Seria (SAOGF): attractively priced, macro-defensive Japanese retail opportunity

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Introduction

Conditions for retailers are tough and likely to get significantly worse from here. Retail P&Ls will face topline pressure as consumers respond to runaway inflation by cutting spending where possible. Margins will be reduced thank you product cost inflation, increased personnel costs and ongoing supply chain issues. In addition to deteriorating operating conditions, in many cases negative investor sentiment is amplified by the optics of comparing earnings to recent results that have been boosted by temporary COVID-related factors.

In this context, I am struck by the fact that the relative winners in the retail sector are likely to be the companies that benefit from consumers changing their buying habits by negotiating and seeking better value offers. -price. While I have questions about the true underlying value proposition of dollar stores, companies such as Dollar General Corporation (DG), Dollar Tree, Inc. (DLTR) and Dollarama Inc. (OTCPK:DLMAF) , seem to me to have much less potential downside earnings risk in a recessionary environment than many other North American retailers. These stocks have attracted a lot of investor attention and are trading at high P/E ratios (20x to 25x for Dollar General and Dollar Tree, with Dollarama at ~30x). As a value investor, I consider these multiples to be fairly comprehensive, so I’m not currently inclined to dig deeper into either stock.

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DG PE Ratio Data by YCharts

The dollar store concept is alive and well in Japan in the form of 100 yen shops. In this note, I take a look at Japan’s number two 100 yen shop market, Seria Co., Ltd. (OTC: SAOGF).

Company and industry background

Seria operates 100 yen stores, selling everyday items at a fixed price of 100 JPY. Given recent strength in the USD, 100 JPY currently translates to around $0.72, but using longer-term average exchange rates, 100 JPY translates to something close to one US dollar . Table 1 below presents a summary of the main product lines sold by Seria (note that miscellaneous items generally represent more than 90% of group sales). The comparison with Dollar General and its peers goes beyond price and the types of products sold; however, Seria also has features that differentiate it from both comparable North American stores and Japanese competitors.

Seria is the second largest 100 yen store player in Japan with 1,876 stores, giving it a significant market share of around 25%. The market leader, Daiso Industries Co., Ltd. (unlisted), is roughly twice the size of Seria. Small competitors Can Do and Watts lack scale and are much less profitable than Seria. The founder’s nephew, Eiji Kawai (joined in 2003), is the current president of the company and has played an important role in the company’s turnaround and success. The Kawai family owns approximately 36% of the company.

Table 1:

Main products of Seria

Shared research August 2022

100 yen/dollar stores are a tough business to run. The segment operates with a high turnover of low-value, fixed-price items, with products that constantly change according to consumer tastes. For example, Seria estimated to have 20,000 SKUs (SKU = Stock Keeping Unit), with around 7,000 SKUs changing every year. Successful businesses can generate strong returns on capital. Seria was a struggling company in the early 2000s until current chairman Eiji Kawai joined in 2003 as general manager. Kawai came from a banking background and had extensive experience in data analysis. He was responsible for the development of Seria’s proprietary point-of-sale (POS) and data analytics systems (which include ordering and distribution systems tied to point-of-sale data) that are critical to stores at 100 yen given the importance of working capital management and forecasting sales trends. . The data-driven approach initiated by Kawai has provided a competitive advantage, resulting in improved margins and market share gains (Seria’s market share increased from ~14% in 2009 to ~25% in 2022) . With competitors struggling to be profitable or focusing on overseas expansion, Seria is well positioned to continue to gain market share through the continued application of its proven strategy.

Risks

The main longer-term risk is that the company’s growth track comes to a halt. Management is confident in its ability to generate longer-term growth through store openings, with a target of 100 to 150 net new stores per year. However, it is difficult to assess what is the sustainable level of retail market penetration for 100 yen stores. Within the segment, while Seria has made significant market share gains over the past decade, competitors may up their game and make future gains more difficult to achieve.

The main near-term risk is the possibility that Seria’s operating profit margin will be squeezed by the combined effects of persistent global inflation, supply chain issues and a weak JPY. These influences have already caused the operating profit margin to fall from ~10% to ~8%. If this were to continue for an extended period, margins could remain depressed. The weak JPY is problematic in two ways: a) it inflates the cost of products imported by Seria, contributing to margin compression, and b) for non-Japanese investors, a weaker JPY creates a drag on the market. share converted into currency.

Can Do (the number 3 in the sector) was recently acquired by Aeon. This could lead to more intense competition in the 100 yen store segment. AEON is a serial acquirer with no experience in this store format, so while this risk should not be ignored, I am not overly concerned about the potential of the acquisition to materially improve Can Do’s competitive position against Series.

The current chairman, Eiji Kawai, has played a crucial role in Seria’s strategy and success. The company maintained a clear strategic direction under Kawai’s leadership and avoided the temptation to expand beyond the 100 yen stores in Japan or venture overseas. Kawai’s key person risk is therefore a factor for investors in the stock.

Valuation Analysis – Normalized Earnings Approach

By doing a normalized earnings valuation, I essentially arrive at a point estimate of how I expect a company to perform over the full cycle or on a sustainable earnings basis. Table 2 shows my base scenario for normalized Seria earnings, along with the Bear Case and Bull Case scenarios. At JPY 2,691 per share (Tokyo Stock Exchange closes September 1, 2022), valuation analysis indicates that Seria is trading at a P/E between 13.3x and 21.8x, with a base case of 17 .0x.

Table 2:

Seria normalized profit

Created by the author using data from Shared Research

For retail stocks, my preferred valuation metric is EV/EBIT. Table 3 shows my calculation of AEV/EBIT, where AEV is the adjusted enterprise value and EBIT is my normalized EBIT.

To get to AEV, I make the following settings:

  • Seria has a very high cash balance. I have assumed that a proportion of reported cash (approximately 5% of annual turnover) is operational in nature.
  • Allow dividends and profits after the balance sheet date.

Table 3:

EVEBIT Series

Created by the author using data from Shared Research

For a retail company such as Seria, I would generally consider an EV/EBIT multiple between 10.5x and 12.5x to represent approximately fair value. Based on a current share price of 2,691 JPY, my analysis indicates that Seria is trading at an EV/EBIT multiple of approximately 8.9x.

Investment Thesis Summary

100 yen stores/dollar stores are a niche segment where market leaders have demonstrated their ability to offer a rare combination of:

  • strong sales growth
  • high returns on capital
  • a macro-defensive topline

Seria focuses solely on its core area of ​​expertise – 100 yen stores – and operates in one of the few retail categories in Japan with prospects for organic growth. Within this segment, Seria has forged a competitive advantage through its proprietary point-of-sale/data analytics systems, which have allowed the company to outperform its peers. Seria’s data-driven approach delivers distinct benefits in the following areas: a) better anticipation of sales trends, b) highly efficient inventory management, c) store design and expansion. As a solid player in a healthy market segment, Seria has been able to deliver strong capital returns over the past decade – with an average RoE of around 20% and an average ROIC of over 40% ( although it should be noted that yields have been slightly lower in recent years). Due to the uniqueness of 100 yen stores in the broader retail space and the low profitability of its peers, Seria can be expected to continue to gain market share. With ample cash on the balance sheet (~25% of market cap), Seria is well positioned to reinvest excess cash back into the core business in an accretive manner, with the potential to enhance shareholder returns (via higher dividends high and/or redemptions) over time.

The combination of high global inflation rates and a weak JPY created significant headwinds for Seria. With an inability to raise prices, cost pressures cannot easily be passed on to consumers. As a result, Seria’s profitability is expected to decline by around -20% in FY23, which will be the first time since FY09 that earnings have fallen by more than -5%. The stock fell out of favor with investors.

In summary, at a share price of around 2,700 JPY, Seria offers the opportunity to invest at a reasonable long-term valuation in a simple, high-yielding, blue-chip macro-defensive company. Assuming current cost pressures fade over the longer term, I expect operating margins to return to recent historical levels of around 10%, and coupled with continued sales growth, an upward revaluation of the share price seems likely. Share prices of North American peers such as Dollar General, Dollar Tree and Dollarama indicate that Seria’s P/E multiple could be significantly repriced to at least 20x.

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