7581:TYO - Saizeriya

[frank]

This is my first post.  Would love to throw this idea to the board and see if I get any feedbacks.  Understand that this is a non-US play and most may be unfamiliar with the name but still this is one of the most interesting ideas I could find in a long time.  I have listed study resources (in English) at the bottom of page and also the URL to my full write up.  Would love to hear your thoughts and comments.  Questions are welcomed, too (do not hesitate to ask!:).

 

Summary of Thesis

 

Saizeriya (TYO: 7581) is a Japanese family restaurant chain operating well over 1200 “Saizeriya” ultra-low-price Italian family restaurants in Japan and rest of Asia (mainly China & HK). It is currently selling for abysmally low enterprise multiples (4.5x TEV/EBITDA, x0.43 TEV/LTM sale, P/E is 27x but less relevant here given high D&A and net cash) due to underperformance of the company’s Japanese store base and FX and cost headwinds pressuring gross margin (the company is a large importer of food & wine) and EBITDA (declined from 17.4 Bil Yen for FY2010 to 11.3 Bil Yen for LTM). However, we think this is a misunderstood play and embedded in the dismay recent trend is the company’s fast-growing Asia division that is growing store count at an astronomical pace and will soon become a significant contributor to firm top and bottom lines going forward. Below is some basic math to our thesis:

 

1) Asian restaurant division: it alone could fetch a valuation of 28 - 42 billion yen or at least half of the current market cap (60 billion yen @ 1191 yen per share) if trading on industry-average EBITDA multiple of 10x or a more aggressive multiple of 15x our projected FYE 2014/8 division EBITDA of ~2.8 billion yen. Room for upside exists due to Asian division’s better growth profile vs. industry (prior 3-yr CAGR of store count of ~34.1%, China store count @ ~180 stores vs. long-run potential of 3000 stores (Pizza Hut Casual Dining already has 1000+ stores in China), less than 3-yr cash paybacks for store investments) and operating leverage now starting to show through earnings.

 

2) Japanese restaurant division: the fundamentals of this division are not nearly as bad as the market multiple suggests but recent underperformance was compounded by high operating leverage (fully-owned store base & vast majority of stores under operating leases). On a trailing-twelve month basis, the Japanese division had net sales of 104 billion yen and EBIT of 4.7 billion yen and for FYE2014/08 we project division EBITDA of ~7.4 billion yen. We think the Japanese business could fetch a valuation of 41 - 59 billion yen (equivalent to 0.39x to 0.56x ((industry: 0.7~0.8x) our projected FYE2014/08 net sales of 105 billion yen or 5.5 to 8x (industry: 9~10x) our projected FYE2014/08 EBITDA of ~7.4 billion yen given the persistent negative store comps and depressed store-level margins). The high end of the valuation range reflects a margin normalization scenario (LTM EBIT @ 4.5% vs. prior 7-yr average @ 10%) as we think the company’s business model and value proposition to customers is still .ubside.

 

3) Net Cash: 9.3 billion yen (16.1 billion in cash & ST investments, subtract 3.8 billion in interest bearing debt, 2.8 billion in ARO, 0.2 billion in other financing obligations) as of MRQ. Dislike the typical distressed restaurant stocks trading at low TEV/LTM EBITDA multiples for a good reason, Saizeriya has a pristine balance sheet and had historically funded most of its expansion capex out of its own free cash flow. Fixed debt and lease obligations are well-covered by operating cash flow with Gross debt/LTM EBITDA ratio sitting at ~0.35x and LTM EBITDAR/Rent ratio at ~1.68x.

 

Add the three pieces together and we get an implied value for the equity of between 78 - 110 billion yen or the equivalent of 1546 to 2181 yen per share or 30 – 83% implied upside from the most recent close price. For the coming 3 years, we think EBITDA can show a CAGR of ~11% to ~21% with the low end of range reflecting future Asian division net store count increase staying the same as the current fiscal year plan and the high end of range reflecting a full turnaround for the Japanese division.

 

The Downside Scenario: let’s say the downside scenario is a liquidation in which the assets can only sell for their current replacement value. Given that the company has 1012 stores in Japan and 200 stores in Asia and on average it costs them approx. 60 million yen in gross CAPEX to build a new store in Japan and approx. 29 million yen to do so in China, the rough replacement value for the store base we calculated is approximately 66.5 billion yen, or 10% above the current market cap.

 

 

Why the opportunity exists?

- The company has a largely Japanese investor and analyst base for the stock, so the likelihood of the consensus over-discounting the headwinds in Japan while underestimating growth coming out of China is high.

- A Japan thing? It’s not hard to find a bunch of Japanese companies selling for abnormally low or negative TEV/EBITDA multiples, but often those are micro-cap names with flattish growth prospects and/or corporate governance issues.

- Minority discount? Company is essentially controlled by the founder (the current chairman) and related parties who collectively own nearly half of shares outstanding; but we are comfortable investing alongside the founder as he has skin in the game and has shown real vision and skill building the company from ground up over the 40+ year period and turning it into the most efficient operator in the family restaurant industry.

 

Key Risks:

- Significant decline in average unit volumes for Japan leading to operating losses (not impossible but the truth is the company had NEVER had an operating loss year for the last 20 years on record)

- Potential store impairment losses due to closures within Japan

- Execution risks and operational constraints for Asia expansion

- Threats from competition (competition finding a way to bypass company’s low cost moat)

- FX risks

- Food safety/reputation risks

- Key man risk (founder)

- Geopolitical tensions between Japan and China

 

Key Catalysts:

- Turnaround for Japan, we look for improving comp store sales & margin improvements

- Asia growth coming in as planned or better than expected and margin leverage greater than we anticipated, this will halt the decline in firm EBITDA and impress the market

- MBO – can’t be ruled out but not the best use of cash at the moment

- Activist investor Dalton Investments took a 5% stake in Feb – will see if they do something down the road if result continues to disappoint

- Potential HK-listing through HDR leading to better appraisal of stock by Chinese investors who better understand the growth story

- Other: potential lower corporate tax rate for corporate Japan, re-franchising possibility for Saizeriya Japan, potential entrance into newer regions (SE Asia) and/or market segments (Fast Food, Home-Meal-Replacement, Packaged Food, etc), TPP free trade talks leading to result benefiting food importers

 

For a full write-up, please visit my blog:

http://always-invert.com/?p=4

 

Study Materials in English:

http://always-invert.com/?p=263

 

Final disclosure: we have a position

[frank]

Just a quick update on the pick-

 

Saizeriya reported Q3 (May-2014 Qtr) results a few weeks ago and EBITDA on a trailing-twelve-month basis appeared to be turning a corner.  Stock is up ~16% (vs. Nikkei +6.5%) since my initial post but at approx. 5x EV/EBITDA (1381 yen/share), this unloved restaurant stock is still a long-term buy.  will be mildly dissapointed if the stock is not a double in 3 years (seriously).

 

Full Q3 update on my blog:

http://always-invert.com/?p=335