Summary
The company has grown globally by serving the niche area which the large construction equipment companies have not focused on. It enjoys a long run way, fueled by global urbanization. Furthermore , this growth comes with a great value preposition. The company’s net worth is 60% of its market cap.
1. Who is Takeuchi Manufacturing Co., Ltd (“TMC” or the “company”)?
TMC, founded by Akio Takeuchi in 1963, is a global leader in mini (compact) excavators. It pioneered the “world’s first 360-degree mini excavator” in 1971, replacing the pickaxes of civil engineering workers and gaining popularity at construction sites.
In 1986, Takeuchi introduced the world’s first compact track loader, which was ideal for rough terrain operations.
Mr. Takeuchi, the 90-year-old founder of Takeuchi Manufacturing, traveled from Japan to Florida to receive the Association of Equipment Manufacturers (AEM) Hall of Fame award on November 30, 2023. He is the first Asian person to receive this honor.
TMC’s main products are:
Mini (compact) excavators (product weight less than 6 tons),
Hydraulic excavators (product weight of more than 6 tons), and
Crawler loaders (Crawler loaders run on two large endless tracks (similar to tank treads). Suitable for uneven terrains.
Mini excavators’ strength: They have high mobility and maneuverability, and can perform well in urban civil engineering and small-scale construction projects in residential areas where large construction machinery cannot enter, as well as in river and forest projects for public health and environmental improvement. Foundation work for housing construction
2. Investment Thesis
1) Global Presence
In order to grow outside Japan where the population is rapidly shrinking, TMC started building a global sales network ahead of its competitors. The first step was a subsidiary in the US in 1979. Today TMC’s excavators are sold through 5 subsidiaries located in Japan, the US, the UK, France, and China to global customers, mainly the US (53% of total sales) Austria (13%), and the rest of the world (33%). Its Japan exposure is 1%.
By expanding its global footprint, TMC has become 1) more responsive to its local customers and 2) less vulnerable to Japan’s demographic and economic issues.
2) Growing production base
The majority of production (95%) is done in Japan with a small facility in China. However, TMC started US production of crawler loaders in 9/22. More than 90% of crawler loaders are sold in the US, and by producing them in the US, which is the world’s largest market, TMC will shorten the lead time and build a more agile support system.
3) Huge TAMs (Total Accessible Markets)
Global urbanization, coupled with the expansion of the US housing market and a strategic focus on mini excavators, positions TMC for significant long-term growth.
3-a) Global population increase
According to the UN, the world reached 8 Bn people on 11/15/22, a human development milestone. The population growth rate is slowing, but it is still projected to reach 9 Bn by 2037.
UN also reported that over half of the world (55% in 2017) live in urban settings. By 2050, it projects that 68% of the world’s population will live in urban areas.
Global urbanization shows no signs of abating, and housing shortages (overcrowding) and aging infrastructure in urban areas are progressing in countries around the world, not just in the EU and the US. TMC’s products are indispensable for urban development and maintenance.
3-b) Steady growth in US housing starts
The company’s performance has a close relationship with US housing starts since 53% of TMC’s sales are from the US. US housing starts are expected to increase per NAHB and MBM.
- National Association of Home Builders (NAHB): They predict a decline in housing starts in 2024 but project a gradual increase thereafter, reaching nearly 1.4 million units by 2028.
- Mortgage Bankers Association (MBA): It also expects housing starts to decline from 1.5 million in 2023 to 1.4 million in 2024, with a slow recovery reaching 1.5 million by 2028.
3-c) Exposure to the growing part of the excavator market
The overall excavator market is expected to grow to support the growing population. However, the global mini excavators (valued at $6,551 MM in 2020) are expected to grow faster than overall hydraulic excavators, based on several market research reports. Equipment India, Straits Research, and Market Research Future predict a growth rate of around 20% for the mini excavator market, compared to 5-10% for the overall excavator market.
The main drivers for the faster growth of mini excavators include:
- Mini excavators are easier to maneuver in tight spaces, require less fuel, and are more affordable than larger excavators (Crowler rollers price tags: $10,000 – $30,000, Mini excavators: $20,000 – $80,000). This makes them ideal for smaller construction projects, landscaping, and urban environments.
- Technological advancements: Mini excavators are becoming more powerful and efficient with the incorporation of new technologies like hydraulic systems and electrification.
- Government spending on infrastructure: Increased government spending on infrastructure development in emerging economies is creating a demand for smaller, more agile equipment like mini excavators.
The above factors combined should provide TMC ample room to grow.
4. A long runway
Takeuchi’s market share ranges from 5% to 10%, depending on the source. The company has a lot of potential to increase its share in a growing industry.
5. High entry barrier
It is difficult for new players to enter the global mini excavator market, as the new entrants face challenges such as low brand awareness, limited size, weak financial resources and inadequate research and development abilities.
Specifically,
- Established Brands and Reputation:
The market is dominated by established players like Caterpillar, Komatsu, John Deere, and Takeuchi, who have brand recognition, loyal customer bases, and extensive distribution networks
- Technological Expertise and R&D:
Mini excavators involve complex design and engineering, requiring significant investment in research and development (R&D) to stay competitive with the latest features and performance advancements.
TMC demonstrated its engineering excellence by launching its “battery-operated” line of equipment in 2022. These machines are more environmentally friendly than diesel ones, but they are also heavier and twice as expensive.
- Economies of Scale and Production:
The larger manufacturers benefit from economies of scale in production, leading to lower costs per unit. TMC has established a global distribution and support network by strategically building 5 overseas subsidiaries.
- Distribution and After-Sales Network:
A strong distribution and after-sales network is crucial for sales, service, and parts availability.
In FY2/23, TMC bumped up its capex to add new 2 factories in Japan and the US. The recently launched US factory should shorten TMC’s response to the US client needs and supply time in both finished products and repair parts. The company financed JPY 8.8 Bn factory with operating cash, maintaining its debt-free balance sheet. In total, the company will have 1.5x production capacity vs. FY2/21 level.
- Access to Capital:
Entering the mini excavator market requires significant capital investment for R&D, production facilities, distribution networks, and marketing.
6) Attractive Valuations
Construction equipment stocks tend to trade at a low PE due to the industry’s cyclical nature and capital intensity. However, Takeuchi’s focus is on compact excavators whose uses are in globally growing areas, thus, demands are more secular. This should lead to a higher multiple. However, even with ~80% appreciation for the past 12 months, Takeuchi is trading at 2/24 expected PE at around 12x vs. the industry average of 11.8x
Takeuchi boasts the industry-leading ROE of 21% vs. 14% for the larger peers.
7) Sustainable profitability
Financial Results from FY2/2019 through FY2/2024 expected
Sales grew at a CAGR of 12.9% for the above period. However, operating profits’ CAGR was only 8.3% as TMC faced cost increases in FY2020 and Covid impacts in FY2021 and FY2022. The main reasons for the drop in operating profits in FY2020 were: 1) strategic price settings to boost sales, 2) higher expenses for materials and shipping, and 3) part shortages and substitution costs
Management guided the company’s FY2/25 sales to increase 12% vs. a year ago level, but operating profits will go down 31% due to stubborn cost inflation. Management has positioned its company for long-term growth driven by its commitment to a healthy production increase and new product introduction.
8) Steady Shareholder Returns
The company has a history of raising dividend payments while managing its global expansion and production base increase without incurring interest-carrying debts. Management has set to maintain a 30% payout target
3. Weaknesses/Risks
1) High capex (fixed costs) business
Construction equipment manufacturing requires large factories which carry high price tags. TMC has operated in this high fixed-cost environment for the last 60 years. Still, it has no interest in carrying debts which proves management’s ability to balance its business growth and funding requirements. The construction equipment manufacturing industry relies on large factories, which come with substantial price tags. For TMC, operating in this high fixed-cost environment has been a consistent practice over the past 60 years. Remarkably, TMC has managed to maintain its financial stability without accumulating any debt. This prudent approach demonstrates the company’s ability to strike a delicate balance between business growth and funding requirements.
2) Negative impacts of currency exchange rates
Currency exchange rates are influenced by a multitude of factors. Among these, the most significant is the interest rate differential between the two countries. When the US Federal Reserve (FRB) is expected to lower interest rates, the gap between the Japanese Yen (JPY) and the US Dollar (USD) rates narrows, leading to an increase in the value of the JPY. However, recent comments from the Bank of Japan (BOJ) indicate that while they will correct negative interest rates to at least 0, further rate hikes are unlikely in the near future.
Another contributing factor is the behavior of Japanese investors. The introduction of the New Individual Savings Account (NISA), which exempts taxes on dividend income, has piqued interest in stock investments, particularly global funds. Despite this, Japanese retail investors remain cautious about the sustained appreciation of Japanese stocks.
It’s important to recognize that predicting currency movements accurately is challenging. While TMC maintains a conservative outlook on exchange rates, it must also contend with currency translation losses that can impact its bottom line. Fortunately, TMC’s robust global expansion strategy helps mitigate this well-known risk.
3) Continuing increase of material costs.
TMC’s greatest strength lies in its highly regarded products. These machines are not only powerful, durable, and easy to operate, but they also prioritize customer satisfaction by minimizing breakdowns, reducing operator strain, and maximizing productivity.
Due to the high quality of TMC’s products, customers have embraced the price increases, which were necessitated by rising costs. The establishment of the company’s US factory is expected to mitigate transportation and service expenses.
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