Fast Retailing 9983 JT
October 12, 2010 - 5:35pm EST by
saps
2010 2011
Price: 11,180.00 EPS $605.00 $590.00
Shares Out. (in M): 106 P/E 13.5x 13.8x
Market Cap (in $M): 1,186K P/FCF 13.2x 12.8x
Net Debt (in $M): 180,220 EBIT 132,378 129,200
TEV ($): 1,010K TEV/EBIT 7.6x 7.8x

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Description

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Summary

Fast Retailing is the owner/operator of the Uniqlo clothing stores which sell cheap high quality basics.  FR has ~790 stores in Japan (#1 apparel mkt share at ~7%) and ~135 stores outside Japan (mainly China and Korea).  In 2009, ~80% of Revenue and 95% of EBIT was from Uniqlo Japan and 6% of Revenue and 1% of EBIT from Uniqlo International.  The rest was split between acquisitions (such as the brands "Theory", "Princesse Tam Tam" and "Comptoir des Cotonniers") and other domestic brands.  In FY Aug-2010, Uniqlo International will be ~10% of Sales and 5% of EBIT and should continue to become an increased proportion on FR's profits.  The CEO has said in 2016 he wants profits from outside Japan to equal profits from Japan.  No analyst forecasts anywhere close to this.

 

FR is one of the worst performers in Japan this year, with shares down ~35% YTD vs the Topix Retail Index down ~5%.  The reasons behind this are 1) weak spring LFLs due to unseasonably cold weather along with a couple of product missteps (which led to a small guidance downgrade), and 2) fears over very difficult comps in Sept-December 2010 due to the lapping of the very successful "heat-tech" product line, 3) weak 2011 guidance.  Negative LFLs and weak guidance have increased worries of oversaturation, competition, quality of the franchise etc.   Buy/Hold/Sell - 3/14/3

 

Valuation and Reference

On normalized 2012 earnings, I value Fast Retailing at ¥17,403 which represents a 56% premium to the current share price.  FR has 15% of mcap in cash, a progressive dividend policy (rare in Japanese management teams), and owns 4% of its shares in its treasury. At my target it will trade on 19x and 8.7x Aug-2012 P/E and EV/EVITDA, below hist. avg of 22x and 10x respectively

 

Why Now?

Last Friday (Oct 8th), FR reported Q4 numbers which were in line with expectations.  However FR guided for a 5% decline in Uniqlo Japan sales and a 15% decline in EBIT and a 17% decline in EPS for Aug-2011.  This got the market spooked and shares fell 10% the next trading day (today).  I have no idea how shares will behave over the coming weeks, but at the current price/valuation (6.5x Aug2010 EV/EBITDA, 13.5x post cash Aug2010 PE), I think FR offers a compelling opportunity to buy a rare high quality apparel retailer (in the league of Zara and H&M but significantly cheaper) with several years of earnings growth to go, both domestically and internationally. 

 

 

Thesis/Positives/Timeline:

  • 2011 Guidance should be beaten and consensus is too low on medium term margins: Q1 will be difficult as there will be discounting and potential inventory write-downs due in large part to the late onset of winter. This will impact gross margins negatively. However, this is a temporary issue and I do not believe this has changed the fundamentals of the business as 1) competitors have given a similar rational for weak sales (cool summer, very warm start to winter) - please refer to analyst or company reports on Point or Shimamura; 2) over the past several years, FR has managed to grow LFLs and earnings in spite the overall industry declining - so benefit of doubt should be given to FR, 3) inventory levels (down 5% YoY, albeit against a late onset of winter) do not look particularly high in light of guidance. Also I think management is low-balling H2 guidance - as they have no reason to be aggressive on guidance right now. Also, there are is a ¥3B one-off above the EBIT line and another ¥12B one time below the line loss due to an accounting change. Consensus numbers have come down significantly for 2011, but moreover, guidance for 2012 and beyond now looks unrealistically low (consensus assumes permanently depressed margins in Japan, and no margin uplift in international even though management has said margins will be low in large part due to inventory markdowns and also that international margins will be hit in 2011 due to a one time ¥3B hit arising from startup costs at its new flagship 5th avenue store in NYC). I think this business should be able to earn ~¥800/share in Aug-2012 (bear in mind this includes goodwill amortization of ~¥50-60/share, which should technically be excluded). I get to this using 20% EBIT margins in Japan (lower than the last 2 years but higher than 2011 as there should be no inventory writedowns in 2012) and 11% EBIT margin in International (which is actually what FR will be at even in 2011 once you adjust for the one time ¥3B cost) - my sales assumptions are only moderately ahead of consensus at +5% in 2011 and +10% in 2012, which are pretty conservative given store growth that management has forecasted.
  • LFLs in Japan should turn positive during Jan-April 2011 and multiples should rerate to historical average - After lapping LFLs of +32% and +36% in September and October, comps become easier, and turn negative in January. FR should be able to post positive LFLs during Jan-April 2011 if weather normalizes, and is comp'ing an easy H2 2010 (Mar-Aug 2010) of -6.5%. The fact that FR posted LFL's down ~25% for September (worse than consensus projections) and the shares were up 3.3% indicates there is a fair amount of bad news built in. FR has managed to post LFL growth in each of the last 6 years (see table below), in a steadily deteriorating retail environment in Japan.
  • High Quality business - FR is a franchise that has not only posted impressive LFL growth in a weak retail economy like Japan, but has been able to continually open new stores while maintaining high returns. 5 year average revenue growth for Uniqlo Japan has been ~10% and margins have increased over this period (EBIT cagr ~15%). 5 and 10 year average earnings growth is superior to Inditex and H&M (though more volatile year on year). Its ROCE has been steady, currently at ~24%, slightly below that of H&M and Inditex (they trade at much higher multiples) and 2 - 4x most domestic competitors. Separating out sales/new square feet added (see table below), I see no indications of saturation (FR is now opening more large format stores, which is why there is a recent uptick in sales per NEW space). While competition is always a concern, FR has managed to continually grow share despite this. Lastly, management is well respected. All this means I think FR should be able to continue to grow total sales and profit in Japan.
  • International opportunity - Though this division is only a small contributor right now, it has recently turned profitable, and early results indicate Uniqlo's concept is well accepted internationally (successful in China, its NY store and its Paris store have very high sales/sq ft). Exit run-rate LFLs for FY2010 were double digit.  As long as this remains the case, there is substantial opportunity to grow and contribute to group earnings, and FR has plans to increase store count aggressively over the next 5 years.  Management's plan is to focus on Asia (China, Korea, Asean) first, as they see more opportunity in those regions. The CEO recently re-iterated his plan for contribution from the international division to resemble that of domestic by 2016 (again, this seems aggressive and no one expects this - but the same could be said when the CEO provided his 2010 guidance in 2005).
  • Timeline: LFL sales in the first week of every month, 1Q11 in Jan-2011.

 

Negatives and Risks:

  • LFLs don't turn positive  -  This can happen either because competition increases further OR because the general retail environment deteriorates more than expected, OR product risk.  One should keep track of monthly retail data in Japan along with Uniqlo LFLs.  If LFLs don't improve or if there is evidence of material market share loss - the investment should be rethought.
  • International expansion expectations fall - there could be some missteps.  However, I would argue that at these multiples, the international expansion premium attached to Uniqlo is not very high (when compared to cos with strong domestic franchise international growth aspirations like Inditex, H&M, Tim Horton's etc)
  • M&A  

 

 

Own Stores+ Online Sales                
                     
Total                    
YoY % Aug-97 Aug-98 Aug-99 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11
Sep       (3.7) 8.8 20.8 (7.5) 27.0 41.5 (21.0)
Oct       25.1 (8.9) 1.0 10.7 0.8 47.7  
Nov       9.1 19.2 15.3 9.7 35.4 16.4  
Dec       0.9 19.9 3.8 11.9 13.7 18.8  
Jan       29.5 (8.0) 14.7 6.2 9.4 0.8  
Feb        (5.0) 12.5 8.7 9.6 9.0 10.2  
1H       10.4 6.9 9.5 8.0 16.7 21.9  
Mar       (7.2) 16.1 14.3 13.8 14.4 (7.9)  
Apr       5.2 (2.8) 14.3 1.6 27.0 (3.5)  
May       0.7 8.2 6.3 11.4 25.7 11.2  
Jun       21.1 4.5 6.5 5.7 11.8 1.5  
Jul       12.0 8.9 (3.9) 15.3 1.0 7.4  
Aug       5.2 21.6 6.4 7.9 11.2 (2.2)  
2H       6.2 7.9 7.1 9.1 15.6 1.5  
Full       8.5 7.4 8.4 8.5 16.2 12.7  

Existing Stores                
                   
Same-Store-Sales                
YoY % Aug-04 Aug-05 Aug-06 Aug-07 Aug-08 Aug-09 Aug-10 Aug-11 % of total
Sep (11.4) (10.8) 1.2 12.6 (12.9) 20.8 31.6 (25.0) 6.5
Oct 9.1 15.0 (15.2) (4.5) 4.2 (2.5) 35.7   10.0
Nov (15.1) 0.3 12.8 8.0 3.2 32.2 7.9   13.0
Dec 12.1 (6.8) 13.6 (3.3) 6.4 10.3 11.5   13.8
Jan 10.8 20.3 (13.4) 8.9 (0.9) 5.7 (7.2)   10.5
Feb  18.1 (12.3) 6.3 3.3 1.4 4.2 1.8   3.0
1H 2.3 1.9 0.5 2.9 1.5 12.9 13.1   56.8
Mar (6.6) (15.2) 9.2 7.4 8.1 7.9 (16.4)   8.3
Apr 3.3 (1.4) (9.3) 6.9 (2.8) 19.2 (12.4)   8.5
May 16.6 5.4 1.3 (2.1) 7.9 18.3 3.1   8.3
Jun (1.8) 13.7 (2.2) (1.3) 0.7 6.4 (5.8)   7.8
Jul 12.0 5.2 1.7 (11.7) 11.9 (4.2) 0.4   6.8
Aug (10.6) (1.6) 13.1 (1.4) 4.2 5.6 (9.3)   3.8
2H 2.7 (0.8) 0.9 (0.6) 4.8 9.3 (6.4)   43.3
Full 2.5 0.6 0.7 1.4 2.9 11.3 4.7   100.0

 

Fast Retailing-  UNIQLO Japan     (in JPY mln) FY 2004 FY 2005 FY 2006 FY 2007 FY 2008 FY 2009 FY 2010
               
Sales -UNIQLO Japan 335,905.0 365,305.0 393,600.0 424,700.0 462,300.0 538,100.0 606,438.7
               
% Change YoY 11.3% 8.8% 7.7% 7.9% 8.9% 16.4% 12.7%
               
Org/LFL Growth 2.5% 0.6% 0.7% 1.4% 2.9% 11.3% 4.7%
               
Total sales floor space (UNIQLO Japan   (In meter) 358,181 392,020 427,412 471,314 502,343 533,745 576,445
  11% 9% 9% 10% 7% 6% 8%
               
Avg Sq Mt Area (direct operated only) 339,789 375,101 409,716 449,363 486,829 518,044 555,095
               
Sales Per Avg Sq Mt   (In 000 JPY) 988.6 973.9 960.7 945.1 949.6 1,038.7 1,092.5
               
UNIQLO Japan stores 637 679 720 748 759 770 788
  7% 7% 6% 4% 1% 1% 2%
Directly-operated 626 664 703 730 740 750  
  8% 6% 6% 4% 1% 1%  
Franchise 11 15 17 18 19 20  
               
UNIQLO International Stores 9 14 30 39 54 92  
               
Total number of stores in Japan 635 775 1093 1233 1310 1454  
               
EBIT     68,800.0 64,000.0 86,400.0 110,700.0 130,488.2
EBIT Margin     17.5% 15.1% 18.7% 20.6% 21.5%
               
Backing out new store Productivity              
               
sales of existing stores (priot yr sales x LFL growth) 309,346.5 337,920.4 367,862.1 399,110.4 437,016.3 514,539.9 563,390.7
sales of new stores (total sales - exiting sotres) 26,558.5 27,384.6 25,737.9 25,589.6 25,283.7 23,560.1 43,048.0
               
avg increase in sq meters (new space) 30,395.5 35,311.5 34,615.5 39,647.0 37,465.5 31,215.5 37,050.8
               
sales per sq ft/ NEW SPACE 873.8 775.5 743.5 645.4 674.9 754.8 1,161.9
               
               
sales per store 527 538 547 568 609 699 770

 

Catalyst

1) LFL sales turning positive in Japan in Jan-April 2011
2) Realization that after the difficut Q1 (and possibly Q2) margins should normalize, providing material eps growth both in absolute terms as well as vs consensus
3) Continued successful international growth
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