Description

Doutor is a Japanese low-priced coffee chain, with over 1,100 coffee shops across the country and a 17% market share domestically. Doutor targets younger customers in the 27-36 age bracket who might otherwise go for higher-priced Starbucks coffees. It also operates another ~900 other types of coffee shops and restaurant outlets.  

The company was established in 1962. The first Doutor branded coffee shop opened in 1980 in Harajuku and the company was listed in 1993. Back in 2007, the company merged with Nichires Restaurant System, partly to fend off an activist campaign. The company has been cutting costs and restructuring the business over the past decade, reducing the number of underperforming Excelsior Caffe stores. Without this restructuring, Doutor’s net growth rate would have been positive. 

Today, Doutor-branded coffee shops can be seen across major metropolitan areas. The company has a stated strategy of opening Doutor Coffee shops close to major railway stations. The average seating time is short, with the chain aiming for a high customer turnover. A typical coffee at Doutor costs about 270 yen (about US$2.5), which is far below what a typical coffee at Starbucks costs. 

Now-subsidiary Nippon Restaurant System owns the Hoshino Coffee chain, which offers a casual dining concept with higher prices. It was developed in-house and launched from 2013 onwards with great success. Management has stated a payback period per unit of 4 years.. It’s popular with seniors who enjoy longer coffee breaks with drinks and food. A typical Hoshino coffee costs 600 yen (about US$6). There are over 200 Hoshino shops across Japan today. Nippon Restaurant System also has pasta restaurants under the Goemon brand name. 

Doutor also owns the coffee chain Cafe Excelsior, a more premium brand with expensive coffee drinks and mostly operates in central Tokyo. 

Doutor coffee is cheaper than that of Starbucks, and the shops are significantly more automated. Doutor uses machines instead of proper baristas, lowering cost - but at the expense of quality. 

Doutor Coffee’s Instagram page gives you a hint of what the menu looks like. The chain is known for its coffee and sandwiches, but it also has cakes and proper meals such as spaghetti on the menu. https://www.instagram.com/doutor__coffee/?hl=en

It’s not a bad business. The pre-pandemic return on capital employed was 13%, which with leverage should yield a respectable high teens ROE. The problem is that Doutor accumulates significant cash on the balance sheet yielding zero interest income. But the cash aside, Doutor’s business is fundamentally profitable, suggesting significant reinvestment potential. 

The Google review score for Doutor does not stand out and looks average, but then again Japanese consumers are notoriously hard to please. 

Typical comments from customers:

• “Iced soy milk [is] insanely delicious.”

• “It's small but I think it's good. Since there is only a high chair, it is suitable for use in a short time.”

• “It's a restaurant where you can eat quickly and get out quickly.”

• “I think it is a beautiful store with a lot of tableware on the tableware return shelf.”

• “The limited-time juice was delicious and memorable!”

• “It's small... but you can rest and calm down there. I am happy that it is also easy on my wallet.”

• “It's located in front of Kalyon Square at Machida Station, so it's a good place to cool off before meeting. It's not suitable for relaxing, but I think it's a [great] because you can drink cappuccino cheaply.”

• “I love Doutor! I bought a cup ice for iced coffee. Drink on top. Delicious”

• “It's a store with a friendly atmosphere and a friendly staff.”

• “No frills coffee, it's rather good coffee. It is a self-service / queue up and order outlet (as expected in Japan). The staffs are very friendly. Sandwiches and pastries are sold here, price wise is fair and not exorbitant.”

The major competitors include:

• Starbucks: 1655 coffee shops in Japan and revenue almost double that of Doutor. Criticised for over-roasting its coffee. Popularised non-smoking coffee shops and offer comfortable relaxing environments. 

• Komeda: Operates roughly 700 coffee shops through a franchisee model. Most coffee shops are in suburbs where land is cheaper. The price of an average coffee is about 420 yen - higher than Doutor’s lower-priced coffees - but customers tend to stay longer as well. The profitability of its franchisees is unclear. 

• Cafe Veloce: competitive prices, strong customer satisfaction award, frequented by older people.

• Tully’s: Seattle coffee chain that’s now left the United States, but remains popular in Japan. Over 700 coffee shops in Japan. 

• Pronto: Over 340 locations across Japan. Offers bar food and party plans for those looking to book entire venues, for example for business meetings or wedding afterparties. 

• Convenience stores: There’s also competition from convenience stores such as 7-Eleven and Lawson, which also offer freshly brewed coffee for low prices. 

The Alexa traffic rank suggests that Doutor continues to be relevant in the eyes of consumers. Doutor’s website traffic is growing faster than any other Japanese coffee chain, including Starbucks and Komeda. 

Total coffee consumption in Japan grows in the very low single digits. Coffee consumption has increased 40% since the early 1990s. But Doutor’s growth strategy includes a plan to increase the number of outlets from the current 1,100 to about 3,000. Those numbers will require an international expansion. Its current plans are bringing the Hoshino Coffee chain to Taiwan and expanding its China business together with partner Xiao Nan Guo. It also has plans for a new coffee shop concept called Oslo coffee, that’s aiming to mimic Scandinavian coffee culture. 

Prices for Doutor coffee has risen from about 200 yen in 2012 to 270 yen today, suggesting a yearly price increase of 3% over a half-decade to account for a rising ingredient cost and a higher consumption tax. Doutur enjoys pricing power in an inflationary environment. 

Doutor’s corporate governance is typically Japanese. The 2007 merger with Nichires Restaurant Systems was probably not in the interest of minority shareholders. The historically targeted payout ratio of 20-30% is on the weak side. A bright point is the consistent share buybacks, reducing the share count by about 1% per year, on average. 

The COVID-19 pandemic has had a negative impact on same-store sales, with March 2020 same-store sales dropping over 50% for a short period of time as some stores were closed, others reduced opening hours and customers stayed at home. Full-year FY2021 revenue ending in February dropped -27% YoY and the recovery has been slow.

The trillion-dollar question is if and when Japan will recover from COVID-19. The country is currently experiencing over 50,000 reported cases of COVID-19 each day, and that number is almost certainly underreporting the spread of Omicron. The number of daily deaths is a fraction of what they were during last summer’s Delta wave. In other words, Omicron is mild. Most of the population will get infected over the next year. 

If Doutor manages to return to pre-pandemic profitability, it will end up at an EV/EBIT of 4.0x. This compares to a historical median of 7.0x. If we ignore the cash position entirely, Doutor trades at 11x against full-recovery earnings. This compares favourably to its historical median level of 17x and Starbucks historical median of 31x. Using a 7.0x EBIT multiple against full-recovery earnings, I value Doutor Nichires at JPY 2,200/share, implying an upside of +41% against today’s share price of JPY 1,565. 

The upside isn’t amazing but revenue is recurring and the Doutor brand name is perhaps the strongest in the industry. Downside risks are cushioned by the massive net cash position, which is equivalent to 42% of the company’s market cap. I see Doutor Nichires as a COVID-19 recovery bet, not as a long-term compounder stock. 

Catalyst

Omicron-induced herd immunity

Return of foot traffic to Doutor Coffee shops