Description

gvinvesting posted this name back in March 2018 and it’s a good time to revisit.  This is NOT your typical cash-hoarding low-ROIC Japanese value trap – it’s just the opposite, in fact.  Shinoken is now emerging from the storm of the 2018 wave of scandals at several of its peers, and more recently from Covid-19.  Two catalysts should help apt and condo sales to rebound in 2H20.  Just as importantly, Shinoken’s base of recurring revenues have continued to grow seemingly unaffected by these headwinds, and these recurring earnings are now over half of EBIT based on LTM results.  All this can be yours for under 5x FTM EPS.

(Note: EPS above in Yen. JPY 137 = LTM JPY 221 = FTM)

I’ll do a quick overview of the business for folks new to the name.  But if this sounds interesting, you really need to read that 2018 writeup, as it goes into much greater detail on many topics.

Shinoken was founded in 1990 by Hideaki Shinohara, who is still CEO today and owns just under 20% of shares.  The name is a combination of Shinowara Kenestu (Shinowara Construction).  Hideaki created a business that allows the typical salaryman to become a landlord.  Shinoken essentially uses other peoples’ money to develop and sell apt & condo buildings to these salaryman-landlords at a modest but decent gross profit, then continues to sell them higher-margin, low-churn services ad infinitum, thus building up recurring revenues over time.

When I first came across this company in 2017 and read that many of their customers are paying them via 100% LTV mortgages from banks, it sounded like a business model that could blow-over in the next strong breeze.  But over time I’ve come to realize it’s actually a durable business.  For example:

• Shinoken is the property manager on about 70% of all the apt & condo units it has built, and has maintained occupancy and tenant credit quality at super high levels.  Specifically, occupancy has been over 99% for years now, while an average of just 0.4% tenants are delinquent on rent vs the national average of 3%.

• Low-churn recurring revenues now contribute 52% of EBIT (LTM 6/30/20).  With each new building, Shinoken gets a 5-year property mgmt contract paying 5% of gross rent that renews every two years.  Their retention rate is ~98%.  Shinoken also supplies liquid propane gas and electricity to roughly 85% and 60%, respectively, of this base of units, as well various insurance products e.g. rent guarantee (a very profitable line of insurance given the sub-1% delinquency rate).

• Banks are comfortable with high LTVs due to the steady employment (remember, this is Japan) of these white-collar borrowers, and the fact that borrowers start receiving rent very shortly after getting their mortgages (around completion of construction).  Note that Shinoken relies only on “pull” marketing (TV ads and word-of-mouth), never “push” (e.g. cold calls).

• Customers stay happy: 40% of sales come from repeat customers and referrals from existing customers

• Excellent balance sheet thanks to risk averse management.  In the wake of the aforementioned storm, Hideaki cleared inventory in 2019 and paid down net debt to de minimus levels.

Shinoken began in Fukuoka Prefecture and later expanded to the cities of Tokyo, Nagoya, Sendai, and finally Osaka.  It builds within a 10-minute walk to the nearest train station, as these apartments cater mostly to yuppies – along with some DINKS - as tenants.  While Japan’s population is declining, this demographic is growing in terms of both numbers and income per person. 

Shinoken is adept at acquiring small, often-irregular shaped plots of land within this radius and adapting one of its 8 apt bldg designs to fit the space.  Typical bldgs have 4-8 apt units.  Shinoken then signs a contract with a 20% deposit before beginning construction (it’s rare for investors to back out).  Land acquisition and construction are financed by the company.  Then, after 6-8 months of construction, the customer takes out a mortgage, pays Shinoken, and becomes a proud new landlord who then pays Shinoken for property mgmt and other services on a regular basis.

The company also builds condo towers in Tokyo which are also sold to investors.  Turnaround times for condos are much longer, as construction takes 2-3 years.  But gross margins for condos are around double those for apt buildings (20% vs 10%).

Shinoken has achieved economies of scale via its in-house general contractor: Ogawa Construction, which it bought in February 2014.  Ogawa now provides ~70% of Shinoken’s construction needs, yet external customers now account for 70-80% of its revenues.  Shinoken has grown the business substantially, such that the original ¥2.6 billion price equates to just 1.5x Ogawa’s LTM EBIT.  Due to these cost savings on design & construction, the company provide attractive returns to landlords while setting rents at 5% below market to ensure high occupancy.

2018 - what a mess

Three public companies in and around Shinoken’s industry blew up in 2018, casing a pall over the whole sector:

• Suruga Bank (8358.JP) – shares were in freefall for all of 2018 when it came to light that execs had forged loan applications for “share-house” schemes – a type of apt that had attracted much investor attention in the preceding 3-4 years.  (Shinoken has no exposure to this area.)

• Leopalace (8848.JP) – in May of 2018, Leopalace announced that vast amounts of the apts it built did not meet gov’t standards due to shoddy construction.

• Tateru (1435.JP) – arguably Shinoken’s closest competitor, Tateru announced in late-August 2018 that an employee had helped a borrower to falsify docs when seeking a loan.  I’m guessing the authorities found more dirt, as they ordered Tateru to completely wind down their real estate development ops, which Tateru is nearly finished doing.

This blog post has a great summary of each scandal (scroll 1/3 down the page).  The author used to live in Japan and seems to understand the market well.

As if guilt-by-association weren’t bad enough, in mid-October that year, a Japanese weekly magazine put out a bogus article bogus article accusing Shinoken of mortgage application chicanery.  Shinoken strenuously denied the allegations, and no evidence of impropriety ever emerged.

While interest from potential customers has never waned, mortgage approval times have lengthened as banks upped their caution, leading to a slowdown in real estate sales.  At the same time, however, net debt has been nearly eliminated (now ~0.5x EBITDA), and growth in both recurring revenues and the construction business never skipped a beat.  Notably, property mgmt earnings have seen major operating leverage as more apt units are added to the platform.

Sentiment was just beginning to recover when Covid-19 hit, although the impact on the business has been fairly minor.  The months of April and May saw a slowdown in mortgage approvals and apt & condo sales, before returning to normal in June.

The CEO took this opportunity to buyback shares as well as add to his own stake.  The amounts aren’t terribly large, but hey – this is Japan.  Any such behavior is encouraging.  Mgmt also committed to a 20% minimum payout ratio, which it has exceeded thus far.

This being Japan, I’m not counting on banks reversing their caution on mortgage approvals.  But that’s ok, since we have two likely catalysts to return apt and condo sales to growth:

1.       REIT - Management launched a ¥10 billion AUM private REIT on 7/31/20.  (A smaller ¥3 billion private REIT was launched in March of 2018, but doesn’t seem to be slated for growth at the moment.)  The goal here is to add an additional source of outside money to finance real estate development by Shinoken.  The focus will be on approx. 20-unit buildings that will sell for over ¥100 million each – too pricey for their salaryman customers.  Management plans to add an additional ¥20 billion of AUM and then take it public.  From there the goal is to add ¥10-30 billion of AUM each year, boosting real estate sales, growing demand for services, and adding REIT management fees which will flow through the RE Mgmt segment.  Shinoken hopes to eventually grow this to ¥100 billion and beyond.  They’re gonna be big in Japan.

2.       Tateru implosion – Shinoken’s closest competitor should have pretty much finished winding down real estate sales around the end of last quarter.  I just don’t see how Shinoken’s #1 competitor – with roughly ¥70 billion in 2019 real estate sales (vs ¥ 57 billion for Shinoken) could vanish from the market without any benefit accruing to Shinoken.  Note that Shinoken started buying land again in mid-2019.

Forecast

Aside from Real Estate Sales, Shinoken reports the following five segments:

• Real Estate Management – property mgmt and insurance products

• Energy - LPG and electricity sales

• General Contractor - Ogawa Construction

• LifeCare - Shinoken has a modestly-growing segment of serviced apts for the elderly.  It’s still tiny at this point.

• Others - includes real estate brokerages in China and Singapore, as well as operations in Jakarta, Indonesia that are tiny but rapidly growing.  This segment is also tiny.

For the NTM (2H20 and 1H21) I’m assuming modest (relative to history) growth and flattish margins for all five of these segments (specifically, an aggregate yoy revenue growth rate of 14%, as well as a 14% EBIT margin).  For RE Mgmt, I’m adding incremental revenue from REIT mgmt fees of 4% of AUM at a 50% EBIT margin, beginning with ¥10 billion AUM on 7/31/20 (as announced) and adding ¥5 billion each quarter per the company’s plan.  This

As for NTM Real Estate Sales, I’m starting with LTM results and adding ¥3 billion to 2Q21 to remove the Covid-19 impact.  I then add ¥20 billion in sales to the REIT (as above) to get ¥71.6 billion in NTM sales (a 47% increase from the LTM).  I’m using a 10% EBIT margin – near the bottom of historical performance.  Again, I’m assuming no improvement on the banks’ slow mortgage approval times.  And I’m assuming no benefit from Tateru’s exit, just to be highly conservative.   

Finally, I deduct corporate overhead at normal 2% of sales and taxes at the same 38% rate we saw in the LTM to get an estimated FTM EPS of ¥221, for a P/E under 5x.

Catalyst

Sales to REIT

Market share gained from Tateru