|Shares Out. (in M):||18||P/E||7.6x||0.0x|
|Market Cap (in $M):||61,064||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||198,604||EBIT||0||0|
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I am long the ordinary shares of Okinawa Electric Power. They have the regulated electric utility franchise
for Okinawa and the surrounding islands.
The ticker is TYO:9511 on Google Finance and 9511 JP <Equity> <Go> on Bloomberg. It’s down 15%
since the earthquake and 50% over the last 5 years. At 49% of book value and a trailing P/E of 7.6x
(vs. 117% P/B and 14.7x P/E for the Nikkei 225) I don’t see how you can lose much money on this essential business.
Over the decade of the 2000s the stock averaged 79% of book with a P/E of 9.7x. The 10 Japanese electric utilities
averaged higher multiples at 119% of P/B and a P/E of 17.9x, but Okinawa’s total shareholder return put them in the
shade with a CAGR of 12.2% vs. a median of 4.6% because it was growing from a lower starting valuation, and because
of its faster asset growth. They also managed to produce those superior per share returns while substantially
de-levering the balance sheet. Its average ROE of 7.1% was almost exactly equal to the group’s.
The stock doesn’t get much love from global investors, which may help explain the historical valuation discount.
Peers Tokyo Electric and Kansai Electric are two of the largest utilities in the world. They have Western sell-side coverage,
multiple foreign listings, and they can be found in many institutional portfolios but little Okinawa Electric only has the
Tokyo Stock Exchange listing and a market cap of USD 762 million.
Average historical P/E ratios of 17.9x for the group are much higher than historical 7.9x FCF multiples because capex
runs well below depreciation across the industry due to the aging population. Industry free cash flow averaged just over
200% of accounting net income for the last decade. I don’t expect that to change meaningfully over the long-term although
it will in the short-term due to increased safety spending.
In Japan the industry is highly concentrated compared with the U.S. – 10 investor owned utilities compared with more than
60 – so you could argue its participants are more systemically important.
It’s hard to have a precise estimate of the stock’s upside at this point – the situation in Japan is fluid as they say- but I don’t
think you need to. What matters is that for the moment, even though this is a solid business at incredibly cheap levels, the
bears are mostly in control of the price discovery process. That doesn’t last forever unless a stock is a terminal short and
this one is not.
Full disclosure – I am pushing the outer bound of my strike zone with this stock. I know the utility business but this is my
first time investing in Japan. Also, my cost basis of JPY 3,159 per share was lower than the last trade at JPY 3,495. I should
have posted this right after I finished buying but I got distracted with some other stuff. If you’re patient and give the
government a chance to scare utility investors with another round of half-baked proposals for dealing with Tokyo Electric
you may get a chance to buy it cheaper.
Japanese electric utility stocks have gotten crushed since the Fukushima meltdown. Tokyo Electric (Tepco) is understandably
down over 85%, but even the median electric stock is down 35% (having been down almost 45% at one point this month)
while the Nikkei 225 is down only 10%. Why?
Japanese electric utility ratemaking allows the companies to experience increased revenues when consumption goes up
and decreased revenues when consumption goes down. The high fixed cost bases of these capital-intensive businesses
mean the lower volumes are causing painful negative operating leverage.
The good news is these risk factors shouldn’t ultimately affect Okinawa Electric too much.
1. Their service territory is on an island and not connected to the mainland grid, so their excess generating capacity isn’t being
siphoned off to other utilities’ service territories where various plants were damaged, thus reducing the consumption of Okinawa’s
I know we’d all love to own stock in great businesses that don’t have any risks, but those businesses don’t exist and Okinawa
Electric is no different. However, the stock is more than cheap enough to give you a margin of safety against normal business
risk factors. Since the situation is fluid there are some black swan risks to keep an eye on anyway.
Okinawa Electric is somewhat levered, and if the government lets Tepco’s creditors take a haircut that is going to have a couple
of consequences for the utility industry.
First, it would obviously hurt all utilities’ ability to raise financing. Okinawa is currently building their first LNG plant, which is
scheduled to come online next year, and they have normal periodic debt refinancings to fund. Their debt/capital ratio is currently
62.3% and a good chunk of that comes from the local bond market, although it is well termed out and Bloomberg indicates YTMs
under 1.4% for all 9 bonds shown under 9501 JP <Corp> <Go>. In fact, they were able to access the bond market last week.
Second, it would hurt revenues by reducing economic activity across the country and causing a dropoff in electricity consumption.
The banks and insurance companies that would otherwise be financing the nation’s recovery would be severely damaged.
Moody’s and S&P have said they would classify haircuts as a default, thus requiring much larger amounts of capital to be held
against Tepco debt. Forcing haircuts looks to me like a date with disaster.
In case the 62.3% seems high it’s actually much lower than its domestic peers. Japanese utilities tend to use more financial
leverage than their Western counterparts. They typically operate with over 70% debt/capital compared with just over 50%
at American electric utilities. They can do this mainly because, as I mentioned earlier, Japan’s regulatory environment is
considered by the rating agencies to be very credit supportive – more so than the state model in the U.S. As a result the typical
credit rating is AA- compared with BBB/BBB+.
It doesn’t hurt that Japanese interest rates are much lower. Partly because of lower interest rates the average cash flow
interest coverage ratio at 6.5x is actually higher than the U.S. with 4x.
Another catastrophic risk I see is the failure of Tepco to bring the Fukushima plants into a permanent cold shutdown, which
in turn causes a much greater radiation crisis which in turn causes a much more severe recession. I don’t have anything
smart to say about the probability of that risk occurring, but if it were material it should also be priced into the broader
equity averages more so than it currently appears to be.
The final black swan risk I see is the potential for the long-awaited Yen death spiral. You guys know how to hedge that risk
better than I do.
Domo arigato, and thank you for reading.
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