Description

Thesis Summary:

• High quality businesses operating principally in asset-light CRE services, with a history of excellent value-creation           
• Suffers from a minor case of "mistaken identity" (viewed and comped partly as construction businesses), which I believe is now a dated perception           
• Ability for them to reframe their narrative and help to rerate their shares
• Pace of value-creation acceptable (~14% earnings yield, higher FCF yield, and growth in capital light divisions) 
• Founder built a nearly ~¥30bn EBIT business from scratch
• Management team has an excellent track record with an impressive average ROE over the past ~15 years   

 Mr. Muraishi is clearly a talented entrepreneur and businessman in the commercial real estate field – having founded Starts in 1969 and producing last years’ sales and pretax income of ~¥230bn and ~¥29bn respectively.

In the noughties Starts had a relatively large focus on residential construction – and that led to some lean years post GFC and a subsequent prioritization of more recurring, low-risk, asset-light services. Namely, they doubled down on apartment management and brokerage, which have become the major value drivers of the firm.

Their most important segment is apartment management – possessing strong cash-margins, organic growth, excellent returns-on-invested-capital, and a good brand with a solid differentiator (perceived advantage in maintaining occupancy via a residential brokerage division). They grow via adding new doors-under-management and those doors growth in rent (both of which I feel fine about).

Their brokerage and advisory businesses are also excellent on any quantitative metrics or measures of long-term performance (although are individually much smaller).

I feel part of Starts’ discounted valuation stems from their (now smaller) construction segment, and their larger legacy therein. While less attractive than the other core segments, it does have an incredibly good history of consistent profits with excellent ROICs. This seems partly due to a repeatable model of building small cookie-cutter-ish apartment buildings (or condos) for small individual landowners. The unique particularities of their model have convinced me that this is a perfectly nice business (which the financial evidence strongly indicates). And while Japan has all the housing-stock it’ll ever need, it’s not all in the best location and local perceptions of “old” construction lead me to believe residential construction in central Tokyo is a sustainable field.

Valuation: the current price of ~7x trailing earnings (with some net-cash and earnings expected to grow) seems highly attractive for a (my opinion) very well-run firm with attractive core segments. Economic earnings could also be understated due to D&A on a fair-bit of owned real-estate. Capital allocation seems OK and improving, with very reasonable cost-of-capital assumptions and their agreeable recent decision to pull back on asset-intensive hotel initiatives.

I feel the misunderstood quality of their earnings and their operational prowess should justify a much higher multiple. It’s worth remembering that Japan itself is not a cheap market (the index has a high P/E), and that this is not a small company by Japanese standards (as measured by magnitude of earnings).

Should this trade well under ~1/2 the multiple of their market considering it is unlevered, has a strong ROE, operates in attractive fields, and has highly defensive characteristics in their core segment? It’s obviously not a perfect comp, but FirstService Corp appears to trade for ~20x trailing EBITDA…

So I feel upside is very good from the firm’s mid-teens earnings yield and distinct rerating potential (upon any narrative shift that recognizes them as an asset-light and defensive-yet-growing services firm). 

I also think downside protection is decent. Their core segment (apartment building management) should be defensive to most macro factors. 

Additionally, shares trade near tangible book value despite having mostly asset-light businesses because a) they have some net-cash and investments, b) they own their 3 main Tokyo offices - a couple of which are blocks from Tokyo Station, and c) they own some hotels that until recently generated losses (but are recovering). 

Risks: Operations and capital allocation I suppose…

Disclosure: Have ownership interest in Starts Corporation Inc. at the time of this write-up that can change at any time without notice. There are no plans to provide future updates on the authors buying or selling activities for this or other stocks. The author may buy or sell shares of Starts Corporation Inc. without notice for any reason at any time.

Catalyst

TBD - but I think there may be some appetite for hidden gems of this approximate size in Japan at the moment...