[edit] Financial Summary

[edit] Recent Updates

[edit] Highlights

On August 20, 2010, the company announced the acquisition of System Kikou Co., Ltd., an oil sludge treatment company. The transaction was expected to be completed September 1, 2010. The company commented that this acquisition would have no material impact on consolidated results for the time being.

Daiseki released Q1 FY02/11 results on July 13, 2010.

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[edit] Trends & Outlook

Quarterly Trends

FY 02/11 Q1 Results

The company released Q1 FY02/11 results on July 13, 2010 (see the table above). As a percentage of the 1H company estimate, Q1 numbers were as follows:

• Sales: 48.2% (vs. 1H estimate of 15.5 billion yen)
• Operating profit: 56.0% (vs. 1H estimate of 2.7 billion yen)
• Recurring profit: 56.7% (vs. 1H estimate of 2.8 million yen)
• Net income: 58.6% (vs. 1H estimate of 1.5 billion yen)

Industrial waste processing: Orders increased in the core industrial waste processing business, as recovery continued for domestic manufacturers. Sales of recycled petroleum products improved YoY due to higher fuel oil prices, providing a boost to sales.

Waste treatment volume in Chubu (mainly Nagoya) was improving, but at a slower rate vs. other regions. Growth potential in the Kansai and Kanto areas continued to develop; utilization rose to 80% in Kansai and about 60% in Kanto.

Costs remained under control during Q1, so the increase in sales meant an improvement in gross and operating profit margins. The industrial waste processing business (parent Daiseki Co.) exceeded the company’s budget in Q1, and it’s reasonable to conclude that if momentum continues through Q2, 1H could exceed expectations. The company’s sales forecast includes a “double dip” in 2H, but as of mid July 2010, the company was beginning to see signs that it could be smaller vs. initial expectations. The key factor will be sales trends from October. Industrial waste processing normally peaks in December making it the most important month (SR Inc. understands that the sales budget for December was about 1.9 billion yen).

Daiseki MCR sales were slightly lower than budgeted; lead prices lower than expected were the main culprit ($2,100 per ton vs. $2,250 per ton budgeted for the full year). The company thinks that prices bottomed in June 2010 and should maintain the $1,700-1,800 range in Q2, which means somewhat lower than budgeted results in the quarter. The company expects lead prices to recover in 2H and if that is the case then full year results should be within reach.

Revenue and profits declined for Daiseki Eco. Solutions, undershooting the budget; demand for soil treatment remained sluggish due to difficult conditions in real estate and construction sectors. The company expects this trend to persist through FY02/11, and commented that reaching the subsidiary’s full year forecast may be difficult. However, the number of research projects is gradually increasing, indicating a likely dawn of recovery in the real estate market, and the company expects to see better demand from 2H.

There was no change to the 1H or full year forecasts.

Full year (FY02/11) Outlook

• Sales

The parent company’s FY02/11 sales forecast includes a “double dip” in industrial activity (note the expected YoY declines beginning at the end of Q3 in the table above). The company’s sales forecasts for the full year do not include several factors which could mitigate the impact of the expected 2H slowdown: sales of Daiseki Eco. Solutions’ Green Arrows subsidiary are not included. Daiseki MCR is operating at 100% capacity, so lead prices are the determining factor in sales (the company assumes $2,250/ton vs. $1,907/ton in FY02/10; +18.0% YoY). The company’s assumption for oil prices is $70-75/barrel (influencing sales of petroleum products and recycled oil materials), with a 90 yen/dollar exchange rate.

YoY sales estimates per facility:

• Chiba: +13.0%
• Kanto: +12.6%
• Kyushu: +11.6%
• Kansai: +11.2%
• Hokuriku: +10.4%
• Nagoya: +1.7%

Nagoya is the largest of the company’s facilities (see Main Facilities for detailed descriptions), and SR Inc. notes that the company’s flat estimate indicates sales levels lower than those during FY02/05-FY02/09.

The FY02/11 outlook for Daiseki Eco. Solutions is for a challenging year, in part due to slow recovery in construction and real estate, but also from expected 1H slowdowns (legal changes making soil clean-ups mandatory, and changing licensing requirements for soil processing companies). The company indicated that after adjustment in 1H, a slow recovery could start in 2H, leading into the following year.

Gross Profit

Consolidated gross profit is expected to be stable YoY, driven by an improvement at the parent level. Company-specific estimates are below (FY02/10 in parentheses).

• Daiseki Co.: 36.3% (34.1%)
• Daiseki Eco. Solutions: 17.1% (18.7%)
• Daiseki MCR: 21.5% (28.0%)

SG&A

The company expects consolidated SG&A/sales to decline about 1% YoY, driven by performance at subsidiaries. Company-specific estimates are below (FY02/10 in parentheses).

• Daiseki Co.: 14.0% (14.5%)
• Daiseki Eco. Solutions: 7.8% (8.8%)
• Daiseki MCR: 6.6% (9.4%)

Operating Profit

The company expects consolidated OPM to improve slightly YoY. Company-specific estimates are below (FY02/10 in parentheses).

• Daiseki Co.: 22.2% (19.6%)
• Daiseki Eco. Solutions: 9.3% (9.9%)
• Daiseki MCR: 14.8% (18.6%)

Capex

The company expects to spend approximately 1.5 billion yen, allocated as follows:

• Daiseki Co.: 1,020 million yen (Nagoya sludge recycling facility, 295 million yen; Kanto supplement fuel factory, 130 million yen; vehicles and equipment, 237 million yen)
• Daiseki Eco. Solutions: 200 million yen
• Daiseki MCR: 230 million yen (maintaining existing assets, not expansionary)

Future Outlook

The company’s mid-term plan is to grow consolidated sales by approximately 11.2% annually from FY02/10 to FY02/13. Implied in the estimates are improving operating and net profit margins. Not included in the figures are the expansion of Daiseki MCR facilities (expected to double by FY02/13), or figures related to Daiseki Eco. Solutions’ Green Arrows subsidiary (expecting sales of approximately 1 billion yen with operating profit of less than 100 million yen).

Daiseki parent expects a gradual increase in processing volume of approximately 20% by FY02/12, which should translate to parent-level sales of 20.8 billion yen in FY02/11 and 23.3 billion yen in FY02/12. The company said that OPM targets of 25%-30% at the parent company are well within reach if depreciation stays under control. The company estimated that OPM could reach about 23% by FY02/13 (before including Daiseki MCR contributions).

Daiseki plans to expand its facilities to handle the expected increase in processing volume. Capacity in the Kansai work reached about 80% in Q1 FY02/11, partially due to higher production levels from electronics firms in the area, something expected to continue. The company estimates that the Kansai facility will exceed capacity before FY02/13. Daiseki plans to expand in Kansai close to its existing facility, at least doubling capacity. In order to respond to growing demand in the region, the company plans to treat waste at Hokuriku and Nagoya facilities which are located relatively close by.

The company seemed optimistic with the mid-term plan, commenting that if the economic recovery continues the trend seen in late 2009 and early 2010, targets could be reached about one year earlier than originally estimated.

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[edit] Business

[edit] Business Description

Daiseki is an environmental specialist focusing on recycling of industrial waste. The main business for the parent company is intermediate processing of liquid waste (waste oil, wastewater, sludge) and separation into reusable components that are then resold. The subsidiaries focus on lead recycling (automobile and industrial batteries) as well as soil treatment and environmental consulting.

The company has three divisions: Environmental Division, Petroleum Products Division, and Other. Sales in the Environmental Division are the overwhelming contributor to consolidated revenue.

Main Business Segments

Environmental Division (95.3% of FY02/10 sales)

The main activities in the Environmental Division are processing (recycling) of industrial waste (approximately 66.5% of FY02/10 sales) and services related to contaminated soil (processing, treating, etc.; approximately 25.0% of FY02/10 sales). Waste processing is the company’s core competence and biggest earnings driver.

Industrial Waste Processing

"Industrial waste" is defined as waste created as a byproduct of any industrial process (vs. generated by individuals). Japan classifies particularly harmful or hazardous waste as “special control industrial waste” (it can contain toxins or other dangerous compounds). After it has been generated, industrial waste travels through three phases: collection and transportation, intermediate treatment (processing to remove any dangerous components), and disposal (final materials are re-introduced to the environment in a non-threatening state). The main activities of the Environmental Division are the first two stages: collection and intermediate treatment.

The general approach to handling industrial waste is making it as small as possible before final disposal (landfills, typically). Reduction in size can be achieved in multiple ways, typically involving crushing, burning, or shredding; burning is the most popular method in Japan. Daiseki specializes in treating liquid industrial waste (such as sludge, waste oil, waste water and special control industrial liquid wastes), but also provides some solid waste recycling (specifically automobile and industrial batteries) through the subsidiary Daiseki MCR. Daiseki’s approach to waste processing is to recycle as much as possible, and has developed technological expertise to capture reusable components. Daiseki does not use incinerators at any of its facilities.

The breakdown of waste processed by Daiseki (parent basis) in FY02/10 was:

• Sludge: 16.8%
• Oil: 35.0%
• Acid: 16.3%
• Alkali: 29.6%

Waste oil processing can take three main forms, based on the type of oil to be processed and desired output.

1. Lubricant oil. Impurities, degraded oil components, and other contaminants are filtered out of the oil, with only lubricant oil remaining for resale.
2. Recycling into fuel oil. Waste oil is treated to separate oil, water, and other particles, resulting in waste water (processed separately), sludge (semi-solid mixture of particles, also processed separately), and oil - free of contaminants and ready for sale as fuel.
3. Supplement fuel. Waste oil that can’t be recycled into lubricant or fuel oil undergoes a process (additional ingredients, etc.) rendering it fit for use as a secondary fuel (to be burned as a coal alternative or supplement).

Wastewater processing refers to the separation of water from oil and other contaminants. It’s a key step in the company’s other waste recycling activities (oil, sludge). Processing involves three steps:

1. Any oil in the mixture is separated, processed as waste oil, and made into a fuel.
2. Collected waste water undergoes neutralization process followed by coagulation and dehydration. It is then biologically treated with activated sludge and released into river or municipal sewage system.
3. The sludge resulting in the process of neutralization is dehydrated (dewatered), leaving a solid cake-like material which is recycled as a cement raw material.

Daiseki transportation trucks. Source: SR Inc.

Specific steps for sludge processing depend on the contents (sludge from construction activities is different from industrial sludge). After analysis and classification, different treatment options are:

1. Mixing in additional compounds to create supplement fuel.
2. Dehydration to separate water and solid material (typically destined for cement manufacturers).
3. Kneading in chemical compounds to transform the sludge into raw material for cement manufacturers.

Processing can involve an additional step: reclaiming certain recyclable matter, depending on the source and contents of the sludge.

Lead Recycling

The lead recycling business is the main focus of Daiseki MCR (lead batteries were approximately 90% of total FY02/10 volume; solid electronics or similar waste the remainder). Most of the batteries are from automobiles (70%), the others mostly from industrial equipment like backup generators, telecommunication equipment, etc. Processing involves separating lead from other parts of the battery (plastic, internal liquid, etc), most of which can be recycled. The liquid waste (acidic wastewater) is processed and treated. Lead and plastic are then resold.

The company estimates Daiseki MCR’s share at approximately 5% of the domestic market. It is operating at full capacity (as of FY02/10). The plan is to expand capacity in FY02/13 (assuming no delays in licensing). Increasing the facility size should have a material impact on consolidated profit margins relatively quickly – the company notes that new waste processing facilities typically require a few years to reach a steady capacity vs. one year for Daiseki MCR. The gross profit margin is somewhat lower than the main waste recycling business (see table above); unlike the main waste recycling business, battery recycling is not seasonal.

Contaminated Soil

The company provides services related to contaminated soil through the Daiseki Eco. Solutions subsidiary. Services include site analysis, testing, decontaminating affected soil, and recycling contaminated soil. Environmental surveys are typically required when factories close or relocate (ensuring no contaminants are left behind), property is redeveloped, etc. The company has recycling centers in Nagoya, Yokohama, and Osaka, together capable of handling a total of 1 million tons of soil per year.

Daiseki Eco. Solutions’ soil processing techniques include recycling (components from contaminated soil become raw material for cement manufacturers), hot soil remediation (removing contaminants via heat exposure at the company’s Nagoya center), and on-site remediation (decontaminating soil without extraction).

Petroleum Products (4.7% FY02/10 sales)

The petroleum products segment encompasses manufacturing and sales of industrial petroleum-based products (lubricants, anti-rusting agents). The segment is minor, with little impact on top-line results.

Main Facilities

Daiseki treatment facility. Source: SR Inc.

Daiseki parent has 6 main recycling works, located near the major industrial areas (Kanto, Chubu, Kinki, Kyushu). All facilities are ISO 14001 certified and licensed to recycle and treat major types of industrial waste.

Proximity to clients has an impact on cost (see Business model); the company’s facilities are located in areas that generated approximately 82% of total industrial waste in Japan during 2008 (data according to the Ministry of the Environment). The company’s plants are highly accessible by major transport links; additionally, 4 of the company’s 6 main facilities (Kyushu, Kansai, Hokuriku, and Chiba) are directly accessible by water.

• Nagoya recycling works – opened in 1963 (oldest facility), handles the most waste in the company’s facility network (quantity and variety); total size: approximately 46,000 square meters. Serves the Chubu area (generated 15.6% of industrial waste in 2008).

• Kansai recycling works – opened in 2002; wastewater, waste oil, and sludge capabilities; total size: approximately 12,000 square meters (biggest recycling facility in Kansai as of 2010). Serves the Kinki area (generated 14.4% of total industrial waste in 2008). As of FY02/10 the plant was operating at approximately 80% capacity, according to the company.

• Kyushu recycling works – opened in 1982; equipped to handle both liquid waste and sludge; total size: approximately 54,000 square meters. Serves the Kyushu area (generated 13.0% of total industrial waste in 2008).

• Hokuriku recycling works – opened in 1973; handles multiple types of industrial waste (liquids, some solids such as glass and concrete); total size: approximately 18,000 square meters. Along with the Nagoya recycling works, serves the Chubu area.

• Kanto recycling works – opened in 1990; equipped to recycle liquid and some solid waste; approximately 47,000 square meters. Serves the Kanto area (generated 27.4% of total industrial waste in 2008). The company indicated that the plant has sufficient capacity to roughly double processing (as of FY02/10).

• Chiba recycling works – opened 1997; approximately 7,000 square meters; focuses on oil recycling. Along with the Kanto recycling works, serves Kanto.

The average facility cost for industrial waste processing is about 1 billion yen (with smaller facilities costing from 500 million yen and larger – up to 2 billion yen). Facilities are typically profitable within the first 3 years of use; with a payback period of less than 7 years (15-18% ROI). The company uses the payback period as a decision-making criterion.

In terms of utilization and room to grow, the company estimates that the current facilities have capacity to generate up to 30 billion yen of revenue (parent basis).

Daiseki Eco. Solutions Facilities

• Recycling centers in Nagoya, Yokohama, and Osaka

Daiseki MCR Facilities

• Headquarters and factories in Tochigi prefecture

Research and Development

Daiseki parent has R&D facilities in all its works; research focuses on improving the recycling (recovery) technology and expansion of treatment methods for handling complex industrial waste. As of FY02/10, the company had 50 personnel dedicated to R&D.

Business Model

The main components of the company’s sales are recycling and waste processing (minor revenue streams include product sales in the petroleum products segment). Prices that Daiseki parent charges for recycling vary for each client, and are largely based on treatment costs (easily recyclable materials cost less). Due to the individual characteristics of manufacturers’ waste, the company doesn’t have a general price list; contract prices are negotiated on a case by case basis. Once set, processing prices are changed infrequently (vs. the company’s petroleum products, which are influenced by market prices of oil). According to the company, recycling prices had broadly been increasing from about 2005 until the 2008 “Lehman Shock” (waste was becoming increasingly complex). Post financial crisis, prices have declined about 4%, but have stabilized to some extent; the company expects prices to be stable through FY02/12.

The company commented that its customers rarely switch to other providers and that it has been growing its market share consistently. The company attributes its success to four factors: price (processing price varies depending on the types of wastes), reliability (strict environmental laws in Japan hold manufacturers responsible to the point of final disposal, making hiring a reliable waste disposal company a necessity), convenience (fast response), and recycling per se (reputation and similar intangible benefits; e.g. manufacturers seeking ISO process certification benefit from participating in waste recycling). As of FY02/10, the company had approximately 5,123 customer accounts (accounts are separated by recycling type and facility) vs. 5,072 in FY02/09 and 4,953 in FY02/08.

The main driver of the revenues is the level of industrial production – recycling volumes that drive revenues directly depend on the amount of waste that industry generates. Volumes lag industrial production by approximately 6 months, especially during the recovery phase (one reason is that manufacturers tend to ship in fewer lots during recessions, producing less waste and holding more waste at their facilities to minimize transportation costs - leading to an initial lag in waste shipment when recovery starts).

Other minor revenue drivers include market prices for lead and petroleum (Daiseki MCR sells recycled lead ingots at market prices trailing by one month and petroleum products are directly influenced by oil prices). Daiseki MCR doesn’t hedge price risk for lead due to the relative illiquidity in the commodity market and the cost of hedging.

Costs are mostly fixed, the largest being labor (57.2% of parent FY02/10 SG&A). Gross profit margins for industrial waste production are relatively stable at approximately 35% (mostly costs for chemicals and other treatments as well as variable costs such as transportation and final disposal).

Understanding the relationship between Daiseki’s sales and profit is straightforward: revenues are driven by volume of processed waste, and profitability is driven by facility utilization rates. The company estimates that a ‘best case’ scenario of full utilization would result in operating profit margins (at the parent basis) in the area of 30%.

Two variables define the company’s existing business growth: increases in either processing volume driven by an upswing in industrial production or market share. The company has been taking share from local competitors who either use less sophisticated processing methods (emphasizing the cost and other benefits of recycling vs. burning) or have insufficient scale to provide regulatory compliance with changing legislation.

Profitability Snapshot, Financial Ratios

The parent company generated over 74% of consolidated FY02/10 gross profit (34.1% GPM); Daiseki Eco. Solutions contributed 14.8% (18.7% GPM); Daiseki MCR 9.5% (28.0% GPM).

Consolidated operating profit margins have been relatively stable; processing volumes of Daiseki parent had been on increasing trends until the financial crisis in 2008 impacted industrial production levels; sales growth has slowed while Daiseki’s fixed labor costs reduced OPM. The company suggests that its OPM is relatively high due to gains realized from recycling, indicating that without recycling its estimated OPM would be significantly lower.

Daiseki’s working capital was affected by the acquisition of Tamura Sangyo (renamed Daiseki MCR), included in consolidated results from FY02/08. The impact of Tamura Sangyo’s inventory in FY02/08 results affected inventory turnover (lower), working capital (higher), and the current ratio (higher).

SWOT Analysis

Strengths

• Reputation built on significant experience. Daiseki has been involved in industrial waste processing and recycling for nearly 40 years. Typically experience alone in an industry isn’t a strength; any company that’s managed to survive can cite “experience” as an attribute. Arguably in industrial waste processing however, experience and a solid reputation are important. Waste producers are liable for their waste until/through final disposal, making the choice of a processing company an important decision (if a disposal company does anything improper, the manufacturer could be subject to fines, legal action, etc.). Daiseki’s approach minimizes this risk for companies, and its experience in processing different waste types means its services can be used by different industries.

• Pragmatic management focused on medium-term earnings growth. In SR Inc.'s view, this strength helps, if not drives, high profitability as the company avoided expanding too rapidly - focusing instead on steady market share gains and building client relationships. This translates directly into shareholder value and substantially lower costs of capital, creating a cycle of high returns and steady growth.

• Specialist focus on liquid waste (the parent company). Daiseki operates in a narrow niche where it can leverage technical expertise and its position as a TSE listed company to maximize its competitive advantage. It has been applying the same approach to other areas, buying other specialist firms and combining their specific focus with Daiseki’s core strengths to grow the business.

Weaknesses

• Market bound by industrial production. Daiseki’s business is ultimately bound by domestic industrial production – the number and output of manufacturing companies (a mature and likely shrinking market). Although Daiseki has taken share from competitors in the past, this is not guaranteed in the future.

• Uncertainty of investment payoff for capex. Investments in processing plants are substantial, and can take a long time (licensing alone can span several years). From an investor’s perspective, this means that there is added uncertainty regarding when the heavy up-front investments for new facilities will pay off.

• Limited available M&A opportunities. The company says that most M&A opportunities presenting themselves involve rescuing troubled companies and are generally unattractive. This limits growth opportunities to organic growth and may lead to less efficient use of the balance sheet than would otherwise be possible. The company’s ROE and ROA have been nearly equivalent due in part to the fact that about 1/3 of total assets were kept in cash as of FY02/10, sitting on the sidelines waiting for the next capex increase or a low probability M&A event.

Group Companies

• Daiseki – main group company, engaged in intermediate treatment of industrial waste.
• Daiseki Eco. Solutions (TSE 1712) – specializes in soil contamination: surveys, analysis, and treatment. The company has one subsidiary (Green Arrows Central – treatment and recycling of industrial waste, mainly plasterboard).
• Hokuriku Daiseki – manufacturers and sells lubricant oil and other petroleum products.
• Daiseki MCR – refines lead recovered from batteries for resale.

Group Strategy

The company’s group strategy has been to develop as a specialist environmental group, with industrial waste recycling at the core. Subsidiary businesses are closely aligned to the core recycling business. Daiseki parent and Hokuriku Daiseki buy petroleum products from each other; Daiseki MCR generates wastewater (battery fluid) which is processed by Daiseki; and Daiseki Eco. Solutions captures environmental response projects from currently active manufacturing plants thanks to close cooperation with Daiseki parent. The group structure is appropriate for the company due to the alignment of input and output materials from the different businesses.

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[edit] Market & Value Chain

The key market for Daiseki is the industrial waste processing market in Japan.

Industrial waste in Japan is classified in two main categories: industrial waste (a broad term for waste created through commercial activity; examples include wood chips, paper, textiles, and organic waste), and special control industrial waste (hazardous waste which requires special treatment, such as oil, acid, medical waste, asbestos, and waste with toxic heavy metals like mercury and cadmium). Generally speaking, processing special control industrial waste requires more sophisticated techniques than less dangerous forms of waste. Creation of industrial waste is driven by industrial activity. Data from the Ministry of the Environment indicates that total levels of industrial waste have been mostly stable from 1999 to 2007, total growth of approximately 5% with little volatility (see table below).

In terms of specific materials in industrial waste processing, the largest single component has historically been sludge (see table below). Liquid waste has been the most volatile, but has also shown the most growth from 1998 to 2007 (almost doubling vs. flat growth for sludge, plastics, and other types).

The market for industrial waste is highly regulated. The first law outlining specific waste types and stipulating appropriate disposal practices was promulgated in 1970, with additional recycling and waste related laws coming into effect in the early and mid-2000s. In 1998 a manifest system to track waste from its origin through final processing was established. The purpose of the manifest system seems to be increased scrutiny and accountability for waste generators (waste generators are required to submit completed manifests within 10 days after final disposal).The ramifications for waste generators are substantial: if an intermediate processor makes a mistake, disposes of the waste improperly, etc. the ultimate responsibility (liability) rests with the company who created the waste.

Companies competing in industrial waste processing must have specific licenses to process different types of industrial waste. The licensing process is lengthy and requirements are relatively strict (obtaining a license can take several years, limiting market growth and reducing mobility of entrants and exits).

Although the company provides collection services, Daiseki’s business is predominantly involved with intermediate treatment. Data regarding the number of competing collection and intermediate waste processing firms is highlighted below:

The total number of intermediate treatment facilities has been increasing since 1992, however the number of facilities using dehydration (used by Daiseki for sludge and wastewater processing) technologies has declined approximately 40% during 1999-2007. The company suggests that as manufacturers have been creating more complex and technologically advanced products, industrial waste has also become more complicated, increasing processing difficulty. Given increased regulatory pressure on treatment companies and more complex waste types, the contraction of dehydration treatment companies could be interpreted as a “survival of the fittest” scenario, eliminating smaller companies unable to effectively compete.

The main forces shaping the market are the number of manufacturers (level of output) and legal constraints (specific treatments for certain wastes, etc.). The company expects regulatory standards to continue tightening in terms of processing requirements and increased pressure on manufacturers to achieve “zero emission” targets (emphasizing recycling and minimized resource consumption). With respect to the quantity of waste generated by factories, the company expects the number of factories to continue a declining trend which began in the mid-1990s as production moved offshore to minimize costs.

Market Growth

Source: SR Inc.

In terms of the core business (industrial waste recycling), important variables for Daiseki are the total quantity of industrial waste and legal requirements for waste treatment. It seems unlikely that Japanese companies will reverse the off-shoring trend and return to using factories located in Japan, therefore a sideways volume outlook for the market could be considered optimistic. Therefore growth for recyclers is more likely to occur from regulatory changes (higher degrees of quality for final output, more stringent recyclable components, etc.) that could increase the need for recycling expertise.

In this context, Daiseki’s growth opportunities are mostly limited to taking share from other companies (including substitute solutions), something that stricter regulations and growing social and corporate environmental awareness probably make easier.

For Daiseki Eco. Solutions, the company estimates the total market potential to be about 100 billion yen. The market for soil survey and treatment services is driven substantially by the housing and construction industries, and given the declining demographic trends, a long-run increase in market size seems unlikely. Regulatory changes could add uncertainty. Short-term opportunities could develop for soil processing companies as licensing requirements change (changes in April 2010 are expected to increase the burden on companies providing the services, potentially forcing a redistribution of market share if weaker companies exit).

Customers

Producers of industrial waste are the customer of Daiseki parent. As the processing price changes depending on content of waste, prices are determined individually with each customer. When costs of outsourced final disposal (landfill) increase, it impacts the processing prices set by the company. Collection, treatment, and disposal of industrial waste is governed by Japanese Law. The company’s largest customers account for approximately 2-3% of total sales, meaning that no single client is big enough to cause significant fluctuations in the company’s sales.

Daiseki MCR buys recycled batteries. The recycled components are commodities (lead, plastic, etc.) which prices are determined on the open market.

Suppliers

Daiseki does not have any critical suppliers for its main waste recycling business. The company’s technology and experience are the key processes ingredients. Core suppliers for the lead recycling business are battery brokers and automobile dealerships. The company commented that success in the battery recycling business hinges on keeping utilization levels high to minimize costs; emphasizing the importance of effective sourcing. The balance of power between suppliers and recyclers of batteries seems roughly equal: battery brokers seek the best prices and biggest buyers, whereas recyclers seek to boost utilization through larger quantities.

Barriers to Entry

High. The main limiting factors are licenses, land, and equipment. Obtaining licenses can take 2-3 years or longer for specific treatment types (incineration licenses are more complicated, for example) and types of services offered (collection and transport, different types of industrial waste etc. all require separate licenses). Land and equipment require capital outlays, which can be significant.

An intangible barrier to entry could include building credibility with waste producers to win business. Incumbents have the advantage of track record and experience; new entrants would need a compelling reason for manufacturers to take on the risk of new waste processors - producers are legally liable for their waste from generation through final processing.

Competition

Transportation costs can have significant influences on waste disposal costs so the competitive landscape is determined more by geography than capabilities. The company claims that it has no peers in terms of similar capacities and treatment methods (recycling). The largest waste disposal competitor is Dowa Holdings (TSE 5714), which offers waste recycling (focusing on solid waste such as electronics, metal scrap, vehicles, etc.), waste treatment (using incineration), and operates final disposal facilities (landfills). Other competitors that offer recycling include Kureha Corporation (TSE 4023), Nihon Chemtech (Unlisted), and Towa Oil (Unlisted).

Competing firms for Daiseki MCR include Toho Zinc (TSE 5707), Mitsubishi Materials (TSE 5711), and Mitsui Mining and Smelting (TSE 5706). In addition to listed competitors, the company commented that there are numerous smaller companies that provide similar services; there were over 10,000 companies licensed to perform intermediate treatment of industrial waste as of 2010 (see Market and Value Chain).

Daiseki Eco. Solutions’ most notable competitor is Dowa Holdings (TSE 5714). Dowa has two soil remediation facilities, and offers both on-site and off-site treatment.

Substitutes

Substitutes for waste recycling include a reduction of total waste output (increased material and production engineering to reduce waste), waste minimization before final disposal (through shrinking, crushing, burning, etc.), and illegally dumping waste. R&D specifically for waste reduction seems unlikely unless recycling costs become otherwise prohibitive. Recycling waste can be cheaper than other treatment methods and provide an element of PR for manufacturers (as eco-friendly companies), so the relative attractiveness of recycling vs. alternative seems to be in favor of recycling. Illegal dumping (which is more typical for solid waste), although technically a substitute for waste treatment, is probably irrelevant for blue chip clients of Daiseki.

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[edit] Strategy

The company’s strategy has been to increase its range of services and geographies where it competes. The company has historically competed in Chubu area (which generated 15.6% of total industrial waste in Japan in 2008); however nearly twice as much waste is generated in Kanto (27.3% of total industrial waste in 2008, according to the Ministry of the Environment). Daiseki has capacity (as of FY02/10) in its Kanto facility, and suggests that it intends to increase utilization of the plant. The factors controlling growth are salespeople and industrial production cycles (essentially, time). The company doesn’t expect any sudden explosive growth, suggesting that low double-digit (steady between 10% and 15%) rates are more reasonable.

Daiseki’s business developed as a liquid waste treatment specialist, but has used M&A to expand into other areas (e.g. Daiseki MCR, then Tamura Sangyo, acquisition in 2007 for battery recycling). The company indicated that other possible options would be other materials such as plastics and industrial (non-precious) metals.

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[edit] Historical Financial Statements

[edit] Summary

Sales on a growing trend from FY02/01, with strong double-digit operating profit margins.

Highly liquid balance sheet – large net cash position.

Consistently positive operating cash flow; generating increasing levels of simple free cash flow.

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[edit] Income Statement

Consolidated sales are driven by the main business of the parent company (industrial waste recycling). The company commented that demand for its services can be driven by industrial cycles (more production means more waste), however sales have been on a generally increasing trend during FY02/01-FY02/09. When discussing the YoY decline in FY02/10, the company identified overall contraction in the economy as the main factor.

Gross profit margins are largely stable at approximately between 30.1%-35.0% during FY02/01-FY02/10, driven by GPM at the parent company (typically a few points higher than consolidated results).

Operating profit margins have been on an increasing trend during FY02/01-FY02/08, from 18.0% in FY02/01 to a peak of 23.3% in FY02/08. Operating profit is a function of maximizing utilization to offset fixed costs; the decline in processing volume in FY02/10 impacted OPM for the year.

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[edit] Balance Sheet

The company’s balance sheet is highly liquid – as of FY02/10 cash on the balance sheet was more than twice the size of total liabilities.

The capital structure is mostly equity: the equity ratio has averaged 79.8% during FY02/01-FY02/10.

Assets

The company’s assets are mostly current, cash historically being the largest component from FY02/01-FY02/10. Inventories on the balance sheet are related to Daiseki MCR (affecting consolidated accounts beginning FY02/08).

The business is based on tangible fixed assets – the plant and equipment used in recycling. This asset base is relatively young in terms of its productive life: total equipment purchases (excluding land) from FY02/01-FY02/10 were approximately 17.2 billion yen– the majority of which (approximately 11.6 billion yen; 67.4%) were made in FY02/05 and later.

Liabilities

The company’s liabilities are minimal. As of FY02/10 the largest component of total liabilities was accounts payable.

Debt on the balance sheet as of FY02/10 was mostly short-term. Annual cost of debt is low: 0.4% for short-term, 1.1% long-term (as of FY02/10). Repayment obligations reported in FY02/10 were negligible (less than 170 million per year through FY02/14).

Shareholders’ Equity

Changes in shareholder equity have typically been driven by net income minus dividends. The exception from FY02/01-FY02/10 was in FY02/08, when the company issued additional equity to purchase Daiseki MCR.

Per Share Data

Daiseki has been using both dividends and stock splits to boost shareholder returns. When discussing FY02/10 results, the company commented that it felt that liquidity in its stock was at a sufficient level and that it would begin to increase the payout rates for future periods (note that the company has historically maintained or raised the dividend amount while increasing the number of shares through splits).

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[edit] Cash Flow Statement

Operating Cash Flow

Daiseki’s operating cash flow is dominated by net income and depreciation; accounting earnings reflect the actual cash performance of the business. The ratio of net income + depreciation to operating cash flow has averaged over 100% during FY02/01-FY02/10.

Investment Cash Flow

Cash for investments have been dominated by tangible fixed asset purchases (investment security purchases typically have been minor). See major capex items below for detail.

Financing Cash Flow

Financing cash flow in FY02/05 was from bank debt (300 million yen short-term bank loans, 700 million yen long-term bank loans). The FY02/08 increase in cash flow from financing was a combination of debt (250 million yen of short-term bank loans, 800 million yen of long-term bank loans) and equity (7.1 billion yen related to the acquisition of Daiseki MCR)

Simple Free Cash Flow

Simple free cash flows during FY02/01-FY02/10 have been on an increasing trend, with some volatility. The company’s business is mainly driven by tangible fixed assets, which can create lumpy capex spending requirements which can push simple free cash flow into negative territory. The company’s capex during most of FY02/02-FY02/09 appears largely expansionary (see below). The simple free cash flow yield (based on average shareholder equity) has been on an improving trend: from low single digits to approximately 10% in FY02/09-FY02/10. The depreciation effect (buildings machinery: from 2-50 years; vehicles: from 2-17 years) should be a substantial boost to simple free cash flow going forward.

Major capex items:

• FY02/01 – Kansai facility (land, 918 million yen), Nagoya (expansion, 564 million yen)

• FY02/02 – Kyushu (land, 656 million yen), Nagoya (water treatment facility, 539 million yen), Hokuriku (sludge drying facility, 498 million yen)

• FY02/03 – Kansai (new establishment, 1.3 billion yen), Hokuriku (water treatment facility, 230 million yen), Kyushu (sludge processing, 218 million yen)

• FY02/04 – Nagoya (Daiseki Eco. Solutions Nagoya recycling center – land, 395 million yen)

• FY02/05 – Kyushu (water treatment facility, 730 million yen), Nagoya (sludge processing, 678 million yen), vehicles and equipment (233 million yen). Daiseki Eco. Solutions – Nagoya recycling center (182 million yen), Yokahama land and factory (803 million yen)

• FY02/06 – Kanto (land, 1.4 billion yen; construction 1.2 billion yen), vehicles and equipment (282 million yen)

• FY02/07 – Kanto (plant, 970 million yen), Osaka (Daiseki Eco. Solutions Osaka recycling center – land 1.3 billion yen)

• FY02/08 – Nagoya (fuel recycling facility, 327 million yen), Kansai (water treatment 500 million yen), Kanto (construction 212 million yen), vehicles and equipment (270 million yen)

• FY02/09 – Nagoya (fuel and other recycling, 337 million yen; Kanto (fuel recycling, 314 million yen), vehicles and equipment (298 million yen). Daiseki Eco. Solutions – land and soil treatment 557 million yen)

• FY02/10 – Vehicles and equipment (103 million yen), Daiseki MCR (land, 401 million yen)

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[edit] Other Information

[edit] History

Corporate Timeline

1945 Founded as a petrol refiner in Mie Prefecture

1958 Constructed a plant for lubricating oil refining in Nagoya city, Aichi Prefecture

1958 Established Daido Petrochemical Industry Co., Ltd (Common stock: 2,000,000JPY, as of October 1)

1963 Opened Nagoya Work in Nagoya city

1966 Opened Kyushu Work in Kita-Kyushu city, Fukuoka Prefecture

1970 Opened Hokuriku Daiseki Co., Ltd. in Kanazawa city, Ishikawa Prefecture

1972 Qualified as an industrial waste disposer in Nagoya city

1973 Opened Hokuriku Work in Hakusan city, Ishikawa Prefecture

1980 Opened Osaka Work in Amagasaki city, Hyogo Prefecture

1982 Opened Kyushu Work in Kita-Kyushu city

1983 Awarded a prize by the Clean Japan Center Foundation for our contribution to resource recycling

1984 Changed corporate name to Daiseki Co., Ltd.

1990 Opened Kanto Work in Sano city, Tochigi Prefecture

1995 Listed on OTC market (July 27, 1995; Common stock: 1,207,000,000 yen )

1997 Opened Chiba Work in Sodegaura City, Chiba Prefecture

1997 Received the Secretary of the Minister of Health and Welfare Prize for improvement of the environment

1998 Received the Secretary of the Maritime Safety Agency Prize and the Governor of the Maritime Disaster Prevention Center Prize for our restoration work on the heavy oil spill from a Russian tanker in the Sea of Japan

1999 Changed corporate name of Daiseki Plant Co., Ltd. to Daiseki Kankyo Eng. Co., Ltd.

1999 Listed in the second section of the Tokyo Stock Exchange, Inc. and Nagoya Stock Exchange (Common stock: 1,381,473,500 yen, as of August 5)

2000 Listed in the First Section of the Tokyo Stock Exchange, Inc. and the Nagoya Stock Exchange (Common stock: 2,575,458,956 yen, as of August 1)

2000 Offered for public subscription (Common stock: 3,701,058,956 yen, as of September 1)

2002 Opened Kansai Work in Akashi city, Hyogo Prefecture

2004 Changed corporate name of Daiseki Kankyo Eng. Co., Ltd. to Daiseki Eco. Solutions Co., Ltd.

2004 Daiseki Eco. Solutions Co., Ltd. was listed in the MOTHERS of Tokyo Stock Exchange

2005 Nagoya Recycle Center of Daiseki Eco. Solution Co., Ltd. was accredited as a contaminated soil purification facility by Nagoya Prefecture.

2007 Offered for public subscription 2,200,000 shares and third-party allocation 330,000 shares (as of April 25 and May 22, Common stock 6,382,605,956 yen)

2007 Acquired Tamura Sangyo Co., Ltd. (Utsunomiya city, Tochigi Prefecture）

2008 Daiseki Eco. Solutions Co., Ltd. was listed in the First Section of the Tokyo Stock Exchange and the Nagoya Stock Exchange

2008 Changed corporate name of Tamura Sangyo Co., Ltd to Daiseki MCR Co., Ltd

Daiseki did not start out as an environmental services company; the company’s roots began in 1945 as a gasoline refinery. The company initially started recycling in order to cut costs, but developed expertise which created the platform for a business which it formally entered in 1958 when Daido Petrochemical Industry Ltd. was founded. The first recycling plant was established in Nagoya in 1963, later followed by steady expansion across Japan. The company received a license to recycle in 1972. The company’s name changed to Daiseki in 1984. Over the counter trading of the company’s shares began in 1995, with a listing on the Tokyo Stock Exchange 2nd section in 1999 (transferring to the 1st section in 2000).

The company expanded into battery recycling through the acquisition of Tamura Sangyo in 2007 (later renamed Daiseki MCR).

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[edit] News & Topics

Company News & Topics

Industry News & Topics

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[edit] Top Management

President Hiroyuki Ito (born April 5, 1943). Ito has spent his entire career with the company, joining the company in 1963 at the age of 20. He was appointed as a Director in 1975 and as a Managing Director in 1978, and as the Representative Director and Vice President in 1990. He was appointed as the company President in 1996.

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[edit] Employees

At the end of FY02/10, the company had 494 employees (659 on a consolidated basis); average age 38.7, working with the company for 9 years, earning an average of 5.5 million yen.

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[edit] Major Shareholders

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[edit] Dividends and Shareholder Benefits

Daiseki’s dividend policy is to pay out approximately 20% of earnings; the company considers its business is still in the growth stage, so the payout rate varies (see Per Share Data). Dividends are paid semi-annually (interim and year-end).

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[edit] Investor Relations

Result meetings are held after the announcement of interim and fiscal year end results. The company maintains a very comprehensive IR site, with detailed information in both English and Japanese.

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[edit] By the Way

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[edit] Latest Q&A

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