Thinking Points

  • Youji Corporation (TSE: 2152) primarily provides physical education courses for childcare facilities and secondarily offers consulting services.
  • Prior to the new coronavirus, the company grew revenues for 47 consecutive years since its founding as it built a highly reputable physical education course offering.
  • The outlook for FY03/21 is grim as the company already noted a 85% sales decline YoY in April 2020 and expects similar revenue levels in May if customer facilities remain closed.
  • At 827 yen per share, Youji Corporation trades at 0.7x EV/EBIT with a market capitalization of 8,934 million yen ($83.1 million USD).
  • Overall, investors can expect an investment CAGR of between 3.6% to 10.0%, inclusive of dividends, over the course of three to five years.

Introduction

Youji Corporation (TSE: 2152) primarily provides physical education courses for childcare facilities and secondarily offers consulting services. As such, the company reports through two segments: Physical Education and Consulting Services.

Source: Kenkyo Investing, based on company data

Despite Japan’s shrinking population and low child-birth rate, Youji Corporation had a track record of revenue growth for 47 consecutive years until FY03/20, when the company was negatively affected by the new coronavirus. Centered around its highly reputable “Cosmo” physical education program, however, the company aims to return to its growth trajectory through improvement in quality and value add of its services.

The business & environment

Youji Corporation was founded in Tokyo in 1972 by Kouichi Yamashita. The company’s roots, however, extend before 1972. Kouichi, who was unable to land a job as a Japanese teacher, decided to teach physical education to a group of kindergarteners as a part time job through a friend’s introduction. 

In a 2017 interview with Shachomeikan, Kouichi recalls his first lesson. Having been a competitive gymnast in his teenage years, Kouichi half-heartedly prepared a lesson in his head the night before. Despite this, the lesson was a hit, and the kids were following Kouichi home asking to play some more. The kindergarten principal went as far as saying he hadn’t seen the kids get so excited in a while.

One week later, Kouichi returns to the kindergarten for the second lesson. To his surprise, he finds about 30 children waiting at the gate. According to the kindergarten staff, the kids have been waiting there every day since the first lesson. This was a turning point for Kouichi. For the first time in his life, he had so many people waiting for him. He discovered his purpose for work – being needed by others and making them happy.

At the time, it wasn’t normal for someone to go to a kindergarten to teach gym once per week. Still, Kouichi managed to fill his calendar, and needed to hire some help. He managed to bring on two fresh college graduates. Both seemed to enjoy kids and exercising, and everything was going well.

Then, about a year later, both employees resigned with a big smile. Just like Kouichi, both employees were unable to secure teaching jobs, and decided to teach kindergarteners. Except in the case of the employees, they secured teaching jobs after a year.

With contracts already signed, Kouichi had no choice but to hire replacements. As it turns out, every single person walking through the door came in for the same reason. This was just filler work for soon-to-be teachers.  

The company fell into a negative spiral with employees flying out the door as soon as they landed a teaching job. The extra work fell onto the employees who stayed. Complaints increased alongside workloads. For Kouichi, this would turn into resentment toward employees for a period of time.

One day, one of his employees talked about when he encountered his friend from college. His friend became a gym teacher for high school. Feeling embarrassed about teaching gym class to kindergarteners for an unknown company, the employee didn’t tell his friend what he does for a living. It became clear to Kouichi that his employees weren’t proud of their work. This was an eye-opening moment.

Another event hit Kouichi in the gut. He was invited to his employee’s wedding. As he was watching his employee happily getting married, he couldn’t help but wonder whether his employees were making enough money to even think about starting a family. This was his first realization that a company owner’s responsibility doesn’t end at the employee, but includes the employee’s family too. Kouichi used to push for a customer-first approach, but realized that without keeping the employees happy, he’d have a difficult time keeping the customers happy. 

Kouichi decided that Youji needed to become a respectable company – something for employees to be proud of. On the 10 year anniversary of the company, Kouichi showed up to work in a suit and tie. From this day forward, the company dress code required employees to wear a suit, tie, and socks.

With Youji essentially being an army of gym teachers, most employees were accustomed to gym wear, both in the office and at the kindergartens. Many employees resisted the new dress code. Half of them quit. There was no room for negotiation with Kouichi. He was ready to watch all of the employees go and start from ground zero if he had to.

The next step in raising Youji to a first class company came through relentless greeting and cleaning, commonly seen in restaurants in Japan. When a visitor comes by the office, every employee (except for the ones on the phone) stops whatever they are doing to greet the visitor, just as a successful restaurant’s staff would. As for cleaning, Kouichi started going to the office at 6am just to clean and employees followed suit. 

This approach eventually built a reputation and a culture. Youji employees would show up to the kindergarten in a suit, bow before entering, change into gym wear to teach, then stay after class to clean. Kindergarten principals would say “just copy Youji employees and we’ll do fine”. Kouichi has a formula for this: “ordinary x continuation = extraordinary”.

As for Youji’s business environment, most people are familiar with Japan’s low fertility rate and declining population. What’s less known is its lack of childcare infrastructure, with over 16,000 children waitlisted to be admitted into childcare facilities. In fact, daycares and kindergartens have been a growth industry over the last several years as the Japanese government pushes for a better childcare infrastructure.

Source: Kenkyo Investing, based on data from Ministry of Health, Labour, and Welfare (MHLW) & Ministry of Education, Culture, Sports, Science, and Technology (MECSST). 2019 Kindergarten data unavailable and replaced with 2018 data.

Source: Kenkyo Investing, based on data from MHLW and MECSST. Kindergarten data not included.

The increase in the number of facilities and children in the facilities are explained by historical low use of facilities due to cultural reasons. Kindergartens are under the MECSST while everything else is under MHLW. According to the MHLW, childcare facility usage (excl. kindergartens) is 45.8% as of 2019, up from 35.9% five years ago.

Meanwhile, Youji teaches classes at 1,175 facilities according to the FY03/20 presentation. 

Source: FY03/20 company presentation, English translations by Kenkyo Investing

In order to provide a point of differentiation, Youji customers are provided with the option to choose up to four nearby competing facilities where Youji will not operate. The most interesting point about Youji Corporation is its 47 year long revenue growth track record, which unfortunately ended in FY03/20 as many childcare facilities were temporarily shut down due to the coronavirus. 

Source: Kenkyo Investing, based on company data

Source: Kenkyo Investing, based on company data

While Youji Corporation is withholding FY03/21 guidance for the time being, revenues are likely to further decline in FY03/21 as the company noted that April 2020 revenues were down approximately 85% YoY. For reference, March 2020 revenues (last month in FY03/20) were down 36% YoY. The company expects April 2020 level revenues in May 2020 if the temporary shut downs continue. If this is the case, Youji Corporation may have a difficult time posting a profit in FY03/21.

Shareholders

As of FY03/20 (ending March 31, 2020), Youji Corporation had 11,784,000 shares issued and 981,364 shares in treasury, putting outstanding shares at 10,802,636.

Here are the major shareholders:

Source: Kenkyo Investing, based on company and Nikkei data

Yamazen is the founding family’s fund and Meiko Yamashita is Kouichi’s wife. Collectively, the founding family holds a 48.5% stake in the company. Interestingly, Koichi and his wife sold 800,000 shares at 905 yen per share on March 2, 2020. As a reference, Kouichi is 73 years old and has been the one and only CEO of Youji Corporation.

In terms of shareholder returns, the company does not offer any equity stock options to the management team. Historically, it’s maintained a dividend payout ratio of below 20%.

Financials & Valuation

  • Youji Corporation (TSE: 2152) primarily provides physical education courses for childcare facilities and secondarily offers consulting services.
  • Prior to the new coronavirus, the company had maintained revenue growth for 47 consecutive years since its founding as it built a highly reputable physical education course offering.
  • The outlook for FY03/21 is grim as the company already noted a 85% sales decline YoY in April 2020 and expects similar revenue levels in May if customer facilities remain closed.
  • At 827 yen per share, Youji Corporation trades at 0.7x EV/EBIT with a market capitalization of 8,934 million yen ($83.1 million USD).
  • Overall, investors can expect an investment CAGR of between 3.6% to 10.0%, inclusive of dividends, over the course of three to five years.

Excluding the fact that Youji Corporation is severely affected by the coronavirus, the operating business is remarkably strong with a solid reputation for its “Cosmo” brand. As for the business environment, many investors may disregard Japan’s childcare industry as a potential investment area based on low fertility rates. However, a closer look confirms that the industry is severely underdeveloped, and the Japanese government has pushed for more capacity in the last few years.

Given that the company experienced an 85% YoY decline in April 2020 revenues, and will most likely experience similar revenues in May 2020, it’s difficult to project a scenario where Youji Corporation performs anywhere near normalized levels in FY03/21. With this in mind, it’s important to note that only investors with a medium to long term time horizon ought to even consider investing in the company.

In terms of balance sheet health, Youji Corporation is more than adequately capitalized with no debt and an equity-to-asset ratio of 0.67. Cash and investments accounted for 82.3% of total assets as of end-FY03/20. It’s worth noting here that Youji Corporation doesn’t have a track record for particularly shareholder return conscious capital allocation. Under current circumstances, however, the company is realizing benefits from its extremely cautious capital allocation as it has near-zero default risk.

Aside from pandemic risk, Youji Corporation’s operating business faces several risks, with reputational risk and labor risk being the key risk areas. Due to the nature of Youji’s business coming in contact with children, any incident or bad publicity may quickly result in loss of customers. Labor risk is largely related to the general labor shortage in Japan, and the Japanese childcare industry being a low-paying industry relative to most industries. Another risk worth considering is the loss of Kouichi, seeing that the company has only ever been operated by Kouichi.

At 827 yen per share, Youji Corporation trades at 2.4x EV/EBIT with a market capitalization of 8,934 million yen ($83.1 million USD). Adjusted for long-term investment securities, the company trades at 0.7x EV/EBIT. Interestingly, Youji Corporation isn’t a stranger to negative EV valuations, and has traded below EV as recently as June 2016. This was in spite of its multi-decade revenue growth record.

More realistically, investors are likely to have buying opportunities in the near term as the continued childcare facility closures in coronavirus affected areas essentially guarantee losses for the quarter, and possibly even for full-year results in FY03/21. 

On a pessimistic assumption where Youji produces operating losses of 500 million yen ($4.7 million USD) in FY03/21, makes a slow but gradual recovery to FY03/20-level operating profits over four years, and has a fair value EV/EBIT of 2.0x, investors can expect an investment CAGR of 3.6%, inclusive of dividends, over the course of five years.

On a positive assumption where Youji reaches breakeven in FY03/21, makes a two year recovery, and has a fair value EV/EBIT of 3.0x, investors can expect an investment CAGR of 10.0%, inclusive of dividends, over the course of three years.

Overall, investors can expect an investment CAGR of between 3.6% to 10.0%, inclusive of dividends, over the course of three to five years. Given the current situation, investors are best advised to keep Youji Corporation on a watchlist and revisit the company should share prices come down to the 650 yen level (investment CAGR of 8.9% to 19.3%).

The bottom line

Youji Corporation is a well capitalized child care service business with an excellent reputation and an even better financial outlook. However, the company is temporarily halted by customer childcare facility closures due to the coronavirus. Investors with a medium to long-term investment horizon are strongly encouraged to keep Youji Corporation on a watchlist and revisit the company should share prices drop to the 650 yen level.


Kenkyo Investing
Kenkyo Investing

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