Seeing Opportunity in Takefuji -- Japan's Most Hated Value Stock

Includes: NIS, TAKAF
by: Steven Towns

John Bethel of Controlled is a value investor who saw opportunity in Takefuji (OTC:TAKAF) (Tokyo: 8564), an undervalued Japanese consumer finance company, despite the risk of government regulation in capping interest rates. Bethel established a position in Takefuji earlier this year, but unfortunately he pulled the trigger too soon.

Kudos to Bethel for his patience as Takefuji's stock has been hammered lower and lower. It looks safe to call a bottom now, and there's even more value as it trades well under book value and remains heavily overcapitalized.

First, here's a link to Bethel's posts on Takefuji for your reference. And here's a separate link to an article published today that has good commentary on the consumer lending situation in Japan, but it does have an overly negative take.

By the way, last I heard from Bethel (last week), he was still optimistic and holding tight, while considering expanding his position. He originally purchased shares at $62.50 back in April. As of Wednesday's Y4,500 (+6.13% gain today) close in Tokyo, adjusting for a conversion rate of Y117.15/US$, it's at $38.41.

Before you read any further you should understand it's difficult to purchase Takefuji's shares over-the-counter in the U.S. I've tried unsuccessfully over the past several trading days. I assume one could purchase if a bid is entered at an unknown percent above its ordinary share close in Japan. I've tried bidding as much as 1% higher to no avail. Don't forget that even if you are successful in purchasing over-the-counter, it may be difficult to sell. That said, Bethel explained to me earlier this year that he purchased through Schwab's global trading desk. Transaction costs and currency conversion costs must be taken into consideration. If you're lucky enough to have a Japanese brokerage account then liquidity is definitely not an issue.

Disclosure: I do not own shares of Takefuji at the time of posting, but am considering making a purchase in yen in Japan.

Now, for Takefuji's story in a nut shell. Consumer lenders are basically a necessary evil that are despised in Japan for their widely publicized "dirty" collection tactics (in some but obviously not all cases) and "usurious" interest rates (up to 29.2% per one of two rate laws, or higher depending on the style of calculation). The fact that there are suspected ties to organized crime, the yakuza (Japanese mafia), doesn't help.

At any rate, Takefuji (the largest Japanese consumer lender) and a number of other top lenders, two of which GE and Citi have separate stakes, are cash cows, trading less than book value, that have seen their stocks nearly slaughtered by the threat (and now reality) of government regulation of lending rates and collections practices. Not to mention, analysts are scared to say much about the group amid the uncertainty of government regulation, which now is a matter of timing of implementation.

Enter the gaijin investors (gaijin means "foreigner" in Japanese), who have clearly seen opportunity in Japan's consumer lenders, despite the government's clamp down, and the market's shunning. Focusing on Takefuji, Bethel has followed "legendary value investor" Peter Cundill raise his stake in the firm to become one of its largest shareholders. Over the years, there has been talks of a takeover, but family ownership has been an obstacle. Over summer however, Yasuo Takei, its founder and former chairman died, but the family still owns about 25% of the company. A article reporting of Takei's death mentioned overseas investors owned about 56% of Takefuji.

Takefuji's latest financial data on Yahoo! Finance Japan shows it is trading at .65x book, 13.51x trailing earnings, has a 55% shareholder equity ratio, and has a yield of 5.11% (it pays an interim and annual dividend). It will have a negative P/E from now and the book value and shareholder equity ratio figures have worsened, the latter now at 46.1% -- but are obviously still attractive -- since it announced interim earnings today, that closely matched its revised estimates released yesterday (see second paragraph below block-quoted text).

Along with its earnings announcement, Takefuji made the following statement regarding its operating environment:

In the consumer finance industry, the amendment of the Capital Subscription Law and the Moneylending Control Law is in its final stages. While a transitional period for approximate three years was included in a draft revision proposed by the ruling parties, the revision also contains provisions that will have a significant impact on the consumer finance industry. These include a substantial reduction in the maximum legal lending rate and the introduction of total amount control. It is anticipated that the industry will be subject to a continuing process of consolidation and reorganization.

The challenges represented by these business conditions are unprecedented, and the Takefuji Group will respond with a full commitment to strengthening its small, unsecured and non-guaranteed consumer loan business by building business with new customers and by attracting quality clients through such measures as reviewing credit screening policies, diversifying the product mix, and expanding sales channels. In addition, we aim to expand and strengthen our earnings base by creating a new business model with consumer finance services as the core, based on the effective use of our ample capital to aggressively engage in new businesses as well as mergers and acquisitions delivering high synergy for our core business.

Although regulations are expected to be tightened with the amendment of related laws, the Takefuji Group had already established strict voluntary rules for its credit screening policy and credit corrections before the Moneylending Control Law was introduced and today strictly adheres to a limit of one million yen for unsecured loans. We will continue to reinforce our compliance system to provide customers with quality consumer finance services so that they can use our services with a feeling of security. In the meantime, we will seek to increase our corporate value by bolstering corporate governance and promoting social responsibility [CSR] activities.

Takefuji announced yesterday that it was lowering its interim and full-year financial forecasts, as a result of establishing reserves to cover refunds for payments made by consumers -- who paid in excess of 20% interest in the so-called 20%-29.2% gray zone -- in order to comply with the Japanese Institute of Certified Public Accountants. Instead of posting expected net income growth of 32% and 46% for the interim and full-year, respectively, it will now post a loss for both periods. Consolidated net income in the interim (Apr. 1, '06 - Sept. 30, '06) is now expected to be -144,200 million yen (~$1.2b), compared to the prior forecast of 40,300 million yen (~$343m). And for the full-year it's expected at -109,500 million yen (~$932m), compared to the prior forecast of 68,600 million yen (~$584m).

Aside from the legal risks, which should not be taken lightly, another risk is the family's owernship and what it could mean in the event of a takeover bid. Last week, Takefuji published a document containing "countermeasures to large-scale acquisitions", that for instance could result in a dilution of shares/voting rights. In any event, the family does own a quarter of the company, and some of the influence to maintain family ownership may have lessened with the death of its founder. Also, it is worth mentioning Takefuji is very serious about its corporate governance, which is evident by the amount and detail of financial data it publishes, and says it places high priority in enhancing shareholder value (share buybacks are reportedly under consideration).

Some positive trends and circumstances I see that make Takefuji a compelling investment, in addition to its valuation include:

  • Large foreign investor ownership
  • Extremely low borrowing rate, that's advantageous even with the lending rate to eventually be capped at 18%
  • Ability to further cut costs by relying more on ATM and credit card lending as opposed to staffed-offices
  • Large asset base that allows it to diversify into other financial services, likely via M&A
  • Position as largest consumer lender, advantageous in the event of industry consolidation at depressed prices
  • Overseas opportunities such as in China
  • Dividend yield is among the highest of Topix 1st Section companies -- Japan is yield-hungry and at 5%+, Takefuji is a rarity
  • Possibility of share buybacks and/or special dividend
  • Potential currency conversion gain assuming yen strength versus US$, my rough estimate is approx. >= 5% over the next 12-15 months

Risks: There are a few cases I can imagine leading to further downside in Takefuji's shares: (1) politically motivated immediate implementation of the rate cap as opposed to doing so after a three-year "transitional" period, (2) value destroying M&A, and (3) share dilution to prevent takeover.

Takefuji's Investor Relations website is one of the best I've seen and has a lot of data. Today it published a variety of data in a separate report in conjunction with its earnings release.

For those readers looking for Japan stock ideas, let me mention that I recently established a position in NIS Group (NIS). NIS is also in the lending business, but focuses more on SMEs and is more diversified in financial services than Takefuji. At this point, NIS is a speculative play given that it has undergone some ambiguous stock splits, and its share price is down by more than 50% from its 52-week and multi-year highs. Yesterday, it announced substantially downward revised interim and full-year financial forecasts due to its exposure to consumer lending and the reserve requirement explained above with Takefuji. Nevertheless, similar to Takefuji, I believe NIS shares have all the negative factors figured in and look attractive at present levels. NIS is listed on the NYSE but is thinly traded. I recommend using limit orders when trading.

Takefuji Corp (OTC:TAKAF) 1-year chart:


NIS Group (NIS) 1-year chart:


Disclosure: The author does not own shares of Takefuji but is considering a purchase, likely through a Japanese brokerage using yen (as explained above). The author is long NIS Group and General Electric. The author has no position in Citigroup.