Description

The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

Let’s start with the impetus for this idea, which is currency.  The yen is really really cheap.  I lived in Japan 30 years ago when Japan was the most expensive country in the world - by far.  I have been back twice since the yen collapsed last year and if Purchasing Power Parity means anything the yen is considerably undervalued.  Everyday things in Tokyo cost about 60% what they cost in New York.  That is far from normal.

If we want exposure to the yen through stocks we do not want to buy a Japan ETF where the biggest two names are Toyota and Sony.  We want “yen businesses”, domestic businesses where the revenues are in yen.  Shimamura is one of those.  If you buy Sony your yen exposure will look the same in your fund’s disclosure, but common sense should tell you that it’s the company’s currency exposure that matters.  Shimamura’s earnings are not going to go down because of currency translation if the yen appreciates.

The Japanese market has run a lot this year and we are not going to argue at all that the Japanese market looks undervalued.  Not overvalued either.  But this is just one company we found where the market level really doesn’t matter to us in the least.  The yen level matters a lot as whatever the stock does in the next year or two, we think we will wind up making another 20-30% above that on currency appreciation as a US dollar denominated investor.

Founded in 1953, Shimamura is a domestic Japanese apparel retailer with ~2,200 stores – that’s a lot! this is a very mature business - primarily located outside of the major cities. This is the #2 apparel retailer in Japan after Uniqlo but few outside Japan have ever heard of them.  Their clothing is known for its affordability and has been described as “Cheap, Chic and Comfortable.”

The stock is trading below 13x FY23 EPS and 6x EPS when you back out the big pile of cash on their balance sheet. Management has laid out an ambitious long-term growth plan which calls for a 4% revenue CAGR and gradual margin expansion through the decade driven by product premiumization, less discounting, and scale benefits.  

Given the balance sheet and the potential for significant currency appreciation even if you applied a significant discount for demographics (the population outside of Tokyo is shrinking long term) downside looks well covered and upside significant.

Background

Shimamura primarily sells women’s clothing though they do sell some mens’ and childrens’.  They sell everything from dresses to underwear to shoes to formal ball gowns to nightwear.  They have 2,173 stores in Japan and 40 stores in Taiwan. Below you can see the various stores. The 3 “core” stores are Shimamura, Avail and Birthday (kids).  Japan has a birthrate problem, but there are some kids. 

31.5% of sales are private label.

80% of stores are outside the big cities with 65% as freestanding stores, 20% in indoor malls and 15% in open air malls.  They own the real estate of many of these stores. 

Shimamura’s strategy is to avoid competition by creating a high entry barrier in its main market of suburban and rural areas. Shimamura dominates the market by opening its stores intensively in one area.  In contrast there are several big department stores and countless boutiques in Ginza competing with each other ruthlessly.  Sure, we’d rather shop in Ginza!  But we’d rather invest in Shimamura. 

Competition–wise, it is the market leader in the special battle ground – suburban area roadside store, that enables it to raise prices without noticeable demand destruction.  Some reports say they could raise prices a bit and still be the one with the best cost-to-value ratio in suburban areas.

Below you can see their 6 brands. Their Birthday franchise is kids clothing. Their core brands are doing well and exhibited impressive resilience during the pandemic. Ecommerce is 6.6% of total sales and is included in each business.

Pricing & Less Discounting Drove Revenue Growth

Management is attacking the higher price range for these brands with higher-end products. The increase in item price could be part of the driver of margin improvements. Avg price per item increased pre-pandemic and was flattish during the pandemic with 3% growth in FY23.

They are also benefiting from inflation in Japan where raising prices on consumer goods is suddenly plausible after several decades of price deflation.

Shimamura does not appear to be a struggling retailer, in fact they continue to grow number of customers and spending per customer.  Given the valuation below and the notion of what a cheap Japanese small cap looks like you would think the business is shrinking and ROIC was very low.  That is not what the numbers say at all.

Buy Online, Pick-up In-Store – The “Digital” Story

They recently entered the ecommerce space and are working to grow that business. In FY23, ecommerce sales made up 6.6% of total sales and grew 46.5% y/y in absolute dollars. The number of digital members reached 3.09 million at the end of the fiscal year, so it is still quite small. ~90% of this is  buy online and pick-up in store (BOPIS), so this is not margin cannibalizing internet retail.  Internet retail is way underdeveloped in Japan relative to markets you are probably more familiar with and continues to be even after the pandemic.  Japan is very different from other Asian markets (notably China and Korea) in this respect.  If this changed significantly of course that would be a risk to this stock but its been over 25 years and it hasn’t happened.  And if it were to it seems unlikely that non- urban markets would lead the change.

Financials

Similar to other Japanese companies they have a pile of cash sitting on the balance sheet, but even for Japan the size of their pile is pretty extreme. Capital allocation to date has been to add to the pile.  There are worse things – an extreme pile of debt for example – but if you invest in Japan you just learn this is what it is.  We have yet to see a company go broke by holding too much cash, but this is a perennial debate among value investors whenever I post something from Japan.  In ten years investing in Japan we have always treated cash at face value and have few regrets about that.

Other than 185 (billion yen) of cash and 77 of short-term securities, they have 138 of PPE on the balance sheet. This is primarily land and buildings as they own a substantial amount of store real estate across Japan.  

FCF generation is very attractive and was a 98% conversion of net income in FY23. They have a 25% dividend payout ratio and have a 2% dividend yield...and a cash pile.  Capital allocation is neanderthal but they are not doing any harm.  They continue to invest organically in a few new stores. They also mention the desire to do M&A in a couple places – unclear what they want to buy and we would probably prefer the cash pile.  If they decided to buy back stock meaningfully as we have seen many companies in Japan do in the last few years, and especially the last few months, we would like that.  But so far neanderthal.

Capex guidance for FY24 is much higher than history. Part of this is they are adding 24 stores, but we believe a big part is also the investment they are making in digital in stores.  We get the idea these operations are fairly primitive.  This is something to watch.

They have an attractive mid to high teens ROIC with ROIC above 20% the past couple of years.  That is not at all what most Japanese companies with this kind of valuation look like.  This is not a bad business.

Mid- and Long-term Management Plan

The company lays out a medium term 2025 plan and a long term 2030 plan. The FY24 goal is for revenues of 628 bn yen, EBIT of 54.5 bn yen, an 8.7% EBIT margin. The FY30 goal is for over 800 bn yen, 35% gross profit margin, SG&A 25% of revenues, and 10% EBIT margin.  Gross margin improvement is expected to come from restraint in promotions, higher prices, and scale benefits.

For FY24, the Company plans to increase group net sales by +3.1% Y/Y, operating income by +2.4%, with operating income margin targeted at 8.6%. The annual capex is planned at JPY16.3 bn. One thing worth noting is FY24 net sales guidance of 635 bn yen includes international revenue whereas the medium- and long-term management plan only includes domestic net sales [i.e. excludes Taiwan].

Valuation

Shimamura is trading at <13x EPS and 6x when you adjust for the cash on their balance sheet. The book value of their PPE and cash gets you to 80% of the current market cap. As noted above, FCF has very closely tracked earnings although the company has guided to a notable increase in capex in FY24.

While management expects LSD growth through 2030, let’s start with a no growth valuation, simply capitalizing 2023 NOPAT at a 7% cost of equity.  One could certainly argue for a lower cost of equity than that in Japan where interest rates remain very low, but let’s use 7%.  That gets us to 533 of business value or 790 with the cash and investments.  This is about 60% north of the current stock price.  And remember, we believe we have an additional 20% “bonus points” in the currency.

We will not go beyond this simple valuation, but will just suggest four things: 

1. We are well below management’s long term guidance,
2. This valuation leaves a wide margin of safety to factor in risks, especially demographics.
3. Shimamura is not a “perma-cheap”.  Although the stock has been a dog for a long time (not our problem – we bought very recently) – the stock is not typically this cheap.  Given the balance sheet and the fact that the cash balance has increased substantially as have earnings, we think EV/EBIT is the best measure to compare historical valuations.  On that measure, except for a couple brief covid period lows, the stock is as cheap as it has been in ten years.
4. Don’t forget the yen.  If we are right on that we don’t need the stock to do so much to make a quite satisfactory return as a US dollar investor.

 Risks

• The biggest risk we see is demographic.  The population of Japan is declining and that is especially true outside of Tokyo and Osaka where Shimamuru is overrepresented.  The market is pricing in about a 5% perpetual decline rate for the business.  This is something we have certainly considered and are not dismissing.  But look at the last 10 years – the population was shrinking then too and yet this business found a way to grow.  Growth would certainly not be our base case but we are just suggesting don’t be too sure that it shrinks either.  And if it does it should be slow – this isn’t some S- curve kind of thing where the population decline suddenly goes parabolic on you.
• Ecommerce – while we haven’t seen it yet, as the online business grows it could prove to be margin dilutive or introduce new competition.
• They mention M&A as part of their growth investment plans- it is unclear what this means and we could wake up one day and find out they have blown the cash to do a large uneconomic deal.
• The Shimamura family controls 25% of the shares.

The views expressed are those of the author and do not necessarily represent the views of any other person. The information herein is obtained from public sources believed to be accurate, reliable and current as of the date of writing.  The author will not undertake to supplement, update or revise such information at a later date.  The author may hold a position in the securities discussed.

Catalyst

Yen normalizes