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Japan reopens

It’s an investment I’ve been thinking about since the start of the pandemic. In my eyes, the Japan Rail system is one of the most optimized systems in the world, and has the take advantage of Japan’s conservative tax practice to bet on. Although it will be some time before the country allows full entry, let alone to return to 2019 traffic levels, there are other factors to consider. This includes the balance between US and Japanese yields, the decline of the yen and even consumption in the country. I will cover these points and more to initiate the first stage of due diligence required for an investment in Central Japan Railway Company (OTCPK: CJPRY), and in combination with articles on JR East (OTCPK:EJPRY), West (OTCPK:WJRYY), and Kyushu (OTC: KYYHF).

An image of the entire JR Central rail map.

JR Center

Central Japan Railways, called JR Central, is currently the largest of Japan Rail’s segments thanks to its operation of the Tokaido Shinkansen, the main high-speed rail artery between Tokyo and Osaka. This thoroughfare is also home to the major cities of Yokohama, Nagoya and Kyoto, and the region represents a GDP of over US$3 trillion. This puts it just between Germany and the UK in size, fifth in the world. In other words, JR Central covers 65% of Japan’s national GDP while covering only 24% of Japan’s land area.

JR Central market area summary.

JR Center

As is often the case with Japanese conglomerates, JR Central does more than just own rail lines and operate trains. The company also owns, operates, and develops real estate around stations, and if you’ve been to Japan, you know that large stations are mini-cities unto themselves. A full list of affiliates can be found here, but they cumulatively represent a minority of 20-30% of revenue per year. Transportation, and the Tokaido Shinkansen in particular, remains the main revenue driver, accounting for between 88 and 92% of transportation revenue per year. Considering the 2.5-hour train ride from Tokyo to Osaka typically costs well over $100 per passenger one way, you can see why this is the case after covering the ridership.

The cost and time of taking the shinkansen between tokyo and osaka.

Hyperdia

Breakdown of revenues 2019 vs 2020.

JR Center

In 2021, the company saw average monthly ridership volume increase year over year compared to pandemic year 2020. While the country has been slow to reopen and remains closed to tourism, the number of users rebounded in good health. The exact number of users is not shown, but indexed to 1987 levels of “100”. Between 2008 and 2019, a huge growth in ridership occurred, driven by a healthy economy, a huge increase in tourism, and operational efficiency. However, the pandemic caused ridership to drop 67% year-over-year. For the whole of 2021, ridership increased to 141, an increase of 166%. In terms of passenger numbers, before the pandemic, major stations had between 33,000 and 216,000 per day, but updated figures for 2021 have yet to be released. More insight can be gained by looking at revenue instead of these traffic metrics, but it’s good to see a significant rebound already. This is exclusively based on Japanese domestic travelers, as the country has only recently opened up to business travel.

train departures and passenger volume on tokaido shinkansen over time.

JR Center

Top resorts by attendance

JR Center

A problem that arises apart from the reduction in passenger traffic is the weakening of the yen. Japanese fiscal policy remains focused on low rates and the value of the yen has therefore fallen while higher yields can be found in the United States and Europe. I don’t have the FOREX expertise to determine how this will affect JR Central’s short-term financial performance, but I suspect the primary impact will be electricity costs. The FOREX impacts would be felt more if the company needed to buy foreign components, but I think most of the work is done domestically. Additionally, trains are extremely efficient compared to other forms of mass transportation, whether planes, buses, or cars, and trains may be able to fetch fares even more competitive ones that power starved planes or ICE vehicles.

Likewise, the Tokaido Shinkansen is already the preferred mode of transport between Tokyo, Nagoya and Osaka, due to time efficiency compared to planes and driving. As can be seen, business and domestic tourism is returning to pre-pandemic levels, which is having a significant impact on the company’s finances. The only concern will be based on the evolution of the Japanese economy, but I find that the temporary weakness is the time to pounce on equities. I will discuss the economic and tourism impacts in more detail in my article on JR East, to come.

A photo of mount Fuji from the shinkansen between tokyo and kyoto.

I’m ready to take the Shinkansen back. Mount Fuji March 2019. (Author)

Financial Summary

As one of the largest rail systems in the world, JR Central rightly generates significant revenue. In fact, revenue peaked at $17.2 billion for the year before the pandemic, from a low of $14 billion in 2014. However, as a growing business with a shrinking population and a stagnant GDP, revenue growth is minor. As expected, the pandemic has taken its toll on the industry, with revenue coming to a near halt due to shutdowns. Although rebounding slightly, overall revenues are about half of their previous levels. The increase in recent quarters is the result of increased travel and tourism nationwide.

A major problem remains related to national and international travel. As JR Central is the main transportation hub for Japan’s three major economic regions, the lack of business travel via Shinkansen is detrimental. While international business travel returned in March 2022, international visitor levels remain well below 2019 levels. Perhaps the pandemic has shifted priorities from in-person meetings to working from home, even at nationwide, reducing the use of the Shinkansen. Whether this lasts indefinitely or the trip slowly returns to normal is unknown. I think the picture won’t be clear until tourism returns, and it’s unclear when that will be.

JR Central Revenues and Growth Rates.

Koyfin

When revenue returns, I expect profitability to return as well. The 2012-19 bull cycle for JR Central saw a strong increase in profits, mainly thanks to a significant growth in tourism. Japan has always been famous for its culture, but that hasn’t translated into significant tourism until recently. However, I will also note that the company has been working on its own internal operational efficiency, which has also played its part in improving profitability. Elements include continued CAPEX around ticketing services, station infrastructure and the development of optimal, energy-efficient trains and routes. Although costly, past profitability and conservative spending continue to allow the lines to perform well. It’s good to see that EBITDA was able to turn positive again through 2021 and into 2022, and I think that bodes well even if revenue is slow to pick up.

EBITDA and Net Income of JR Central

Koyfin

One issue that can be raised with regards to JR Central is their large debt load. A significant sum was raised in 2017-2018 to begin construction of the Chuo Line, a magnetic levitation (maglev) shinkansen. This famous project has been in the works for at least 20 years and is finally approaching its initial completion in 2027. In fact, a majority of the line has been built (from scratch in the interior of the country rather than along the coast ) and there remains only the crossing of the great Southern Alps in the prefecture of Shizuoka. When complete, travel speeds of up to 500 kilometers per hour (310 mph) will cut travel times from Tokyo to Nagoya in half. While the pandemic puts a damper on work, adds risk from debt and reduced revenue, and may delay the completion of the new line, I find that JR Central remains financially strong for long-term security.

Total debt and cash of JR Central.

Koyfin

Although there is little evidence that one of the world’s largest train service providers is financially weak, problems do exist and will impact the share price. One of the most important is that the company’s valuation has not kept pace with financial performance. Due to the safety offered, investors have only sold the stock around 40% off the all-time highs of 2019. As such, the current price-to-sell ratio is double what it is trading for. normally, about 2.0x. Unfortunately, this means that the upside is limited due to the fact that a return to normal earnings will only bring the valuation back to normal at the same time. As such, margin expansion is not expected on the current financial statements. However, the key indicators will be the profitability and progress of the Chuo line, and successful breakthroughs could keep the valuation high.

JR Central share price and P/S.

OTC stocks as a benchmark. (Kofin)

Conclusion

Although it is often difficult to predict market lows, I find that there is currently more chance of improvement than decline, at least financially. Tailwinds include increasing international visitors, now students and corporate sponsors, with tourists expected to return, eventually. Uncertainty, however, is the main problem plaguing the stock price and leading to new lows. Personally, I think we are approaching a time when the share price will start to rise, in line with the number of users. Also seek to improve the country’s profitability and economic stability.

The current weakness of the yen may not be a problem as most costs are expected to stay in the country and foreign visitors will bring stronger currencies. However, tourism has less of an impact in this economically important region, and business travelers are the high-margin revenue stream that is needed. I will carefully monitor the monthly number of visitors and traffic, and may begin to add company stock in phases over the next few quarters. Then, when tourism returns, look for strong upside potential. It certainly doesn’t hurt to add a small portion of a safe international asset to your portfolio.

* As of May 6, Prime Minister Kishida appears the government is planning to open more in June 2022, a favorable sign regardless of the final timetable.

Thanks for reading.

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