Japan-based TechnoPro (TSE:6028, Financial) caught our attention for its combination of superior growth and return with a massive runway ahead. The company represents one of the country’s largest groups of engineers and researchers and provides one-stop solutions in a wide range of technology areas.
As of fiscal 2019, the R&D outsourcing (mainly relating to information technology, software development, electrical/electronic and biochemistry) accounted for almost 80% of the total sales. The business also provides construction management outsourcing (12% of the fiscal 2019 sales). Over 90% of the revenue comes from the domestic market at the moment. In 2014, TechnoPro went public with a market cap of 66.4 billion Japanese Yen ($620 million), making it the largest domestic Japanese offering of that year.
As the market leader, TechnoPro shares roughly 8% of the ¥1.8 trillion engineer dispatch industry. Per the management, Japanese companies are increasing their research and development spending by 5.5% a year. Continuous technological advancement, combined with a shortage in the workforce (especially in the engineering-related field) is creating a secular tailwind for the industry, which could expand by as much as 8% annually according to Yano Research Institute.
We also observe that the software development area, which represents more than half of the engineer staffing services market, may expect a higher growth, as the digital penetration of the economy still remains low in Japan compared with the likes of other regions like the U.S. and China. According to the Ministry of Economy, the current gap between the supply and demand in IT staff could widen by almost 100% by 2030.
Major peers Meitec Corp. (TSE:9744, Financial) and OUTSOURCING Inc. (TSE:2427, Financial) possess respective market shares of 5.4% and 4%. As you can see, the market is quite fragmented, offering long-term growth opportunities for the leading player. Checking these top companies further, we notice that TechnoPro is the only one achieving a decent balance between return and growth for its owners. The business earns a 10% return on assets and has increased its top line by a five-year compound annual growth rate of 14%. By comparison, Meitec achieves a 12% return on assets but only grew its sales by 5.5% for the last five years. OUTSOURCING, on the other hand, delivered a remarkable five-year growth rate of 43% but earned around 5% return on assets over the period.
In terms of the downside, the management at TechnoPro asserts that the research & development field is less susceptible to the economic cycle. The sales at both Meitec and OUTSOURCING were mildly impacted throughout the Global Financial Crisis (though TechnoPro only went public in 2014). Other than that, we think that the company may want to continue to solidify its economic moat by leveraging its market-leading position, reputation and scale.
Meanwhile, we notice that acquisition plays a significant role in the company’s growth strategy. By the end of fiscal 2019, the management team had engaged in 13 deals. It is worth pointing out that the management acknowledged the risk and started to disclose the return on invested capital concerning such investments. For instance, the return for fiscal 2019 was 8.6%, as was shown in the annual report, compared to the estimated 7.2% cost of capital. Although there was an economic value, the absolute return for an owner with a high opportunity cost is, admittedly, quite low. The management claims to work actively towards its long-term target for an above 10% return. Based on Urbem's calculations, TechnoPro achieved a three-year incremental return on equity capital of 11%.
Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the stock market. We do not own any security mentioned in the article.
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