It is nowadays popular to invest in foreign markets, including Japan, by using exchange traded funds. These funds however only represent an index with a very wide variety of companies, of which some might be excellent, but others not at all. ETFs that mirror Japanese markets are, for example, EWJ (representing the iShares MSCI Japan index), SCJ (iShares MSCI Japan small-cap), DXJ (Japan total Dividend) or DFJ (Japan small-cap dividend). While these ETFs might have their merits for diversification, it is per definition impossible to outperform the market using them (since they mirror the market, you don’t underperform either – excluding the fees, of course).
Today I want to go stock-picking in a specialized sector in Japan: the natural gas utilities. The tragedy of the Tohoku earthquake has put a focus on Japan’s need for natural gas. More LNG imports are needed in the short term in Japan to supply natural-gas power plants, which have to balance the shortfall caused by idled nuclear power plants. The city gas utilities themselves are not that influenced by these events. They mainly supply gas to retail customers for heating and cooking. Only the largest companies are also active in the power sector.
Japan has 13 publicly listed gas utilities, which supply their respective areas. I also added Nippon Gas (NPPGF.PK) [TYO:8174] to the list, which is Japan’s largest LPG supplier.
The graph below shows the long-term share price performance since May of 1999 for the seven largest companies by market capitalization, excluding dividends. The best performers were Nippon Gas (+120.7%) and Toho Gas (THOGF.PK) [TYO:9533] (+100,9%). The share price of the other companies had single- or low double-digit performances, and only the stock of Osaka Gas (OSGSF.PK) [TYO:9532] saw negative returns (-25.5%).
The gas utilities mostly have regulated tariffs, so that rising natural gas prices may impact them negatively. However, a stronger yen has a positive effect on these companies’ bottom line. For example, if the JPY/USD rises by one yen, it would boost Tokyo Gas’ (TKGSY.PK) profit by about 700 million yen.
The following section provides an overview of the 14 companies covered in this article. It is meant as a short first introduction to these companies with which many are probably not familiar. Except Chubu Gas (which trades only on the Nagoya Exchange), all companies are traded on the Tokyo Stock Exchange. For those who wish to trade stocks in the U.S., Tokyo Gas, Osaka Gas, Toho Gas, Nippon Gas, Saibu Gas (SBUGF.PK) [TYO:9536] and Hokkaido Gas (HGCLF.PK) [TYO:9534] can be traded on the U.S. pink sheets. Liquidity is probably limited if you desire to trade these stocks via U.S. exchanges, so I strongly suggest to place your orders in Tokyo if you'd like to trade in any of these stocks. Any decent broker should be able to place orders on the Tokyo Stock Exchange at reasonable transaction costs. The size spectrum of the gas utilities is broad (see table below), but the largest utilities have multi-billion-dollar market caps and have a liquid market. The issues of Tokyo Gas, Osaka Gas or Toho Gas regularly trade several million shares each day.
Tokyo Gas is Japan’s largest gas utility, and supplies more than 10 million customers, mainly in Tokyo and five other prefectures. It is also involved in the development of overseas gas fields, leading in the LNG field and operates large-scale air-conditioning systems (gas heat pumps). Also involved in electricity generation via Ohgishima Power, a joint-venture with troubled utility TEPCO (Tokyo Electric Power) (TKECF.PK). More than 70% of Tokyo Gas’ sales are from the sale of natural gas. The rest is made up by gas appliances, gas engineering works, real estate leasing and others. Tokyo gas has the largest market capitalization at nearly one trillion yen, a dividend yield of 2.5% and trades 20% above book value. It has the largest foreign ownership of all Japanese gas utilities, with more than 30% foreign shareholders.
Osaka Gas is the second-largest gas utility, supplying about seven million clients in the Kansai region (Osaka, Kyoto, Kobe). Like Tokyo gas, the company has moved into power generation and is further diversifying its revenue sources. Sixty percent of the company’s sales are from gas, 15% from LPG, electric power and other energy sources, and the rest comes from appliances, gas engineering, real estate and others. The company has recently hiked its dividend to 8 yen per share, giving it a current yield of 2.6%. The market capitalization is around 650 bn yen, and the share trades around book value. Foreign ownership is the second-largest among gas utilities, at 20%.
Toho Gas is the third-largest gas utility, serving the Nagoya region and central Japan. Its gas supply comes mainly from LNG (80%) and it is also supplying gas to co-generation plants. Sales are 70% gas, 13% LPG, 8% engineering and appliances. Foreign shareholders account for 10% of the company’s stock. Its market capitalization is around 230bn yen, and the share trades at a slight premium to book value. Dividend yield is less than 2%.
Saibu Gas is the main gas utility on Kyushu. It supplies over a million customers in the cities of Kita-Kyushu and Fukuoka. It also operates in Kumamoto, Nagasaki, Sasebo and Shimabara. The company is currently building LNG terminals in Kita-Kyushu, and is also developing fuel cells. A subsidiary of the company grows looseleaf lettuce in a hydroponics facility, which is currently being enlarged. Foreign ownership is low, at 2.3% of shareholders. The stock trades at a 30% premium to book value, and the equity ratio of the company is the lowest in the gas utility sector, at barely above 20%. Gas sales make up 70% of its sales, 8% come from LPG, 8% from engineering and appliances.
Nippon Gas is not a gas utility company. It is however the largest shareholder of Higashinihon gas (64%) and Shinnihon Gas (40%). It also fully-owns Kitanihon Gas, and owns 64% of unlisted Tosai Gas. Nippon Gas is the country’s largest dealer of LPG, with a vertically-integrated structure which covers the whole chain of material import to retailing. Also, 96% of the company’s sales are from gas, and 4% from aerosols and fuel filling. The company has a dividend yield of 1.2% and trades at about two times book value.
The company is based in Shizuoka prefecture, and 60% of its gas is sold to industrial customers – including co-generation plants Shizuoka gas has concluded a long-term LNG supply agreement with Osaka Gas and TEPCO for about 60% of its supply needs after 2016. Also, 82% of the company’s sales are from gas, the rest from LPG and other energies. The stock is trading at 0.8 times book value, and foreigners hold about 9% of shares.
The company serves about 860,000 customers in the western urban part of Chiba prefecture, and is cooperating with Tokyo Gas on the supply side. Nearly 90% of sales come from gas. The stock has low foreign ownership and trades at 40% of book value.
As the name suggests, Hokkaido Gas is the largest urban supplier of gas on Hokkaido, serving about 600,000 households in Sapporo, Otaru, Hakodate and Chitose. Its sales are projected to increase because of Sapporo’s rise in population. The company is also into co-generation systems and has ties with Tokyo gas. The company operates the Ishikari LNG terminal. The stock has low foreign ownership and trades at 60% of book value. Its equity ratio is comparatively low (27%). City gas and LPG account for 70% of sales.
Hiroshima Gas is the largest gas utility in the Chugoku region, with 600,000 customers in large cities such as Hiroshima and Kure. About 70% of its sales are gas, and 15% LPG. Iwatani corp (largest shareholder of Nippon Gas) is a large shareholder (12.2%). A lawsuit regarding self-dealing of subsidiaries is currently pending. The stock trades at around 60% of book value.
The company mainly serves 340,000 customers in Nagaoka, Niigata prefecture, using natural gas and LNG. LNG accounts for 30% of supplies. Eighty percent of the company’s sales are gas, the rest comes from appliances and engineering. The company has a high equity ratio but low return on equity. The stock trades at only 30% of book value, and the dividend yield is 3.2%.
The company supplies about 200,000 households in Toyohashi, Toyokawa, Iwata and Hamamatsu. The company is affiliated with Sala Corporation, in which it holds a 20% stake. Gas pipelines between Shizuoka and Hamamatsu are scheduled to be completed by 2012. Eighty percent of the company’s sales are gas, while appliances, works and real estate make up the rest. The company has the highest dividend yield in the gas utility sector, at currently 3.3%. Its equity ratio is 33% and the company trades at about half its book value. The stock is only traded on the Nagoya stock exchange.
The company sells and supplies natural gas to four cities, four towns and one village in Chiba prefecture. It is mainly selling to households rather than industrial customers. The company was separated from Kanto Natural Gas Development in the 1950es, and still depends on this company for its supply of natural gas. Kanto NG Development holds 56% of the company’s shares, and 9% of shares are held as treasury stock. Ninety percent of sales are gas. The company has the highest equity ratio in the sector and the stock trades at 40% of book value.
The company is an affiliate of Nippon Gas, which holds a 40% stake, and supplies gas mainly in Saitama prefecture. Iwatani holds a further 16% of the company’s shares. Eighty percent of sales are city gas, and 20% LPG. The stock trades at about half of book value, and the return on equity is the lowest in the sector.
The company is also an affiliate of Nippon Gas, which holds a 64% stake in the company. The company was established in 1999 through the merger of Abiko Gas and Toride Gas. Sells gas mainly to households. Seventy percent of sales are gas, and 20% engineering and gas appliances. The company is expanding its supply area, and aims to grow its LPG customer base to 10,000. Earnings have been growing over the past years, and the equity ratio is over 50%. ROE was 6% in the last year, expected to fall to 5%. The stock trades at about 40% of book value and a little more than 5 times next year’s projected earnings. It is the smallest gas utility by market capitalization (2.23bn yen).
An overview of all companies and their key figures is provided in the table below, where the companies are sorted by market capitalization in descending order.
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Which Company Is the Best Pick?
Sorting the companies by earnings yield (reverse of the P/E ratio, or ROE divided by P/B ratio), it becomes clear that big is not necessarily beautiful in this sector. The small-cap companies Higashi-Nihon Gas, Otaki Gas and Hokkaido Gas, for example, have earnings yields in excess of 10%, while the “big three” (Tokyo, Osaka and Toho Gas) are trading at nearly the same earnings yield of 6.6%-7.0% (P/E ratio of 14-15). The fourth largest gas utility, Saibu Gas, has the lowest earnings yield of only 3.9%.
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Now yield is not the only thing that counts. The financial condition of the company also has to be taken into account. To get a better idea of the relative situation of the various companies in the sector, the earnings yield is plotted against the companies’ equity ratio in the figure below. The higher the equity ratio of a company becomes, the more conservative is its balance sheet. A 100% equity ratio means a company is completely debt-free. Now lower equity ratios (higher gearing) usually mean higher returns, but in the land of decade-long deflation, the situation is very different.
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In deflationary environments, taking on debt actually destroys shareholder value. In this most unusual picture, the companies with the lowest gearing have the highest earnings yields. This is great for a value investor, as we want to own companies which provide a great return on investment, but also strive for safety and fiscal prudence.
Saibu Gas appears least attractive in the sector. Its large borrowings make it a darling of the banks which also hold some stock in the company, but not of outside shareholders. Shinnihon Gas has much lower gearing, but its earnings yield is also low. The large caps - Tokyo Gas, Toho Gas and Osaka Gas - are all valued at approximately the same level and operate with similar levels of debt. Hokuriku Gas and Hiroshima Gas have approximately the same earnings yield as the “big three," but Hiroshima Gas has higher gearing, while Hokuriku Gas has the second-largest equity ratio in the peer group.
Hokkaido Gas, Chubu Gas, Shizuoka Gas and Keiyo Gas all trade at attractive earnings yields, with different levels of gearing.
The most attractive stocks in the sector are Higashinihon Gas and Otaki Gas, which trade at the lowest P/E ratio, have low price-to-book ratios (both around 40%), growing earnings and stable dividends - and rather low gearing. Both companies have a dominating shareholder, which may or may not be beneficiary. Otaki Gas relies on Kanto Natural Gas for its supply, while Higashinihon Gas is a member of the Nippon Gas group.
As you see, it pays to dig deeper rather than brush over a whole country or sector with an ETF. The individual companies making up the index can be very different, and doing more research can help you find some hidden gems.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I am long Higashinihon Gas (9544 on the Tokyo Stock Exchange).