Use rags for riches

by admin on January 25, 2013

As I said in a previous post, I do not think it is safe any longer to rely on macro factors to generate riches for you in the Japanese stock market. I think it is likely that from now it is a good idea to focus more on stocks with actual built in alpha generation. The good news is that, much more so than in the US, it is not uncommon to see companies in Japan where growth is quite obvious but completely ignored, and then suddenly the market rushes to catch up with reality.

The following stock idea is a similar mental construct to the bets on car parts retailers which are so well known amongst value investors such as Sequoia and The Buffett himself.

I originally started investigating トレジャー・ファクトリー after my research into short candidates in the UK pawnbroker space last year, which got me thinking about store expansion. I did not end up shorting ABM.LN and HAT.LN. However, at that time, both companies gave me the distinct impression of being like a vehicle labeled “Store Expansion” rapidly approaching a brick wall emblazoned with “Welcome to Saturation”. All you need to open a “gold purchasing” (aka “stealing from the poor”) joint is some brightly colored cardboard and a guy with cheap shirt and an indifferent expression.

Now, with second-hand stores in Japan, the situation is actually completely different. The fundamental dynamic is that you need to get the merchandise. The goods come from people who want to sell them, and from manufacturers’ excess lots. There is only a limited supply of stuff in a given area. If you have ever played a strategy computer game where you need to get the gold to make more armies to invade more territory to get more gold, then you have a reasonable idea of how to win – keep on growing and take away the other players’ gold.

If you are a small operator, your cost per store will be high, efficiency low, and manufacturers with excess lots will not bother to deal with you. Less goods means less customers, means eventual death.

Scale matters.

TF is the biggest “recycle/reuse” shop in the greater Tokyo area. This strategy is not a happy coincidence – they actively went out and did this, and they discuss all of these strategic factors in their filings.

Store expansion:

Period ending Feb: 2008 2009 2010 2011 2012
New store openings 5 6 8 10 6
Stores closed 0 0 1 1 0
No. of stores 27 33 40 49 55

The strategy going forward is to expand outside the Tokyo area. They have the infrastructure from the current operations, so they need to use it to get merchandise in other areas.

More about the company:

Products sold are clothes, electronics, furniture, branded goods, jewelry, hobby goods, etc. Their biggest categories by sales as of last FY were clothes & accessories (52.7%) and electricals (20.8%).

They buy stuff from customers who come to their stores, and also visit customers to buy things from their homes. Their other merchandise comes from manufacturers’ excess lots and via their websites. They are more organized than general recycling shops because they have call centres and logistics centres.

About the market:

Customers in Japan take amazing care of old stuff. In an average Japanese home there will be boxes and instructions for everything, so that the products can be returned/sold if necessary. Second-hand goods in Japan are much more expensive than in Europe. I have never seen a second hand shop in the US, so I cannot comment about that. Sorry, I don’t hang out in that part of the Bronx.

The market for re-used products has been growing in Japan despite all the bad news related to the general economy in recent years. The reason for this is that consumers want to have nice things but also don’t want to splash too much cash (or at least feel that they are not doing so).

As bizarre as it sounds, in Japan you need to have an operating licence to run a second-hand goods store. It gets even better – the rules change by prefecture. I do not know this for sure, but I have the feeling that there was more of a free market in second-hand goods in parts of the Soviet Union, because there were lots of restrictions but everyone ignored them, whereas in Japan there is no such thing as disobeying rules. This regulation is potentially an issue when moving outside of their current area, although they are already in five prefectures in the Kanto region. There are other regulations they are exposed to, such as those related to retailing electronics. All of this red tape favors the big players.

Interestingly, one of the risks disclosed in their annual filing is that if they procure stolen goods and if it is found that they are stolen within one year then they need to give them back to the original owner. I was not aware that stealing exists in Japan, other than in the context of government corruption/ Olympus-style fraud. In November, I left my iPad in my bicycle basket (yes, I have an uncool bicycle) for 25 min about 20 m from Roppongi Crossing – the equivalent of perhaps Times Square or Piccadilly Circus. Of course, it was still there when I came back. I won’t do that again.

Risks: They are not the only change doing this. Competition is increasing. But then, the market is growing. If Japan suddenly bursts into a fully-fledged night-vs-day recovery, then interest in “reuse” stores will go down. If little changes domestically, then the environment for them should be net positive, I believe.

Development other than new stores: They are working in collaboration with other companies on shared purchasing. They are also introducing new ways of getting goods, such as new forms of advertising and using coupons

Valuation

The value in this company is not in the balance sheet, but rather in the network and ability to dominate regional markets due to having good systems and infrastructure.

Balance sheet: Not much to see here. Their current assets (c. 1.9 B Yen) contain quite of lot of products (0.82 B Yen), but then again that merchandise would be readily salable in a liquidation, albeit at lower prices. They have some buildings.

Although they do own some existing property outright, they rent new stores, and do not buy them. In Japan, you need to put up a huge amount of money when renting any property, and typically get ripped off (as has happened to me three times already) when moving out of somewhere – when I moved out of my last place they charged me something like $350 for “cleaning the air conditioner”(!). The company’s deposits and guarantees related to property rented totaled 0.57 B Yen out of 0.69 B Yen of investment assets as of the last Q. Basically, you need to cut those investment assets by, say, half. Total liabilities are 1.5 B Yen, which is about equal to current assets if you cut the product inventory by half. Yawn. I think their enterprise value adjusted according to my method might be 2.98 B Yen (current mkt cap) – 0.75 B Yen = 2.23 B Yen.

P&L: The largest component of SG&A is payroll, which, if you include although bonuses and welfare etc., came to 2B Yen in FY2012, up 14.8% YoY, while store lease expenses (including utilities) were 0.93B Yen, up 11%. It seems like their operating leverage is a bit constrained with this headcount growth. However, as you will see below, they are still growing margins with sales.

Cashflow: They say that their capex is focused on new store expansion, which makes sense. They are not a capital-guzzling monster, only spending 100M Yen on tangible fixed capital investment in 2012 and 226M Yen in 2011, despite 6 and 10 store openings in those respective years. FCF for 2011 and 2012 was 121M Yen and 336M Yen, respectively.

The question:

How much are you willing to pay for a company like this?

TF financial metrics & growth rates TF financial metrics & growth rates

My answer: 13 times EV/FCF, which I think might be a market cap of around 5.1B Yen, and that is approximately 1870Y/Sh, or upside of 80% or so. Either I have completely missed some big iceberg here or the stock is pricing in big growth failure.

Disclosure: I always talk my own book, and never say anything unbiased.

{ 2 comments… read them below or add one }

罗臻 January 30, 2013 at 5:32 pm

Can you recommend any sites for info/financial data on Japanese stocks? I’m really looking for a screener, but anything would be better than nearly nothing. There is a “firewall” between Japan and the rest of the world, such as Yahoo Finance having an entirely separate Japan site with no crossover info.

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admin January 30, 2013 at 6:08 pm

I recommend you use Bloomberg. If you want detailed and accurate information on specific stocks, I recommend you use my translation service. The only safe place to get data from is government filings (equivalent to SEC filings), in my opinion. It is in Japanese. If you don’t have any money for Bloomberg or translation/research, then you can look into mutual funds.

JP

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