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Gfoot (2686 JP): a really cheap billion-dollar footwear retailer you probably never heard of

Gfoot is a large (722 self-operated stores, +USD 1 billion sales) but little-known Japanese multi-brand footwear retailer listed on the sleepy Nagoya Stock Exchange earning a respectable ROE selling for 8.5x current earnings and 3.9x near-future earnings (on EV/EBITDA basis that’s 1.9x current EBITDA and 1.3x near-future EBITDA).[1]   The company, now 78%-owned by Aeon Co Ltd after a recent tender offer, is little-known even to dedicated Japan analysts because it’s a roll-up of several competitors acquired over the last decade. [2]  Still, Gfoot’s high sales productivity and low market valuation stack up very favorably against domestic/international peers.

• Only three Japanese footwear retailers generate +USD 1 billion in total sales.  Of these, Gfoot ranks third in total sales (JPY 100 billion) but first in sales to women (JPY 32 billion), second in sales per square meter (JPY 410,000), and second in total retail square footage (248,767 square meters). 

• Among several large global footwear retailers with +USD 1 billion sales – i.e. ABC Mart (Japan), Chiyoda (footwear division), Daphne, Belle, DSW, Footlocker, Sports Direct – Gfoot has by far the highest sales/assets (2.3x) and lowest valuation multiples: 0.18x price/sales, 8x price/earnings, 1.9x EV/EBITDA, and 0.48x price/replacement cost. 

I’ve done a bunch of homework on Gfoot and conclude that owning its shares at this price – a market cap of just JPY 18.8 billion or USD 183 million – is a compelling risk/reward for several reasons.[3]

1)      I believe Gfoot’s sustainable profit margins are on the verge of a big step-up thanks to a gradual product mix shift towards ~50-60% gross margin private brands (vs. ~30-40% gross margin third-party brands).  Private brands now already account for 27% of Gfoot’s sales, up from nothing four years ago.  Raising the private brand sales ratio to 35% over the next few years could easily double Gfoot’s potential profit.  I have a strong sense this is possible because Chiyoda, a competitor with inferior locations/brands/productivity, went through the exact same transition four years ago and it paid off handsomely: the company’s gross profit, net profit, and stock price skyrocketed once private brands eclipsed 30% of total sales (see here: https://www.dropbox.com/s/pilkjblnxic6hqr/Gfoot%20VIC%20charts%201.pdf).  In other words, even though Gfoot and Chiyoda sell a similar amount of shoes each year, Chiyoda’s 35-40% private brand sales ratio has enabled it to generate enough extra profit to support a market cap nearly 5x greater than Gfoot’s!   

2)      Gfoot’s 361-store Greenbox format – a suburban-centric, shop-in-shopping mall, value-for-money footwear chain – has quietly enabled the company to post an industry-leading 2.3x sales/assets multiple (no other listed billion-dollar footwear retailer in Asia, the US, or the UK that we know of comes close) and significantly lowered the risk of losses from “negative operating leverage” in a potential sales downturn.  Unlike Gfoot’s 361-store urban-centric Asbee format which operates on fixed-rent leases and requires JPY 78-90 million per store in start-up investment cost (i.e. JPY 24-30 million for interior renovation, JPY 24-30 million for rental deposit, and JPY 30 million for inventory), the asset-light Greenbox format requires just JPY 30 million of inventory to open a store and only leases space from landlords on a percent of sales basis with little or no minimum rent thresholds. 

A key reason Gfoot has been able to secure prime, low-risk locations for the Greenbox format with minimal upfront investment and variable-rent leases is because many Greenboxes are actually located inside Aeon Malls, the ubiquitous suburban mall chain owned by 78% shareholder Aeon Co Ltd.  Now that Aeon raised its stake in Gfoot to 78% (from 51% previously) via a tender offer in September 2013, the plan going forward is for the Greenbox format to be rolled out as the default/in-house footwear department at all Aeon Malls/GMS outlets – not only in Japan, but in China/Southeast Asia too.  To be able to roll out new Greenbox locations with the full support of Aeon, especially outside of Japan, is an enormous advantage for Gfoot.  I’ve spoken with management at Aeon’s Hong Kong/Southern China subsidiary Aeon Stores (984 HK) and they acknowledged they recently started rolling out Greenbox locations too.

3)      Gfoot shares strike me as cheap for what the company is today, and really cheap for what it could be in the future.  Consider these two back-of-the-envelope calculations: what it would cost to build Gfoot again from scratch, and what the company might be worth once its private brand sales ratio reaches 35% or more.  The first calculation is straightforward since Gfoot’s management told us that the typical Greenbox store (333 square meters) costs JPY 30 million to open while the typical Asbee store (333 square meters) costs JPY 78-90 million.  Assuming half of Gfoot’s 722 store count is Greenbox style and half is Asbee style (this is more or less true), this means that the cost to build Gfoot’s store network again from scratch would be at least JPY 38.988 billion (i.e. 722*0.5*78+722*0.5*30 = JPY 38,826 million), or more than double the company’s JPY 18.8 billion market cap today. 

The second calculation – what Gfoot would earn and be worth once private brand sales reach 35% – requires more guesswork, but we can try.  Let’s say after three years Gfoot’s total sales reach JPY 110 billion (just 10% higher than today) and 35% of those sales are private brands earning an assumed gross profit margin of 60% while the other 65% of sales are third party brands earning a 40% gross profit margin.  We won’t assume any improvement in operating expense management (that stays at 39% of sales like it is now, and in line with its competitors).  What happens then?  EBIT and net income more than double from today’s levels to hit JPY 8.8 billion and 4.8 billion, respectively.  With a little bit of luck, all that profit growth will generate some attention for Gfoot, and its shares might actually trade for a 10x multiple of earnings (up from 8x now, and still a large discount to domestic peers Chiyoda/ABC Mart).  That would mean Gfoot’s market cap three years from now could surpass JPY 48.4 billion, up from just JPY 18.6 billion today (see below).

Private brand shoe sales: JPY 38.5 billion (assumption: private brand hits 35% of total sales)

3^rd party brand shoe sales: JPY 71.5 billion

Consolidated sales: JPY 110.0 billion

Private brand gross profit: JPY 23.1 billion (assumption: 60% GP, rule of thumb in Japan)

3^rd party brand gross profit: JPY 51.7 billion (assumption: 40% GP, rule of thumb in Japan)

Consolidated gross profit: JPY 51.7 billion (47% blended GP)

Operating expenses: JPY 42.9 billion (assumption: 39% of sales, in line with past and peers)

Consolidated EBIT: JPY JPY 8.8 billion

Consolidated net income: JPY 4.84 billion

Implied P/E ratio at JPY 4.84 billion net income: 3.9x

“Fair” P/E ratio: 10x

“Fair” market cap: JPY 48.4 billion (158% upside from current market cap)

Is this scenario too farfetched to be reasonable?  We think the 35% private brand sales ratio could actually be too conservative; Gfoot already achieved a 27% private brand sales ratio in the first half of this year (en route to a 9% total sales increase with +2.1% SSS growth, 13% GP increase, and 46% EBIT increase), so at this pace the private brand sales could exceed 40% in three years.  As for the assumed P/E ratio of 10x, that is more art than science: the P/E three years from now could be 6 or 16, your guess is as good as mine.  But even if Gfoot’s market cap were to remain unchanged for the next three years, that would mean its price to potential earnings ratio would be only 3.9x.  In our experience it is extremely rare to find a consumer facing business with its own/exclusive brands (see some examples here https://www.dropbox.com/s/m78tjj78yuux4ve/Gfoot%20VIC%20charts%202%20pb.pdf), +USD 1 billion of revenue, some industry-leading metrics, high earnings growth, a reputable control shareholder, and double digit ROE with a P/E ratio as low as 3.9x.   

The above upside potential is interesting, but since there’s limited idle assets to cover our potential downside – only about 1/3 of Gfoot’s JPY 18.8 billion market cap is in rental deposits, and another 1/10 is in non-essential real estate like its headquarters building in Nagoya – we need to be extra cautious.  Although the Aeon group has been successful at growing their businesses everywhere, close followers of their listed subsidiaries will remember that in certain instances, most recently in their Hong Kong-listed subsidiary Aeon Stores (984 HK), their interests were not always aligned with minority shareholders (i.e. the parent opened a “competing” store not too far from the listed subsidiary’s main territory).  This is something to watch very closely.  My conversations with Gfoot management indicate they care about creating value for all shareholders (see latest annual presentation http://www.g-foot.co.jp/ir/_pdf_news/20130409_3.pdf, they made a big deal on p. 8 of showing off ROA, ROE, dividend, and price-to-book multiple improvements), but only time will tell.  

Catalyst