Best Idea For 2021: Sekonic Corp

Seeking Alpha has asked Marketplace authors to present his or her "Best idea for 2021". It needs to be a position in a stock, so long dated out-of-the-money put options in Tesla (TSLA) do not qualify. But remember markets seem to be dominated with ignorant investors investing in excessively overvalued stocks. Therefore such put options are the ideal hedge against a major market crash.

I use an investment strategy that does not depend on high conviction ideas. Instead it is about many small positions in unpredictable companies, hoping that the good ones will pay for the losers. What also makes it difficult nowadays is that many of great  picks have gone straight up. In particular the stocks I like most are going up fast: cheap nanocaps based on earnings related metrics such as EV/EBIT, EV/Revenue and P/E that also have substantial intellectual property or know how.

A laggard among these nanocaps with substantial intellectual property or know how is Sekonic Corp with ticker 7758 in Japan. Since August 2020 the stock is up 6.4% in JPY, so about 8% up in USD. Below is what I wrote in August 2020. I have updated most numbers. 

Ticker, Fin Strength	Share Price Volatility	Market cap EV, millions	EV/EBIT EV/Revenue	P/Tan B P/Ret Earn	NCAV / MC Liq Val / MC
TYO:7758 6	975 JPY 0.045	1859 JPY 538 JPY	- 0.086	0.35 23 (8 yrs)	1.49 2.3
Date cash flow	EBIT, ttm until mrq	Cash flow from ops	Free cash flow	P/FCF	Yield %
2020-09-30	-186 JPY	340 JPY	98 JPY	19	2.1

Sekonic Corp develops “exposure meters, color meters, optical mark readers, recorders, temperature/humidity recorders, viscometers, inorganic electroluminescence and surveillance cameras” and operates also as a contract manufacturer of “copier option units, plotters, display panels”and provides “board mounting for various electronic devices and bundle processing.” The company also owns houses and the former head office and a former factory building for rental.

The company owns 2 factories in Japan and 2 factories in China. During last fiscal year about 60% of the revenue was from contract manufacturing and the rest was mainly from instrument development. The company gets about 2/3 of its revenue from Japan and the rest is mainly from China (including Hong Kong). Segment assets for the manufacturing and instrument segments are almost equal. Also losses for the 2 segments are roughly the same. The real estate segment is very profitable with 231 million JPY of segment profit on only 988 million JPY of property.

Almost all fixed assets are in Japan.

A search on the company name and keyword “fraud” did not reveal any relevant information.

According to the cash flow statements in my screener the company raised about 5% extra equity in the year ending on 31 March 2012. A year later the company spent about 1% of its equity on repurchases. In March 2020 the company bought back more than 2% of the shares for 971 JPY per share. Only during the last 3 years the company paid a dividend.

The 5-year low was 6.49 USD (722 JPY) on 23 March 2020. Based on weekly prices 3-year volatility is 0.045.

I estimate research and development costs were at least 350 million JPY over the last 5 years. A patent search returns 4 patents expiring in more than 10 years. When searching for patents from the last 20 years the search returns about 50 links. A couple of patents from subsidiary Hakodate Sekonic Co are also included in the search results.

I had a look at the annual report over the year ending on 31 March 2020 and the most recent quarterly report (30 September 2020).

There are 1.6694 million shares net of treasury shares. Because of the treasury shares the market cap is 1.628 billion JPY, so lower than the 1.859 billion JPY displayed in my screener (table above).

The most of the loss over the last 4 quarters is a one-time loss: In the last quarter of last book year (ending on 31 March 2020) the company did an inventory impairment of 182 million JPY. In the quarterly report the company writes revenue was much lower because of the coronavirus but it has also reduced costs.

All in all I expect the company to be slightly profitable going forward. Moreover if business picks up again the company could become much more profitable than before corona.

Retained earnings are 2.197 billion JPY so Market cap/Retained Earnings = 1.35. Based on net earnings minus dividends over the last 8 reporting years only the multiple is much higher, see the table above.

The balance sheet is strong with low leverage, a high current ratio, lots of cash and a small amount of current debt. The combination of a large cash pile and current debt is a red flag.

The book value of the current assets is 4.0 billion JPY including 1.4 billion JPY of not so valuable assets (mainly inventory). Among the non-current assets there is 0.7 billion JPY of land and 0.9 billion JPY of investment securities. The book value of the liabilities is 1.2 billion JPY. Therefore my estimate of liquidation value = 4.0 -0.5*1.4 +0.7 +0.9 -1.2 = 3.7 billion JPY and Liquidation Value/Market cap = 3.7/1.6 = 2.3. This estimate does not include an unknown amount for buildings held as investment, probably 200-400 million JPY. Moreover the 231 million JPY of rental profits over last book year suggest a much higher value of the investment property, may be over 2 billion JPY.

Substantial shareholders: MUTOH Holdings Co 19.77%, TCS Holdings Co 17.97%, Akimoto Toshiki 3.89%, CBC Co 2.61%, Inageya Co 2.40%, Hayakawa International Co 2.10%. I do not think this is an easy target for an acquirer, also because of potential hidden stakes related to the companies non-current investment securities.

4 directors earn 16 million JPY together, no bonus. This is probably excluding any salaries they earn as employees.

Related party transactions: the company does sales and purchase transactions with the affiliates of shareholder TCS Holdings Co. Last fiscal year the total of these transactions was almost 700 million JPY (so about 10% of the revenue).

My take: loss making Japanese manufacturer and instrument developer. But the loss was mostly a one-time loss. Cheap based on P/B, EV/Revenue, NCAV/Market cap and above all Liquidation Value/Market cap.

I have not found any governance issues. I find the company shareholder friendly with a buyback in March 2020 and paying a dividend.

The company owns valuable property. From the rental profit it seems the property is worth much more than book value. Having spent substantial amounts on research and development the company also owns a couple of patents.

Dividend paying net-nets are very attractive investments on a risk adjusted basis. What I also like is the relatively low stock price volatility. While I do not rule out a lower stock price if we see a major market crash in 2021 I think stocks like this one will rebound soon. In other words, a portfolio of cheap nanocaps like this one is also a good hedge against a broad market crash, just like long dated out-of-the-money put options in Tesla.

I do not think it is wise to do high conviction investing with net-nets and nanocaps. That said this is the best idea I can find among literally hundreds of net-nets, nanocaps, falling knives and low EV/EBIT stocks.

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