Philippine Markets Newsletter

Manufacturing energy-efficient products shows this company’s commitment to go green, resulting in 9% Uniform ROA

April 28, 2021

It has been a year since the “At-Home Revolution” began, and some companies continue to thrive in the current situation. The winners include remodeling and DIY companies, homebuilders as people move out of the city, and appliance makers.

However, as-reported metrics do not seem to show how this company is benefiting from more people staying at home in the past year and from the world’s effort to “go green.” Uniform Accounting, on the other hand, shows that the business has a better Uniform return on assets (ROA) than what you might think.

Also below, Uniform Accounting Embedded Expectations Analysis and the Uniform Accounting Performance and Valuation Tearsheet for the company.

Philippine Markets Daily:
Wednesday Uniform Earnings Tearsheets – Asia-listed Focus
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A year from its take-off, the “At-Home Revolution” is still growing, still fueling home improvements of consumers who are forced to stay at home during the pandemic.

Being comfortable is one of the main purposes of home improvements. These home improvements range from making their homes more work-friendly, to buying appliances to make chores easier to manage, to even larger projects such as renovating parts of their houses.

At the same time, green products have seen a surge as consumers become more conscious about their waste and their utility bills. In a 2020 survey by Accenture, 45% of respondents from across the globe are making more sustainable purchases.

Similar to Suntory Food & Beverage Limited, today’s company prioritizes its environmental initiatives to conserve energy. With the push driven by the At-Home Revolution, this company is robustly generating income while giving its fair share in environmental responsibility.

This company is one of Japan’s leading appliance corporations—Rinnai Corporation.

The company was started in 1920 by Hidejiro Naito and Kanekichi Hayashi in Nagoya, Japan, with the purpose of selling and manufacturing gas appliances. Today, the company provides a “comfortable lifestyle” in more than 80 different countries and regions across the world.

Rinnai is best known for creating energy-efficient tankless water heaters, kitchen appliances, and other home heating appliances. For example, its water heaters are 30% more energy efficient than the usual natural gas water heaters and 50% more efficient than the electric ones.

In addition to that, Rinnai integrated Samsung’s SmartThings in 2019 to create the first automated water heater, just in time before COVID-19 hit. This technology allows homeowners to automatically activate their recirculation system and also control the water’s temperature.

Riding on the At-Home Revolution and an increasing demand for advanced eco-friendly appliances, Rinnai was able to maintain strong sales of tankless gas water heaters at JPY 196.1 billion despite the economic effects of the pandemic. That alone constitutes 57.6% of the company’s total sales in 2020.

When looking at Rinnai’s environmental initiatives and the shifting demand for eco-friendly products like tankless water heaters, one can assume the company is enjoying high returns. However, as-reported metrics reflect moderate returns with ROAs ranging only from 5% to 7% in the past eleven years.

Using Uniform Accounting, a clearer profitability narrative is uncovered. Specifically, the company’s Uniform returns are actually significantly higher than its as-reported metrics in recent years. For example, while as-reported ROA was only at 5% in 2020, Uniform ROA was actually almost double that at 9%.

What as-reported metrics fail to do is to consider the company’s excess cash on the balance sheet. While most companies inherently need some level of cash to operate, the portion of that balance that is earning limited or no return—or excess cash—ends up diluting as-reported ROAs.

When excess cash remains included in the company’s asset base while computing its performance metrics, the company’s profitability and capital efficiency may appear weaker than it actually is. Removing excess cash allows investors to see through the distortions that come from management carrying much more cash on the balance sheet than what is operationally required.

From 2010 to 2020, Rinnai has had a significant amount of excess cash sitting idly in its balance sheet, ranging from 18% to 34% of its as-reported total assets.

After excess cash and other significant adjustments are made, we can see that Rinnai’s returns are actually a lot stronger than what as-reported metrics show. Without these adjustments, it appears that the company hasn’t been benefiting from its expansion investments, leading to significantly poorer valuations.

Rinnai’s profitability is much more robust than you think

As-reported metrics are distorting the market’s perception of the firm’s profitability. If you were to just look at as-reported ROA, you would think that the company is a weaker business than real economic metrics reveal.

Rinnai’s Uniform ROA has been higher than its as-reported ROA in the past eleven years. For example, when Uniform ROA was at 9% in 2020, as-reported ROA was only 5%.

The company’s Uniform ROA for the past eleven years has ranged from 7% to 13%, while as-reported ROA has ranged only from 5% to 7% in the same timeframe.

Specifically, Uniform ROA gradually improved from 7% in 2010 to 13% levels in 2014. It then declined to 9% levels in 2019 to 2020.

Rinnai’s Uniform earnings margins are weaker than you think but its robust Uniform asset turns make up for it

Volatility in Uniform ROA has been driven by trends in both Uniform earnings margins and Uniform asset turns, with peaks and troughs lining up historically with that of Uniform ROA.

Uniform margins steadily expanded from 3% in 2005 to 7% peak levels in 2013 to 2014, before falling to 6% levels from 2017 onwards.

Meanwhile, Uniform turns gradually rose from 1.3x in 2005 to peak levels at 1.9x in 2014. It then contracted to 1.5x levels in 2019-2020.

SUMMARY and Rinnai Corporation Tearsheet

As the Uniform Accounting tearsheet for Rinnai Corporation (5947:JPN) highlights, the Uniform P/E trades at 14.5x, which is below the global corporate average of 23.7x but above its own historical average of 12.5x.

Low P/Es require low EPS growth to sustain them. In the case of Rinnai, the company has recently shown a 2% Uniform EPS growth.

Sell-side analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, sell-side analysts’ near-term earnings forecasts tend to have relevant information.

We take sell-side forecasts for Japan’s Modified International Standards (JMIS) earnings and convert them to Uniform earnings forecasts. When we do this, Rinnai’s sell-side analyst-driven forecast is a 24% and 6% EPS growth in 2021 and 2022, respectively.

Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Rinnai’s JPY 11,320 stock price. These are often referred to as market embedded expectations.

Rinnai is currently being valued as if Uniform earnings were to shrink 3% annually over the next three years. What sell-side analysts expect for Rinnai’s earnings growth is above what the current stock market valuation requires in 2021 and 2022.

Furthermore, the company’s earning power is 2x above the long-run corporate average. Also, cash flows and cash on hand are 7x above its total obligations—including debt maturities, and capex maintenance. All in all, this signals a low credit and dividend risk.

To conclude, Rinnai’s Uniform earnings growth is above its peer averages, and the company is trading in line with its average peer valuations.

About the Philippine Markets Daily
“Wednesday Uniform Earnings Tearsheets – Asia-listed Focus”

Some of the world’s greatest investors learned from the Father of Value Investing or have learned to follow his investment philosophy very closely. That pioneer of value investing is Professor Benjamin Graham. His followers:

Warren Buffett and Charles Munger of Berkshire Hathaway; Shelby C. Davis of Davis Funds; Marty Whitman of Third Avenue Value Fund; Jean-Marie Eveillard of First Eagle; Mitch Julis of Canyon Capital; just to name a few.

Each of these great investors studied security analysis and valuation, applying this methodology to manage their multi-billion dollar portfolios. They did this without relying on as-reported numbers.

Uniform Adjusted Financial Reporting Standards (UAFRS or Uniform Accounting) is an answer to the many inconsistencies present in GAAP and IFRS, as well as in PFRS.

Under UAFRS, each company’s financial statements are rebuilt under a consistent set of rules, resulting in an apples-to-apples comparison. Resulting UAFRS-based earnings, assets, debts, cash flows from operations, investing, and financing, and other key elements become the basis for more reliable financial statement analysis.

Every Wednesday, we focus on one company listed in Asia that’s relevant to the Philippines and that’s particularly interesting from a UAFRS vs as-reported standpoint. We highlight one adjustment that illustrates why the as-reported numbers are unreliable.

This way, we gain a better understanding of the factors driving a particular stock’s returns, and whether or not the firm’s true profitability is reflected in its current valuations.

Hope you’ve found this week’s Uniform Earning Tearsheet on an Asian company interesting and insightful.


Angelica Lim
Research Director
Philippine Markets Daily
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