TOCALO : Updated Research Report by Shared Research Inc. (1H FY03/23 report update)

Research Coverage Report by Shared Research Inc.	Coverage initiated on: 2019-11-19
Last update: 2022-12-26

3433

TOCALO

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INDEX

Executive summary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3. Key financial data . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5. Trends and outlook . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6.

Quarterly trends and results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6. Medium-termmanagement plan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17. .

Business . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26. . Business overview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .26. . Business model . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27. . Group structure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35. . Profitability analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48. .

Market and value chain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49. . Competitive landscape . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50. . Strengths and weaknesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51. .

Historical results and financial statements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53. . Income statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53. . Balance sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53. . Cash flow statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55. . Historical performance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55. .

Other information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69. .

Company profile . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72. .

TOCALO 3433

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Executive summary

Business overview

TOCALO Co., Ltd. (TOCALO) provides surface treatments that improve the performance of materials used across a range of industries by adding properties such as abrasion and heat resistance, conductivity, insulation, and heat shielding and dissipation. Its core technology is thermal spraying, which involves coating target surfaces by spraying metals or ceramics that have been melted using high temperature heat sources (e.g., plasma and gas). The company particularly excels in functional thermal spraying that provides both growth potential and high added value, and leads the Japanese market for thermal spraying with a share of 40% (Shared Research estimate based on data from Yano Research Institute, Digital Research, and other sources). The company also offers other surface treatments as ancillary services. These include the Toyota diffusion (TD) process, zinc alloy coating (ZAC), plasma transferred arc (PTA) process, and physical vapor deposition (PVD) process. (See the box on the next page for details.)

TOCALO's surface treatments are made to order. Accordingly, selling volume is not a business priority. The company procures coating materials and generates sales by applying surface treatments to goods and parts provided by customers. In FY03/22, it reported a GPM of 37.9%, an SG&A ratio of 14.4%, and an OPM of 23.4%, on a consolidated basis. Over half of the parent company's total manufacturing costs in FY03/22 were labor (29% of the total) and outsourcing costs (25%). Other manufacturing costs included materials (14%), consumables (11%), utilities (4%), depreciation (8%), and other costs (10%). TOCALO's business is labor-intensive, with personnel expenses accounting for about 50% of SG&A expenses.

The thermal spraying industry divides into companies that conduct thermal spraying internally and companies that perform thermal spraying as a contracted service. In 2018, the market for contracted treatment in Japan was worth approximately JPY60.0bn, while the global market was about JPY700.0bn (source: Yano Research Institute). Some overseas competitors sell thermal spraying materials and equipment in addition to providing contracted treatment services, but TOCALO specializes in services. Overseas sales accounted for 21.1% of sales in FY03/22 and mainly came from Japanese companies that have expanded abroad. The company also receives royalty income from licensing agreements with overseas companies, including competitors.

By area of application, 20% of thermal spraying in Japan is associated with industrial equipment, 20% semiconductors and flat panel displays (FPDs), 13% steelmaking, 10% bridges and structures, 10% paper manufacturing, and 27% other uses (2018 actual; Yano Research). At TOCALO, semiconductor/FPD-related sales at the parent made up about 47% of consolidated sales in FY03/22. The bulk of sales are to the Tokyo Electron Limited group (TSE Prime: 8035). Semiconductor-related business is TOCALO's growth driver, and TOCALO and Tokyo Electron have built a close relationship that allows them to conduct joint development.

In September 2004, TOCALO acquired all shares of Japan Coating Center Co., Ltd. (JCC), expanding into the thin coating technology known as the physical vapor disposition (PVD) process. PVD is a surface treatment method in which metals (e.g., titanium and chromium) are ionized with reactive gases in a vacuum to form highly adhesive ceramic coatings that are hard and dense but thin. Applied to surfaces of cutting tools, metallic molds, and other items, these coatings add functionality such as abrasion and corrosion resistance. JCC's profit margin is high (19.6% in FY03/22; before segment profit adjustments), but not as high as that of the Thermal Spraying (Parent) business. Shared Research notes that synergies between the parent and the subsidiary have generated.

By segment, Thermal Spraying (Parent) accounted for 75.4% of sales in FY03/22, Domestic Subsidiary (JCC) for 5.5%, Overseas Subsidiaries for 13.0%, Other Surface Treatments for 5.7% and Royalty Income 0.4%. The segment profit margins (recurring profit basis) were 24.5% in Thermal Spraying, 19.6% in Domestic Subsidiary, 27.0% in Overseas Subsidiaries, and 18.7% in Other Surface Treatments (before segment profit adjustments).

Trends and outlook

In FY03/22, sales were JPY43.8bn (+11.5% YoY), operating profit JPY10.3bn (+15.4% YoY), recurring profit JPY10.6bn (+18.6% YoY), and net income attributable to owners of the parent JPY6.9bn (+26.5% YoY). Thermal spraying for industrial machinery struggled somewhat, but business in the core semiconductor and FPD fields grew, driving increased performance. Performance at subsidiaries worldwide also contributed, such that the company posted record highs for two consecutive years in sales and all forms of profit, including recurring profit. Annual dividends will be JPY45.0 per share (JPY40.0 per share in the previous plan), and the payout ratio is expected to be 39.6%.

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The company plan for FY03/23 calls for sales of JPY48.2bn (+10.0% YoY), operating profit JPY11.2bn (+9.2% YoY), recurring profit JPY11.4bn (+7.8% YoY), net income attributable to owners of the parent JPY7.4bn (+7.7% YoY), and EPS of JPY122.4. In July 2022 the company upwardly revised its FY03/23 forecast based on Q1 results and orders received. When it released 1H (April-September) results in October 2022, TOCALO left its forecast for FY03/23 unchanged, and it still expects to post new record profits at every level (including recurring profit) for a third straight year. The company is planning an annual dividend of JPY45.0 per share, the same as in FY03/22, and expects a payout ratio of 36.8%.

On November 9, 2021, the company publicly announced its medium-term management plan for the first time ever. This medium-term management plan clearly defines the company's vision for 2030 and outlines the growth strategy the company plans to implement over the five-year duration of the plan, which concludes with FY03/26. For FY03/26, the company has set a sales target of JPY53.0bn (versus actual sales of JPY39.3bn in FY03/21) and a recurring profit target of JPY12.0bn (versus actual recurring profit of JPY8.9bn in FY03/21). In addition to maintaining and enhancing its financial strength and profitability, the company also clearly indicated that it would aim to increase shareholder returns. However, the company additionally stated that it would periodically monitor and review expansion associated with its business operations targeting semiconductors (expected to be a major driver of results during this medium-term management plan), as it is highly subject to impact from changes in trends within the semiconductor market.

In May 2022, the company announced the progress made on its medium-term management plan. Since only half a year had passed since the plan was created, there had basically been no change. However, the company has indicated that both sales and recurring profit are growing faster than originally envisioned. The company suggested that semiconductor- related sales and recurring profit would be revised when the financial results for FY3/23 were announced, but it has maintained a cautious stance to date.

Strengths and weaknesses

Shared Research believes that TOCALO's three main strengths are its portfolio of diverse surface treatments that makes the company the leader in a niche market; its ability to acquire top-class customers in major industries through joint development focused on meeting future needs; and stable earnings due to high domestic repeat demand for technologies with added value.

Shared Research has identified three notable weaknesses: a lack of peripheral technologies and mass production bases necessary to process large orders; lackluster cultivation of overseas markets; and low profitability of the Other Surface Treatments business. (See the "Strengths and weaknesses" section for details.)

Surface treatment technologies offered by TOCALO

Thermal spraying

A surface treatment technology that involves forming coatings on the workpieces by spraying them with molten metals, ceramics, cermet*, and other materials.

*Cermet: a composite material that is created by combining powder from hard compounds (metal carbide, nitride, etc.) with metal bonding materials, then sintering the mixture

Chemically defined zinc alloy coating (CDC-ZAC)

A chemical densification treatment for forming composite ceramic coatings through chemical reactions. It is characterized by excellent corrosion resistance and high degrees of hardness, which are unique properties of ceramics.

Toyota diffusion (TD) process

A surface treatment method that enables the formation of super-hard coatings. It is essential to the metallic mold industry as a surface treatment technology.

Plasma transferred arc (PTA) process

An overlay-welding method that utilizes plasma and produces excellent impact resistance.

Physical vapor deposition (PVD) process

This process minimizes heat deformation of the workpiece because it allows for a wide selection of temperature ranges, enabling treatments that best suit the substrate (the material to which spraying deposit is applied).

Source: Shared Research based on company data

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KeyIncome statement financial	FY03/14	datFY03/15	aFY03/16	FY03/17	FY03/18	FY03/19	FY03/20	FY03/21	FY03/22	FY03/23
(JPYmn)	Cons.	Cons.	Cons.	Cons.	Cons.	Cons.	Cons.	Cons.	Cons.	Est.
Orders	23,097	27,137	28,343	29,506	36,851	38,915	38,011	39,021	45,394
	YoY	10.2%	17.5%	4.4%	4.1%	24.9%	5.6%	-2.3%	2.7%	16.3%
Order backlog	2,774	3,843	3,440	3,983	6,725	6,081	6,195	6,143	7,896
	YoY	21.9%	38.5%	-10.5%	15.8%	68.8%	-9.6%	1.9%	-0.8%	28.5%
Sales	22,599	26,068	28,746	28,964	34,109	39,558	37,896	39,294	43,813	48,200
	YoY	8.0%	15.4%	10.3%	0.8%	17.8%	16.0%	-4.2%	3.7%	11.5%	10.0%
Gross profit	7,564	8,964	9,727	10,536	12,646	13,761	12,780	14,593	16,585
	YoY	10.8%	18.5%	8.5%	8.3%	20.0%	8.8%	-7.1%	14.2%	13.7%
	Gross profit margin	33.5%	34.4%	33.8%	36.4%	37.1%	34.8%	33.7%	37.1%	37.9%
Operating profit	3,483	4,568	4,806	5,646	7,110	7,741	6,550	8,890	10,255	11,200
	YoY	19.9%	31.2%	5.2%	17.5%	25.9%	8.9%	-15.4%	35.7%	15.4%	9.2%
	Operating profit margin	15.4%	17.5%	16.7%	19.5%	20.8%	19.6%	17.3%	22.6%	23.4%	23.2%
Recurring profit	3,657	4,890	5,028	5,801	7,363	8,076	6,812	8,914	10,571	11,400
	YoY	19.6%	33.7%	2.8%	15.4%	26.9%	9.7%	-15.7%	30.9%	18.6%	7.8%
	Recurring profit margin	16.2%	18.8%	17.5%	20.0%	21.6%	20.4%	18.0%	22.7%	24.1%	23.7%
Net income	2,176	3,031	3,016	4,070	4,836	5,441	4,404	5,463	6,909	7,444
	YoY	16.2%	39.3%	-0.5%	34.9%	18.8%	12.5%	-19.1%	24.0%	26.5%	7.7%
	Net margin	9.6%	11.6%	10.5%	14.1%	14.2%	13.8%	11.6%	13.9%	15.8%	15.4%
Per-share data
Issued shares FY-end('000 shares)	63,200	63,200	63,200	63,200	63,200	63,200	63,200	63,200	63,200
EPS	35.8	49.9	49.6	67.0	79.6	89.5	72.5	89.9	113.6	122.4
Dividend per share	12.5	15.0	18.8	21.3	26.3	30.0	25.0	35.0	45.0	45.0
Payout ratio	34.9%	30.1%	37.8%	31.7%	33.0%	33.5%	34.5%	38.9%	39.6%	36.8%
DOE	3.3%	3.7%	4.2%	4.4%	4.9%	5.1%	3.9%	5.0%	5.9%	5.3%
Book value per share	390.2	427.4	456.9	504.1	562.1	617.8	662.3	727.1	807.3
Balance sheet (JPYmn)
	Cash and cash equivalents	10,181	8,404	8,197	8,387	9,234	12,660	16,889	16,227	17,110
Total current assets	19,700	21,527	20,830	23,000	25,941	27,749	31,837	33,140	36,365
Tangible fixed assets	12,735	14,055	16,151	20,305	24,589	27,395	26,786	28,594	30,740
Investments and other assets	553	597	914	911	1,871	1,838	2,160	2,183	2,180
Intangible assets	519	467	97	115	260	295	338	264	231
Total assets	33,507	36,647	37,992	44,331	52,664	57,278	61,122	64,183	69,517
	Accounts payable	2,442	3,189	3,036	1,229	1,434	1,271	1,157	1,194	1,397
	Short-term debt	1,137	943	511	905	879	1,218	2,153	1,802	1,460
Total current liabilities	7,393	8,383	7,877	8,884	14,054	13,362	11,323	12,193	13,334
	Long-term debt	653	284	117	2,419	1,701	3,337	6,045	4,267	2,825
Total fixed liabilities	1,421	1,112	1,045	3,195	2,470	4,250	7,163	5,097	3,723
Total liabilities	8,814	9,495	8,922	12,079	16,524	17,613	18,487	17,291	17,058
Total liabilities and net assets	33,507	36,647	37,992	44,331	52,664	57,278	61,122	64,183	69,517
Total interest-bearing debt	1,790	1,227	628	3,324	2,580	4,555	8,198	6,069	4,285
Cash flow statement(JPYmn)
Cash flows from operating activities	3,465	4,546	4,534	5,238	7,611	8,044	6,621	10,588	9,873
Cash flows from investing activities	-177	-4,889	-895	-6,537	-4,681	-4,617	-4,217	-4,615	-5,044
Cash flows from financing activities	-165	-1,475	-1,743	1,581	-2,217	40	1,871	-3,798	-4,547
Financial ratios
ROA (RP-based)	11.5%	13.9%	13.5%	14.1%	15.2%	14.7%	11.5%	14.2%	15.8%	15.7%
ROE	9.5%	12.2%	11.2%	13.9%	14.9%	15.2%	11.3%	12.9%	14.8%	14.5%
Equity ratio	70.8%	71.5%	73.3%	69.1%	64.9%	65.6%	65.9%	68.9%	70.6%	71.0%
Capex, other (JPYmn)
Capital	2,513	2,678	3,730	5,936	6,361	5,965	2,313	4,822	4,385	5,500
expenditures
Depreciation	1,388	1,440	1,560	1,703	1,948	2,658	2,991	2,771	2,783	3,000
R&D expenses	653	746	862	834	905	1,003	1,159	1,296	1,296	1,425
	R&D ratio	2.9%	2.9%	3.0%	2.9%	2.7%	2.5%	3.1%	3.3%	3.0%	3.0%
Employee data (JPYmn)
No. of employees
(ex. temp.	802	824	857	898	955	1,021	1,060	1,121	1,176
workers)
	Temporary workers	242	243	239	245	236	251	263	253	265
Total no. of employees (incl. temp. workers)	1,041	1,056	1,080	1,123	1,163	1,239	1,304	1,344	1,414
Sales per employee	21.7	24.7	26.6	25.8	29.3	31.9	29.1	29.2	31.0
Operating profit per employee	3.3	4.3	4.5	5.0	6.1	6.2	5.0	6.6	7.3

Source: Shared Research based on company data

Notes: Per- share data is adjusted for stock splits. Figures may differ from company materials due to differences in rounding methods.

Citing the application of the accounting standard for revenue recognition from FY03/22, the company has not released YoY growth rates, but Shared Research has provided estimates as the size of the impact appears to be limited.

TOCALO 3433

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