2749: JP Holdings Well Positioned For Long-Term Growth

Summary

  • JP Holdings operates the largest chain of day care centers in Japan
  • Macro tailwinds support further growth of JP Holdings
  • Japan’s birthrate problem may be a function of insufficient childcare infrastructure.

Company Background

Founded in 1992, JP Holdings (Ticker: 2749 on Tokyo Stock Exchange) opened its doors by delivering coffee to corporate offices. Soon after, they expanded their coffee delivery business into Pachinko shops. Now, in 2016, they operate the largest chain of child care facilities in Japan with 238 locations (as of June 30, 2016).

So, what is a Pachinko shop and how in the world did this company go from delivering coffee to running Japan’s largest chain of child care centers? Admittedly, it’s a little difficult to describe, so you may want to grab a cup of coffee and a snack before reading any further.

A Pachinko shop is a mainstay in Japanese culture. It is about equivalent to the slot machine in the US. Here’s what it looks like:

File:Pachinko machine 1.JPG

 

When you turn the knob (bottom right of picture – the black thing), a silver ball is shot to the top of the machine. The ball then falls down, hitting pins on its way down. If you’re lucky, the ball hits one of the prize pins or falls into a special hole and the machine gives you more silver balls. The objective is to collect as many balls as you can. These balls can be exchanged for prizes or tokens (basically money, but it’s technically illegal to exchange directly to money in Japan).

Hiromi Yamaguchi, the founder of JP Holdings, was an avid pachinko player in his younger days. In figuring out how to expand his existing office coffee delivery service, he figured out just what pachinko fans needed: Coffee carts in pachinko shops. Much like you would have someone walking around selling hotdogs and beer at a ballgame, Mr. Yamaguchi started having people pushing a cart in a pachinko shop selling coffee. This became a big hit, company satellite offices were opening all over Japan, and pachinko coffee carts started showing up at pachinko shops all over Japan. This pachinko coffee cart business took the company all the way to JASDAQ (the Japanese version of NASDAQ).

Now, the employees pushing these ever-so-popular coffee carts were mostly women. As the company expanded, the company started having trouble keeping these women. Somewhere between Japanese culture and the lack of affordable daycare facilities resulted in a high turnover of female employees. In Japan, it’s relatively common for a woman to leave a job once she gets married and/or starts a family. Many of these women wanted to work, but either couldn’t find a daycare facility that could accept more babies or couldn’t afford to pay for the services. To make matters worse, finding a daycare facility that is available in the evenings and weekends was next to impossible. This is where the incredibly flexible Mr. Yamaguchi comes in once again: Let’s start a daycare center for employees and pachinko players. JP Holdings opened its first daycare center in 2001 – open 365 days a year. 15 years later, they operate a total of 238 child care facilities – including the largest daycare operation with 165 daycare centers.

 

The Macro Environment

As a foreign investor looking into Japan, you may wonder what sort of opportunities there are for a large child care operation in a nation that seems so troubled with a consistently low total fertility rate (1.46 births per woman as of 2015 – Japanese reference). The good news for JP Holdings is that the lack of childcare facilities may be part of the national problem.

Early childcare in Japan

Japan’s pre-elementary school child care facilities (referred to as “care centers” for the rest of this article) have had a long wait list for quite some time now:

Here’s a breakdown of the 23,553 children on the 2016 waitlist by age:

Source: Ministry of Health, Labour, and Wefare

The shortage in care centers is mainly for children under 3 years old. This can be explained by how care centers work in Japan. There are two types of care centers: Daycares and Kindergartens. Here are the main differences:

Daycares are more or less like a babysitting facility and Kindergartens are more like schools. There are 3 types of daycares: Federally Approved, Municipally Approved, and private. In order to receive federal funding, daycares are required to meet certain requirements like child/careworker ratio, child/floor space ratio, kitchen capacity, play area size, hours of operation, etc. These are generally the most affordable daycares. The municipally approved facilities are sort of a wildcard as the rules of the game change depending on which municipality the facility is located in. Many of them receive funding from the individual municipality in varying amounts. These are typically the second most affordable option. The private daycares typically do not meet one or more of the requirements set at the federal level.

As for the Kindergartens, they are all federally approved facilities.

Let’s go back to the Ministry of Health, Labour, and Welfare for a minute. They provide more data on how many pre-elementary school children are in care centers as well as how many total pre-elementary school children exist in Japan:

# of children below elementary school age in care centers

** Percentages are % of total estimated population in the age group.

# of children below elementary school age

You may notice that year over year, the utilization of care centers went up from 37.9% to 39.9%. Frankly, this is no accident:

 

 

The Japanese government has been aggressively expanding childcare infrastructure since the Ministry of Health, Labour, and Welfare initiated a plan to reduce the number of waitlisted children in 2013. The plan initially set out to increase care center capacity by 400,000, which was later revised to 500,000 by the end of 2017. To be perfectly clear, care centers are not operated by the government. However, the government has relaxed regulatory requirements and subsidized care centers that meet certain requirements. Here’s a snapshot of the past 3 years of childcare infrastructure expansion:

The child care infrastructure problem in Japan is not geographically spread out either. In other words, it’s not a capacity shortage of 2 children in 12,000 cities. In fact, 74.3% (17,501 children) on the waitlist are from 7 prefectures (out of 47 total) + 67 designated cities that have populations greater than 200,000. 22 of these cities are in the 7 prefectures.

Tokyo Capital area (11,449 children) – Tokyo, Saitama, Chiba, Kanagawa (Pinkish area on the East mainland on map)

Keihanshin/Kinki area (2,548 children) – Kyoto, Osaka, Hyogo (Pinkish are on West mainland on map)

The problem gets even bigger: The waitlist does not portray the true picture of parents seeking care centers for their pre-elementary school children. One of Japan’s major news publications, Sankei Shimbun, reports that the “real” figure of the waitlist is likely in the 60,000 range (Japanese link). The current 23,553 figure does not reflect children whose parents are on maternity leave or have temporarily stopped their job search. Additionally, children that are waitlisted for federally approved facilities, but currently attending private or municipally approved facilities aren’t included in the 23,533 figure.

 

The Workforce

So the Japanese government is aggressively expanding care center capacity. That means increased demand for daycare and kinder teachers. While demand is rising, day care teachers’ salaries are significantly below the national average, which makes things complicated. Japan’s national average salary (at $1 = 100 yen) is $48,900 as of 2015. For women of all ages and job types, that figure is a staggering $37,300. Now, it is important to note that 94.7% of day care teachers in Japan are women. The average salary for female daycare teachers? $32,200. Needless to say, becoming a daycare teacher isn’t exactly the hot career path to take. Starting in 2016, the Japanese government made an effort to increase daycare teachers’ salaries by 2% (2015 average salary is baseline) and is expected to further increase salaries in 2017.

In 2014, there were 41,845 people who obtained the daycare teacher’s license. Of the 41,845, only 21,692 (51.2%) of them went on to actually work for a day care. This has evolved into a nationwide shortage of day care teachers. As of January 2016, there was only 1 day care teacher job seeker per 2.44 job listings. During the same time period in Tokyo, the shortage was even more extreme, with 1 day care teacher job seeker per 6.24 job listings. What this means for day care facility operators is that daycare teachers can walk away from their job and walk into a new facility the next morning.

The macro story of child care in Japan is rather simple. Despite the low child birth rate, Japan has a shortage of care centers as well as daycare teachers and has been diligently working on improving infrastructure in the recent years. This is evident by the increase in applications and increase in care center use as a percentage of population that has followed the increase in total care center capacity.

 

Company Specific Matters

Regardless of market conditions, you are bound to find losers in a boom and winners in a bust. So where does JP Holdings stand?

Growth

JP Holdings’ core business revolves around 3 types of childcare centers:

  • Daycare (165 facilities – 137 federally approved, 24 municipally approved, 4 private)
  • After school clubs (61 clubs)
  • Children’s Recreational Center (12 facilities)

JP Holdings jumped into the Childcare industry in 2001 with two facilities and have grown to 238 facilities (as of March 2016) in just 15 years.

The management team’s focus is on all the right topics as well. As outlined in their Q1 (YE 3/2017) investors presentation (Japanese link), they are focused on the following 5 points:

  1. Improved safety standards and quality of childcare
  2. Buildout of new facilities and childcare capacity expansion in existing facilities through increased number of daycare teachers.
  3. Investment in human capital (improve recruitment, training, and employee performance rating program)
  4. Risk management through revisiting corporate structure (basically setting up venture companies as separate legal entities)
  5. Profit expansion through new synergistic businesses

While this may be speculative, JP Holdings has been explosively growing and it is about time to focus on housekeeping chores like safety. This is both a solid and a tough decision at the same time as it is too easy to get caught up in growth. As JP Holdings grows, their brand grows, and the cost of a safety incident grows as well. No parent is interested in dropping their little one off at a childcare facility loaded with safety issues after all.

#2 & #3 are closely related as Japan has had trouble securing a stable workforce in the childcare industry. Federally approved facilities are required to maintain a minimum child to teacher ratio:

Now, JP Holdings does not disclose enough information about the distribution of the age of the children under their care for us to dig into the numbers and gain any meaningful insight. Additionally, there are floor space requirements for children of different ages and different services. Again, this may be speculative, but it is likely that JP Holdings maintains a lower Child to Teacher ratio than the chart above as you can’t exactly send 20 three year olds home because 1 teacher called in sick.

At any rate, the management team is interested in continuing their expansion, both through new facilities and higher utilization of existing facilities. In the next two years, JP Holdings plans to expand at roughly 20 new facilities per year. Management hasn’t commented on details of how much revenue/profit can be increased by additional staffing of existing facilities.

Simple economics says that wages of daycare teachers will increase. This problem is exacerbated with JP Holdings as they intend to stay ahead of the salary game in order to gain a competitive advantage while keeping a loyal team of daycare teachers:

 

As far as building their daycare teacher workforce goes, JP Holdings plans on doing more than just paying higher salaries:

  • JP Holdings’ sponsored scholarship program for students pursuing daycare teacher certification.
  • Internal daycare teacher certification preparation program for employees.
  • Reduction of office work for daycare teachers through increasing office staff.

An important note for the initiatives above is that mom and pop operated daycares cannot afford to deliver on any of them. For the first time, Japanese daycare centers are becoming “corporate-y”, and the country needs that to resolve its birth rate problem.

Financials

The company isn’t trading cheaply by any measure: 21~22x P/E, 13~14x EBIT, 3.7x BV, and the list goes on. Since money is made in the buying, it’s important to pay attention to whether these metrics paint an informative picture of future growth.

While JP Holdings doesn’t disclose how much it costs to open a facility or how much revenue a single daycare vs. after school program vs. recreation center generates, you can make a few reasonable assumptions and come up with a rough estimate. One of the assumptions I made is that JP Holdings uses roughly 90% of their capital expenditures for growth and 10% for maintenance. Now, digging into historical financials uncovered that JP Holdings started buying up land in 2012, increasing the land value on their balance sheet by 200~400M Yen per year (roughly $2~$4M/yr) going to 2016. During the same time period, capital improvements on leased assets worked its way down to 0. This tells me that they’ve started buying and building/refurbishing real estate to put some childcare facilities inside. By looking at capital expenditures and cross referencing that information with the number of facilities opened within a year, I’ve estimated that it costs roughly 110M Yen ($1.1M) per facility to buy the property and get it to an operational state. Each facility contributes to about 86M yen ($860K) of revenue, 16M yen ($160K) of gross margin, and the incremental increase in SG&A per facility is 8M yen ($80K – expensive!).

The management team discussed a company wide IT implementation with no real details. The budget is 100M yen ($1M), which seems incredibly low for any sort of serious IT system implementation. Having said that, cash is always tight in a growing organization, so investing a large sum in IT infrastructure to get that SG&A lowered may not be a priority yet.

If the company decided to stop all growth and maintain its current fleet of childcare facilities, I estimate that free cash flow (OCF – maintenance capex) is roughly 1.5B yen ($15M) per year. Discount this over 10 years with a discount rate of 11% and we get a fair value of 14.7B yen ($147M) or 167 yen per share. Compare that to the 24.3B yen ($243M) market cap and that tells me that at least some of the growth is priced in.

If the company continued its 20 facility per year expansion for the next 10 years, I estimate that free cash flow starts at 1.5B yen ($15M) at year 1 and ends at 2.7B yen ($270M) in year 10. Discount this over 10 years with a discount rate of 11% and we get a fair value of 21.6B yen ($216M) or 246 yen per share.

Even with the growth taken into consideration, JP Holdings seems to trade at a premium. Now, the DCF model basically takes JP Holdings’ current state and extrapolates over 10 years. Some of the things that haven’t been taken into consideration are:

  • Japanese government’s doubling down on efforts to build childcare capacity (= lots of subsidies for federally approved facilities)
  • JP Holdings’ efforts to reduce SG&A
  • JP Holdings’ startup value-added services companies that have a drop in the bucket revenue, but seem to be well aligned with the company’s overall direction (English classes, healthy meal program, music lessons, etc)
  • Rising costs of keeping certified daycare teachers.

With every company, especially the growing ones, there are hiccups. Personally, I’d find JP Holdings very interesting at about 170-180 yen/share or 14.9B~15.8B ($149M – $158M) market cap as that’s where the investment starts to look more “Dhando” like.

From a broader perspective, I believe most investors (even the Japanese investors), would not seriously consider investing in Japanese education or childcare companies after hearing about the seemingly everlasting low birth rates. However, if you flip the baby problem upside down, maybe now is the time to be investing in Japanese baby infrastructure so the Japanese families can feel more comfortable about having children. At any rate, the industry in general is hot on my watchlist so please look forward to more articles on Japanese babies!

 

Author: Clayton Young

Hi! I'm Clayton. My value investing journey began in 2012 during my college days. It was not until recently (2016!) that I decided to leverage my Japanese language skills to research Japanese equities. I hope to provide valuable insight on Japanese companies to the English-speaking world through this blog!

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