'Quantamental' Japan Specialist, LightStream Research

Campbell Gunn

'Quantamental' Japan Specialist

ja research

ja research is an independent research platform focused exclusively on Japanese equities. Leveraging data and graphic analysis provided by Japan Analytics, we provide insights on small and medium-sized companies that have been ignored by the sell-side as well as challenging conventional wisdom on larger companies. We also offer analyst and corporate access, the latter with translation if required. 

Equity Bottom-Up

INVENTORY WATCHLIST OUTLIER -  <a href="https://www.smartkarma.com/entities/18346" target="_blank" data-smartkarma-citation="entities:18346:1">Nipro Corp (8086 JP)</a> appeared on our list of larger cap companies where Inventory Cash Flow is excessive relative to Operating Cash Flow over the last eight quarters. This note aims to dig deeper into the reasons and assess if there is anything actionable on the horizon.NIPRO AS #1 - Nipro aims to have sales of ¥1 trillion by 2031. If this implied respective 7.5% compound growth rate was to be achieved, Nipro would become Japan's leading medical device manufacturer, surpassing both Terumo and Olympus, assuming both those companies maintain their current rates of growth.4 QUARTERS OF DECLINING ROLLING TTM OPERATING MARGINS - 2017Q1 and 2017Q3 were the two best quarters in the last 10 years for Nipro's Operating Income and 2018Q3 was the third best. Despite these strong quarters, the rolling TTM pattern is not encouraging.  At present, incremental revenues are not incrementally profitable, however, this has yet to slow the pace of Nipro’s expansion. NET INCOME/OTHER COMPREHENSIVE INCOME (OCI) - JGAAP prefers to avoid the volatility of OCI items by excluding them from the Income Statement and including them in Net Assets but not Shareholder's Equity on the Balance Sheet.  Nipro is a good example of why the Japanese accounting profession dislikes this form of fair value accounting. Nevertheless, for Nipro, OCI and not Net Income is the main driver of changes in Net Assets. NEGATIVE RESIDUAL RETURNS - Investments that produce returns that exceed the cost of capital are to be encouraged, but sub-5% returns fail to meet even the most conservative hurdle rates. Net Operating Assets have grown at an annual rate of 8.5% since 1990.  Using a required return on Net Operating Assets of 6% Nipro has only been able to meet this hurdle for 8 years of the last 28 years - the last of which was 2010 - and in none of the last 28 quarters. After improving for 13 straight quarters from 2014Q3 to 2017Q3 Nipro's Residual Return on Net Operating Assets has been trending lower in each of the last four quarters and as of the last quarter was -2.7%. By focusing on the gross profit ratio 'as an indicator of efficient management of invested capital, the company is consistently destroying shareholder value.THE ¥1 TRILLION SALES TARGET - Assuming a 3% organic growth rate, the company will have to acquire over ¥475b worth of sales over the next 12 years, in order to meet the stated ¥1t sales target. With sales multiples on acquired businesses likely to be well above Nipro's 0.7x, we assume that the company will have to spend between ¥700 million and ¥1 trillion on new acquisitions by 2028.   This cannot be funded without shareholder assistance.ABSOLUTE/RELATIVE PERFORMANCE - Although Nipro's shares have appreciated by 61% over the last five years, relative performance has been more volatile. After a spike up in 2013 and a gradual recovery, over the last year, the relative share price has lost 0.9 points despite a continued increase in foreign ownership.   The market's response to Nipro's recent performance is clear - Nipro is the third-worst performer in its Peer Group of 34 Medical &amp; Dental Equipment &amp; Supplies companies over one year after <a href="https://www.smartkarma.com/entities/13606" target="_blank" data-smartkarma-citation="entities:13606:1">Cyberdyne [7779 JP</a>] and <a href="https://www.smartkarma.com/entities/7592" target="_blank" data-smartkarma-citation="entities:7592:1">Daiken Medical [7775 JP]</a>. Much of the current earnings drift has been discounted. The next surprise will be a further capital deployment and a running down of the current US$1b war chest. When it is clear that the company is back on the acquisition trail, it will only be a matter of time before the next equity financing.

INVENTORY WATCHLIST OUTLIER -  Nipro Corp (8086 JP) appeared on our list of larger cap companies where Inventory Cash Flow is excessive relative to Operating Cash Flow over the last eight quarters. This note aims to dig deeper into the reasons and assess if there is anything actionable on the horizon.NIPRO AS #1 - Nipro aims to have sales of ¥1 trillion by 2031. If this implied respective 7.5% compound growth rate was to be achieved, Nipro would become Japan's leading medical device manufacturer, surpassing both Terumo and Olympus, assuming both those companies maintain their current rates of growth.4 QUARTERS OF DECLINING ROLLING TTM OPERATING MARGINS - 2017Q1 and 2017Q3 were the two best quarters in the last 10 years for Nipro's Operating Income and 2018Q3 was the third best. Despite these strong quarters, the rolling TTM pattern is not encouraging.  At present, incremental revenues are not incrementally profitable, however, this has yet to slow the pace of Nipro’s expansion. NET INCOME/OTHER COMPREHENSIVE INCOME (OCI) - JGAAP prefers to avoid the volatility of OCI items by excluding them from the Income Statement and including them in Net Assets but not Shareholder's Equity on the Balance Sheet.  Nipro is a good example of why the Japanese accounting profession dislikes this form of fair value accounting. Nevertheless, for Nipro, OCI and not Net Income is the main driver of changes in Net Assets. NEGATIVE RESIDUAL RETURNS - Investments that produce returns that exceed the cost of capital are to be encouraged, but sub-5% returns fail to meet even the most conservative hurdle rates. Net Operating Assets have grown at an annual rate of 8.5% since 1990.  Using a required return on Net Operating Assets of 6% Nipro has only been able to meet this hurdle for 8 years of the last 28 years - the last of which was 2010 - and in none of the last 28 quarters. After improving for 13 straight quarters from 2014Q3 to 2017Q3 Nipro's Residual Return on Net Operating Assets has been trending lower in each of the last four quarters and as of the last quarter was -2.7%. By focusing on the gross profit ratio 'as an indicator of efficient management of invested capital, the company is consistently destroying shareholder value.THE ¥1 TRILLION SALES TARGET - Assuming a 3% organic growth rate, the company will have to acquire over ¥475b worth of sales over the next 12 years, in order to meet the stated ¥1t sales target. With sales multiples on acquired businesses likely to be well above Nipro's 0.7x, we assume that the company will have to spend between ¥700 million and ¥1 trillion on new acquisitions by 2028.   This cannot be funded without shareholder assistance.ABSOLUTE/RELATIVE PERFORMANCE - Although Nipro's shares have appreciated by 61% over the last five years, relative performance has been more volatile. After a spike up in 2013 and a gradual recovery, over the last year, the relative share price has lost 0.9 points despite a continued increase in foreign ownership.   The market's response to Nipro's recent performance is clear - Nipro is the third-worst performer in its Peer Group of 34 Medical &amp; Dental Equipment &amp; Supplies companies over one year after Cyberdyne [7779 JP] and Daiken Medical [7775 JP]. Much of the current earnings drift has been discounted. The next surprise will be a further capital deployment and a running down of the current US$1b war chest. When it is clear that the company is back on the acquisition trail, it will only be a matter of time before the next equity financing.

Nipro [8086 JP] - A Serial Destroyer of Shareholder Value on the Acquisition Trail

Japan

NIPRO CORPORATION manufactures medical products.  The Company's products include artificial dialysis and blood transfusion equipment, hypodermic syringes, and glass products for medical use.

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Nipro [8086 JP] - A Serial Destroyer of Shareholder Value on the Acquisition Trail

INVENTORY WATCHLIST OUTLIER - Nipro Corp (8086 JP) appeared on our list of larger cap companies where Inventory Cash Flow is excessive relative to...

Campbell Gunn