Nihon Kagaku Sangyo Co., Ltd., is an industrial company that has been in business for many decades. According to the company’s website, it has two business segments:  Chemicals and Building Materials.

The Chemicals segment produces catalysts for a wide range of customers. It also produces. “chemicals for plating, coating materials, printing ink, electrical conductivity, ceramics and glass, and battery materials.”

The Building Materials segment builds on the company’s expertise in chemicals. In this segment, the company uses aluminum, steel and stainless steel to make products used in residential and commercial office construction.  

The company’s businesses appear mature. Growth has been minimal over the past few years.

The balance sheet appears very strong. Cash is about 40% of total assets. The current ratio is nearly 5.4.  

Cash from operations has averaged about 2,650 – 2,700 million Yen per year. With capital spending of 800-900 million Yen per year, free cash flow averages more than 1,800 million Yen per year. The company has 20.7 million shares outstanding. Therefore, free cash flow per share averages around 80 – 90 Yen.

Recently, the stock traded at about 850 Yen. Cash per share is more than 680 Yen and net current assets per share is about 850 Yen per share. The stock trades for a little more than cash per share and it trades for less than net current assets per share.  

Price-to-Free-Cash-Flow (P/FCF) is a little less than 10x. If one deducts cash per share from the stock price, P/FCF drops to only 2x.

The stock has no obvious catalyst to trigger a significant revaluation in the near term.  In addition, Japan’s sub-par economic performance over the past decade or two is well known. However, change is afoot in Japan. The Stewardship Code of 2014 and the Corporate Governance Code of 2015 are encouraging Japanese companies to become more focused on improving shareholder returns. Management teams are increasingly accountable for taking proactive steps to improve returns. Major institutional shareholders are also increasingly accountable for exercising more vigorous oversight over the companies in which they invest.  

With a strong balance sheet and a deeply undervalued stock, Nihon Kagaku Sangyo has some obvious opportunities to increase shareholder value:

• A stock repurchase program
• Recapitalizing the company
• Selling the company to a strategic buyer 

In increasing value for the shareholders, we would like to see management take advantage of the undervalued stock price. They could also simply increase the dividend – there is more than enough free cash flow to increase the payout by a significant amount.

By our calculations, pretax returns on net invested capital are in the high single digits. Based on these returns, we believe the company should minimize reinvestment in its core business unless management can raise returns on capital. We think buying back stock at these levels is a better use of the shareholders’ money.  

One can buy Nihon Kagaku Sangyo through a broker like Interactive Brokers. The symbol is 4094 and it trades on the Tokyo Stock Exchange.