Cycle Worries Have Opened A Window Of Opportunity At Shin-Etsu Chemical

Even the best companies aren’t immune to macro challenges, and that’s certainly the case these days at Shin-Etsu Chemical (OTCPK:SHECY) (4063.T) (“Shin-Etsu”). One of the best-run companies I know in the broader chemical space (and perhaps irrespective of industry grouping), Shin-Etsu shares have come under pressure on worries about the impact of weaker housing on polyvinyl chloride (or PVC) prices/margins, as well as concerns about weakness in the semiconductor and electronics markets.

Concern is appropriate, and Shin-Etsu is very likely to see weaker profits over the next 12-18 months, but I think the downturn needs to be kept in context. Namely, this remains the world leader in PVC cost structure and North American capacity, and the U.S. housing market should resume growing after this upcoming correction. Likewise, while I do see some risk to semiconductor demand, demand for leading-edge chips is unlikely to weaken substantially for long. Even with some risk to earnings expectations over the next 12 months, I believe the shares are priced for attractive long-term returns.

 

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Cycle Worries Have Opened A Window Of Opportunity At Shin-Etsu Chemical

Shin-Etsu Chemical Leveraging Its Excellence Through The Pandemic

Regular readers of my articles know that I’m not a “valuation doesn’t matter” sort of investor, but for every rule, there are exceptions, and Japan’s Shin-Etsu Chemical (OTCPK:SHECY) is one where I’m often tempted to relax my approach to valuation. Not only does Shin-Etsu have a strong track record where operational factors are concerned (margins, returns on capital, etc.), the shares have comfortably beat its sector peers and come close to beating the S&P 500 over the past 15 years, while handily beating the index over the last 20 years. What’s more, this is a company that continually reinvests in itself; it’s never the first to pursue the hot new thing, but it generally ends up being one of the best operators where it chooses to compete.

The PVC market is starting to look quite a bit stronger, and that should help offset some potential turbulence in the semiconductor silicon business. Longer term, I think Shin-Etsu will continue to grow revenue at around 3% to 4%, with healthy double-digit FCF margins driving mid-single-digit FCF growth. Shin-Etsu shares aren’t inarguably cheap here, but it’s a borderline “buy” call and definitely one to watch as meaningful pullbacks do occur from time to time.

 

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Shin-Etsu Chemical Leveraging Its Excellence Through The Pandemic

Shin-Etsu Going Through A Choppy Bit, But Still Attractive

I was a little cautious about Japan’s Shin-Etsu Chemical (OTCPK:SHECY) back in August of 2018, largely due to the risk of how the market would react to the ongoing correction cycle in semiconductors, not to mention the risks from a macroeconomic slowdown affecting businesses like PVC/Chlor-alkali and Silicones. Since then, the shares are down about 6% (versus a roughly 6% rise in the S&P 500), though the company has done pretty well relative to expectations and the challenges in these businesses are likely to be relatively short-lived.

I believe Shin-Etsu is about 20% to 25% undervalued today, and I believe this company is both one of the best-run in Japan and one of the best-run in the chemical/specialty chemical space. Timing is tricky, though. I do think there’s some risk of a “lower for longer” correction cycle in the more industrial-exposed businesses, but I also think waiting to buy the shares at the absolute bottom is a good way to miss out. All told, for investors with a longer horizon and who are willing and able to overlook some near-term underperformance risk, I believe these shares are worth considering.

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Shin-Etsu Going Through A Choppy Bit, But Still Attractive

Wafer Worries Weighing On Shin-Etsu

When the stock of a well-run company that you’ve long admired gets to a point where the apparent annualized returns are in the double-digits, it’s a good time to refresh your due diligence. Such is the case with Shin-Etsu (OTCPK:SHECY) (4063.T), where management continues to execute at a high level and where the company’s core markets are healthy, but where recent fears relating to the semiconductor market seem to be having a disproportionate impact on the share price.

The risk of a sudden drop in semiconductor demand is not trivial, as Shin-Etsu’s wafer business generates about 30% of total operating profits today, but I also don’t think it’s particularly likely given the tight current supply situation and the relatively constrained capacity expansion plans across the industry. I also don’t think my modeling assumptions are all that ambitious, as I’m looking for long-term revenue growth of 4% and high single-digit FCF growth from a company exposed to global construction growth, semiconductor production, and EVs.

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Wafer Worries Weighing On Shin-Etsu

ON Semiconductor Performing Well As The Cycle Ages

Like a lot of chip companies, ON Semiconductor (ON) has seen its share price slide over the last few months as investors have become more worried about lengthening lead times and the prospect that the cycle is peaking. I wouldn’t advise ignoring that risk (it’s really never different this time, and semiconductor demand is still cyclical), but ON’s leverage to growth opportunities in auto and industrial end-markets and ongoing synergies from the Fairchild deal can still support a worthwhile outlook. I’d also note that expectations aren’t exactly robust – mid single-digit free cash flow growth would be enough to support a higher share price.

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ON Semiconductor Performing Well As The Cycle Ages

Almost Everything Going Right For Shin-Etsu Chemical

When an uncommonly well-run company intersects with stronger than expected underlying end-markets, very good things can happen for the stock. Such has been the case for Shin-Etsu (OTCPK:SHECY), where strong results up and down the line have pushed the shares up another 25% or so from where they were when I last wrote about the company, even after a double-digit pullback from the January high.

I still lean positive on these shares. Although I fully expect the company's growth rate to slow from its recent trajectory, I believe the company's exposure to the strong PVC and wafer cycles as well as exposure to other growing specialty markets, biases the story in a favorable direction. Although the shares have enjoyed a very strong run since 2016, healthy end-markets should still support a high single-digit annual return at this point.

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Almost Everything Going Right For Shin-Etsu Chemical

SUMCO's Rocket Ride May Not Be Over Yet

In the world of silicon wafers, two companies stand apart – Shin-Etsu (OTCPK:SHECY) and SUMCO (OTCPK:SUOPY). These two Japanese companies control close to 60% of the market between them, and an even larger share of the most sophisticated and demanding wafer types. I wrote about Shin-Etsu here, and now, it is time to take a look at SUMCO – a company that is benefitting from strong wafer price increases and healthy volumes as fabs continue to ramp up production of memory and logic chips.

SUMCO has already enjoyed a strong run and the wafer sector is cyclical. Right now, the industry is going through a significant up-cycle, but capacity additions have been restrained, and the outlook for wafer pricing over the next few years is healthy. While a lot is already in the share price, I don’t think SUMCO’s potential is tapped out just yet.

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SUMCO's Rocket Ride May Not Be Over Yet

Shin-Etsu Chemical Leading Its Peers For Good Reasons

Large chemical companies with mid-teens operating margins aren't very common, but Japan's Shin-Etsu (OTCPK:SHECY) has managed it for some time and that has helped the stock outperform both the Nikkei and the S&P 500 over the last five years. With leading positions in PVC, silicones, and multiple markets serving the semiconductor space, I believe Shin-Etsu is looking at a relatively favorable revenue and margin outlook for at least the next few years.

With both the Tokyo-traded shares and the ADRs up around 70% over the last year, a lot of the positives about this company are in the stock. That said, the shares don't look particularly expensive on a DCF basis and improving conditions in the wafer market could drive some near-term upside. I'd rather see a better entry price, but Shin-Etsu's all-around quality argues for a spot on a watch list, and I wouldn't be in a rush to sell if I owned the shares.

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Shin-Etsu Chemical Leading Its Peers For Good Reasons

Seeking Alpha: Hoya Continues To Execute Very Well, But Growth Looks Tied To M&A

Publicly-traded Japanese companies are not often lauded for their strong, shareholder-friendly operating excellence, but Hoya Corp (OTCPK:HOCPY) certainly deserves a lot of credit in that regard. Not only does Hoya have a good record of generating ROIC despite serving cyclical (and in some cases, declining) tech markets, the company has done a good job of maximizing the potential of its electronics operations while building up its healthcare/medical operations.

The lingering question for Hoya Corp is what drives the next leg of growth. Extreme ultraviolet could be an underappreciated driver for the photomask business, but lenses and endoscopes are more likely to be long-term mid-single digit growers from this point. Management has ample cash with which to execute growth-oriented M&A, but a very commendable level of price discipline could lead to a longer wait for a meaningful deal.

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Hoya Continues To Execute Very Well, But Growth Looks Tied To M&A

Seeking Alpha: Hoya's Prospects Brightened By Life Care

As the computer and display-weighted technology businesses stabilize and the life care/health care businesses grow, Hoya's (OTCPK:HOCPY) prospects have improved. Sell-side analysts still seem to have relatively restrained revenue growth expectations, despite double-digit growth in life care today, significant untapped potential in emerging markets, and both a balance sheet and cash flow profile that could support acquisitions to drive further growth.

Valuation is a little more complicated. With the shares up almost 70% over the past year (the Tokyo-listed shares, that is), the valuation is not quite so compelling but I wouldn't say the shares are overvalued. Consistently solid returns on capital would argue for an attractive discount rate, and the sell-side may well be underestimating the company's ability to grow both sales and profits.

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Hoya's Prospects Brightened By Life Care

Seeking Alpha: Industry Headwinds Masking Some Progress At Axiall

The trouble with commodity businesses is that there's only so much that a company can do to control its fate. In the case of Axiall (AXLL), the company seems to be doing well with respect to its synergy targets, but the underlying PVC and caustic soda markets haven't improved as much as hoped. While this could have the effect of shifting out some of the obvious profit and cash flow leverage by a few quarters, Axiall remains an undervalued play on a recovering housing market coupled with company-specific margin improvement opportunities.

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Industry Headwinds Masking Some Progress At Axiall

Seeking Alpha: Is The Growth Story Over For Hoya Corp.?

As a very loose rule of thumb, when I see a company with a solid history of returns on capital, good market share, and a clean balance sheet trading for mid-single digit multiples to EBITDA, I take a closer look. In the case of Hoya Corporation (HOCPY.PK), the debate is pretty simple - will this company ever really grow again or not? Nobody really seems to doubt that the company's traditional technology businesses have likely peaked (at least from a growth perspective), but there's ample doubt as to whether the company can (or will) reallocate its assets and build itself into a growth story once again.

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Is The Growth Story Over For Hoya Corp.?