Okamoto Industries (TYO:5122) – The Quiet Innovator

Say, what’s the most expensive condom selling in Lazada.com? A quick search revealed the one product that beats the rest hands down.

Snapshot from Lazada.com

There we have it. Okamoto’s Zero One, arguably the world’s thinnest condom yet, is the most expensive selling at about $5 per condom (box of 3) while the rest ranges from $0.50 to $3 each.

Under their slogan, “Science delivers better living”, Okamoto Industries (TYO:5122) leverages upon its technical capabilities and intangible know-how to continuously launch innovative new products. Their Zero One condom, which is selling at a huge premium over its peers, is just one of the many products that Okamoto manufactures.

I feel that Okamoto is a resilient company due to its wide-moat with high barriers to entry business and strong balance sheet. What surprises me is that it is currently fairly valued at around 8.3 EV/EBIT. I think this provides an opportunity to invest in a business that is able to compound its growth in the long run.

Business Overview

Okamoto Industries has 3 main categories.

  • Industrial Products
  • Household Products
  • Others

Industrial Products

For Industrial products, it provides plastic films, flexible container, automotive interior materials, food packaging products, wall covering and wood grain film. Two of the more interesting products that they have are their automotive interior materials and food packaging products.

Automotive Interior – Their synthetic leather materials are used in surface materials for instrument panels, car seats and doors. In addition, they are also supplying seat materials for motorcycle manufacturers like Honda, Harley Davidson, Yamaha, Kawasaki and Suzuki. According to their website, http://okamotosandusky.com, they hold a majority market share in the motorcycle seat industry.

Types of Automotive Interior

Food Packaging – In this division, their main product is called the “Pichit”, a patented product which is a film that exhibits dehydration effects by osmotic pressure. It plays an important role in the supply chain of fresh seafood from the processing area to the consumer. More info can be found at http://www.pichit.info/.

Uses of Pichit

Household Products

In this division, Okamoto produces a wide range of items like condoms, dehumidifying dish, heat pads and rubber gloves for both medical and household use etc.

Condom – Since Okamoto introduced the world’s thinnest condom at 0.03mm in 2005, they forge ahead and aim to create the thinnest condoms at the molecular level.

In their quest to go even thinner, they managed to disrupt themselves by replacing latex with special treated polyuethane, which is much more resilient and not susceptible to breaking than latex. Not long after that, they launched the 0.02mm series.

Come 2015, Okamoto introduced their latest innovative product, the Zero One 0.01mm series.

Others

This category is still not yet significant. Basically, Okamoto is also in the solar energy business, generating about 4250kWh max output in their Gunma solar facility.

Competitive Advantage

1 – Product Differentiation

Okamoto has always strive to be ahead of their competitors by launching new products based on their cutting edge technology and material knowledge. This itself has created a wide moat for Okamoto, where they are among the market leaders for most of their products.

It is evident from their Zero One condoms that they are pushing the boundaries of science to their limits. Although Sagami, one of their competitors, has also created a 0.01mm condom (actual thickness is 0.018mm). Okamoto has differentiated themselves by having a unique feature of EVEN thickness throughout. This itself is very difficult to achieve. https://spafe.com.au/japanese-condoms/

Example of description of Okamoto’s condoms in online shopping sites

As for automotive interiors, don’t you hate it when your car’s interior leather gets all sticky after leaving it under the hot sun? It is worse for motorcycles as their seats are exposed to both rain and shine. Okamoto have created a product that is so resilient that they are able to command the largest market share in this space.

2 – Compounding Effect from Deep Knowledge in Material Science

Through years of research, Okamoto has accumulated deep knowledge in Material Science, especially in rubber and plastics. With this, they are able to continuously launch innovative products in different markets.

For example, through their dehydration film “Pichit”, they are able to leverage on this technology to develop OsmoAid, an osmotic water absorbing bandage able to keep wounds dry.

Okamoto has also leveraged on their cutting edge research in latex to develop fingertip gloves that are “thin, strong and easy to use”.

OsmoAid on left, Fingertip gloves on right

Okamoto has developed a culture of cooperation between their divisions. By making full use their own network, expertise and manufacturing facilities, they are able to expand their business into different perspectives and continue to develop new innovative products.

3. Premium Products = Premium Price

From the 2 points above, we see that Okamoto is able to deliver products that are a cut above the rest. Their products are widely received by consumers and this allowed them to sell at a premium price.

As I have mentioned in the introduction, their Zero One is the most expensive condom in Lazada.com, even more expensive than Sagami’s 0.01mm.

The power of the brand Okamoto has developed ensures that they can maintain an exclusive price tag.

Areas of Growth

1 – Bakugai

Japan’s 2015 buzzword of the year, Bakugai which means “buying explosion” is used to describe the lavish Chinese spending in Japan. They come in hordes of tour bus and buy certain items in bulk. One of which is Okamoto’s condom.

This has been a boon for Okamoto. Before Bakugai, Okamoto is facing headwinds as the Japanese population is the fastest ageing in the world and marketing cannot be as bold as what Durex is doing in other parts of the world (Japan is a very conservative society).

Source: The Asahi Shimbun

Fast forward to today, it has become clear to Okamoto’s management that growth cannot come from within and demand is strong from overseas. Japan has received more than 30 million foreign travellers in 2018, tourist spending topped 4 trillion yen for the first time (source: http://www.asahi.com/ajw/articles/AJ201812190037.html).

As income levels in Asian countries are set to rise, I can foresee that Japan will continue to be one of the top vacation destination for them. Some upcoming events such as the Rugby World Cup and Olympics would help boost tourist arrival numbers.

2 – Online Presence

Condoms used to be something that people had to buy conspicuously from supermarkets. But not anymore, with rising convenience and speed from online shopping (same day delivery is crazily efficient), this is an area set to expand as people will not be embarrassed buying condoms over the internet. (see article below)

https://www.scmp.com/business/companies/article/2138007/condoms-pregnancy-test-kits-and-lubricant-top-sales-charts

To meet the rising demand from the Chinese market, Okamoto opened a factory in Guangdong, China to produce their 0.03mm condoms. In doing so, they managed to lower their cost price by producing in China while still selling a high quality product at premium price.

Business Risks

1 – Raw Material Price

Okamoto’s products are mainly based on rubber and plastics. Hence, any increase in prices in rubber and oil could lead to margin contraction. In fact, they have been facing this problem since last FY and hence, their bottom line was affected.

2 – Japan-China Relations

The fragile relationship between Japan and China is always at risk of breaking down, resulting in anti-Japanese sentiment in China and could lead to boycotting of Japanese products and a sharp drop in tourism.

3 – Seasonal Risks

Some of Okamoto’s products are sensitive to seasonal changes. For example, sales of their heating pads could reduce if the weather in Japan in warmer than usual. For their “Pichit”, slowdown in fishing could also mean a reduction in sales for their de-watering film.

Financials

Income Statement

Revenue, Gross Profit and Net Profit

Okamoto’s revenue is on an increasing trend overall. As you can see, Their net income started to see improvements in 2015, which coincides with Bakugai trend in Japan, launch of their 0.02mm condoms and operations of their factory in China.

However, profit was lower for FY17/18 due to increase in material cost and replacement of equipment.

Huge jump in EBITA in 2015.

Cash Flow Statement

From chart above, we see that Okamoto has been a FCF machine and it is increasing 13.1% CAGR. However, Capex has also been increasing due to replacement and investment in equipment to meet rising demand of their products.

Outstanding Shares

Okamoto has been using their FCF to repurchase their stock consistently. Shares outstanding has been steadily decreasing (more than 10% for past 10 years) as the company purchase and cancel their shares. By doing this, the company has been taking care of their shareholders by increasing the value of their shares.

Valuation

Comparison Table of Okamoto with Japanese Consumer Goods companies and Global condom makers

Strong Balance Sheet

Okamoto has a strong balance sheet, with low debt to equity and high cash to debt ratio. Their cash holdings stands at about 22,000 million yen. This provides some downside protection in case of a recession or price war.

Valuation Discount to Peers

Japanese consumer goods companies like Kao, Unicharm and Lion are trading at an average of EV/EBIT 21.23x, EV/EBITA 17.49x and EV/Rev of 2.9x, more than 100% premium over Okamoto.

As for the global condom makers, they are trading at an average of EV/EBIT of 30.19x, EV/EBITA of 27.96x and EV/Rev of 4.04x, even higher than Okamoto (results are probably skewed due to Karex’s valuations).

Looking at the table, I am surprised that companies like Church and Dwight Co Inc, Hartalega Holdings Bhd and Reckitt & Benckiser LLC have a much higher market capitalization but are generating much smaller revenue compared to Okamoto.

Given the technical excellence, I feel that Okamoto should be trading at a much higher multiple and thus, it’s undervalued in my opinion.

Conclusion

Okamoto Industries, Japan’s No.1 condom brand with a dominant market share, is a quiet innovator which leverages on its accumulated knowledge in material science to launch innovative products.

Both its industrial and household divisions have a broad range of products that contrast themselves with their competitors with their own unique aspects that makes it superior. This also enables Okamoto to command a premium price in their products.

With the ever increasing tourist arrivals to Japan since “Bakugai” and increase usage of online marketplaces for shopping, their game-changing products will continue to be in high demand.

Armed with strong free cash flow generation and healthy net cash balance sheet, Okamoto is conducting regular share buybacks and retiring treasury stocks to increase shareholder value.

Finally, with an EV/EBIT of 8.3x, it is valued at a steep discount compared to its peers and competitors, which I feel is unjustified given its wide moat and strong branding. Given its innovative profile and technical excellence, I am confident that Okamoto will continue to deliver quality earnings with high ROE.

Cheers

The Moss Piglet is currently not vested in Okamoto Industries but is considering to be invested in this company within the month.

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