Summary:

Hub (www.pub-hub.com) was founded in 1980 and listed on the Osaka Stock Exchange in 2006.  Today the company owns 84 (going on 86) self-operated British-themed pubs in Tokyo, Osaka, Nagoya, and Sendai under the brand names “Hub” (for younger clientele into beers) and “82” (for older clientele into whiskeys).  Most of Hub’s revenue comes from retailing alcoholic beverages that range from its in-house craft beer brand “Hub Ale” (10% of total sales) and an assortment of other imported beers/spirits/cocktails.  The concept of Hub is unique in Japan: to this day it’s the only westernized pub chain in Japan with a branch network above 15-20 with nationwide brand recognition.

(See photos: https://www.dropbox.com/s/w6m3aqrpcup78sz/photos.pdf)               

Over the last decade, Hub has developed cult following among 18-35 year old locals and expatriates (think English teachers, exchange students, diplomats, US military, MNC executives, etc.) alike by providing a consistently friendly, fun, and affordable environment to wind down after a long day at the office.  We know this because we’ve been Hub customers since 2003 and have sampled drinks at 40 different locations.  Ask any of your friends under 45 that live in Tokyo/Osaka if they’ve ever heard of Hub and you’ll be surprised how many of them say yes. 

Hub’s President, who has hands-on experience serving customers, obsesses over organic store-level performance so the company has almost never closed an outlet and no stores are losing money today.  Hub’s dedication to perfecting the basics – quality, service, cleanliness, atmosphere, and price – has generated tremendous goodwill from its most loyal customers, the +180,000 (and counting) member’s card owners that paid JPY 500 cash upfront for a membership card in exchange for a 5% discount on subsequent purchases.  These loyalty members already generate almost 40% (and counting) of Hub’s total sales and are the key reason Hub has consistently generated positive same store sales growth in a mature restaurant market like Japan.  New members continue to vote with their wallets: Hub now sells enough loyalty cards in a year to fund the start-up costs of at least one new store.   

Despite the impressive track record below which few Asian fast food chains have matched over the same period, Hub still trades at just 4.0x 2014 EV/EBITDA and 8.9x EV/(Net income + depreciation – capex), a wide discount to many peers and an even wider discount to what control of the company would sell for to an informed acquirer (note: according to the major shareholder, there has been casual interest from third parties).  Even if Hub’s discount to peers doesn’t narrow in the short-term, we think this is the ideal company to hold for decades while the core business – which is still in its early stages of domestic expansion, to say nothing of international expansion – naturally compounds into something much larger and worth waiting for. 

2014:   Pubs: 84          Sales: 8.48b (+1.9% sssg)       EBITDA: 1.04b          Equity: 2.48b              DPS: 84

2013:   Pubs: 79          Sales: 7.59b (+6.3% sssg)       EBITDA: 0.95b          Equity: 2.14b              DPS: 79

2012:   Pubs: 71          Sales: 6.81b (+0.5% sssg)       EBITDA: 0.84b          Equity: 1.87b              DPS: 67

2011:   Pubs: 66          Sales: 6.40b (+3.0% sssg)       EBITDA: 0.59b          Equity: 1.65b              DPS: 47

2010:   Pubs: 60          Sales: 5.62b (-2.2% sssg)        EBITDA: 0.48b          Equity: 1.49b              DPS: 34

2009:   Pubs: 53          Sales: 4.99b (+4.2% sssg)       EBITDA: 0.41b          Equity: 1.38b              DPS: 34

2008:   Pubs: 45          Sales: 4.38b (+3.7% sssg)       EBITDA: 0.35b          Equity: 1.29b              DPS: 25

2007:   Pubs: 42          Sales: 3.81b (+2.4% sssg)       EBITDA: 0.32b          Equity: 1.21b              DPS: 20

2006:   Pubs: 36          Sales: 3.27b (-1.2% sssg)        EBITDA: 0.27b          Equity: 0.84b              DPS: 20

Good qualitative effort…

Heavy alcohol consumption is part of Japanese culture.  Going out regularly for intense drinking parties or nomikai (???) with colleagues and clients is semi-compulsory for millions of Japanese salary men and women.  A lot of money is spent on these drinking parties every night, and thousands of conventional Mom and Pop bars, restaurants, and Japanese izakaya (???) taverns exist to earn a share of that pie.  Hub, however, is not one of them.

Rather, the atmosphere in a Hub branch – pay cash for your own drink at the counter, sit anywhere that looks comfortable for as long as you want with no peer-pressure to drink – is more like a Starbucks than a Japanese izakaya.  It’s no accident that customers gravitate toward their local Hub outlet in the evening the same way they gravitate toward their local Starbucks outlet in the morning: Hub also strives to be a “third place” between work and home.  As you can tell from the pictures below, it’s fun to be a Hub customer.   

It can be fun to work at Hub, too.  After talking with Hub’s management on dozens of occasions, my sense is that they share the same “we’re in the people business serving [beer], not the [beer] business serving people” philosophy as Starbucks, especially when it comes to staff morale.  For example, all staff are entitled to paid annual leave (even part-timers); all new hires experience the same orientation program called “Hub University”; new full-time recruits are flown to London for authentic pub training; store-level staff get free transportation home if they work overtime; and in areas where real estate is expensive store-level employees receive subsidized rent.  Hub’s branch managers, the most important people in the company, are very well compensated by Japanese restaurant industry standards (i.e. they earn JPY 5.5 million or more per year versus JPY 4 million or less at other chains).  Hub also has a culture of internal promotion and upward mobility where the best part-timers can expect to be promoted to full-time positions, so Hub’s ratio of full-time to total employees is 32% versus 10% or less for most peers.  Thanks to initiatives like these, Hub is among the best companies to work for on http://jobtalk.jp, the top employer review website in Japan.  

… Leads to good quantitative results:

The way Hub treats its customers and employees probably has something to do with the company’s exceptional growth and profitability over the last decade.  Hub’s gross margins (73%),  gross profit / total assets (144%), EBITDA growth (+284% since 2006), EBITDA / ex-cash rental deposits equity (68%), and after-tax return on average equity (19%) have reached industry-leading levels in Japan – better than Starbucks Japan (2712 JP) and Hiday Hidaka (7611 JP), the only two domestic quick-service chains that are beverage/alcohol focused with a comparable record of same store sales growth since 2006.  Hub achieved this thanks in part to A) increased sales of 80-90% gross margin cocktails, B) increased sales of house-brand “Hub Ale” (now 10% of total sales), and C) attractive new store designs that don’t require much cash investment net of refundable rental deposits. 

That last point is important, because lucrative per-store economics are a big reason behind Hub’s success to date.  Generally speaking, it costs JPY 50-60 million to build a new Hub outlet from scratch.  Of that amount, about JPY 35 million is deposited with landlords as “rental deposits,” a quirky convention in Japan where landlords routinely demand large upfront cash rental deposits worth many months (or in some cases years!) worth of rent.  Since that JPY 35 million of cash rental deposits will eventually be returned to Hub at some point, the actual net cost to build a new Hub branch is only JPY 15-25 million.  This is cheap considering that the average sales, gross profit, and EBITDA per branch (including all headquarters expenses) are is JPY 105 million, JPY 77 million, and JPY 13 million, respectively.  The elite Hub branches can even generate JPY 150-250 million in sales per year, with store-level pre-tax profit margins as high as 30-40%. 

This is no small feat for a beverage-focused chain like Hub.  According to QSR Magazine http://www.qsrmagazine.com/reports/top-50-sorted-average-sales-unit, in North America there were only two beverage-focused quick serve chains that in 2011 achieved average sales per store of USD 1 million (JPY 102 million): Starbucks and Tim Hortons.  

Hub has been able to scale-up and sustain its attractive per-store economics over time.  According to the return-on-incremental-invested-capital (ROIIC) metric that McDonald’s uses internally (http://www.aboutmcdonalds.com/content/dam/AboutMcDonalds/Investors/Investor%202013/McDonalds%202013%20Financial%20Information%20Workbook.xlsx) which divides the annual increase in EBITDA by the total cash outflow from investing activities, Hub is getting very good returns for every dollar of investing cash outflow.  

2014:   Increase in EBITDA: 0.10b                Cash outflow from investing: -0.38b              ROIIC: 25%

2013:   Increase in EBITDA: 0.11b                Cash outflow from investing: -0.25b              ROIIC: 45%  

2012:   Increase in EBITDA: 0.25b                Cash outflow from investing: -0.08b              ROIIC: 330%

2011:   Increase in EBITDA: 0.11b                Cash outflow from investing: -0.29b              ROIIC: 39%

2010:   Increase in EBITDA: 0.07b                Cash outflow from investing: -0.07b              ROIIC: 100%

2009:   Increase in EBITDA: 0.06b                Cash outflow from investing: -0.17b              ROIIC: 36%

2008:   Increase in EBITDA: 0.02b                Cash outflow from investing: -0.13b              ROIIC: 16%

2007:   Increase in EBITDA: 0.05b                Cash outflow from investing: -0.12b              ROIIC: 43%

2006:   Increase in EBITDA: 0.01b                Cash outflow from investing: -0.09b              ROIIC: 7%

Here’s another way we look at Hub’s return on invested capital: in FY2014 Hub generated JPY 1.04 billion of EBITDA on an equity base of about JPY 2.48 billion.  But Hub’s equity base is actually inflated by JPY 0.94 billion of un-invested rental deposits (marked on the balance sheet as ?????).  Excluding those idle rental deposits, Hub’s true equity base was JPY 1.54 billion.  So Hub really generated JPY 1.04 billion EBITDA from just JPY 1.54 billion of equity that was actually invested in the operating business, or 68%. 

Hub: better than Starbucks Japan?

The numbers we have indicate that, pound for pound, Hub is the best beverage-focused quick serve chain in Japan – even better than Starbucks Japan, which is more widely acknowledged to be industry’s gold standard.  Why is Hub better than Starbucks?  The average Hub is about the same size (maybe slightly smaller) than that of an average Starbucks, but Hub’s branches achieve comparable levels of sales and EBITDA (i.e. JPY 105 million and JPY 13 million for Hub, versus JPY 130 million and JPY 16 million for Starbucks Japan).  That’s noteworthy, because the average Hub branch is only open for about 8-9 hours a day, versus 14-15 hours for the average Starbucks in Japan.  Conclusion: on an hourly basis, the average Hub is roughly 30% more productive than the average Starbucks. 

Granted, Starbucks Japan is a nationwide business that serves a lot of smaller towns whereas Hub is only in wealthier cities of Tokyo, Osaka, and to a lesser extent in Nagoya.  But even if you compare Starbucks Japan and Hub on an apples-to-apples basis prefecture by prefecture (note: prefecture level sales and store data is public information), Hub still comes out on top.  For example, in the Northeastern prefectures of Tokyo, Chiba, Saitama, Kanagawa, and Miyagi, we estimate Hub’s hourly sales per store was JPY 30,000 versus JPY 23,000 at Starbucks Japan.  In the Southwestern prefectures of Aichi, Osaka, Kyoto, and Hyogo, we estimate Hub’s hourly sales per store was JPY 33,000 versus JPY 25,000 at Starbucks Japan.

Hub’s higher sales per hour are a direct result of its superior customer loyalty program.  Hub generates an even higher percentage of its sales (almost 40% and counting) from loyalty members than Starbucks Japan, or even Starbucks globally http://www.morningstar.com/earnings/PrintTranscript.aspx?id=58524309.  Today Hub has over 180,000 members on a store base of just 84, versus 1.05 million My Starbucks Reward members on a store base of 986.  So Hub has over 2,000 members per branch versus fewer just over 1,000 per branch for Starbucks – amazing considering Hub doesn’t even allow members the convenience of pre-loading cash on its member cards or paying with mobile apps or even credit cards. 

The top 10% of Hub’s members alone generate 28% of member’s sales.  That means these hardcore members on average spend JPY 50,000 per year at Hub, which works out to hundreds of beers/cocktails annually.  According to management, Hub is adding 6,000-7,000 new members per month, and the year on year sales growth from members never turns negative (even in the rare months when Hub’s same store sales takes a brief dip).

Revenue from the sales of new loyalty cards, broken out on Hub’s P&L as ????????, have been growing much faster than overall sales every year since the IPO in 2006, and are a good leading indicator of future business performance.  We also look at this number as proof that the churn rate of loyalty members – which happens because the loyalty card expires after 12 months of inactivity – is decreasing.  We know the churn rate is decreasing because the revenue generated from selling new members cards totaled JPY 44 million in 2014, and since the price of a Hub member’s card is always JPY 500, we can deduce that 88,000 new loyalty members joined in 2014.  These 88,000 FY2014 new members represented about 51% of total members as of February 2014 whereas the 70,000 FY2013 new members represented about 53% of total members as of February 2013.  In other words, older loyalty members are visiting Hub more frequently in the years after they first joined.

International potential:

Initially we were unsure about whether or not Hub’s success in Japan would translate well in other countries. Copycats in Korea, however, are definitely sure.  On a trip to Seoul a few years ago, we were shocked to stumble upon a fake Hub outlet in the middle of the Yeouido financial district: identical logo, similar interior decorations and vibe (see photo https://www.dropbox.com/s/w6m3aqrpcup78sz/photos.pdf).  We’ve discussed the potential for Hub to expand overseas with Hub’s President, and the President of Hub’s major shareholder (Royal Holdings), and while both agree the overseas opportunity is intriguing, their top priority right now is to fulfill their domestic growth potential.                                                                                                                           

Ownership:

Hub started out as a subsidiary of now-defunct Daiei (formerly the largest retailer in Japan), a pet project of their former President.  After Daiei went bankrupt in 2002, control of Hub was bought and sold a few times (with management and culture in tact) before it found a permanent home as a 33%-owned associate of Royal Holdings in 2010 https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=92684&filename=pdf_file.pdf.  Royal Holdings is one of the oldest fast casual restaurant chains in Japan (Royal Host http://www.royalhost.jp/index.php) and is today run by Mr. Tadao Kikuchi, a former Deutsche Bank corporate finance guy who speaks fluent English and really gets what Hub’s potential is.  To his credit, he leaves Hub management to operate independently from Royal Holdings – Hub’s logo, let alone the controlling stake in Hub, isn’t even mentioned on Royal Holdings’ website or investor presentations.  We’ve chatted with him in person twice and he joked that he gets cold calls all the time inquiring about Royal Holdings’ stake in Hub (his pat answer: Royal Holdings is not going to sell).

Kuze (2708 JP), the largest food wholesaler/distributor in the Tokyo metropolitan region, acquired a 10% stake in Hub in 2012 https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=123995&filename=pdf_file.pdf.  Hub was a long-time customer, and Kuze’s President could see how well the business was doing so they pulled the trigger on a block trade: a really smart move in hindsight.  Based on our discussions with Kuze’s President and senior management, their stake in Hub is strategic (i.e. they are cooperating with Hub on various food and supply-chain improvements) and they aren’t interested in selling – ever.

Kawachiya (unlisted), is a liquor supplier of Hub’s that acquired a 10% stake for similar reasons as Kuze above.  That Hub appealed to Kawachiya is not surprising.  According to Hub’s 2006 IPO presentation, Hub was already the number one seller in Japan for Guinness beer (4% market share), Bass beer (11% market share), and Havana Club rum (17% market share).  We have not been able to get in touch with Kawachiya, but our understanding is that they intend to hold their shares in Hub for a long time, too.

Management:

Hub’s 53-year old President, Mr. Tsuyoshi Ohta, is the driving force behind the company’s culture today.  He spent his entire career with Hub and maintains a granular feel for the store-level details.  Based on the dozens of face to face conversations we’ve had with him over the last few years, including one long dinner, he is a genuinely passionate entrepreneur/manager with ambitious goals for his company.  Mr. Ohta told us his weekend hobby is to go fishing – perhaps this has something to do with his patient, long-term perspective on Hub’s growth.  In the last investor presentation he said something to the effect of “we have to focus on the long-term… once we reach our old goal of JPY 10 billion sales and 100 stores then that is not the end, it’s just the beginning.”  It’s as pity to us that Mr. Ohta only owns +1% of the company’s shares (worth JPY 51 million, or 4-5x his annual salary/bonus).  From a Japanese perspective, however, executives at local companies rarely get richly rewarded for their work (in fact, they appear to get cheated by western compensation standards), so if Mr. Ohta can compound Hub’s stock price a few more times before he retires, he’ll have at least a few hundred million JPY nest egg to retire with – plenty to live like a king in Japan.

2014 results: short-term vs. long-term

In April 2014 Hub reported another year of positive same-store sales (+2%) and same-store traffic (+2%) growth, record loyalty members (171,000), record sales of new loyalty members cards (+26%), record total sales (+12%), record gross profit (+12%), record EBITDA (+10%), record net income (+19%), record dividends (+6%), and record after-tax return on average equity (19%).  Curiously, Hub’s stock price dipped as much as 12% in the days after these results were announced because the President’s new three-year plan calls for A) modest renovations of all stores older than ten years, and B) temporarily relocating the company’s single best-performing store while the landlord redevelops the current property.  The net effect of these temporary disruptions, according to the three-year plan, would be flattish profit growth in each of the next two years followed by a step-up to more rapid profit growth in the third and final year of the plan. 

We agree with the President’s decision to invest long-term in enhancing the customer experience and disagreed with the market’s focus on the flatter first two years of the new three year plan.  Why?  First, the proposed renovations make sense: we’ve personally visited nearly half of Hub’s 84 outlets, and even our untrained eyes can tell that Hub’s oldest stores would benefit from a face-lift.  The President reiterated to us that the decision to renovate the oldest stores does not signal any change in Hub’s per store return-on-investment targets – all new stores must pay back their original investment cost within five years on an after-tax basis.  Since all Hub stores slated for renovation have already paid back their original investment a few times over, and none of them will need to be closed for even one day to effect the renovations, an investment in things like better ventilation and additional seating capacity strikes us as something that should be applauded, not criticized. 

As for the temporary relocation of the single best-performing Hub store, that merely involves temporarily moving that store a few hundred meters away until the landlord invites Hub back into the original location after redevelopment.  Loyal customers of that original store should not feel stranded after the relocation because Hub has six stores in the vicinity (Shinjuku) that are ready to pick up the slack.  The actual pre-tax profit loss in the year ending February 2015 from this temporary relocation will almost certainly be far less than the JPY 85 million forecasted by Hub’s CEO because that number assumes that the six nearby stores will not pick up even 1% of the lost revenue from the temporarily relocated store.  That assumption strikes us as being way too conservative since we know that Hub has been handing out special discount cards to the regular customers of that soon-to-be-relocated branch to encourage them to visit nearby outlets.  But only time will tell – based on Hub’s latest five year track record of P&L forecasts, actual results have always over-delivered by at least 5-10%.  

We remain very optimistic about Hub’s prospects.  Hub’s same store sales growth in the first quarter of this year (Mar-May), FY2015, was +1.7% (same store traffic +2.4%) https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=161153&filename=pdf_file.pdf and showed no fatigue from the nationwide consumption tax increase that took place on April 1, 2014 (same store sales growth was stronger in April/May than they were in March, and members reached a record high).  Despite growing EBITDA +284% since it IPO’d in 2006, Hub’s valuation multiples are as cheap today as ever.  This makes no sense to us considering the industry-leading growth and ROIC that Hub has consistently achieved, and the fact that this is a World Cup year (note: Hub’s customers love the World Cup, and during the last one in June 2010 the company posted +27% same store sales growth https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=98811&filename=pdf_file.pdf). 

As you can see from this comparison table https://www.dropbox.com/s/k3l7fvbaw4rk3ap/table.pdf, Hub accumulated $3.2 of EBITDA for every $1 of cash invested in its business from FY2006-2014.  No other chain in our table achieved that.  Hub achieved these industry-leading returns on investment while delivering profit growth and margins as high as any other beverage-centric chain (i.e. Starbucks Japan).  In short, Hub’s business model works – we don’t think it’s a coincidence that Starbucks just unveiled plans to transform 1,000 Starbucks branches in the United States into evening hangouts that serve alcohol and pub snacks (http://www.starbucks.com/coffeehouse/starbucks-stores/starbucks-evenings/menu).   

Conclusion:

Hub is probably not going to be the next Starbucks, but it must be doing something right if its suppliers are eager to own large blocks of its shares and copycats are eager to imitate them in foreign countries.  We don’t know if the next decade will be as good to Hub as the previous one was, but owning their shares at 4x EBITDA is a cheap way to find out. 

Important background information:

May 2014 same store sales report (note how strong performance has been since April 1, 2014 when consumption taxes were hiked nationwide): 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=161153&filename=pdf_file.pdf

February 2014 same store sales report: 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=157446&filename=pdf_file.pdf

FY Feb 2014 annual presentation: 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=160871&filename=pdf_file.pdf

FY Feb 2014 semi-annual presentation: 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=154247&filename=pdf_file.pdf

2006 IPO presentation: 

http://vspm.irstreet.com/browse/pdf.php?code=caeJVBpnxZK2w&br= 

Other investor relations updates (English):

http://www.irstreet.com/en/brand.php?&content=brand_newsrelease&brand=87

2012 acquisition of 10% stake by key food supplier Kuze: 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=123995&filename=pdf_file.pdf

2010 Royal Holdings cooperation: 

https://ircms.irstreet.com/contents/data_file.php?template=51&brand=87&folder_contents=10478&src_data=92684&filename=pdf_file.pdf