Friday, April 20, 2007

Katokichi: Cooking the Books?

In most other developed markets (and many emerging ones) major league fraud would spawn hundreds of news articles and much hand-wringing searching for culpability from janitors to auditors. Katokichi Co Ltd. (TSE Code# 2873) food manufacturer and distributor of frozen convenience foods, and owners/operators of variously-themed restaurants and pubs admitted recently ((see Yomiuri article here to (no pun intended) cooking the books. Katokichi has long stood out as a steady and profitable grower in an otherwise moribund sector, that, for the most part, has rather limited international growth and appeal. For despite the international popularity of sushi, none of Japan’s “ceremonial rice cake” makers, or “natto” (peculiarly foul-tasting fermented bean paste adjacently pictured) have succeeded in landing that contract with Whole Foods, WalMart, of WuMart, thus transforming themselves into the much sought-after secular growth company that, it would seem, so enamors foreign hedge fund investors.

In respect of the book-diddling at hand, Katokichi apparently fabricated sales transactions and related invoices between affiliated companies in a carousel fraud over a period of three years, to the tune of up to YEN20 billion gross sales per year, presumably in a bid to window-dress firm sales and profits (although it remains possible, pending investigation, that it was a scheme for parochial enrichment). At the top-line, this is a drop in the bucket for a co with YEN350 billion of sales, though it is potentially very meaningful at approx 3x the company’s reported net profits which were in the vicinity of YEN6.5 billion, hence the reaction of the firm’s share price (see chart left relative to the TOPIX). The company said: “it’s investigating and can’t comment”. Un-named sources, according to the Yomiuri daily suggested the amounts of false profit or fabricated indebtedness were negligible relative to aggregate turnover and recent firm net profit levels, though such intimations were apparently insufficient to prevent almost half the float from changing hands in the ensuing three weeks to date.

So while disclosure is far from sufficient, fear of roaches is now, an international phenomenon. Dump first, ask questions later. Such fear however, has, despite the potential for more ugliness, created an interesting opportunity to acquire interests in one of the few growing, successful, diversified food manufacturing and distribution business at a nice discount to peers, absolute historical valuation, peer-relative valuation, and probably a 30% discount to prevailing fair value, with a now-diminished foreign ownership ratio.

Feeling brave?


Anonymous said...

The type of fraud you describe is quite common the world over. Given my experience, I suspect that most Japanese sales offices have two sets of books: one for the bosses, and one which tells the true tale (from newspapers reports of various 'scandals' this practice must be endemic to public services, too). Although the scam will boost sales and profit, in the CF statement it should come out in the wash through offsets in working capital.
Assuming the data on "msn" is correct, 'kichi's HP doesn't offer too much (always a bad sign), 'kichi has an unexciting average 5-year Free Cash Flow/ Enterprise Value of around 3%. Also, note that despite roughly 10% sales growth p.a. over the same period, net profit has been much less dynamic, and dividend growth has been.... well, er, um, none.
One for the brave? Toyo Suisan, 2875, looks better value to me.

Cassandra said...

I concur almost to the letter. Yet, the sheer scale of the value-change over such an interval as pictured, in the event that the carousel is but a flesh-wound, and and worries of SnowBrand-like impropriety, a canard, have historically made such wagers relatively attractive. And, I am not suggesting marrying her, just a roll-in-the-hay.
And to her credit, she's been reinvesting in this-and-that, rather than hoarding and creating a sub-optimal capital structure, though I agree it would be nice to see as much flow through to the bottom-line as they are apparently growing at the top.

Cassandra said...

and from my studies, fcf-oriented strategies - while seductive - have been far less efficious than their intellectual appeal, though I'd be pleased to entertain and test flavours to the contrary. Perhaps I've just been fishing in the wrong lake with the wrong flies?