Seria (SAOGF): Attractively Priced, Macro-Defensive, Japanese Retail Opportunity

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Introduction

Conditions for retailers are tough and likely to get materially worse from here. Retail profit and loss will face the main pressure as consumers react to runaway inflation by cutting spending where possible. Margins will shrink thanks to product cost inflation, rising personnel costs and ongoing supply chain issues. In addition to worsening operating conditions, negative investor sentiment is in many cases amplified by the view of comparing earnings to recent results that were driven by temporary COVID-related factors.

Given this backdrop, it seems to me that the relative winners in retail are likely to be those companies that stand to benefit as consumers change their buying habits and seek better value deals. While I have questions about the true underlying consumer value proposition of dollar stores, companies like Dollar General Corporation (managing Director), Dollar Tree, Inc. (RTDL) and Dollarama Inc. (OTCPK:DLMAF), seem to me to have much less potential risk of falling profits in a recessionary environment than many other North American retailers. These stocks have attracted a lot of investor attention and have been trading at high P/E ratios (20x to 25x for Dollar General and Dollar Tree, with Dollarama at ~30x). Being a value investor, I find these multiples to be fairly comprehensive, so I am not currently willing to delve into any of the stocks.

Frame
DG PE ratio data by YGraphics

The dollar store concept is very much alive in Japan in the form of 100 yen stores. In this note, I take a look at the number two player in the Japanese 100 yen store market, Seria Co., Ltd. (TBT: SAOGF).

Company and industry background

Serie operates 100 yen shops, selling everyday items at a fixed price of 100 JPY. Given the recent strength of the USD, 100 JPY currently translates to approximately 0.72 USD, but using longer-term average exchange rates, 100 JPY translates to something close to one US dollar. Table 1 below provides a summary of the main product lines sold by Seria (note that miscellaneous items typically account for more than 90% of group sales). Comparison with Dollar General and its peers extends beyond price and types of products sold; however, Seria also has features that set it apart from both comparable North American stores and Japanese competitors.

Seria is the second largest 100 yen store player in Japan with 1,876 stores, giving it a significant market share of ~25%. The market leader, Daiso Industries Co., Ltd. (unlisted), is about twice the size of Seria. Smaller competitors Can Do and Watts lack scale and are much less profitable than Seria. The founder’s nephew, Eiji Kawai (joined 2003), is the current president of the company and has played a major role in the turnaround and success of the business. The Kawai family owns ~36% of the company.

Table 1:

Main Series Products

Shared research August 2022

100 yen/dollar stores are a tough business to do well. The segment operates with a high turnover of low-value items at a fixed price, with products that constantly change according to consumer tastes. For example, Seria estimated that they have 20,000 SKUs (SKU = Stock Keeping Unit), with ~7,000 SKUs changing each year. Companies that do well can generate strong returns on capital. Seria was a struggling company in the early 2000s until current chairman Eiji Kawai joined in 2003 as CEO. Kawai came from a banking background and had extensive experience in data analysis. He was responsible for the development of Seria. Proprietary POS (point of sale) and data analysis systems (including ordering and distribution systems linked to POS data) that are crucial for 100 yen stores given the importance of managing working capital and predicting sales trends. The data-driven approach promoted by Kawai provided a competitive advantage, leading to better margins and market share gains (Seria’s market share increased from ~14% in 2009 to ~25% in 2022). With competitors struggling to be profitable or focused on overseas expansion, Seria is well positioned to continue to gain share through continued application of its proven strategy.

risks

The main longer-term risk is that the company’s growth track stops. Management is confident of driving long-term growth through store openings, with a target of 100 to 150 net new stores per year. However, it is difficult to gauge what the sustainable level of retail market penetration is for 100 yen stores. Within the segment, while Seria has made significant gains in market share over the past decade, competitors may up their game and make future gains harder to come by.

The main short-term risk is the possibility that Seria’s operating profit margin will be reduced by the combined effects of persistent global inflation, supply chain issues and a weak JPY. These influences have already reduced the operating profit margin from ~10% to ~8%. If this were to continue for an extended period, margins could remain low. JPY weakness is problematic in two ways: a) it inflates the cost of products Seria imports, helping to squeeze margins, and b) for non-Japanese investors, a weaker JPY creates a drag on stock prices. shares converted into currency.

Can Do (the number 3 player in the industry) was recently acquired by Aeon. This could lead to more intense competition in the 100 yen store segment. AEON is a serial acquirer with no experience in this store format, so while this risk should not be ignored, I am not overly concerned about the potential of the acquisition to materially improve Can Do’s competitive position relative to Seria.

The current president, Eiji Kawai, has been crucial to Seria’s strategy and success. The company has maintained a clear strategic focus under Kawai’s leadership and avoided the temptation to expand beyond 100-yen stores within Japan or venture abroad. Key person risk related to Kawai is therefore a factor for stock investors.

Valuation Analysis: Normalized Earnings Approach

By doing a normalized earnings assessment, I am essentially arriving at a point estimate of how I expect a company to perform through the cycle or with sustainable earnings. Table 2 sets out my base case for Seria’s normalized gains, along with the Bear Case and Bull Case scenarios. At JPY2,691 per share (Tokyo Stock Exchange, close 1st Sep 2022), valuation analysis indicates that Seria trades at a P/E between 13.3x and 21.8x, with a base case of 17 .0x.

Table 2:

Serial Normalized Gains

Created by the author using data from Shared Research

For retail stocks, my preferred valuation metric is EV/EBIT. Table 3 sets out my calculation of AEV/EBIT, where AEV is adjusted enterprise value and EBIT is my normalized EBIT.

To get to AEV, I make the following adjustments:

  • Seria has a very high cash balance. I have assumed that a proportion of reported cash (approximately equal to 5% of annual sales revenue) is operational in nature.
  • Allow dividends and profits after the balance sheet date.

Table 3:

EVEBIT Series

Created by the author using data from Shared Research

For a retail company like Seria, you would typically consider an EV/EBIT multiple in the range of 10.5x to 12.5x to be a representation of fair value. Based on a current share price of JPY2691, my analysis points to Seria trading at an EV/EBIT multiple of ~8.9x.

Investment Thesis Summary

100 yen/dollar stores are a niche retail segment within which market leaders have demonstrated their ability to offer a rare combination of:

  • strong sales growth
  • high returns on capital
  • a superior macro-defensive line

Seria focuses solely on its main area of ​​expertise, 100 yen stores, and operates in one of the few retail categories in Japan with organic growth prospects. Within the segment, Seria has created a competitive advantage through its proprietary data analytics/POS systems, which have enabled the company to outperform its peers. Seria’s data-driven approach offers distinct benefits in the areas of: a) better anticipation of sales trends, b) highly efficient inventory management, c) store layout and expansion. As a strong player in a healthy market segment, Seria has been able to produce strong returns on capital over the last decade, with an average RoE of ~20% and an average ROIC of over 40% (although it should be noted that returns have been slightly lower in recent years). Due to the uniqueness of 100 yen stores in the broader retail space and the low profitability of its peers, Seria can be expected to continue to gain market share. With ample cash on the balance sheet (~25% of market cap), Seria is well positioned to reinvest excess cash in the core business in a value-enhancing manner, with the option to enhance shareholder returns. (through higher dividends and/or buybacks). ) overtime.

The combination of high global inflation rates and a weak JPY has created significant headwinds for Seria. With the inability to raise prices, cost pressures cannot be easily passed on to consumers. As a result, Seria’s profitability is forecast to decline by around -20% in FY23, which will be the first time since FY09 that earnings have declined by more than -5%. The stock has fallen out of favor with investors.

In short, with a price per share of around JPY2,700, Seria provides an opportunity to invest at a reasonable long-term valuation in a blue-chip, high-yield, uncomplicated macro-defensive company. Assuming current cost pressures subside in the long term, I expect operating margins to return to recent historical levels of ~10% and, coupled with steady sales growth, an upward revaluation of the stock price seems likely. Stock prices of North American peers such as Dollar General, Dollar Tree and Dollarama point to the potential for Seria’s P/E to be materially downgraded to at least 20x.

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