NYK needs more focus, not differentiation – and not keeping its investors in the dark

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Dateline: 16 April: “Good morning. I’m Tadaaki Naito, and I have been appointed as the new president of NYK Line as of today. I’d like to take this opportunity to share with you my thoughts as I step up to this new position.”

However, Mr Naito didn’t get off to the greatest of starts – at least on the evidence of NYK’s share performance since he took office. Enthusiasm was shortlived – after a four-week rise, during which NYK stock almost hit its one-year high, it has subsequently lost 16% of its value since 18 May, amounting to a net loss of 7% over the period.

Its shares now trade significantly below book value.

In that opening speech, Mr Naito outlined management policy (“sound and proactively bold”), while praising innovation (“NYK has always been an innovator”) and the appeal of a group that, to paraphrase his own words, would continue to be one the best companies to work for in Japan.

Investors need more reassurance, however, not least because if things do not go according to plan, they may be the last port of call for a large fundraising round. NYK’s capital structure doesn’t look good indeed.

More than shipping

Mr Naito placed emphasis on the company’s strong commitment to its plan “More Than Shipping 2018 — Stage 2 Leveraged by Creative Solutions.”

If you are puzzled, you are in good company. Over the past few months I have been commissioned to write a series of analyses for The Loadstar on the financial health of publicly listed companies in the freight and logistics sector, and I have yet to read a set of reports that so appear to have been written with the aim of keeping investors firmly in the dark.

If anything, NYK has proved way too creative over the years, without delivering.

Not only is its assets base too diverse, but its financials are complex. They are not clearly presented, and the message they try to communicate to investors is not what you’d expect from a public company. When it comes to value, simplicity is the answer, but NYK seems to have a different focus.

“While shipping remains our core business, we are also following a differentiation strategy through a wide range of marine, land, and air services beyond the boundaries of traditional shipping,” Mr Naito said.

To be sure, trading conditions are tough in its core markets, but growing assets for the sake of it is a strategy that rarely pays off. It is one thing to run a diversified company, but a wholly different thing to run an overly diversified conglomerate showing sub-par returns across different segments, while capital structure at group level is not properly balanced.

NYK’s stretched financials are not very different from those of its troubled domestic rival Mitsui OSK Lines (MOL): its market cap as percentage of its enterprise value stands at 42% versus MOL’s 31%.

Over-diversification is often a problem for Japanese firms, and hinders performance. With seven different business units of completely unrelated assets, such as real estate and cruise, management could easily get lost – “focus” ought to be the mantra, while diversification is a weakness.

Projections

Its return on equity is projected to rise to 12% in 2018, from 5% in 2014, on the back of rising revenues (from ¥2.3trn to ¥2.5trn), a surge in operating income (from ¥70bn to ¥120bn) and declining debts (from ¥1.1trn to ¥1trn).

Even though these figures are not converted into US dollars, it’s easy to gauge that net leverage, once depreciation and amortisation are taken into account, is at a critical level and could remain problematic for some time.

Ambitious plans and projections are good on paper, but NYK needs more than that – it needs deeper cost cuts. For instance, in fiscal 2013, the group achieved “cost reductions of ¥25.7bn,” which were well below expectations.

“Initially, we targeted cost reductions of ¥30bn, but because we had to accelerate the navigation speed of certain vessels, fuel costs rose, and we were unable to reach the target. Going forward, lowering fuel costs will remain central to cost reduction efforts,” NYK said.

Lowering fuel costs does not differentiate NYK; lowering fuel costs is central to cost reduction efforts of every shipping company in the world.

The number of operating vessels has disproportionally risen in recent years, and may have topped out simply because NYK does not boast the scale to compete economically with many of its largest rivals on a global scale.

In its 2014 annual results, titled “Taking a step forward”, the group said it was “leveraging and achieving differentiation by honing technological capabilities and professional skills.” NYK discussed this month the outlook for its core operating units, whose prospects are a tad better than those of MOL. But delivering value – something that has not been done for a few years now – should be the top priority of any comprehensive new strategy.