Description

Short pitch:

Doing business primarily as “Gin No Sara” 銀のさら, Ride On Express is a founder-owned/operated 374-location nationwide sushi delivery franchise system in Japan with a near-identical business model to Dominos Pizza (i.e. profiting from independent franchisees, full control of customer data, ability to raise prices, etc.) trading at 8.7x March 2021 EPS or 9.4x March 2022 EPS per company guidance. 

·         Over 40% of market cap now is net cash and treasury shares. The bulk of treasury shares (~6% of outstanding stock) were opportunistically repurchased by the company on-market between September and December 2021 at no more than 12x P/E.  Today’s stock price represents a ~25% discount from those repurchase levels.

·         After growing organically for a decade, management finally opened up to new franchisees.  The company is aiming for at least 20 new locations a year for the next few years, with a mid/long-term target network size of 500 (versus 374 today). 

·         The recent share price decline smells of an urgent foreign seller (if we had to guess from the Bloomberg shareholder list: Dimensional Fund Advisors).

·         Perhaps the closest local public comp in terms of business model (i.e. wholesaling food ingredients to independent franchisees while extracting % of sales royalties) is coffee shop franchisor Komeda Holdings (3543 JP), which trades at >2x the P/E of Ride On Express.

·         On 2/28 the sole broker that covers this stock published these growth forecasts through FY2024 March (the current stock price is JPY 1,206).     

Long pitch: Ride On Express - Delivering Sushi in 30 Minutes and Share Repurchases in 3 Months

Ride On Express (Japan ticker: 6082) was founded in 1992 by Mr. Akira Emi, a Gifu prefecture high school graduate who, in lieu of attending university, spent seven years working in the United States including at a sushi restaurant.  After returning to Japan, Emi launched a subway sandwich business that he ran for six years before pivoting to pure sushi delivery in 1998 under the “Gin No Sara” 銀のさらbrand.  Today, Ride On Express is a nationwide delivery-only sushi restaurant franchise system with JPY 42.6 billion of systemwide sales across 374 locations, of which 271 are franchisee-owned/operated. 

Key aspects of the Ride On Express business model are:

-          Like Dominos Pizza, revenue sources include 1) selling food ingredients to franchisees, 2) levying a 5% of sales royalty on franchisees, and 3) self-operating delivery-only sushi restaurants. 

-          The 374 locations are “dark kitchens” that a) aren’t situated in prime areas with expensive rent, and b) support the preparation/delivery of multiple types/brands of cuisine.  For example, most locations serve both Kamatora-brand kamameshi (a rice dish often consumed for lunch, alone) and Gin No Sara sushi (often consumed for dinner or special occasions, in a group).

-          80% of customers (3.76 million active users) order directly from Ride On Express (online or by phone) and 20% order indirectly via Demae-can[CH1] , the Softbank-affiliated delivery aggregator that competes with Uber Eats, Doordash, Wolt, etc.[1] 

-          Last-mile delivery to customer doorsteps is never outsourced, even for orders via Demae-can.  Ride On Express and its franchisees use their own (trained/uniformed) staff and bikes/motorcycles (with sushi-appropriate temperature controls and casing/packaging that won’t ruin presentation) to make deliveries.  As such, delivery speed is exceptional: 47% of all orders from June to September 2021 were delivered in under 30 minutes. 

-          The customer data is proprietary to Ride On Express.  Hence, Ride On Express really knows its customers and has mastered what they term “one-to-one marketing” to elicit incremental orders.  Over time, this has produced a) increased customer order frequency, and b) highly predictable results: since the company’s 2014 IPO, it has never missed revenue guidance with only once instance of missed EBIT guidance.

According to Fuji Keizai’s “Restaurant Industry Marketing Handbook 2021,” Ride On Express dominates Japan’s pure-delivery sushi / kamameshi restaurant segment (see below).  Granted, this data might present a somewhat narrow definition of the competitive landscape.  Based on what we can observe in the public markets, there are very few delivery-oriented restaurant systems in Japan serving any type of cuisine at Ride On Express’ scale and sustained profitability, and even fewer whose growth over the last decade has been almost entirely organic. 

In our opinion, Japan’s pizza delivery segment is probably most similar to Ride On Express.  Of Japan’s major pizza delivery firms, Domino’s Japan has taken market share most aggressively over the last decade and is the easiest comparable to benchmark Ride On Express against.[2]  What raised our eyebrows during this comparison is that Ride On Express has consistently generated superior per store sales, per store sales growth, and unleveraged returns on equity versus to Domino’s Japan.[3]  Likewise, Ride On Express’ growth over the last decade has been almost entirely organic (i.e. no new locations). 

On one hand, the lack of new store expansion in recent years demonstrates how conservative Ride On Express’ management has been.  On the other hand, it also demonstrates how committed they’ve been to delivering attractive investment returns for their hundreds of independent franchisees – the same franchisees that might eventually be asked to expand their store footprint.[4]  

What really raised our eyebrows was Ride On Express’ mid-2021 decision to re-open their franchise system to new franchisees/locations after a decade-long hiatus.  Ride On Express even announced a mid-to-long term goal of reaching 500 total locations and JPY 60 billion of system wide sales – the first time management ever committed explicitly to a longer-term expansion target.  Why was this the time for Ride On Express to expand?  With a track record of delivering attractive franchisee economics, a growing list of prospective franchisees (including current employees at self-operated locations) had been eager to join the Ride On Express system.[5] 

This decision to finally expand aggressively was a key reason why we started accumulating shares of Ride On Express from mid-2021, a fact we communicated to a friend last fall.  At the time, we wrote: 

            Our Japanese franchise business, which we’ll name Nihon Commissary (“NC”) here, actually runs a delivery-only business model that, in our eyes, is nearly identical to Domino’s Pizza Japan (minus the pizza).[6]  NC actually generates much higher revenue per location (well over USD 1 million, a rarity in Japan) and pre-tax return on assets than Domino’s Japan.  That is especially interesting because Domino’s Japan’s EBITDA contribution over the last five years has been a key catalyst behind the meteoric stock price of its parent company (Australia-listed Domino’s Pizza Enterprises), which currently trades at 70x trailing twelve-month P/E.

            NC, however, spent most of summer 2021 trading at 11x trailing twelve-month earnings and less than 2.5x net cash and securities despite averaging 16% ROE from March 2012 to March 2021, a period in which EBIT rose 8x.  To us, NC’s paltry valuation multiple implies that a) delivery platforms like Uber Eats or Wolt will steal many customers, and b) NC’s growth over the last year was a COVID-19 lockdown fluke.  In our view, these pessimistic assumptions fail to recognize: 

·         The food NC delivers is often enjoyed in group gatherings, and these have obviously decreased since the onset of COVID-19 but could rebound when vaccination rates exceed 50%.[7] 

 ·         Historically, 80% of NC’s customers have been retained after ordering for the first time.  Even if that retention rate drops post-COVID, as frequent and happy NC customers we’re convinced a) many of the 640,000 new customers attracted from the onset of the pandemic will be retained, and b) customer order frequency is at such a low base (only 2.35x per year!) that if even a small chunk of customers get into the habit of ordering on a bi-monthly or quarterly basis the P&L would see a big boost.    

·         The latest quarter ending June 2021 that lapped the quarter ending June 2020 (which included the most severe of Japan’s COVID “lockdowns”) showed a revenue decline of just 5% YoY.  This proves a) many of NC’s new pandemic customers have been retained, and b) this level of sales is still 25% higher than the same quarter ending June 2019 (the most recent “pre-covid” comparable period).

 ·         Unlike Domino’s Japan, which earns a substantial amount of “carry-out” revenue (i.e., customers walk-in to pick-up orders), NC has historically generated minimal carry-out business.  This could change since NC just started offering carry-out options at an increasing number of locations.

 ·         The 57% revenue growth NC generated between 2013 and 2021 was 100% organic thanks to same-store sales growth.[8]  2021 will be the first time in a decade that NC will open up their brand to new franchisees to capitalize on strong demand.  This should allow NC to meaningfully grow its network of franchisee locations (management is guiding for a 37% increase in total locations over the next five years).

What happened since?  On September 7^th, 2021 a significant share repurchase exceeding 6% of total shares outstanding was announced and completed on December 14, 2021 (six weeks early).[9]  The rationale for the share repurchase as disclosed in the public announcement was about as blunt as it gets by Japanese standards:

“Taking into consideration the strong sales situation and business outlook, etc. We will acquire treasury stock in order to return profits to our shareholders, improve capital efficiency, and implement agile capital policies in response to changes in the business environment.” 堅調な売上の状況ならびに業績の見通し等を考慮した上で、株主の皆様への利益還元を図るとともに、資本効率の向上、経営環境の変化に対応した機動的な資本政策の遂行を可能とするため、自己株式の取得を行うものであります。

Then, on January 27^th, 2022 Ride On Express announced an upwards revision to their original revenue and profit guidance for the year ending March 2022.  The revised guidance for the year ending March 2022 indicates revenue will exceed that of the vaccine-less, COVID-boosted year ending March 2021 while EPS will only decline by 6.5% despite a) recent raw material inflation and b) more spending on new franchisees and locations.[10]  On a two-year basis (i.e. pre-COVID vs. FY March 2022), revenue and EBIT will be 25% and 54% higher, respectively.

These pleasant surprises confirmed our view – formed over eight investor relations events (two group, six one-on-one) – that Founder/President Akira Emi, himself a 26% shareholder, a) cares about minority shareholders, and b) is successfully retaining many of his newly acquired customers throughout COVID-19.

In sum, Ride On Express has not only delivered a uniquely aggressive share repurchase (at an attractive price), it’s delivered “post-COVID” results showing continued same-store sales growth even when strong peers like Domino’s Japan are showing post-COVID same store sales declines.[11]  Given that fact pattern, we would have guessed that Ride On Express’ current share price would be markedly higher than the JPY 1,624 average cost (12.3x P/E for March ’22) the company spent on its latest repurchase exercise.  In fact, the company’s share price closed at JPY 1,206 on March 14, 2022 for a March 2022 P/E of 9.4x (or 5.5x excluding cash, securities, and treasury stock).

What gives?  We aren’t completely alone in our enthusiasm.  On February 21, 2022 Seiichiro Samejima of Ichiyoshi Securities, the sole sell-side analyst covering Ride On Express, published a March 2024 EPS forecast of JPY 181, implying 28% EPS growth over COVID-boosted FY March 2021 for a March 2024 P/E of 6.7x.[12]  In our opinion, there is no justifiable reason why Ride On Express now trades at half the trailing twelve-month P/E of, say, Komeda Holdings (ticker: 3543), a sit-down coffee shop franchise system whose business model is also based on the wholesaling of food ingredients to independent franchisees.    

To be sure, recent world headlines have been troubling (i.e. Russian aggression in Ukraine, US inflation at 40-year highs, anti-capitalist comments from Japan’s new Prime Minister, etc.).  Yet we haven’t seen any news that might dissuade 3.76 million mostly loyal customers from ordering sushi a 2-3x a year, especially for celebrations.  If there are investors following Ride On Express closely today, the doubters might caution that the jury is still out on two threats: food inflation, fuel inflation, and delivery aggregators like Uber Eats.  Sure, these threats could evolve into bigger problems, but a) Ride On Express shareholders are currently well-compensated for that risk with “total cash return” (i.e. dividend plus share repurchase) yields in the high-single digits, and b) these two threats are far more nuanced than they seem.

-          Food inflation:    

§  Ride On Express has not been spared from recent food inlation.  In the quarter ending December 2021, food inflation was a key reason why Ride On Express reported a 44.7% gross profit margin, below the 47.3% achieved for the same period last year.[13]  This was also less than the 46-50% gross margin range the company has maintained since 2014. 

On the bright side, however, operating expenses as a percentage of sales (opex/sales) was 39.2%, far less than the 42.7% opex/sales ratio the company has averaged in the previous five years.  In other words, thanks to greater scale owing to what we feel could be permanently higher sales volume, Ride On Express’ fixed costs are far less burdensome today than they were in earlier years.  Hence, the company can still achieve EBIT margins at or better than their historical averages (i.e. mid-to-high single digit) even at lower, inflation-affected gross profit margins. 

Still, such a scenario assumes zero menu price increases will be passed onto the end consumer.  In reality, the company has a history of successful menu price increases and margin expansion – even after periods when the Japanese yen has depreciated sharply versus the US dollar.[14]  In our first meeting with Ride On Express over five years ago, management emphasized that while fish prices can fluctuate wildly year-to-year, in a worst-case scenario there’s many varieties of cheaper fish that can be substituted on short notice. 

Likewise, the company sources its seafood from Mitsubishi Shokuhin (the food sourcing arm of Mitsubishi Trading), and that relationship is not based on real-time spot market price adjustments.  In other words, major seafood buyers like Ride On Express get plenty of heads up about upcoming price hikes so they can stock up ahead of time at cheaper prices, something small sushi outfits can’t afford to do.

Lastly, anyone following menu prices should notice that believe Ride On Express has already raised prices YTD, especially for key items like salmon or tuna.

-          Fuel inflation:

§  Pre-2022, fuel costs (i.e. gas for delivery motorbikes) averaged only 1-1.5% of sales at the store level.  If 2022’s elevated oil prices persist, this burden maybe goes up to 2-3% of sales at the store level – an unwelcome development, but nothing the average franchisee store doing 13-14% EBITDA margins can’t overcome with sneaky menu price increases over time.

Where else can money be saved?  Today the company charges nothing for delivery fees, but they are aware that a) Dominos does charge delivery fees in certain countries with no effect on volumes, and b) Dominos UK successfully introduced delivery fees at 150 locations over the last six months with no impact to sales.[15]  Since Uber Eats / Demaecan have trained the Japanese public to pay up for delivery and other service fees, there’s now a wide price umbrella for Ride On Express to shelter beneath should they ever decide to sneak in some delivery fees of their own. 

-          Food aggregators:

§  Demae-can’s latest results make clear that food delivery aggregators are still growing rapidly in Japan.  Still, as the recent exit from Japan by Delivery Hero’s Foodpanda shows, surviving as an aggregator is not easy when profits are so tough to come by.

The best delivery franchise companies like Ride On Express and Domino’s Pizza pre-date the existence of aggregators like Uber Eats by decades, do not struggle to show profits thanks to franchisee royalties, and have control over reams of invaluable customer data.  Yet there is a narrative we have seen that suggests that aggregator platforms are a growing threat to the Dominos’ Pizzas of the world.[16]  

What Ride On Express has taught us, however, is a) the success of aggregators is growing the pie for all delivery businesses in Japan, and b) the two business models (i.e. aggregator vs. franchisor) don’t necessarily compete for the same customers.[17]  How do we know?  Ride On Express has historically received 80% of incoming orders directly (online or by phone) and 20% indirectly via Demae-can’s platform.[18]  Because Ride On Express fulfills all Demae-can orders with their own deliverymen, they know for a fact that the customers that order indirectly via Demae-can are not the same customers that order directly via the Gin No Sara app.

Why should customers continue to order sushi directly from Ride On Express’ Gin No Sara’s app when they have a handy Uber Eats or Demae-can app that recommends so many other sushi restaurants?  In our view, the top reasons include:

1)      Customization: Gin No Sara offers a level of customization and service that is currently impossible to find on Uber Eats or Demae-can. For example, if you order a sushi set for the whole family but dislike salmon, just replace the salmon with tuna and have your bill instantly recalculated.  Likewise, if you placed an order online, but realize after-the-fact you neglected to select the “without wasabi” option – just dial the nearest location to make last-minute changes for free. 

2)      Speed: Gin No Sara has exceptionally fast delivery times: ~70% of orders complete in under 40 minutes in most years, while 47% of orders completed in under 30 minutes in the quarter ending September 2021 (up from 23% in the quarter ending September 2020).[19]  On rainy/snowy Sunday nights when Uber drivers are scarce, Ride On Express customers can rest assured a uniformed/trained employee will definitely complete their delivery – without damaging the sushi.

3)      Value: there are no delivery charges or tips at Gin No Sara. Likewise, for its quality (i.e. better than most sushi restaurants outside of Japan), Gin No Sara is priced lower than many sushi restaurants that list on Uber Eats or Demae-can.  Granted, customers could order Gin No Sara sushi indirectly via Demae-can’s app, but in that case they’ll be paying up for the exact same menu items to make up for the hefty platform commission fees.  In other words, value-conscious consumers are highly incentivized to order directly from Gin No Sara rather than go through an aggregator app.

4)      Rewards: Gin No Sara provides valuable loyalty “delipoints” and discount coupons for frequent direct customers.  These perks aren’t available to indirect customers via Demae-can.  

5)      Regional familiarity: though it may not seem like it, there are big differences in the way sushi is enjoyed across Japan, and Gin No Sara understands that.  As such, Gin No Sara locations are organized according to five different sushi regions – Hokkaido, East Japan, Tokai, Kansai, and West Japan / Kyushu.  Something as simple as the sweetness of sushi vinegar or soy sauce varies greatly between regions.[20] 

6)      Food safety: many restaurants listed on aggregators are small outfits with unproven hygiene.  Long-time Gin No Sara customers know that Ride On Express is a publicly traded company where a) food sourcing and training are at a high standard, and b) if there is a problem, a manager will definitely answer the phone to take care of it.

Catalyst

Additional franchisee locations, price hikes, and dividends/repurchases.