by admin on December 9, 2012

I wrote this article for the Value Conferences Japan Investing Summit, held a few weeks ago – highly recommended with good insights.


Although not well remembered, the day before the earthquake last year, there was a pre-tremor. My apartment is designed to wobble, and I remember it. At that very moment, I was speaking to someone on the phone about analyzing a company, and the wobbling was distracting me.

The name of the company was Doshisya (7483), and I was considering whether to increase my small position in it.

The next day, we all know what happened. And, I did not even think about my shares even while the market was still open and the building started moving around a lot. There was a lot of confusion for central Tokyo – most restaurants, even McDonalds, was closed; a lot of people in uniforms were saying things on megaphones, crowds assembled in front of anywhere selling fast food, all the bottled water in convenience stores had gone, and throngs of salarymen were walking home through the streets, but they were much more lively than usual.

During the weekend, escaping Tokyo for Osaka was surprisingly easy – the train was only half full. I remember watching unreal scenes on the television with friends, everyone blown away, not believing that it was happening. I knew the market is going to get completely decimated when it opened on Monday, and I knew I had to go all in.

The two biggest positions I opened were Doshisya and Sotsu. These are both growing, high-value adding companies that were priced comically low before the disaster, and after it they were priced for … I don’t know what.

I still have a sizable position in Doshisya, and a small one in Sotsu. I think they are still cheap given how good they are, although obviously they are not as cheap as they used to be.

This post is about Doshisya – I will talk about Sotsu another time.

The company does a relatively good job of explaining what they do in English:

“… planning and development, manufacturing, procurement and a wholesale of household products. Rather than a standard wholesaler, we regard ourselves as a distributor-cum-service-provider that creates products, marketing approaches, and systems from totally fresh perspectives and, through collaboration with our customers, resolves various issues that can arise in the series of processes involved in distribution”

You can see the full document here:

They also have a set of data in English here:

Essentially, they get private brand products made for retailers (Development segment) and they import luxury products and sell them in Japan (Wholesale segment). Margins for Development are higher, because you can’t simply go to China, pick the first manufacturer, and expect your golf clubs to come out looking like you wanted them to. They add value by making sure things here don’t go wrong.

Wholesale has grown operating income 26% from 2010, and Development has grown 6.5% during that time.


Doshisha Sales Doshisha Sales etc.

The company is not expensive (valuation below), but the question is: are there margins sustainable over the long term?

Although I think that in the short term they may have some deterioration in margins because of their specific product mix this year, over the long term the outlook is better.

The reason why I believe this are:

1. I think their existing customers get value out of them. Retailers get rewarded for bringing out new products to counteract deflation. Doshisya is involved in the entire product planning process with their clients (in their Development segment), the cost of failure is high, so it is difficult for them to move to a different vendor, and Japanese clients will often stick to their suppliers out of habit.

2. They have a good track record of margin expansion and increasing inventory efficiency, as shown in the following chart of sales, inventories and “ordinary profit” (operating income + non-operating income) from 1996 to 2012:

(Blue = sales; Yellow = inventories; Red = ordinary profit)


Doshisya long term view Doshisya long term view

3. The strategy going forward is to hire sales people for more niche products, which can attract higher margins. (Although this can be risky for areas which they have not dealt with yet, it should diversify risk overall.)

4. They have shown that they are adaptable to the consumer environment. For example, after the earthquake, they were very quick in bringing out energy-saving products, such as LED lighting and products to deal with the summer heat without air conditioning (for people in some parts of Tokyo).

The company’s grand target is “50 business units, each doing 5 Billion Yen of sales” – which seems ambitious at the moment, as they are only doing 100 B Yen in total sales. In the nearer term, they are targeting sales of 150 B Yen by FY15. Is this nearer-term target achievable?

They have done better than that in a single year – in 2010, they grew earnings impressively (by 68%) in the face of a recession by expanding sales channels and focusing on lower-priced items.  Not every year is equal – the business has some inherent lumpiness, particularly when a big event occurs, but their track record during the ‘08/’09 financial crisis and the ’11 Japanese annus horribilis speaks for itself.

150 B Yen in 3 years is a revenue growth rate of about 14% per year. Given that they grew about 8% per year from 2008 to 2012, they really need the new specialization concept to work, or buy an overseas company, which they said they are trying to do – this might not be the best allocation of capital, but it is better than keeping cash just lying there.  The company says that it is going to go about this growth through specialization gradually. They recently put out a bunch of press releases about moving people around their organization, so it seems they are doing something. They point out that they have been agile in the past, restructuring loss-making units quickly. Indeed, they have around 2000 people, which is not that small, but they do seem to make decisions quickly – and they have been lightning fast in the past compared to most Japanese companies.

I would prefer to not buy companies where their competitive advantage is the management, but management at Japanese  companies is not one person – often, it is not even one team, but a pervasive culture, so that makes me feel a little better on this point.

My biggest concerns are poor explanation of what is going on with the cashflow statement, and their recent hiccup with electronic goods that might ruin their annual results and potentially give rise to a market disappointment and selloff – see below for details.  The lack of apparent cashflow accountability is a recurring theme with Japanese companies – it would be nice if they did not sell 617.8 M Yen of stock last year but would buy some back instead, and the capex plans are foggy – half-jokingly, I tend to suspect Japanese companies of building golf courses for management use.


My valuation method is to value the balance sheet conservatively and then take a stab at the long-term cashflow. For the balance sheet, I take that part of the current assets that might survive a bankruptcy scenario, subtracting total liabilities, and then adjust pension liabilities and add on any investments and land if necessary.

Main bills receivable counterparties:

These account for about half of the bills receivable.


Main accounts receivable counterparties:

These account for about 16% of accounts receivable.


After taking some parts of the current assets out, I get to an adjusted current asset value of 36 B Yen, and an adjusted net current asset value of 22.7 B Yen.

I gave them a lower discount for inventory and accounts receivable than I do for other companies. The reasons for this are: 1. they are good at clearing inventory – it’s what they do; 2. their counterparties are mostly cash retail businesses – generally a robust model from a creditor’s point of view (as noted by Graham), and it is unlikely that more than 25% of their counterparties would go bust simultaneously; and 3. for a lot of their counterparties they can control their own destiny to an extent.

Anyway, on their books they also have 5 B Yen of investments, 4.2 B Yen of buildings (net of depreciation), and 4 B Yen of land. The land basically consists of 1,618m2 of office space in two sites in central Osaka, and 1,274m2 in the best part (in my opinion) of Tokyo. The land in Osaka is very conservatively valued – I know the area (Shinsaibashi), and it is not cheap. The average price of commercial real estate in that district is about 1.3 M Yen per m2, and the most expensive is about 4.9 M Yen/m2. Even though their Osaka land is in a good area, it is valued at only 0.5 M Yen/m2. The Tokyo land is a similar story, valued at 1.9 M Y/m2 on the balance sheet, but worth at the very minimum that much – the average for the district is 3.2 M Y/m2. I did not cut the value of their land in the valuation.

It is difficult to work out what the buildings might be worth, so I cut the distribution center out completely, and cut the remainder by 50%, leaving 1.6 B Yen.

Of their investments, the only part I took into consideration was the securities (book value of 1.6 B Yen). Of this amount, the actual value is probably lower. In the last annual filing, the book value of the securities was 1.2 B Yen, and those might only be worth about 1 B Yen – I looked at each of the names given, and one of the companies on there appears to be bankrupt (Honma Bussan), or at any rate is not listed. I used the figure from the annual filing (more conservative), assumed that “Others” are worth zero, and discount the rest by 50%, assuming that they will likely not sell these shares (they seem to be those of their counterparties).

This all gives us a value for the dead business of 28.8 B Yen.

Doshisha holdings Doshisha holdings

The market cap is 42 B Yen, meaning that you are paying around 13.2 B Yen for a company that is forecasting net income of 5.1 B Yen for this fiscal year, and is growing (although they could well shrink this year). The business is not capital intensive, so I assume that net income is basically free cash flow.

Consider two scenarios: firstly, if they can reach half their target for 2015 for sales with flat net margins, then their net income CAGR will be 7% – how much would you pay for that? Surely you would cough up 7x earnings net of the balance sheet value, right? Well, that would be about 73 B Yen, or 82% upside. Now consider, just for the sake of argument, what would happen if they met their target and their margins expanded by 50 bp – that would imply a value of about 86.5 B Yen. You can see that doubling the growth rate and increasing margins a bit does not have a huge impact on the valuation, because so much of it is already in the balance sheet to start with.

I think that the risk with the stock here is that the company has bad results this year and the stock gets sold off – they missed guidance recently for the half year by 21%, and they revised down their guidance for the full year, saying it will be in-line with the first half.

This is due to a large drop in audio-visual sales because of the end of the switch to digital TV. It’s pretty bad that they could not anticipate this. However, they have had much worse slip-ups in the past, such as their massive 1997 inventory build, which they were completely honest about and cleared up properly.

If it does get sold off due to this reason, it would be another good entry point into a stock with long-term growth and otherwise good margins. However, if this does not happen, then the stock could perform rather well. The market can already see the deterioration in the quarterly results, so any surprise would have to be worse the already reduced guidance.

Applying a risk weighting to the sell-off/ non-sell-off scenarios can help you think through these situations, even if the probabilities are unknowable. For instance, there might be a 30% chance of a year-end miss in the results that send the shares down 20%, and a 70% chance that they grow at half their target (the assumption of no margin improvement is too conservative for that scenario, but let’s just run with it for now). That gives us an estimate of 51% upside with somewhat conservative estimates. Even if they do not hit half their growth target, knowing their track record lets me sleep a bit easier, even if the treatment of shareholders is not ideal.

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