Description

Overview of the Real Estate Business

Takara Leben (Takara) is a Japanese developer of condominiums. (They also develop a smaller number of single-family dwellings, but that is less than 15% of total real estate development). Real estate development has historically constituted > 85% of operating profit. They have been growing a real estate rental business and a property management business as well to complement their development business. What differentiates Takara Leben from all other residential developers in Japan is that they focus on the suburbs of Tokyo and other regional cities, e.g., Kukui, Kanazawa, etc. In the fiscal year ending March 2015 (FY 2014), the company developed ~1,700 units, 1,200 of which were in the suburbs of Tokyo (70%) with the rest in various regional cities. Within Tokyo, no other developer focuses on the types of projects that are typical of Takara. Other developers tend to build in downtown Tokyo (generally very high rise) and to the extent they do build in suburban Tokyo produce large projects right next to rail stations. Takara builds small projects (usually < 60 units) that are close but not necessarily right by rail stations. Within regional cities we believe the company faces very little competition. Over time we expect regional cities to represent closer to 45% of total units. In FY 2014 the company earned 52 Yen in EPS almost entirely from these activities.

Overview of the Solar Business

As we will argue below, we believe Takara’s condo business is in good shape and will face a solid cycle over the foreseeable future. What draws us to the opportunity is that Takara has significant value in its Mega Solar business that is about to be unlocked. Takara was a pioneer in adding solar panels to its condo projects as a perk for customers. In September 2011 post the March 2011 Fukushima nuclear accident caused by theearthquake and tsunami, the Japanese government introduced incentives for the development of solar in Japan. The system created a Feed-in-Tariff (FiT) that sets a fixed price for selling power from solar projects to the grid for 20 years. Takara, among others, entered the business. The company currently has > 100 MW of solar under development and a total pipeline of 150 MW (including units in operation). At the end of Q2 FY 2015 (end March 2016) they had 18 MW in operation. We estimate they will have > 40 MW in operation by the end of the current fiscal year. Importantly, the current 100 MW of pipeline all have contracts with utilities, which is in contrast to many players who started projects but were never able to finalize agreements. Project economics are straightforward and we estimate that 150 MW of solar could be worth 70% of the entire market cap of the company. What is exciting about Takara Leben right now is that the Tokyo Stock Exchange has started a new separate exchange for the listing of REIT-like renewable assets. Takara is set to be the first company to list assets on this exchange. It will begin to spin off solar assets into an entity listed on the exchange at the start of the next fiscal year (ending March 2017). We believe they will list at roughly 2x the cost to build. At that time the company will use the entirety of the cash proceeds to either buyback stock or pay special dividends.

Why does the opportunity exist?

Takara issued March 2016 guidance that included gains from the sale of some amount of solar assets (undisclosed) into a solar REIT on the operating profit line. To “smooth” earnings they intentionally reduced condo deliveries this year from 1,700 to 1,450 units. They view the solar earnings as recurring given that they would be listing far less than the full 150 MW pipeline (analysts estimated the initial listing to be 20-30 MW). The company first applied for the listing in April 2015. The stock started 2015 at ¥529 and ran to > ¥800 in June in anticipation. The process took longer than the market expected (though not the company) and the stock sold off to ¥465 on concerns the assets may never list. In September they received initial approval to list and the stock ran back above ¥700. In December a very favorable tax change was enacted that allowed solar REITs to receive tax exemption for 20 years as opposed to the original 10 years starting in April 2016. While most anticipated this change would ultimately occur and be applied retroactively, perversely the law change raised concerns the listing would be delayed into the new fiscal year and that current fiscal year earnings would be revised down significantly. With Q3 FY 2015 earnings this indeed came to pass. The company revises operating profit from ¥13.35b to ¥7.35b and EPS from ¥73.11 to ¥36.20. While the stock does not appear “cheap” on ¥36 yen at 15x, we see next year showing both growth in condo deliveries and the REIT listing. Additionally, ¥36 only includes ~15% of earnings from on average < 25 MW of operating solar assets on a pipeline of 150 MW. We understand that they were ready to start marketing the listing but were advised by counsel and the underwriter to wait to April 1 just to ensure the new tax treatment applies. Being a small cap Japanese stock with a lot of retail flow, we believe the market has been overly skittish about the prospects for the listing.

Why are we comfortable with the condo business?

You are starting to get investor concern about a bubble in Tokyo real estate. Over the last three years property prices in Tokyo have doubled. There is also evidence that a significant amount of purchasing activity has been driven by the desire to avoid property taxes. Units in high rise buildings all have the same assessed value per square meter, which implies the appraised value for tax purposes is much lower than the market value of units on higher floors. Upwards of 20% of the high rise market may be driven by this type of activity. The government is investigating this and intends to close this tax loophole. Takara Leben was not spared in the previous serious housing downturn in 2008. Like others it was buying land into a pricing frenzy and ended up losing money in FY 2008 when the market collapsed.

We don’t see the same type of correction as likely. Despite high prices, inventories in Tokyo are at low levels and demand has been steady. Regardless, we actually see the issues in central Tokyo as a positive for Takara Leben. Suburban Tokyo pricing has increased 50-70% over the same three years but Takara’s price points are only up 28%. As a result, Takara is able to gain new buyers. The average income of its buyers has increased > 50% over the timeframe. It also has scope to raise price. In regional cities, we see a long-term structural bull case. The government is encouraging the building of condos for the elderly in these types of cities that have not seen serious economic development in some time. Lastly, Takara owns land for more than four years of development at prices that are 40% lower than the land on which they were building in 2011. The company’s mid-term plan calls for growing condo units from 1,450 this year to 2,200 in the March 2019 fiscal year. They do not have to deliver that level of growth for this to work.

Why are we comfortable with the solar business?

Since the start of the Japanese solar program FiTs have been reduced three times to lower returns (on future projects). Some regional utilities have stopped accepting applications due to the unstable nature of solar and its impact on the grid. As a result there is periodic concern about solar returns.

We have reviewed Takara’s pipeline in detail and have confirmed their projects are solid. Most of their projects are contracted with Tepco, which has been the most receptive to new solar. Takara has a good reputation in the business given its long-time involvement through condo development. The government has been concerned about projects that received early permits but have not been developed. Takara has been able to purchase some of these projects at the behest of the government. All of Takara’s projects are at the first two FiT levels. The value of these projects is very easy to model. Construction costs are ¥300m per MW. Debt financing is readily available at a fixed 1.7% for 17 years. The average revenue per MW is ¥56m for a year. Based on this, we estimate the value of a MW to be > ¥450k. This foots with the value Takara revealed in its earnings downgrade and also comports with what we have heard from other industry players. Takara is the first to list on the new exchange and we understand they have been instrumental in its development. We see a low probability these assets do not list soon.

Risk/reward?

We value Takara on a three year sum of the parts basis. In our base case we assume 80 MW of solar is injected into the REIT with the proceeds used to buy back stock. Note that the company is an active purchaser of its own shares. In the past four years they have bought back on average 3.6% of the float each year. (The current dividend yield is 2.2%.). We add the value of the company’s holding in the REIT (at book value) and value the dividends they receive from the REIT. Based on this our base case value for solar is ¥126. The stock is currently trading at ¥556. We see this value as quite conservative. As a sanity check, 80 MW of operating solar generates > ¥10 in EPS. At 20x the value would be ~¥200. This is a 5% yield on a guaranteed 20 year return, which seems quite reasonable in Japan. (This does not include the boost to real estate EPS from the buyback). We then value the earnings from rental and property management at 15x. We apply 10x to the real estate business at a conservative 1,800 units (most developers are trading at ~15x). (Non-solar EPS in the base case under these assumptions is ¥83.5.) This produces a ¥1,017 stock for ~80% upside. In our bull case we assume 1,900 units at higher gross margins and 100 MW of solar. At a 12x multiple on real estate this yields a ~¥1,700 stock for 200% upside. In our bear case we assume 1,600 units with lower gross margins at 8x and 50 MW of solar to yield ¥480 for 14% downside. We don’t see this trading to, say, 10x this year’s ¥36.2 yen number (35% downside) as this would imply a 3.6% dividend yield. 

Catalyst

-Solar REIT listing at expected valuations

-Continued growth in solar pipeline beyond 100 MW

-Stable to better real estate earnings