JR Central: Reinitiating Coverage; Stock Screens as Overvalued

We initiate research coverage of Central Japan Railway Company 9022, or JR Central, with a fair value estimate of JPY 16,000 per share, based on a weighted average cost of capital of 4.5%. While owning high-quality infrastructure, we think it is overvalued, trading about 20% above our valuation. Forward valuation metrics are undemanding, with a P/E ratio of 15 and an enterprise value/EBITDA multiple of 9. But we think returns on invested capital are destined to fall when the Chuo magnetic levitation Shinkansen starts operating late this decade, even if this costly project is delivered on time and budget. The forecast dividend yield is 0.7% because of a very low dividend payout ratio of about 10% as the firm retains earnings to pay for the new Shinkansen.

We assign a narrow moat rating based on the firm’s high-quality rail infrastructure. Its Tokaido Shinkansen dominates passenger transport between Tokyo and Osaka, generating strong returns on invested capital. Competition is minimal given the Shinkansen’s unbeatable departure frequency, convenience, travel times, safety, and reliability. The superfast Chuo Shinkansen will further cement JR Central’s dominance on this route, though we expect it to dilute returns. Basic train fares are regulated but the firm can boost returns through add-ons like first-class tickets and seat reservations. Additionally, its in-station retail and advertising business generates solid returns by leveraging foot traffic through the stations.

We expect strong earnings growth in coming years, driven by recovering demand from commuters and tourists following the pandemic. But further out, earnings are likely to fall as the Chuo Shinkansen adds costs and cannibalizes revenue from the Tokaido Shinkansen.