This article is about a specialist retailer with a highly stable business trading at an extraordinary price.
The business
Tsutsumi jewelry’s motto is “cheaper and better”, and they have a vertically integrated system, starting from purchasing precious stones overseas, to manufacturing and sales. This manufacturing-plus-sales combination (including sales to wholesalers) obviously means they capture more of the value chain than a simple retailer, and makes analysis (such as same-store sales) more difficult. Approximately 90% of their sales is retail, and approximately 10% is wholesale. The Wikipedia entry for them states that in 2006 they were the largest importer of diamond rings into Japan for 12 years consecutively. They have 179 stores. In the last year period they set up seven new stores, renewed nine existing stores, and closed down three stores.
Net margins are around 6%, whereas Tiffany has net margins of about 12%.
They state that they are focused on cash flow, eps, and return on equity (which is a little mind blowing for a Japanese company).
Their long-term strategy is to basically do what they are all already doing, but to do it even better. Although that may sound a little simplistic, the lack of a desire to engage in M&A, which Japanese companies often do so badly, and just stick to the knitting, is good news.
The company only provides sales and production data for segments, but no operating income data. As you can see, they sell a lot more than they produce:
Tsutsumi Jewelry Segments
What draws me to this company is that, despite having an outrageously attractive balance sheet, the business is stable in character and produces a good stream of free cash flow.
Outlook
Management has recently been complaining about Europe, oil prices, and the general economy, and they expect these factors to continue.
Within their industry, they expect customers to continue to be very selective, and for the market to continue to be very tough (but, of course, they will continue to work really hard to develop new products and set up attractive stores).
Dividend policy
The basic policy is to continue stable dividends. Somewhat disingenuously, they say that they are “effectively” investing retained cash in new stores and improving the “foundation” of the business. Perhaps they will do a sudden U-turn and start investing their mountain of cash soon, however, there is no apparent sign of it.
Also, they expect to keep the dividend unchanged for the next year – what is the point of having all that cash on your balance sheet? Yield is currently pathetic.
EPS forecast for 2013: 119.55 yen
If this sort of thing excites you, then you should note that 2013 eps is forecast to be greater than 2008.
Land
They have 2617 m2 of owned retail space in the Kanto region alone (in and around Tokyo), which they put down on their books as worth 8.8 billion yen, or 3.38 million yen (c. $42k) per m2. Such a valuation seems preposterous at first glance. However, we must bear in mind that you don’t put a jewelry store in the same place as you put a grocery store. These sites are expensive. Just take a look at their locations here: http://www.tsutsumi.co.jp/shop/area02/
Click on any of the store names to see the map. Basically, most of them are near train stations, and while not the absolute center of jeweler paradise (Ginza), they appear to be good locations where relatively rich people live in Tokyo. As an example, I randomly selected one of these (吉祥寺, http://www.tsutsumi.co.jp/shop/area02/26/shop26_18.html), and had a quick look on some real estate websites to get an idea for what kind of prices real estate transacts at in that area.
Land with residential housing on it in Kichijyouji appears to sell for around 0.47 – 0.53 m yen/m2, and with general retail space at around 1.5 m yen/m2. Obviously, the kind of retail space required for selling jewelry is going to be significantly more expensive. However, for the purposes of our valuation, we can assume that it is worth only slightly more than general retail space in roughly the same area. The other property is valued much lower, with its headquarters at 0.36 m yen/m2, about in line with residential real estate prices in a local area, and its factory much lower.
Largest customer
This company: http://gold.tanaka.co.jp/index.php, at 4,847 M yen in FY 12 (15.6% of sales, up from 2448 M yen in FY 11).
Balance sheet
Obviously, when looking at the stress case for a jewelry company, you do not need to aggressively mark down their raw materials, but their inventory is more complicated. If the latter consists of a truckload of gold and diamond rings, then the markdown does not need to be very sharp, as a bankruptcy would involve taking some material marked at retail values and reselling it at a discount to wholesale value. However, if the inventory consists of highly fashion-dependent items, then a serious discount is required. In this case, most of their inventories are rings (10.1 b yen), followed by necklaces/ bracelets (5.6 b yen) and small articles (1.8 b yen). I know next to nothing about jewelry, but it seems to be appropriate to heavily mark down necklaces and bracelets rather than rings. Wedding rings in particular are less of a discretionary purchase, and it appears to me that there is less stylistic concern with rings than with larger items.
Guarantee deposits consist of money held at something like a real estate agent when you lease a property. Since bankruptcy would involve the release of part or all of such deposits, they are very relevant to a valuation. However, as we do not have any information on where these deposits are held, and what kind of a haircut would be involved in unwinding them, we just have to take a guess at an appropriate discount (20% used.) Last time I moved out of an apartment in Japan the remediation expense was ridiculous, given that there was nothing to remediate. My guess is based on that experience plus a consideration of potential credit risk.
Tsutsumi Jewelry Balance Sheet
Cash flow
The company basically has very stable cash flow for a retail enterprise. This can be seen from the following numbers, including the year 2009:
Tsutsumi Jewelry Cashflow
Owners
Seiji Tsutsumi (48.5%), Shizuko Tsutsumi (6.33%), Tsutsumi Educational Foundation (4.97%), State Street Bank And Trust Company (4.50%), as well as a lot of other foreign banks.
Conclusion
This company is selling significantly below bankruptcy value but yet has a stable character to its business, as evidenced by its free cash flow. It is not quite clear why this company is trading at such a significant discount, besides the fact that it is in Japan. The only thing I can guess at is that its earnings and cash flow multiples are significantly higher than those of retail peers due to its bloated current asset position (the median PCF for retailers in Japan is about 5.9), and that it has no immediate prospect for a big payout, and no prospect at all for a change of control. Some more disclosure would be nice.
This is not Tiffany, and likely will never even aspire to be, but it is a stable business selling at a price below bankruptcy value. I choose to look at this issue as a bond substantially below par.
Disclosure: I am long this stock.
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Nice call – 56% in 9 months. Wish I was reading this back then.
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