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Clayton Young
Clayton Young
Articles (12)  | Author's Website |

Buybacks, Dividends and No Market Recognition at This Japanese IT Company

The market seems to overlook Ines' solid business performance and healthy capital allocation

September 19, 2017 | About:

Overview

Ines Corp. (TSE:9742) is a Japanese information technology solutions company with origins that can be traced back to Kyoei Life Insurance’s IT department. In 1964, Ines spun off and commenced operations as its own company. In 1968, it became the first private enterprise to develop a resident recording system for municipal government. The company went public in 1987. Today, Ines takes on clients from municipal governments (50% revenues), financial institutions (31%) and industrials (19%).

In its over 50-year history, Ines has worked with big names like SAP Japan, Microsoft (NASDAQ:MSFT), Hewlett Packard Japan, IBM Japan and Hitachi Software Engineering on various IT systems, primarily related to municipal government software.

Shift in corporate culture

It probably does not come as a surprise to most readers that corporate Japan has historically valued long work hours. The boundary between personal time and work time is hardly distinguishable. However, Ines CEO Etsuro Mori takes a different stance from the corporate norm. Mori believes having personal time and the life experiences associated with it leads to creative value-added ideas. Lately, the company has encouraged employees to take time off.

As a part of the push for increased personal time, Mori himself has worked his schedule around taking “Premium Friday” off. Premium Friday is the last Friday of each month. The Japanese government coined the term earlier this year and started pushing companies to let employees get out of work early so they can go have some fun (i.e., spend money).

Another interesting, non-Japanese push is Ines’ paternity leave program. Of course, the company also has a maternity leave program. In Japanese culture, childcare is generally considered the mother’s job and the father taking time off soon after a child is born is mostly looked down on. At Ines, new fathers get a message directly from the CEO saying “Congratulations! Please take some time off."

Elusive nature of growth

It may sound like Ines is a yuppie tech company with explosive growth. The reality is the top-line figures, though with some fluctuation, have basically gone nowhere over the past 10 years:

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It is not all bad though. Part of the corporate culture shift includes productivity improvements. This makes sense, especially given the company wants its employees to proactively take time off without negatively impacting business performance. Gross margins have improved from 14% in 2008 to 20% today.

Both gross profit and operating income improved during the same 10-year period:

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Without the top-line growth, however, there typically is not a whole lot to be excited about with tech companies. In the case of Ines though, capital allocation has been remarkable, mostly because of buybacks:

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In per-share terms, revenues actually grew at a 4.5% compound annual rate over the past decade. It is also important to note the buybacks were accompanied by dividend payouts. Again, with some fluctuation, Ines has typically paid out somewhere between 30% and 40% of net income in dividends.

To be sure, business performance has not been all that impressive, especially for a tech company:

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That said, business performance has been healthy and consistent enough to comfortably afford dividend payments and share buybacks.

Going forward

The Japan Information Technology Services Industry Association (JISA) expects the industry to grow at a CAGR of 2% through 2020. Ines management is in agreement with this. The company is expecting replacement demand as well as increased demand from welfare services and law changes affecting welfare in municipal government software. As for financials, management expects incoming work related to financial technology (fintech) and consolidation of regional banks. Management has not made any specific comments about demand from industrial clients.

Overall, Ines management is guiding for a 3.9% increase in revenues and an 8% decrease in operating income. Management commented about one-time costs for fiscal 2018 without going into any detail. Dividend guidance is 20 yen (18 cents) per share for fiscal 2018, which would put Ines' dividend yield at 2% with today’s share price of 996 yen.

I cannot help but wonder - shares outstanding decreased by a little over 13% from fiscal 2016 to fiscal 2017 and EBIT per share came in at the highest it has ever been in 2017 (91.7 yen), yet the market cap has fallen by almost 19% from year-end 2016. It seems to me like none of the market participants understand the impact of buybacks. Either that or there is an incredible amount of pessimism about Ines’ future business performance. EV/EBIT went from around 10 to 13 in 2016 to 5 today, despite improving business performance. Perhaps the lower guidance for fiscal 2018 had something to do with the downfall in market cap, but it seems overblown or misunderstood to me. I think a 2018 guidance discount of 8 times EV/EBIT would be more appropriate. This puts Ines stock somewhere around 1,200 yen to 1,250 yen per share, a 20% to 25% premium to today’s price, though without a clear catalyst.

Disclosure: I do not own any shares of companies mentioned in this article.

About the author:

Clayton Young
I grew up in Japan and completed an MBA in the U.S., but learned more from reading Howard Marks. I apply an American value investing approach to Japanese companies that are often inscrutable to outsiders who lack fluency in the unique cultural context.

Visit Clayton Young's Website


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