Description
Step: the best education firm in Kanagawa (maybe Japan?) for < PP&E cost + net cash
Step (ticker: 9795 JP, www.stepnet.co.jp), founded in 1975 by Kyoji and Kikue Tatsui (a husband/wife team) is a Japanese “juku” 塾 (cram school) face-to-face test prep company (group lessons, not 1x1) with 29,467 students across 154 school locations. Most of Step’s students are middle schoolers trying to test-in to the best high schools in Kanagawa prefecture (i.e. South of Tokyo, home to Yokohama and Kawasaki). Like college in the US, high-school (many of which like have “escalator” arrangements with universities) in Japan is perceived to be a key determinant of a student’s chances of reaching “the good life.”
Useful links:
https://www.stepnet.co.jp/company/data/202203e.pdf
https://www.stepnet.co.jp/company/data/202109e.pdf
https://www.stepnet.co.jp/company/data/2021_company.pdf
VIC parents: remember those initial COVID school closures and how basically nobody got tuition refunded for the lost face-to-face instruction? Believe it or not, thanks to rainy day cash reserves, Step did refund 90% of tuition for the months of lost face-to-face instruction (even for those lessons where Zoom was an option) because they felt that was the right thing to do for parents. In an amazing show of boldness, Step launched this refund policy at the start of the pandemic, when there was no vaccine in sight or any idea when government lockdowns might end – one of the most interesting (and successful) marketing ploys we have seen in Japanese small caps in some time.
As a result, Step’s EBIT declined 28% for one year, but post-COVID customer loyalty has soared, tuition price increases have been no problem, EBIT is back to record highs (42% higher than pre-COVID), market share has likely permanently increased, and more market share has been identified for the taking.
Yet thanks presumably to ugly headlines about Ukraine and US inflation, Step’s valuation is about the cheapest it’s been in a decade on a trailing P/E (10x), EV/EBIT basis (5.4x) and far cheaper than many peers. Remarkably, Step is even trading at a discount to a) net cash, plus b) the original replacement cost of their property plant and equipment (mostly school land and buildings).
Further, Step’s ROE could structurally improve from here thanks to management’s discipline over the last few years to refrain from acquiring more property at elevated prices. Hence, in our view either a) retained earnings will push cash higher than the current market cap in less than a decade, forcing the market cap to rise or b) more cash will be paid out as dividends than has historically been the case (i.e., a 30% after-tax payout ratio could rise much higher).
What gives? Step’s multiples don’t get much love from the stock market, presumably because it doesn’t grow fast enough (1995-2021 EBIT CAGR: 7%) to attract many growth investors. In fact, Step even refuses to expand to any territories outside their one dominant region (Kanagawa prefecture, home to Yokohama/Kawasaki), which is a fraction of the total size of the national test preparation market. Likewise, Step doesn’t earn a high enough ROE (1995-2021 average ROE: 10% with almost no debt) to attract many “quality company” investors because the controlling shareholder is strictly “old school” and has long preferred to buy/own the majority of the company’s locations.
Still, our checks over the years show that Step is consistently ranked highly by its employees (most of which are full time career staff) on websites like jobtalk.jp, and its students are consistently accepted to the best high schools in their region. These are two reasons why Step has been able to increase the number of students, locations, revenues, profits, and dividends for nearly 30 straight years.
