Finance and M&A Strategies

Finance Strategy

Basic Policy

We place great emphasis on our ability to compound sustainable EPS. Accordingly, we will direct cash generated towards M&A activities to ensure future growth, thereby delivering value to our shareholders.
While w maintain detailed KPIs at each asset level, our approach as Asset Assembler dictates that we refrain from setting uniform margin and CCC targets that disregard the individual circumstances of local operations. The management teams of our partner companies are steadfast in their commitment to improving operations while ensuring sustained growth. We strongly believe that the combined strength of our Group, forged through the collaboration of these partners, transcends the pursuit of standardized indicators.

Finance strategy aimed at accelerating EPS compounding

Our financial discipline

Our financial discipline focuses on prioritizing debt financing while preserving leverage capacity to maintain access to low-cost funding. Recognizing the crucial importance of fostering a clear understanding of our Company’s risk profile among financial institutions and rating agencies, we are facilitating active dialogue with these entities and enhancing our disclosure materials.

Capex/M&A

While we proactively implement capital expenditures that foster sustainable growth in the future, our current businesses require relatively limited capex compared to scale of revenue and cash flow. We are making new investments, such as expanding production capacity and reinforcing our DX (Digital Transformation) and R&D efforts around the globe with discipline. Consequently, M&A is indeed the main source for additional capital needs. Under our Asset Assembler model, we will continue to accumulate “good and low risk M&A” at a reasonable valuation.

Shareholder returns

We give paramount importance to growth-focused investments, primarily through M&A, with a primary goal of enhancing TSR through EPS growth.
Our dividend policy is to maintain stability with a payout ratio of approximately 30%, while also considering various factors such as performance trends, future investment opportunities, and dividend payout ratio in a comprehensive manner. (For information about the trends in dividends and TSR, see “Financial Highlights.”)

Balance sheet management

In terms of balance sheet management, we have established Cash Conversion Cycle (CCC) as one of the key performance indicators. Each partner company is working to shorten CCC by reviewing transaction terms within each region and business. As a result, we saw a considerable improvement in our CCC in 2023, particularly within our Asian operations, notably in China. While our fixed assets (tangible and intangible assets, goodwill) have increased primarily due to our M&A activities, we have been proactively monitoring these assets with an emphasis on efficiency and profitability. Our marine business within Japan Group, for one, has undergone structural reforms. Regarding goodwill, we strive to minimize impairment risks by selecting cash-generating target businesses, ensuring smooth post-merger integration (PMI) through our autonomous and decentralized management approach, and consistently pursuing high-quality M&A at reasonable valuations.

Regarding our financial leverage, in 2023, we saw a significant rise in cash generation, driven by revenue growth and an improved CCC. As a result, our net debt/EBITDA ratio decreased to 2.2 times by the end of the year. Our debt financing is primarily denominated in yen, and as of the end of 2023, we have achieved a highly stable debt composition, with an average duration of 3.5 years and a pre-tax average interest rate of 0.4%. Moving forward, while retaining adequate debt capacity to seize new opportunities, we will strive for an optimal capital structure and work towards fostering trust and creditworthiness with financial institutions and rating agencies. (For trends in ratings, please refer to the “Bonds and Ratings” section on our website.)

ROIC

Our consolidated ROIC performance

In 2023, our consolidated Return on Invested Capital (ROIC) reached 6.9%, reflecting a 1.5 pp increase compared to 2022. This improvement is primarily attributed to: (1) limited increment in goodwill absent large-scale M&A activities in 2023, (2) accelerated compounding of EPS within our existing businesses, and (3) improved CCC, particularly in our China business. We estimate our Weighted Average Cost of Capital (WACC) to be around 6%. Over the past five years, while EPS has steadily increased, ROIC has remained static in the range of 5-7%. This stability is largely due to the posting of goodwill associated with our M&A activities. We consider this to be inevitable for a company that places M&A as a pillar of its growth strategy.

* ROIC (IFRS): After-tax operating profit / (net debt + total equity)

Our approach to ROIC

Acquisition of companies with high capital efficiency

Our strength as Asset Assembler lies in our ability to consistently make safe acquisitions. While our goal is to maximize long-term and sustainable EPS through these acquisitions, we believe that a strategy overly focused on improving ROIC does not optimally utilize our platform nor align with our overall strategy. I would like to emphasize that the companies we acquire (1) operate their businesses with high capital efficiency relative to the invested capital, such as working capital and capital expenditure, and (2) generally present low business risks and high safety due to their stable business models, strong brand power, and quality management teams.
Since we are allocating capital entrusted to us by investors for acquisitions, our standard procedure is to examine the respective ROIC of each acquisition. Our goal is to achieve an ROIC that surpasses the WACC within a few years post-acquisition. Indeed, the major five companies we acquired since 2019 have either already seen their ROIC exceed the WACC or are on a steady path towards this goal, with all demonstrating year-on-year improvements in their ROIC. For your reference, observing the evolution of individual companies’ ROIC excluding goodwill shows that these companies already had relatively high ROIC immediately after their acquisition, specifically in Year 1 or Year 2 post-acquisition.
There is a common perception that companies actively engaged in M&A carry significant risk. However, a unique characteristic of our business is its high efficiency: we generate cash and profits locally, and our capex requirements are relatively low. As we consistently acquire such safe companies, our Group, even with the inclusion of goodwill in our consolidated accounts, can be confidently described as a collection of very low-risk assets.

Our approach to returning value to shareholders and enhancing shareholder payouts

During our dialogues with investors, some have expressed a desire for double-digit expected growth rates. We note that our business domain generates substantial cash flow that can be deployed towards share repurchases, rather than undertaking M&A, which will consistently improve ROIC. Indeed high-ROIC paint manufacturers can demonstrate a scenario of achieving double-digit growth through a combination of single-digit organic EPS growth and share repurchases.
On the other hand, as outlined in our Medium-Term Strategy, we already have the potential for double-digit growth, with a medium-term consolidated CAGR target of 10-12% organic growth in EPS without any repurchases. The substantial cash flow generated is primarily allocated towards M&A that contribute to the maximization of long-term EPS. We aim for robust growth with 10-12% organic EPS growth, plus additional upside through M&A contributing to EPS from Year 1 post-acquisition.
Based on this strategy, our approach to returns is twofold: (1) to expand the basis of EPS growth through M&A rather than focusing on short-term shareholder returns, and (2) to reserve cash flows as dry powder (standby funds) for future M&A, even if this reduces leverage in the short term. While we have consistently acknowledged the potential for equity financing in acquisitions, we prioritize debt financing given the lower cost. In this context, short-term returns such as share repurchases could also create an opportunity loss by limiting our financing optionality for larger-scale acquisitions.
Within our Asset Assembler model, we do not set limitations on the business areas, regions, or scale of our M&A targets as long as they are low-risk and offer good returns. Given the abundance of safe targets that contribute to EPS, we believe our policy and strategy are justifiable. As we naturally consider ROIC as one of the key indicators, we are dedicated to achieving organic profit growth and shortening CCC. However, we believe it is not appropriate to rely solely on consolidated ROIC to evaluate the potential of our Company.

Capital allocation

Our capital policy prioritizes growth-focused investments while maintaining financial discipline, with the primary objective of sustainable and long-term maximization of EPS, ultimately leading to the maximization of PER. We deploy capital expenditures aimed at securing future sustainable growth noting the burden of capital investment is relatively small, accounting for only approximately 3% of revenue, mostly in maintenance capex. We maintain a disciplined approach to new investment initiatives aimed at enhancing production capacity, reinforcing digital transformation (DX), and advancing research and development across all regions and business segments. Consequently, M&A remains our most capital-intensive investment. In line with our Asset Assembler model, we will continue to focus on accumulating high-quality, low-risk M&A at reasonable valuations.

Our current dividend policy aims to maintain steady payments with a target payout ratio of 30%, considering overall business performance and investment opportunities.
Reflecting on the three-year period from 2021 to 2023, we generated approximately JPY370 billion in operating cash flow, while allocating approximately JPY120 billion to capital investments, approximately JPY80 billion to dividends, and more than JPY300 billion to M&A activities. Although our net debt increased, we also experienced a rise in EBITDA. Given the nature of our businesses we remain in a safe zone for debt leverage.

Regarding share buybacks, despite our dissatisfaction with the current stock price as of the end of July 2024, they are not under consideration at this point in time. We believe that utilizing our valuable capital for safe M&A activities will contribute more to the sustainable compounding of EPS in the future than allocating it to the purchase of our own shares. However, we remain flexible and will continue to assess market trends, keeping all options open for the future.

* Operating cash flow (on a continuing operations basis)

Financial Highlights

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