7646:JP Plant

PLANT is a rare opportunity in today’s market – a noncyclical, discount retailer with a strong balance sheet, expanding margins, and opportunities for growth, trading at only 3x normalized FCF.  Furthermore, there are several catalysts that could accelerate the stock’s move towards intrinsic value, roughly 2 to 3 times higher than the current share price over the next several years.

Business Model

Plant operates 20 stores in 9 prefectures in Japan.  The bulk of sales comes from 15 supercenters (13,200m2 on average), which are located in less densely populated areas where there is little to no competition.

The company’s strategy is to become indispensable to the communities that they serve and account for a high share of the local population’s consumption expenditures.  The core of this strategy is maintaining the lowest SGA/Sales ratio in the industry, at 16% vs. the industry average of 25%.  This allows the company to profitably maintain significantly lower gross margins than their competitors, which translates to the lowest available prices for the end consumer.

Improving Fundamentals

Over the past five years, revenue declined due to no new store openings, one lost store in Fukushima, slight population declines in operating regions, and a deflationary economic environment.  However, the company has been quite successful at margin improvement and debt reduction despite these headwinds.

The company has announced plans to open one new store this year and expressed the desire to open at least one new store per year going forward.  The company issued the following guidance at the end of 2012:

Through the first half of 2013, revenue and EBIT have slightly missed targets.  This is an interesting period to observe for clues about future performance, as the yen weakened substantially from 78 JPY/USD to 94 JPY/USD.  Perishable goods, which are primarily sourced domestically, account for about 25% of sales.  Most other consumer goods are imported.  The fact that margins dropped only slightly despite such a sharp movement in the yen and a high dependence on sales of imported goods shows that Plant has the ability to pass on price increases to the consumer.  The company posts monthly sales figures ahead of its results, so we can monitor this page to model near-term revenues:

http://www.plant-co.jp/ir/uriselm.html

Valuation

It is important to note that low maintenance capex (less than JPY200m) and much higher depreciation (JPY1B) add significantly to FCF.  In recent years, improvement in inventory turnover has also added to FCF, but our model will not assume any further improvements in working capital.  Normalized FCF, which we feel is the most appropriate metric to determine the value of the existing stores, assumes no growth capex.  However, management is guiding for one store opening per year at JPY1.5B per store, so we will take that into account when calculating net debt.

Closest Listed Comparables:

We peg fair value at 7x EV/EBIT, about 110% higher than the current share price.  For investors with a longer time horizon, the shares could triple within 5 years as debt is further reduced and free cash flow is allocated either to new stores or an increased dividend payout.

Management Alignment

The founder and his family members collectively own 41% of the shares outstanding.  The company does not disclose executive salaries, which in Japan means that these salaries must be less than JPY100 million ($1m).  By this line of reasoning, it appears that the founder collects more from annual dividends than from his salary.  With the exception of a small dilutive offering in conjunction with the listing on the Tokyo exchange, we believe management have acted as rational business owners and shareholders should be well aligned going forward.

Why is it So Cheap?

• Prior to October 2012, Plant was listed on the Osaka exchange, where valuations are generally lower than the Tokyo main board.
• The Company informed us that there has been no communication with investors for 7 years, as management was focused solely on debt reduction and margin improvement. 
• Plant’s headquarters in Fukui is well off the beaten path for most investors, and we were apparently the first foreign investors to contact the company for a visit. 
• The company lost one store due to the Fukushima nuclear disaster, for which it had to take a JPY1.8B writedown.  This obscured otherwise steadily improving financial results in FY2011.

Catalysts

• The company moved its listing to the Tokyo main board in October 2012.  Valuations are generally higher on the Tokyo exchange, and we expect this move will help the stock get more attention from investors. 
• In April, the company’s newly formed investor relations team made their first trip to Tokyo to meet with analysts and brokers.
• A new store opening this year should result in a return to revenue growth in FY2014.
• The company has already received JPY650m compensation from TEPCO in connection to the Fukushima incident and should receive a further JPY1.15B of cash in the coming years.
• As debt is reduced, the company plans to allocate FCF between new store openings and dividends.  The combination of organic growth and increasing dividends should attract investors to the stock.
• Plant could benefit from increased consumer spending if Abenomics successfully alters inflation expectations.

Risks

• Declining Population – Plant operates in regions with declining populations.  We expect same store sales to continue to decline.
• Natural Disasters – As the incident in Fukushima demonstrated, we can’t rule out another major disaster leading to a store closure.
• Deflationary Economy leading to further same store sales declines
• Weakening Yen – We have fully hedged the yen in the event that it weakens further
• Subpar capital allocation, potential equity raise 

• The company moved its listing to the Tokyo main board in October 2012.  Valuations are generally higher on the Tokyo exchange, and we expect this move will help the stock get more attention from investors. 
• In April, the company’s newly formed investor relations team made their first trip to Tokyo to meet with analysts and brokers.
• A new store opening this year should result in a return to revenue growth in FY2014.
• The company has already received JPY650m compensation from TEPCO in connection to the Fukushima incident and should receive a further JPY1.15B of cash in the coming years.
• As debt is reduced, the company plans to allocate FCF between new store openings and dividends.  The combination of organic growth and increasing dividends should attract investors to the stock.
• Plant could benefit from increased consumer spending if Abenomics successfully alters inflation expectations.