Summary
- Seasoned corporate culture and a purely functional product focus has driven rapid growth, both domestically and internationally, for Ryohin.
- Balance sheet is squeaky clean and business performance metrics like ROE remains strong (15% – ish ) compared to peers.
- Exceptional corporate culture, clean balance sheet, and strong business performance is already built into share price – the bet is on continued rapid growth.
Brief History
Ryohin Keikaku (TYO: 7453) is a Japanese retailer operating with the MUJI brand, which is short for Mujirushi Ryohin, or “No brand, good product” in English. MUJI was born in 1980 as a private label brand for Seiyu, a prominent Japanese retailer. At the time of inception, MUJI consisted of 40 household and consumer good products. The idea behind MUJI is simple: To provide good quality products at lower costs. That idea hasn’t changed since inception. 36 years later, MUJI has ironically become a brand in and of itself, and the product lineup consists of roughly 7,000 items – this includes everything from clothing to furniture, food, and even automobiles. They sell there products through three main channels:
- Company Operated Stores
- Licensed Retailers
- Internet Sales
In addition to their core business, MUJI has various different smaller businesses which include: Their own trucking company, camp site business, home building and sales business, etc. The governing philosophy behind their whole business revolves around simplicity. If we reduce MUJI down to a few words, it would be something like this: Maximum utility for minimum price with good quality.
Product Design and Development
If you are familiar with supply chain terms, MUJI’s product design and development is best described by the term “Lean”. The product design process starts by thinking about what the basic needs in everyday life are. Next, they build a product in a way that maximizes utility, minimizes costs, and maintains good quality. This is achieved by paying attention to three things:
- Material Selection
- Process Inspection
- Simplified Packaging
Material Selection
Utility, price, and quality are at the core of material selection. MUJI explores alternative materials for conventional products – cheaper materials that can substitute what is typically used, without sacrificing quality. They pay attention to what is being sacrificed for the sake of better appearance and then eliminate the sacrifice to stay true to their focus on utility, price, and quality.
Process Inspection
MUJI ruthlessly inspects every step of their manufacturing process. If a process does not relate to product quality, it is removed. Finishing touches that serve aesthetic purposes rather than improving product quality are eliminated.
Simplified Packaging
MUJI’s products typically have one tag or sticker on them with product information listed and nothing else. They value simplicity through and through – this means no special aesthetics, no presentational shenanigans – just plain packaging.
Here are a couple examples to demonstrate some of the products MUJI produces:
Okay, so what the hell does this do, you ask? It becomes a broom, window washer, carpet cleaner, floor mop, etc:
The value provided by these products probably aren’t immediately clear to the average western investor. To give you an idea, monthly rent for a 1 bedroom apartment outside of Tokyo costs roughly $800/month. Move within the city and you are already at $1,300/month easy (does not include parking space for your car), and these apartments aren’t large by any means. While it would be nice not to have to attach and reattach cleaning tools to a pole, it sure is nice to save closet space, especially when space is expensive. By the way, this pole is about $4.
Apparently this product was developed as a result of Japanese women having trouble sleeping in public (during travel, lunch break, etc) with their face showing. On goes MUJI to provide a solution: A neck pillow with a face mask. What’s more? MUJI shows alternative uses for this neck pillow on their website:
This product sells for about $19 – and at the time of this writing, the gray colored neck pillow was on sale for $13, sorry if you missed it.
Rebuilding MUJI – Making the shift from surviving to thriving
I ran into an invaluable interview of the previous CEO (retired in 2015), Tadamitsu Matsui here (Japanese source). He took the throne in 2001, a difficult time for MUJI. After 10 years of growth, MUJI suffered 3.8B Yen in losses. As Mr. Matsui puts it, MUJI came down with “Big Business Syndrome” – where confidence is flying high and problems aren’t being addressed properly. His tenure entailed several key initiatives:
- Series of store closures
- Improved inventory management
- Structure-focused business operations
- Expansion through the global, local market
- Driving corporate culture change
The bullet points above are all interrelated, and they all tie into the overarching theme of building a winning corporate culture. Mr. Matsui’s approach to problem solving is an interesting one. The way he saw it, MUJI was operating on a losing corporate culture – where confidence was flying high while the world around MUJI was changing. Competition was creeping up and the MUJI brand was losing its edge. In the interview, Mr. Matsui explains that creativity comes to fruition only after basics are mastered. What he means is that in every domain – whether we are playing chess, monopoly, or real-life business – there are domain basics and learning the basics is a prerequisite to achieving any degree of creativity within the domain. With chess, you learn the rules of the game and movements of each piece, a set of opening strategies and maybe a few end-game strategies before you develop a deeper understanding of the game. As far as Mr. Matsui was concerned, MUJI was running on a losing culture, where basics were replaced with confidence from past success stories.
The first order of business, then, was to stop the bleeding. Mr. Matsui decisively took action and closed about 10% of MUJI’s stores within a year of his tenure. This started the dissection of a losing culture and rebuilding of a winning one. He talked about how much excess inventory MUJI carried: roughly 10B Yen worth. Clearly, inventory reduction was a must… and Mr. Matsui reduced inventory in style.
MUJI’s merchandisers developed a habit of ordering more inventory than needed to avoid the risk of stocking out. According to Mr. Matsui, the merchandisers were ordering double the product that MUJI could actually sell. To make his point loud and clear, he took all the merchandisers out and burned the excess inventory in front of their eyes. Six months later, he noticed excess inventory was accumulating again and repeated the same exercise. After the second round of inventory burning, the merchandisers got the message.
Once the fight for survival ended, the next order of business was to build a corporate culture to thrive on. This started with reorganizing MUJI’s business into a structure-focused one. MUJI was developed as part of the Saison Group, which is known to value human sensibility. Thus, the group as a whole had a tendency to rely heavily on the experience of individuals. What this meant is that whenever someone retired, a valuable company asset was lost. In a retail environment where companies need to compete on various levels from product development to sales to logistics to store expansion, building a collectively competitive team-oriented company environment became that much more important. Mr. Matsui pushed to add structure to MUJI in order to mitigate the reliance on individual talent and to build a team-oriented environment. This lead to the development of the MUJIGRAM, an extensive corporate manual that describes every step of every process in the company – from cash register operations, to accounting management, to workforce management. To this day, the MUJIGRAM continues to evolve every day as additions and modifications to processes are suggested and implemented by front-line employees.
When the platform for thriving was set in place, the next objective was to scale it. As such, MUJI has been on a mad rush for global expansion, and they have been executing well. In 2010, MUJI had 359 stores within Japan (including licensed retailers) and 134 stores outside of Japan. Now, they have over 400 stores in Japan and a little over 340 stores internationally. Their focus has been on China, where store count grew from 26 in 2010 to 160 by the end of 2015.
The mad expansion did not take place through copying and pasting what worked in Japan. Mr. Matsui has another interesting approach to global expansion. According to Mr. Matsui, there is no such thing as a global market, but there is such a thing as an accumulation of various smaller local markets. MUJI operates at a peculiar balance between structure and flexibility. While corporate developments like the MUJIGRAM make it loud and clear that MUJI values structure, they also make local adaptations that takes the different living and business environments into consideration.
Today, revenue from international operations accounts for roughly one-third (110B Yen ish) of total revenues (307B Yen ish). Interestingly, MUJI’s East Asian operations yields higher gross profits than its core Japan business. In 2015, East Asian operations (including 160 stores in China) yielded 83B yen of revenues for 17.2B Yen of gross profit. In comparison, MUJI’s Japan operations yielded 198B Yen of revenues for 17B Yen of gross profit.
Financials
MUJI’s financials are as simple as their products. Here are a few charts to give you the idea:
Revenue and Gross Profit both roughly doubled over the past 10 years. This growth has been achieved with very little debt:
MUJI has maintained uncharacteristically high returns for a Japanese company:
I looked at the Financial Times financial data at a few other established Japanese retailers and how their ROA, ROE, and ROIC compares:
Valuation
Here are some of the current valuation data points:
And to add some historical context, here are data points from the past 10 years:
From a purely quantitative standpoint, Ryohin Keikaku’s current valuation appears a bit high. However, adding some qualitative context into the mix makes Ryohin’s price understandable. It’s an exceptionally well-managed brand and business, and it took a while for Ryohin to get to where it stands today. The current runway for Ryohin appears to be roadblock-free. Stores are profitably expanding endlessly and ROE floats around 15% (right where management wants it to be). I’m not going to attempt to build a DCF model and pretend like I can assign a reasonably accurate value to this business. However, looking at historical values tells us that Ryohin is trading a bit on the expensive side. I think it is interesting to note that Ryohin’s East Asian Operations (28% of total revenue in 2015) is more profitable than its Japan Operations (⅔ of total revenue). The largest block of stores in their East Asian Operations is in China (160 stores). So far, the whole East Asian Operations has seen growth in gross profits for 2016, it will be interesting to see how MUJI’s store profitability holds when times get tough.
Conclusion
To get straight to the point, I wouldn’t invest in Ryohin at its current price. At least to some extent, their “intrinsic value” is derived from qualitative factors like exceptional management, healthy corporate culture, brand strength, etc. While this is not a problem, it is difficult to gauge any sort of deterioration of these factors until it is too late. In other words, on a qualitative perfection scale of 0 (imperfection) to 100 (pure perfection), Ryohin is probably at an 80, where it is incredibly difficult to get those last 20 upside points, but way too easy to lose points. I think the most likely scenario is that they maintain their current “perfection score”, but it is still difficult to gauge if or when there is a change in the score. That said, maintaining the 80 score and continuing on the global scaling rush will probably be very lucrative.
Frankly, sometimes we don’t see the roadblocks until we actually get to it. Common sense says that MUJI cannot scale to infinity. I may be missing the MUJI train here, but my approach tends to revolve around some combination of cheap and quality. MUJI certainly brings the highest of qualities to the table, but I’m just not comfortable with the price. Personally, I’d be more interested if they traded below 2x P/B, even though most of their peers seem to trade around a 4x P/B multiple. For those looking for GARP opportunities, Ryohin is certainly worth a look.
Click here for the Google Sheet file containing Ryohin Keikaku’s 10 year financials that I compiled for this post.
