An amazing story – an unheard of firm that has 55% of the Japanese paint market!

Well, you may think that we are overly sentimental, but my fiancé and I have decided to paint our house blue.

Tiffany Blue to be exact.

Well, there are a number of reasons for that, like what’s in the little blue box with the ribbon, but for now I want to focus on what should interest you if you are an investor with an interest in finding exceptional small-cap companies with great growth prospects and reasonable valuations.

But yes, I did ask the rhetorical question in the title: “These guys make high-tech what?”

Paint?

Yes, and here’s the story behind the stock, SK Kaken (4628) which I will talk about in more detail below.

The magic in the paint that we chose is not just the romantic color, Tiffany Blue, but rather the engineering that went into this paint, and many others that SK Kaken makes. But first, a snippet of information to whet your interest. SK Kaken already controls about 55% of the entire Japanese market for building paints and coatings. And is almost unknown outside the building trade. More than half the market means they have built a moat around their business, and expanded it.

You see the chief executive of the company, Takashi Fujii, made a shrewd decision about 20 years ago – almost to the date. The Japanese stock market bubble – or more accurately, the Japanese asset bubble – had just burst, and with it sayonara to the housing and property boom that of course had thrived in the few short years of the boom. (For you readers who know the depths to which the US housing market has fallen since the Lehman crisis, that is what it was like in the early 90s. What you may not know is at the moment, Japan with its population of 128 million had more housing starts in 2011 than the entire US. Oh well, don’t blame the borrowers, blame the lenders who should have known better, as fiduciaries.)

Fujii-san realized that going forward, the driver for the Japanese exterior paint business was going to be renovation, not new construction. Japan has some 40 million buildings, and if on average they are renovated – ie. repainted – every 20 years, that means 2 million per year, and if 10 years double that. Housing starts which peaked at 2.2 million in 1989 have been below a million for the past 2 decades.

But that insight alone would not have been enough to propel SK Kaken (4628), the company established by CEO Fujii-san’s dad in 1958, to the top of the league tables. Rather, he understood that to serve the needs of a vast range of new customers, not just new home builders, SK Kaken would have become an innovator, and that is indeed what they have accomplished. When last I visited them near Osaka, I had some 20 minutes before the taxi arrived to take me back to the station, so I asked for a tour of their showroom. A senior managing director gave me a personal tour. Not a big space, but an eye-opener to a layman with little previous “exposure” to paints and coatings. SK Kaken has several hundred patents for its coatings, which reflect light to cool buildings, absorb UV rays to extend their useful life, and can give a very realistic look of granite at a fraction of the weight.

So why did we go for Tiffany Blue? Well, our general contractor is Sumitomo Forest (1911), a lumber and quality wooden-home builder that happens to own about 1% of the entire land surface of Japan. They have a renovation subsidiary which provides home-owners a sophisticated computer simulation of earthquake stress. The model told us we needed to put in bracing, so we had to tear out the old kitchen, put in a rigid cross-frame, and bring in a new one made by Yamaha. But Sumitomo is one of the major users of SK Kaken paint and coatings, so naturally I was excited to go through their catalog and later paint samples. Our Tiffany Blue home, like a pigeon egg, will provide shelter against heat, rain, winter, sleet and UV radiation, leaving us snug and safe with the knowledge that if the Big One comes, we’ll do OK.

Here at Capstone Japan we take pride in the fact we live, eat, wear, ride, and spend money with our favorite small-cap value investments. Every day.

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