Thinking Points
- Nitori (TYO: 9843) has delivered outstanding performance with a lovable story.
- Going above and beyond with its “high quality, affordable products” branding, Nitori is Japan’s most loved furniture brand.
- At 20x EV/EBIT, however, a considerable level of growth is already priced in. I’ll take another look if share price gets below 10,000 yen vs. today’s 16 ~ 17,000 yen.
Introduction
Nitori Holdings (TYO: 9843) is a Japanese company primarily engaged in the manufacturing and selling of home furnishings. This is probably how Bloomberg or Reuters would describe the company. While the description is true, there is a whole lot more to Nitori. I like to think of this company as the “IKEA of Japan” and my reasoning will become apparent through this post.
Broad Industry Overview
If we rewind time by 45 years and take a surface level look at the home furnishing industry in Japan, it’s a bit constricting in a very Japanese way. Basically, the product flowed like this:
- Trading company imports raw materials.
- Manufacturer buys raw material from trading company and manufactures furnishings.
- Distributor buys furnishings from manufacturer.
- Retailer buys furnishings from distributor.
- Customer buys furnishing from retailer.
This is a pretty typical industry set up, probably even for today. There weren’t any nationwide furniture retailers at the time, and distributors had a lot of leverage. Retailers wouldn’t dare cut the distributors out of the chain as the distributors often had regional control.
There were two companies that cut the distributors out, bought straight from the manufacturer, and built empires: Nitori Holdings and Otsuka Furniture (TYO: 8186).
Eliminating distributors from the equation was about the only thing the two companies had in common. Nitori Holdings proceeded to vertically integrate virtually every step of the supply chain while Otsuka Furniture expanded its business as a mid to high-end furniture retailer.
In Japanese culture (45 years ish ago), a common time to purchase big furniture (like a chest drawer) was when a couple got married or a family purchased a home. This was back in the days when living alone was far less common. Since then, Japanese living has shifted. People are moving to the city, marriage is less popular, and apartment living is more common.
According to an August 2017 Nikkei article (Japanese), the size of Japan’s furniture industry is about 3.2 trillion yen (~$28.6 billion US dollars @ 100 yen = $0.89 exchange rate), roughly half of the peak in the early 1990s. I guess this isn’t so surprising. A straight calculation would give Nitori about a 17% share (542 billion yen fiscal 2017 revenues divided by 3.2 trillion yen).
Otsuka Furniture’s 2016 Annual Report (Japanese) pointed out that the furniture and broader interior market started shifting to a “lifestyle” focus after the year 2000. My interpretation of this statement is that interior design now holds a characteristic similar to fashion with apparel. Instead of ending the sofa buying experience at “this is the last sofa I will ever need in my life”, people started buying different sofa covers for different moods, seasons, occasions etc.
Today, the line that distinguishes furniture retailer from specialty retailer is often blurry. For example, specialty retailer Ryohin Keikaku’s (TYO: 7453) MUJI brand offers furniture as a part of its wide product selection, which includes everything from food to skin care products to clothing to writing utensils. Otsuka Furniture’s annual report seems to be right on the money.
Nitori’s humble beginnings
There are a couple different versions of Nitori’s early days. One is Nitori Chairman Akio Nitatori’s. The other story is the chairman’s mother’s story. The differences in the two stories evolved into a family feud after Nikkei published Akio Nitatori’s column “My resume” back in 2015. The column highlighted a few extreme stories about Akio’s life; like being abused as a child, cheating through school, etc. In any case, the Nitori story I’m outlining here leans toward Akio’s version. A various parts of this section is sourced from an article published by Jprime.jp (Japanese).
After cheating his way through college, Akio found a job with an advertising agency. Unable to pull in new customers, he was let go after 6 months. With no luck finding a new employer, Akio ended up at his father’s construction company. After a construction site burned down, the company no longer had work flowing in.
Using one of the properties that the construction company owned, Akio pulled out a 1 million yen loan to start a furniture store. Why furniture? Because there were no other furniture stores in the neighborhood.
Store #1.
Source: Nitori Holdings home page
You would think being the only furniture store in town would be profitable. It wasn’t. Akio had social phobia and didn’t care much for customer service. To save money, Akio would eat cheap ramen noodles every day. Eventually, his body gave in. This was when his parents suggested he marry someone and have the wife handle the customers. So he did.
Soon after Akio’s wife, Momoyo started handling the customers, monthly sales doubled. When asked about her impression of Akio as a young entrepreneur, she commented that he was always out playing around. Since Akio was nowhere to be found and customers wanted their furniture delivered, Momoyo went ahead and got her commercial driver’s license to deliver the furniture herself.
A picture of Momoyo and Akio.
Source: Jprime.jp
Business was good. Akio and Momoyo opened store #2 about 8 times the size of store #1. Before long, a competitor opened a store about 5 times the size of the new stores nearby. Sales dropped like a rock, banks stopped extending credit, and again, Nitori was on the brink of bankruptcy. Akio looks back on this and commented that he constantly thought about running away or committing suicide.
A furniture industry consultant reached out and asked Akio if he’d be interested in attending a seminar in the US. Akio figured out a way to borrow more money to fund this trip. What Akio witnessed in the US was eye opening. At the time, US income was triple that of Japan, yet furniture prices were one-third of Japan. He realized this was possible because of the massive scale of furniture store chains in the US. Furthermore, American furniture stores coordinate the sales space to reflect a real living space. This was mindblowing to Akio, since Japanese furniture stores mostly laid beds in the bed section, cabinets in the cabinet section, and so forth.
Upon returning to Japan from the seminar, Akio started figuring out how to lower prices and express American wealth in Japan; Not just financial wealth, but wealth in design, presentation, coordination, etc. Of course, other seminar participants were amazed by American furniture retail, but most were convinced an American strategy would not work in Japan because of the cultural differences.
Soon, Akio’s vision for Nitori changed. He wanted to build a furniture chain to make Japanese living more affordably comfortable. Akio wasn’t alone in thinking through this. His new mentor and leader of retail chain research group “Pegasus Club” Shunichi Atsumi helped. In 1972, Akio set a tangible goal for Nitori: 100 stores and 100 billion yen in sales by 2002. Nitori reached its goal in 2003, just one year late.
Business strategy
Today, Nitori’s goal is 1,000 stores and 1 trillion yen of sales by 2022, then a subsequent 3,000 stores and 3 trillion yen in sales by 2032. Akio’s vision about making Japanese living affordably comfortable extended its scope beyond Japan, now including the rest of the world. As of February 2017, the company operates 471 stores. Fiscal 2017 sales totalled 513 billion yen.
Nitori’s strategy reminds me of an Above the Crowd article written by Bill Gurley. The article talks about Uber’s BHAG, or “Big Hairy Audacious Goal”, a term coined by Jim Collins and Jerry Poras. In discussing Uber’s corporate strategy of pursuing price leadership, Bill pulls up interesting quotes by a couple of the retail greats: Sam Walton and Jeff Bezos.
Sam Walton on price leadership:
“… But this is really the essence of discounting: by cutting your price, you can boost your sales to a point where you earn far more at the cheaper retail price than you would have by selling the item at the higher price. In retailer language, you can lower your markup but earn more because of the increased volume.”
And a little lengthy, but Jeff Bezos on business strategy:
“I very frequently get the question: ‘What’s going to change in the next 10 years?’ And that is a very interesting question; it’s a very common one. I almost never get the question: ‘What’s not going to change in the next 10 years?’ And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection. It’s impossible to imagine a future 10 years from now where a customer comes up and says, ‘Jeff I love Amazon; I just wish the prices were a little higher,’ [or] ‘I love Amazon; I just wish you’d deliver a little more slowly.’ Impossible. And so the effort we put into those things, spinning those things up, we know the energy we put into it today will still be paying off dividends for our customers 10 years from now. When you have something that you know is true, even over the long term, you can afford to put a lot of energy into it.”
I was reminded of the article because Nitori’s strategy is very much in line with what some of the American retail greats have talked about. For starters, the company isn’t shy about setting BHAGs; which carries a lot of weight in terms of “different-ness”, mainly because Japanese companies are often conservative with long term goals.
Then we have Sam Walton’s quote. Nitori’s inventory strategy includes “coordinating” the sales floor to look like a home setup; an American style product presentation. Nobody replaces new sofas, beds, dining tables, etc every year. However, something interesting happens when you package and present your store a little in a fashionably coordinated manner: Home fashion becomes a thing. So instead of enticing customers to buy furniture all the time, Nitori puts a considerable amount of effort into selling “home fashion” items. These are things like sofa covers, table cloths, bed sheets, etc. It’s almost like buying clothes for different occasions, seasons, and moods. Home fashion items tend to be high volume, low margin. About 60% of Nitori’s sales come from these high volume items.
As for Jeff Bezos’ quote on business strategy, Akio plainly mentions that people will always want high quality furniture for a low price. This is the mentality that drove Nitori to skip the distributors and go straight to furniture makers early on. Today, Nitori’s supply chain is several layers deeper. The company sources its own material, manufactures its own products, and developed its own leading edge distribution network.
Nitori cut out the Japanese trading companies for raw material sourcing, built factories in Southeast Asia, and implemented fully automated warehouses before it was cool.
American retail runs deep at Nitori. Every year, nearly 1,000 employees (both full and part time) are sent to the US to study American retail. Nitori’s strategy isn’t such a surprise now. In case you are wondering: Yes, they visit Walmart on this trip.
Retail display and vertical integration would probably be a good summary description of Nitori’s strategy. This has lead to 30 consecutive years of increased profits. By now, you probably have a pretty good feel as to why I call Nitori the “IKEA of Japan”.
I have not talked about Nitori competitors in this section. This is because there is no real direct comparison. Otsuka Furniture caters to a higher end market. There is little to no overlap with Nitori. If a consume is looking for affordable furniture, they go to Nitori. If it’s a special occasion (like marriage) that warrants a luxurious item, they go to Otsuka. That said, IKEA caters to Nitori’s target market, but IKEA only has 9 stores in Japan.
Going forward, we can expect Nitori to focus more on international expansion. It is part of the management strategy to accelerate store openings outside of Japan between 2018 and 2020. For fiscal 2018, 16 of Nitori’s 61 planned openings are outside of Japan. Capital allocation is pretty much focused on store count expansion, though the company explores other verticals that leverage Nitori’s strengths as a scaled furniture business operator. Other verticals include: Mall operations, apparel retail, home renovation/redesign consulting, office layout planning, etc. For apparel, Nitori has broadly expressed interest in acquiring an apparel chain, then introducing Nitori’s own apparel product line.
Financials, performance, and valuation
I think it is more appropriate to compare Nitori’s financials, performance, and valuation with apparel and specialty retailers like Ryohin Keikaku (TYO: 7453), Fast Retailing (TYO: 9983), and Shimamura (TYO: 8227) for three reasons:
- All three companies have a similar branding strategy to Nitori – high quality, affordable products.
- Approximately 60% of Nitori sales are in home fashion, which is comparable to apparel and specialty sales.
It makes little sense to compare Nitori to Otsuka because of Nitori’s fashion angle and Otsuka catering to a completely different market.
Let’s start with gross margins:
At first glance, Shimamura falls way behind the pack. However, this is due to a difference in strategy. Nitori, Fast Retailing, and Ryohin all pursue a strategy commonly referred to as “SPA” in Japan. This is a butchered abbreviation of “Specialty store retailer of Privately labeled Apparel”; a strategy made popular by GAP back in the 1980s. In Japan, the SPA strategy has taken on another meaning and the term often seems interchangeable with vertical integration. Basically Nitori, Fast Retailing, and Ryohin all design, source, manufacture, distribute, and sell their own products. On the other hand, Shimamura purchases from apparel makers, then handles their own distribution and sales network. Hence, Shimamura has considerably lower gross margins.
Nitori beats the crap out of the competition in terms of operating margins. Interestingly, Shimamura maintains comparable operating margins with Fast Retailing and Ryohin despite the considerably lower gross margins.
Inventory turn explains Shimamura’s ability to hang in there with the SPA strategy. Shimamura is known for absurdly low excess inventory. They have an “inventory controller” team whose sole job is to make sure every piece of inventory purchased is actually sold. The company is also known for “Urikire Gomen”, which means “Sorry, we’re sold out”. Basically, when a product is sold out, Shimamura doesn’t reorder. They do, however, have a dense distribution network which enables the inventory controllers to transfer inventory from other stores if a customer wants a specific product that just sold out. Additionally, the inventory controller team advises buyers on purchase quantities to avoid excessive purchases.
Nitori appears to perform marginally better than the other SPA group. I haven’t dug deep enough to clarify this, but it would make sense that the SPA strategy would require inventory to remain on the books longer than a pure sales and distribution apparel retailer. After all, raw materials and work in process inventory are included on the books when you source and manufacture your own products. I’m unsure whether inventory turn comparison between Shimamura and the SPA group is meaningful.
While dwindling down in recent years, Fast Retailing delivers excellent Greenblatt ROIC. Fast Retailing operates with negative working capital. A surface level thought tells me they probably negotiated healthy payment terms with vendors. This is worth a look in the future. The picture changes a when looking at ROE.
About 55% of Fast Retailing’s total assets is in cash and short term investments. In comparison, Nitori’s cash + ST investment to asset percentage is ~13%, Ryohin is at ~18%, and Shimamura is at 42%.
Nitori’s balance sheet strength appears to have improved considerably more than its peers over the past decade. I thought Fast Retailing would have a higher Equity/Asset ratio given its ROIC performance and cash heavy balance sheet, but I was wrong.
Next, here are three charts with price multiples: EV/EBIT, P/E, and P/B
First, I’d like to note that 2018 in the charts above basically reflect today’s multiples. I’m not proficient with Google Sheet charting tools (yet) so we’re stuck with that for now. Second, these are multiples as of the date of fiscal year filing, which doesn’t reflect the daily movements in price. Fiscal year end is February for Nitori, Ryohin, and Shimamura. August for Fast Retailing. Moving on!
Nitori, Fast Retailing, and Ryohin have all traded at comparable multiples in recent days. Fast Retailing had a bit of a hiccup with its UNIQLO brand (basically H&M of Japan) when raising prices in late 2015. This caused an immediate loss in customers/sales, which quickly made UNIQLO lower prices back to previous levels. If anything, Fast Retailing’s recent hiccup should tell us how important a function price is when it comes to the “high quality, affordable products” branding.
Thus far, Nitori has not had the hiccups that Fast Retailing just went through. The real question (for me) is whether Nitori’s business justifies today’s seemingly lofty 20x EV/EBIT multiple. Frankly, Nitori’s story (and business performance) is no secret. It’s about as famous a growth story in Japan as Uber’s story is in the US. In other words, there is no real edge from an information angle; but then again, value oriented investors are a rare breed in Japan.
Next, Fast Retailing’s UNIQLO gave us a glimpse as to where the “high quality, affordable products” brand followers stand in terms of price sensitivity. I’m comfortable in saying that Nitori serves the same general customer base as UNIQLO. At the very least, Nitori would need to keep its brand fresh, quality high, and price low to earn its keep. Generally speaking, I think EV/EBIT of 6~10x is about right for an average business in Japan. Between Nitori’s impressive track record and size, maybe we can be a little more generous on the multiple (11~12 EV/EBIT?). However, I think most of the current 20x multiple implies payment for future growth.
Nitori has a history of setting wild goals and actually achieving them. It’s not my style to bet on Nitori to succeed in reaching a wild goal though, and I think it’s out of most value investors’ comfort zone. I love the story and the company, but I’ll pass on it at today’s price. I’ll take another look if share price gets below 10,000 yen vs. today’s 16,000 ~ 17,000 yen.
The bottom line
Nitori has delivered outstanding operating performance with a lovable story. That said, the lofty valuation multiples assigned by the market implies that at least some of future growth is already priced in. Similarly positioned brand UNIQLO’s slip up made the highly price sensitive nature of it and Nitori’s customers apparent. Given this, I will pass on Nitori at 16,000 ~ 17,000 yen per share, but would gladly take another look if prices come down below 10,000 yen per share.
