anonymous
June 20, 2008 at 8:47 PM

I am curious, which broker do you use for your Japanese purchases?

I remember reading one of your pages that mentions HSBC for owning yen. Is that who you use?

How much does a trade cost when buying Japanese or other international assets?

Are you able to buy Hong Kong companies also?

Sorry for all the questions.

Thanks!

hpmst3

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