TYNPF - Nippon Sanso: Unit Margins Up Thanks To Electricity Price Declines

2023-11-17 03:52:58 ET

Summary

• Nippon Sanso's operating incomes have increased due to unit margin effects thanks to cost improvement programmes and massive base effects.
• In particular, the YoY declines in electricity prices have rocketed results.
• There is a decent relative valuation case still in effect here compared to Western peers.
• However, in an absolute sense, there is some fatigue in end markets, and while not terribly cyclical, we do think there may be safer stocks with lower multiples in Japan.

Nippon Sanso (TYNPF) is delivering a hot performance with operating incomes up substantially thanks to unit margin effects. While base effects in the input line are really helping results, there are signs of fatigue in end markets, and we don't expect a repeat performance in 2024. Nonetheless, Nippon Sanso remains below peers in terms of valuation, despite the massive share run-up since we first covered the stock. On a relative basis it's a go, but on an absolute basis we still prefer other picks on the market.

Earnings

Producing air separation gases is a pretty energy intensive undertaking:

Electricity prices YoY have come down about 50% in some parts of our coverage, which is absolutely massive. These base effects have rocketed the results for this quarter YoY compared to last quarter, where the figures looked a lot more modest and in line with what you'd expect from steady project growth and stable volume delivery. However, general cost reduction programmes have also contributed to improved unit margin. But the major delta in moderation of electricity prices is massive this quarter.

In some geographies, prices are coming down for some of these gases, as well as volumes in almost all the geographies, as industrial demand begins to slowdown and customers demand lower prices on account of the deflationary environment in some of the more primary commodities.

But in other geographies prices continue to be inflated, and it's only volumes that are coming down. In geographies outside of Europe, prices continue to rise, and the lower input costs of energy means substantially improved unit margins and therefore incredible growth in segment income, even stripping out FX effects. Oceania and Asia suffered on the fact that the LP gas exposure dominates this geography, and economics have been poorer for that than air separation gases.

Thermos suffered a lot on account of the weak Yen making the necessary imports to produce Thermos products especially expensive.

Bottom Line

The reality is that the rate situation is beginning to hit producers, which is upstream from consumers. While unit margins are still good for Nippon Sanso, it is mainly happening on the cost side. There is pressure on the end markets that Nippon Sanso serve, including steelmakers and electronics companies.

There is a strong relative case still for Nippon Sanso. Despite a massive run-up in Japanese markets in general and for Nippon Sanso in particular, there is still a discount between Nippon Sanso and western competitors. L'Air Liquide (AIQUF) trades at around 12.9x EV/EBITDA, while Nippon Sanso trades at around 9x EV/EBITDA. The relative case is pretty strong in that respect. However, we still think it is possible to find better deals than this in the current markets, especially in other parts of the Japanese markets which remain heavily discounted, and are seeing catalysts through management responses to Tokyo Stock Exchange pressure to increase PBRs.

For further details see: