Thinking Points

  • Tsutsumi Jewelry (TSE: 7937) is one of the largest jewelry companies in Japan, and has a vertically integrated supply chain handling everything from sourcing to retail sales.
  • The last decade has been challenging for the company, as revenues have been on a free fall and operating margins compressed. Still, the company remains marginally profitable aside from impairment losses recorded in 2016 and 2017.
  • More importantly, Tsutsumi is overcapitalized with a 0.98 equity to asset ratio. Historically, capital allocation has been bad. Over the last several years, however, the company has repurchased 12.9% of issued shares, and continues to repurchase more.
  • At today’s 1,899 yen per share price, the company trades at 89.3% net cash and 60% NCAV. Seeing that the company is continuing to repurchase shares, it’s likely share prices will appreciate to 100% NCAV or more, on a shorter timeframe than what we normally assume for Japanese net nets (5 to 8 years).
  • With that in mind, investors can expect to gain a three year investment CAGR of between 18.6% and 26%.

Introduction

Tsutsumi Jewelry (TSE: 7937) sources, manufactures, and sells jewelry. The company is among the largest jewelry retailers in Japan, with a strong focus in the Kanto region (Tokyo and surrounding area). Although the company is a single segment operation, it splits revenues into four different categories:

Source: Company filings


Tsutsumi is widely considered a mid-tier jewelry brand retailer with prices generally lower than higher end brands like Harry Winston, Cartier, or Tiffany. The company considers its biggest strength to be its full vertical integration from raw material sourcing to retail storefronts.

The business & environment

Japanese jewelry market

Prior to Japan’s economic bubble burst in 1991, the country’s jewelry market size was over 3 trillion yen ($27.7 billion USD). Over the next 17 years, the market contracted down to the 1 trillion yen ($9.3 billion USD) level. In 2009, amidst the global financial crisis, the market size dipped below 1 trillion yen ($9.3 billion USD) and has not recovered:


Source: Ministry of Economy, Trade, and Industry (METI) (Japanese), Yano Research Institute (Japanese)


With Japan’s economy improving over the last few years, inbound tourism at record levels (and still on the rise), and the 2020 Tokyo Olympics in sight, Yano Research Institute projects the Japanese jewelry market to be at 1,001.7 billion yen ($9.3 billion USD) in 2020.

Tsutsumi’s performance

During this weak, but stable (since 2009) Japanese jewelry market, Tsutsumi’s revenues have fallen from 27,637 million yen ($256 million USD) in 2009 down to 17,566 million yen ($162 million USD) in 2018, or at an annualized rate of negative 4.9%.

Source: Company filings


What’s interesting, however, is that gross margins have actually been improving. In its filings, Tsutsumi breaks down manufacturing costs by the same categories as the chart above. Using these figures, gross margins look like this:

Source: Company filings, author calculation


Margins for the miscellaneous category has remained below 1% during this period. At the same time, the inventory to revenue ratio has increased by 39% to 1.00 (2018). In other words, Tsutsumi has one year of sales worth of inventory. Seeing that Tsutsumi is vertically integrated from raw material sourcing to retail, it’s not surprising that the company’s inventory seems high relative to revenue. With that said, the sharp increase over the last decade is concerning, and Tsutsumi may be due for a write-off.

Tsutsumi hasn’t figured out a plan to slow or stop the revenue decline yet. So far, its focus has been on maintaining profitability by closing down unprofitable stores. The company’s maintained profitability at the operating level, but reported net losses in 2016 and 2017 after recording impairment losses of 1,891 million yen ($17.5 million USD) and 1,573 million yen ($14.5 million USD), respectively. Most of this consisted of reassessing land values where some of its stores are. Now that the company has recorded these losses, it’ll be interesting to see whether management can continue improving margins into 2020.

Management guidance

For fiscal 2019, management originally guided for revenues of 17,200 million yen ($159 million USD) and operating income of 900 million yen ($8.3 million USD). Trailing twelve month performance isn’t helpful when analyzing Tsutsumi as the company makes the bulk of its income during the third quarter (ending in December). With that said, the company saw continuing revenue decline and stronger operating performance during the first half of fiscal 2019 compared to 2018.

Shareholders

As of Q2 2019 (ending September 30th, 2018), Tsutsumi Jewelry had 20,080,480 shares issued and 2,580,373 shares in treasury, putting outstanding shares at 17,500,107.

Here are the major shareholders:

Source: Company filings & Nikkei


Seiji Tsutsumi is the founder of the company and Shizuko Tsutsumi is his wife. Seiji is 75 years old and currently the board chairman. The company is very much a family business with Seiji’s daughter’s husband, Satoshi Tagai, as CEO. Additionally, Katsumi Okano, Seiji’s little sister’s husband, is the director and general manager of products. In other words, the Tsutsumi family owns 68.6% of outstanding shares and four of the 7-member board consists of family members.

Back in 2014, Brandes Investment Partners submitted a filing noting that it owned 5.05% of issued shares. Presumably, this is still the case as major investors (5%+ stake) are required to disclose changes in ownership stakes.

Some may be delighted to find that practically all of Tsutsumi’s treasury shares were repurchased in the last few years (2015~). In fact, the company has been buying shares nearly every trading day since August 2018, when it announced its most recent share repurchase program.

Financials & Valuation

  • Over the last decade, Tsutsumi Jewelry’s business performance has deteriorated, forcing the company to record large impairment losses in 2016 and 2017.
  • A year later in 2018, operating margins improved, however, the company is still in a precarious position with revenues continuing to decline.
  • The current operating business is mediocre at best. Fortunately, Tsutsumi sits on a mountain of cash and has started putting it to good use through share repurchases.
  • At the current 1,899 yen per share price, Tsutsumi’s market cap is at 32,876 million yen ($304 million USD) and its net cash position is at 36,822 million yen ($340 million USD). In other words, the company trades at 89.3% of net cash.
  • With the company aggressively buying back shares, investors can expect a three year investment CAGR of between 18.6% and 26%.

The last decade has been challenging for Tsutsumi, with revenues in a free fall and operating margins contracting. Although margins improved after recording major impairment losses in 2016 and 2017, the company still stands in a precarious position as revenue continues to decline.

In its current state, Tsutsumi’s operating business is mediocre at best. Fortunately for investors, the company has an incredibly overcapitalized balance sheet with an equity to asset ratio of 0.98. In fact, Tsutsumi has maintained this level of overcapitalization for more than a decade.

At today’s 1,899 yen per share price, Tsutsumi’s market cap is at 32,876 million yen ($304 million USD). In comparison, the company’s net cash position is at 36,822 million yen ($340 million USD), more than twice the company’s revenues. Tsutsumi currently trades at 89.3% net cash.

While the disproportionately large net cash position is a clear sign of poor capital allocation, change is on the horizon. After about a decade of no meaningful share repurchases, management proceeded to repurchase 12.9% of issued shares between 2015 and 2018

The company hasn’t stopped repurchasing shares either. In August 2018, Tsutsumi’s board decided to spend up to 1,000 million yen ($9.3 million USD) on share repurchases over the course of a year. Although this is still small portion compared to the company’s 36,822 million yen ($340 million USD) in net cash, it’s a move in the right direction.

With the Tsutsumi family already owning 68.6% of outstanding shares and controlling the board, the company may end up going private before long.

Although the company has 8,208 million yen ($75.9 million USD) of land on the books, most of it is the company’s Tokyo stores. Unfortunately, the land holdings for all of its Tokyo stores are consolidated into one line item, so it’s not possible to figure out whether the book value reflects current market prices.

Summarily, Tsutsumi’s operating business is mediocre, but its assets are more than plentiful with far more cash than necessary. While the operating business faces serious threats (i.e., revenue decline), there are signs of improvement (op margin recovery). Seeing that the company has repurchased a significant portion of its issued shares, it’s likely that the current management has a better understanding of capital allocation. With this in mind, it’s likely that Tsutsumi will trade at or above 100% NCAV sooner than the usual 5 to 8 year timeframe that we typically use for Japanese net nets. Thus, investors can expect a three year investment CAGR of between 18.6% and 26%.

The bottom line

Tsutsumi Jewelry is among the largest jewelry companies in Japan with a vertically integrated supply chain. Over the last decade, business performance has deteriorated considerably. With that said, the company is overcapitalized, currently trading for 89.3% of net cash. Seeing that management has repurchased 12.9% of issued shares since 2015 and continues to repurchase shares, investors can expect a three year investment CAGR of between 18.6% and 26%.


Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.