Description

Fwd Numbers Above are Consensus Estimates

Business Overview & Background

Ricoh is a Japanese industrial conglomerate that was founded in 1936 and is based in Tokyo. The company went public in May 1949.

The largest and most profitable segment (53% of revenue / 70% of EBIT) is Office Printing (OP). OP manufactures and sells multifunctional printers (MFPs) for use in offices, as well as imaging devices such as scanners and fax machines. OP’s sales mix is 36% Hardware (equipment, peripherals) and 64% Non-Hardware (Maintenance and Consumables). A3 MFP’s are ~80% of overall HW demand and remain a highly competitive market with four large competitors (Xerox, Canon, Ricoh, Konica), none of which has >30% share, and many smaller players.

The other major segment (26% of revenue / 13% of EBIT) is Office Services (OS). OS encompasses a variety of activities from IT services to business process services that range from reselling PCs and Windows software to providing software and support for printing. The majority of the business is providing IT services and so the business tends to benefit with the timing of Windows software service sunsets. OP and OS are often viewed holistically, and were previously classified as one segment called Imaging & Solutions.

The other segments are a grab bag of other businesses (22% of revenue / 17% of EBIT) including Commercial Printing (printing equipment for printing companies), Industrial Printing (industrial inkjet heads, ink and printers for printing furniture, wallpaper, auto exteriors), Thermal Media (thermal paper used for POS labels for food products, barcode labels, etc.) and Other (device components, cameras, medical imaging).

CEO, Yoshinori “Jake” Yamashita, is 62 years old and became CEO in April 2017. He joined Ricoh in 1980 at age 23 and has been there for life. Despite being a “lifer”, he (likely under the guidance of Ricoh’s largest Japanese activist shareholder, Effisimo Capital), has enacted a number of changes to improve Ricoh’s overall profitability and governance including: holding the first analyst day, shifting to a policy of a 30% dividend payout ratio and discussing the potential for share repurchases, introducing term limits on the BoD, introducing equity-based comp, emphasizing profitability over market share growth, implementing enormous headcount reductions and a large cost savings program, divesting non-core assets (a logistics and bottling business) and growing EBIT from 61B at the start of his tenure to 107B today.

In February 2018, he announced a strategy to grow EBIT to 185B (from 107B today), achieve 8% EBIT margins (vs 5.3% today), and a 9% ROE by 3/31/23. This is expected to be achieved by “changing the business portfolio” aka investing organically in “growth” segments as well investing in M&A. He has earmarked 200B for M&A to do this (but only 40B has been spent to date). While he has certainly delivered in his cost reduction targets during the first years of his tenure, the next phase of the plan seems unachievable.

Investment Thesis

We believe Ricoh is a compelling short as the company’s primary profit pool is in secular decline. Ricoh’s financial performance and stock price has benefited from a turnaround under CEO Yamashita who took over in April 2017, and the market has recently become enthusiastic about revenue growth that appears to be inflecting upwards. However, we believe there is limited further room for cost savings that will impact the bottom line, and the recent revenue growth is purely a function of demand pulled forward from the increase in Japanese consumption tax and the sunsetting of Windows 7, and this growth and will prove to be ephemeral. We believe Ricoh’s core profit pool will decline in perpetuity, while consensus is expecting earnings to increase, creating substantial downside potential as earnings decline and Ricoh trades at 14x P/E with a 2% dividend yield. Since the release of 9/30 results, Ricoh is up 35% vs the Topix up 5%, and is trading near peak multiples relative to the last decade.

1)       Ricoh’s core profit pool (70% of EBIT) is in perpetual decline. We don’t believe there will be any tapering in revenue declines for printing equipment and supplies, as society continues to become more environmentally conscious, tablets proliferate and electronic document tech improves to easily allow marking up / saving / organizing, the younger generations are digital native and are becoming a larger % of the workforce, and companies continue to push for ways to become more cost effective. Ricoh has managed to obfuscate this decline by reclassifying segments and through a massive restructuring program along with some large write-downs that reduced intangibles and thus amortization, flattering EBIT, along with other cookie jars. However, based on our analysis, underlying demand for equipment and supplies has declined at -4% to -6% per year and the trend has generally been getting worse. In addition, we believe the potential for additional cost saving programs to outrun revenue declines will be much more difficult going forward. 

2)       Ricoh’s recent revenue growth (7.2% in 9/30/19), the strongest in years, is purely a function of discrete events that have pulled forward demand, and revenue will soon revert to declining again. Ricoh has benefited from two specific items: 1) Japan’s consumption tax increased from 8% to 10% on 9/30/19, which spurred pre-buying activity in advance of the increases, 2) Microsoft has ended support for Windows 7 on 1/14/20, which created a demand spike for new PCs and IT services. The first has benefited all of Ricoh’s Japanese business while the second has benefited Ricoh’s OS segment.

We can better see this by examining the underlying geographic trends: eg in the most recent quarter Japan grew +17% vs Overseas grew 0.5%. While management has insisted the improvement is a function of an enhanced go-to-market approach and underlying growth, we are skeptical. In addition, we can look at what occurred in the 2013-2015 period as an analog. During this time, the consumption tax increased from 5% to 8% in April 2014, and MSFT ceased providing support for XP on 4/8/14. Ricoh’s Japanese revenue, especially the segment that used to house the OS division, exploded upwards for several quarters, before falling off a cliff.

Bottom Line: At ~14x P/E and 17x EBIT, with the stock up >30% since October, Ricoh is an attractive short. We think earnings are likely to disappoint in the coming years, as the ongoing demand decline for printing continues, and the Office Services market rolls over. We think consensus estimates, which contemplate EBIT growing 5-7% per year, are likely at least 15% too high, and the multiple could easily re-rate back to 11x, which would generate >30% downside.

Our only caution is this coming quarter has the potential to beat results, driven by ongoing strength in the Office Services segment, as Japan PC shipments continued to be strong in advance of the Windows 7 sunset which occurred on January 14^th, 2020. That said, we are comfortable taking a position now, and adding in the event the market is enthusiastic about the coming quarter results.

Catalyst

Lapping positive comps leads to dramatic growth deceleration

Inability to hit cost-out targets

Inability to cut past decrementals