Divestment Of Shinsho Corporation & Kobe Steel – TTI’s Post-Mortem
1stly, some thanks is in order.
Lilin from SGX told me they’re sending “Team ThumbTack” (as they so affectionately put it) some red packets for CNY, and I was expecting a couple of packs in the mail.
Then my guard passed me this:
Inside was a massive box of several packs of red packets.
Wow, that’s enough for several CNYs. How’s that for some festive mood?
Plus they’re smart enough to have generic red packets that can be used regardless of which year it is.
So thank you, SGX!
3 months ago, in Nov 2017, I wrote about my investing thesis for Shinsho Corporation and Kobe Steel:
As stated, I accumulated a position of 2,500 shares in Shinsho Corporation, and 2,000 shares in Kobe Steel
Since then, both companies have reported Q3 results that have handily beaten market’s expectations, the share prices have shot up, and I have taken profit in 2 batches, the 1st being a sale of 1,000 shares of Shinsho Corporation at 4,100 JPY on the 1st Feb 2018.
To build my positions, I converted SGD 124,000 into JPY at a rate of 84.34291, ending up with JPY 10,458,521
Following complete divestment, I ended up with JPY 12,257,387, giving me a capital gain of approximately 17.2% for 3 months.
The real returns were further boosted by Fx gains, as the recent bout of volatility in the markets resulted in a rapid strengthening of the yen, and my conversion of yen to SGD was done at a rate of 82.784, resulting in a balance of SGD 148,064.
Real returns for the past 3 months or so is thus, SGD 24,064 or a ROI of 19.4%
Not too shabby for 3 months huh.
I’ve previously already described my rationale for my core positions, with a particularly large one in Shinsho Corporation, and a smaller one in Kobe Steel.
Since then, the markets have proven me to be largely correct. All japanese steelmakers have seen their share prices rally, but Shinsho’s and Kobe Steel’s have rallied much more strongly on most days compared to their peers.
As I said earlier, it’s really difficult taking up contrarian positions, especially when the markets continue to move against you AFTER you’ve completed your accumulation. And trust me, it ALWAYS does.
Expecting to accumulate right at the bottom, is akin to expecting to learn to fly right after jumping out of a moving plane. It just doesn’t happen. And when the markets continue to move against you, every day feels like an eternity.
Each time that happened though, I took solace in my research. In this case, I dug deep to analyze the trends in Japanese steel production figures, and compared that to the relevant market share of each player. I also kept track of Chinese steel production figures, particularly it’s export figures.
Japanese steelmakers are having a field day right now, from a rare combination of lack of cheap chinese steel exports, as well as huge demand from construction projects within Japan, in view of the Olympics 2020. Another source of huge demand comes from the Jap automakers, which have been ramping up production.
In 2017 to date, China has greatly restricted it’s steel production, choosing to consolidate within the industry and cut exports. This created a sudden void, and steel prices such as rebar steel (used in the construction industry) and hot rolled sheet steel (used by automakers) firmed up strongly.
My tracking of the production volumes also gave me the confidence to build a core position and hold resolutely.
The Japanese steel market is dominated by 3 players:
- Nippon Steel & Sumitomo Metal
- JFE Holdings
- Kobe Steel (a distant third)
With that, I figured that the overall industry figures would fairly accurately reflect the fortunes of the 3 players, proportionately.
The data that I have compiled and assessed, constantly gave me the confidence to be contrarian. Check it out.
This table shows the steel products orders by end clients. Comparing y-o-y growth, hot rolled sheets (used mainly by automakers) and steel pipes and tubes (used in construction), showed the strongest growth of over 6% more than the corresponding period in 2016. (Highlighted in yellow)
Steel manufacturing is the largest division of Kobe Steel, and the largest contributor to earnings. Within the steel manufacturing division, these 2 particular sub types are the main types that Kobe Steel supplies.
As mentioned before, the huge demand on the industry, supported by the drop in chinese exports, resulted in a rare environment where steelmakers could raise prices on their products. In fact, domestic demand was so strong, that Japanese steel exports dropped by more than 10% y-o-y as producers found clients to take up their production easily:
In addition, we can see from the table that demand growth came mostly from construction projects and automakers.
I even went to investigate the steel product orders by regions, as I postulate that the higher the regional demand that Kobe Steel resides in, logically, the greater the business for Kobe Steel.
Kobe Steel’s headquarters reside in Kobe, which is within Kansai.
In fact, Kobe Steel is the single largest employer within Kobe. That further gave me confidence that it is not in the interests of politicians to overly penalize Kobe Steel so as to cause insurmountable troubles.
Don’t bite the hand that feeds you, ya.
I prefer to look at y-o-y data for the periods I track, instead of month on month data, so as to smoothen out seasonal demands. The steel demands tend to be substantially stronger in 1H, with the lull being in the Oct-Dec winter period (which is Q3, as they all have a March year end)
Now, having digested all this data…….. logically, does a 40% drop in the share price due to this scandal seem kinda illogical? A 40% drop means the markets are pricing in a catastrophe type of scenario, and perhaps, even pricing in insolvency and bankruptcy.
TTI didn’t think so, looking at all the data.
But that’s not all. The best investments are always those that you have superior insights that would give you a competitive advantage over the markets.
So… How did I actually end up looking at Japanese steelmakers? (I actually hate to look at Japanese companies. The financials are presented differently from what I’m used to, the numbers in yen always look so large and it’s not fun for a number cruncher like me, and the english in their website is usually atrocious).
Answer: By chance, actually.
I’d really like to say that I’m a genius who had the foresight to determine where the Japanese steel market was going, but it was really an idea that I chanced upon.
Because of my position in Dutech, I was actually tracking rolled sheet steel prices in China (that being a major cost for Dutech), and noticed rising prices. I also noticed a sudden drop in Chinese steel exports, and came across an article which described how the Chinese gov was consolidating the industry, shutting down inefficient steel mills and producing higher quality steel. They were also limiting steel exports in an attempt to regulate steel prices. (whether it’s by choice or due to political pressures, I wouldn’t know)
Specifically, when looking at the Kobe Steel scandal, I also knew that unlike the doomsday scenario that the press painted, it is more likely that Kobe Steel’s clients would work together with Kobe Steel, to contain the fall out, rather than go after Kobe Steel with pitchforks.
This confidence is gleaned from my previous investment in CDW Holdings.
CDW’s CFO Mr Philip Dymo, gave me precious insights into the manufacturing industry and corrected many misconceptions I had.
For example, I used to think that the manufacturer – client relationship is one where the power resides in the clients. It seems logical right? The manufacturer doesn’t have any competitive advantage, the client can just go to the cheapest manufacturer who can provide the same goods, at the lowest cost. What pricing power does the manufacturer have?
But in reality, their relationship is more like a partnership. At least for CDW’s industry, a client would need to accredit the manufacturer before beginning on a working relationship, and that process can take as long as… 2 freaking years!
In fact, for Kobe Steel, I believe some of their clients are actually aware of the discrepancies in their product specifications themselves. Complicit agreement is what this is.
I’ve been discussing Kobe Steel’s fortunes above, that’s because Shinsho Corporation’s macro fortunes really mirrors that of Kobe Steel’s.
For the financials though, let’s look at Shinsho’s, since that was my core position to begin with.
Q3 financials put many of the market fears to rest, and rewarded my positions heavily.
Earnings definitely surprised the markets, coming in at 515.68 yen per share. Market’s fears of clients bailing out on Kobe Steel / Shinsho Corporation did not materialize. Earnings were just as strong.
More importantly, check out Shinsho’s forecasted earnings for the full year:
Projecting full year EPS of 564.68 yen.
That’s actually very very close to my own estimate in my investing thesis.
For 1H of fiscal 2017, reported EPS of 322.41yen
(assuming earnings for 2H comes in at 72% of 1H) FY17 EPS of 554.5 yen
At share price of 3140 yen,
That’s a forward PE of 5.6 times”
My own ascribed fair value for Shinsho Corporation is actually much higher than my divested price, at around 4,500 yen. That would give a forecasted PE of around 8 times.
I chose to divest now, and leave approximately 20% of gains on the table, because I need the liquidity right now. (No, I did not foresee the markets will suddenly turn volatile)
The needed liquidity is related to this:
Maybe I’d write about it at a later stage when the deal gets done and dusted.
Alright, that’s all I have for this post.
Have a good CNY ahead!
Wishing all readers a prosperous year ahead!