TOTO, the Japanese company best known for high-tech toilets and its dominant “Washlet” brand, has become an unlikely AI winner. Here's why, with as little potty-talk as I could muster.

Shares in the Tokyo-listed group, code 5332.T, have jumped almost 30 per cent over the past month. Much of that gain has come since 17 February, when London-based activist investor Palliser Capital published a detailed presentation arguing that TOTO is one of the most undervalued beneficiaries of the artificial intelligence boom.

Between Friday 13 February and Wednesday 17 February alone, the stock rose by almost 12 per cent, before extending its rally in the days that followed.

Before we go any further, it's worth noting the elephant in this particular room in that Palliser is already a holder of TOTO stock and benefits from any kind of increase in its share price. And likening any company to an AI investment can do wonders for its value these days.

For most investors, TOTO is a plumbing company. In Japan it holds about 56 per cent of the Washlet market and 45 per cent of the toilet market. It sells basins, taps and bathroom fittings around the world.

Palliser’s - in its recent presentation - argued that TOTO's real future value could be unlocked in an entirely different way. As a specialist supplier to the semiconductor industry, making advanced ceramic components used in the machines that manufacture memory chips.

AI systems, from chatbots to image generators, rely on vast data centres filled with powerful chips. These chips need memory, which stores and retrieves the data the system works on. When demand for AI surges, demand for memory chips often follows.

Making those chips is extraordinarily complex. Companies such as Samsung, Micron and SK Hynix build memory by stacking hundreds of microscopic layers on top of each other. To carve precise holes through these layers, chipmakers use specialised machines made by equipment suppliers such as Lam Research.

TOTO’s Advanced Ceramics division makes pieces called electrostatic chucks for a specific type of etching process known as cryogenic dielectric etching, used in advanced 3D NAND memory. Phew. The punchline here, according to Palliser, is that TOTO is the dominant supplier for this niche and has worked with Lam Research for decades.

In effect, TOTO supplies a critical part of the machinery that enables the production of cutting-edge memory chips. It does not design the chips. It does not own the data centres. It provides the “picks and shovels” used in the digital gold rush.

This part of the business is far more profitable than its bathroom operations. Palliser says Advanced Ceramics now contributes more than half of group operating profit and earns returns well above the company’s cost of capital.

Yet the market has continued to value TOTO largely as a mature housing equipment company. Over the past five years the stock has significantly underperformed Japan’s broader market. Its valuation multiples sit near 10-year lows and are similar to domestic peer LIXIL, despite stronger margins and returns.

That disconnect is the crux of Palliser’s case.

The investor argues that as AI drives demand for higher-performance memory, chipmakers must adopt more advanced manufacturing techniques. That increases the use of cryogenic etching tools and, in turn, the need for TOTO’s components.

Boldly, it forecasts revenue growth of more than 30 per cent a year for the Advanced Ceramics division over the next two years.

Palliser also contends that TOTO has not done enough to highlight this business to investors. In its January investor presentation, only one page was devoted to Advanced Ceramics.

Given the increase in the stock price, Palliser seems to have done what TOTO wasn't when it comes to advertising the company's AI contributions.