Most of you reading this would be familiar with Uniqlo.
The Japanese clothing brand is one of the fastest-growing apparel retailers in the world. I experienced first hand how much Uniqlo has thrived over the past few years. Its popularity in our homeland, Singapore, has exploded, with Uniqlo outlets appearing at most major malls in the country (I’m a big fan of its products too).
The numbers speak for themselves. Sales at Fast Retailing (Uniqlo’s parent company) increased by 179% from its financial year 2011 to its financial year 2019. Its shares have reflected that growth, climbing 320% during that time.
But with Fast Retailing’s share price sitting near a record-high, have investors missed the boat? I decided to take a closer look at its business to see if its current share price still presents a good investment opportunity. I will use my blogging partner Ser Jing’s six-point investment framework to dissect Fast Retailing.
1. Is Fast Retailing’s revenue small in relation to a large and/or growing market, or is its revenue large in a fast-growing market?
As mentioned earlier, Fast Retailing is now the third-largest apparel retailer in the world. It recorded 2.3 trillion yen (US$20.8 billion) in sales in the year ended 31 August 2019. On paper that seems huge. You may be thinking: “How could it possibly grow much larger?”
However, looking under the hood, I realised that Fast Retailing’s US$20 billion in revenue is tiny in comparison to its global market opportunity.
The global apparel market is expected to hit US$1.5 trillion this year. More importantly, Uniqlo is well-placed to grab a growing share of this tremendous market. Uniqlo International saw sales of around 1 trillion yen (US$9.34 billion). That’s a drop in the ocean when you compare it to the global apparel market.
Putting that in perspective, Uniqlo’s revenue in Japan was 872.9 billion yen (US$7.9 billion) in the 12-months ended August 2019. Japan has a population of roughly 126.8 million and yet revenue from Japan made up 36% of the company’s total revenue. China’s population alone is more than 10 times as big as Japan. That gives us an idea of the massive international opportunity that Uniqlo can potentially tap into.
With Uniqlo opening its first shops in India recently and expanding its presence in Europe, China, the United States, and Southeast Asia, I expect Uniqlo International’s sales to become much more important for the company in the coming years.
In his FY2017 annual letter to shareholders, Tadashi Yanai, CEO of Fast Retailing, said:
“My focus is to ensure solid growth in Greater China and Southeast Asia, which have the potential to grow into markets 10-20 times the size of Japan’s. We have announced five-year targets of increasing revenue from current ¥346.4 billion to ¥1 trillion in Greater China, and from ¥110 billion to ¥300 billion in Southeast Asia and Oceania.”
2. Does Fast Retailing have a strong balance sheet with minimal or a reasonable amount of debt?
A robust balance sheet enables a company to withstand any economic slowdowns. It also enables the company to use its extra cash to expand its business.
Uniqlo ticks this box easily. The Japanese retail giant boasted around ¥1.1 trillion (US$10 billion) in cash and cash equivalents and around ¥660 billion (US$6 billion) in debt as of 30 November 2019. That translates to a healthy US$4 billion net cash position.
Equally important, Fast Retailing is a serious cash machine. The company has consistently generated around US$1 billion in cash from operations at the minimum in each year since FY2015. The table below shows some of the important cash flow metrics.
3. Does Fast Retailing’s management team have integrity, capability, and an innovative mindset?
To me, management is the single most important aspect of my stock investments.
Fast Retailing’s founder and CEO, Tadashi Yanai, has proven himself to be everything you can ask for in a leader.
He founded the first Uniqlo store back in 1984 and has since built it into an internationally recognised brand with a network of more than 2,000 stores globally. Uniqlo is also one of the most innovative companies in apparel retail. It has patented some of its unique materials such as Heat tech and Airism.
Yanai was also able to transform the company’s brand image. Previously, Uniqlo was perceived as a discount retailer selling cheap and low-quality apparel. Seeing this, Yanai decided to open a 3-story iconic store in Harajuku in central Tokyo in 1998. This was the turning point for the brand as consumers’ perceptions shifted. Uniqlo became viewed as a brand that offered affordable but high-quality products. Yanai’s willingness to spend big to improve the brand-perception is testament to his foresight and capability.
More recently, Fast Retailing has embraced technology to improve its work processes and decision making. The Ariake Project, which aims to transform the company digitally, was initiated two years ago and is beginning to bear fruit. Through the Ariake project, Fast Retailing restructured its decision-making process and now small, flat teams are able to faster analyse the business, make decisions, and implement ideas. Fast Retailing also has automated warehouse processes such as stock receipts, sorting, packing, and inspection.
The company has been treating shareholders fairly too, by paying around 30% of its profits as dividends.
It is also heartening to see that Yanai owns around 44% of Fast Retailing. With such a large position in the company, his interests will likely be aligned with shareholders.
4. Are Fast Retailing’s revenue streams recurring in nature?
Recurring revenue is an important yet often overlooked aspect of a business. Recurring revenue allows a company to spend less effort and money to retain existing clients and instead focus on other aspects of the business.
In Fast Retailing’s case, I believe a large portion of its revenue is recurring in nature. The company has built up a strong brand following and repeat customer purchases are highly likely.
5. Does Fast Retailing have a proven ability to grow?
Fast Retailing has been one of the fastest-growing apparel retailers in the world. The chart below shows Fast Retailing’s sales compared to other leading apparel retailers since 2000.
The red line shows Fast Retailing’s annual sales. As you can see, Fast Retailing started from the lowest base among the top five global apparel retailers. However, it has since seen steady growth and has overtaken traditional powerhouses such as Gap and L Brands.
It is worth noting that the most recent quarter saw a slight dip in revenue and operating profit. However, I believe the long-term tailwinds should see the company return to growth in the longer-term.
6. Does Fast Retailing have a high likelihood of generating a strong and growing stream of free cash flow in the future?
A company’s true worth is not based on its accounting profits but on the cash flow it can generate in the future. That is why Ser Jing and I have an eye on companies’ free cash flow numbers.
I believe Fast Retailing has all the ingredients in place to consistently generate increasing free cash flow in the years ahead.
The company is expanding its store count internationally, with China and Southeast Asia set to become important drivers of growth. As mentioned earlier, Fast Retailing’s free cash flow has been increasing from FY2015 to FY2019.
Fast Retailing’s management is also cautiously optimistic about its International market expansion prospects, and showed the chart below in its FY2018 annual report:
Based on the chart, management is expecting Uniqlo International sales revenue to double from 2018 to 2022. That tremendous runway of growth will likely provide the company with a growing stream of free cash flow.
Risks
A discussion on a company will not be complete without assessing the risks.
I think the most important risk for the company is key-man risk. The current CEO and founder, Yanai, is the main reason for Fast Retailing’s growth. His vision and ability to grow the brand, develop new products, and enter new markets is the driving force behind Uniqlo’s success.
As a major shareholder of the company, he has also made decisions that have been favourable towards other shareholders. Moreover, Yanai is not getting any younger and will be turning 71 in February this year.
That said, I believe Yanai is still going strong. Despite ranking as the 31st richest man in the world, and the richest in Japan, he still has the ambition to drive the company further. Yanai is aware of succession planning for the company and is confident that the new leaders will step up to the plate. He said in late 2018:
“Okazaki (current CFO) and others in management have been progressing to where, even if I am not here, the company will be run properly.”
In its bid to expand internationally, Uniqlo also needs to properly manage its brand image. Mismanagement of the brand can have a detrimental effect on sales, as was the case with Under Armour.
In addition, I think a large part of Fast Retailing’s sales growth will have to come from new product offerings. Uniqlo needs to maintain its high standards while developing new fabrics and designs to keep its customers coming back.
Valuation
Valuing a company usually requires a wee bit of estimation and assumptions, so bear with me here.
In Fast Retailing’s case, I will assume it can hit management’s targets of doubling its International sales to around ¥1.6 trillion by 2023. This assumption seems fair, given the potential for China and Southeast Asia alone to hit around ¥1.3 trillion in sales by that time.
For this exercise, I also assume that its sales in Japan will maintain at around ¥900 billion. In addition, I assume that operating margins for Japan and International sales are 11.5% and 13.5% respectively (based on historical margins).
Given all these assumptions, Fast Retailing can expect profits after tax in the region of around ¥225 billion yen (30% tax rate on pre-tax operating profits).
Nike currently trades at a price-to-earnings multiple of around 35. Attaching that multiple to my 2023 earnings estimate, I estimate that Fast Retailing can have a market cap of ¥7.9 trillion in the next few years.
That is 17% higher than its current market cap, despite assuming a fall in the price-to-earnings multiple from its current 39 to 35.
The Good Investors’ Conclusion
Fast Retailing is undoubtedly a company that possesses many great qualities. A visionary leader, a powerful brand, an enormous addressable market, patented products that consumers love, and more. Its finances speak for themselves, with strong cash flow, earnings, and revenue growth.
Based on my estimates, the company’s valuation has room to grow over the next four years even if there is an earnings-multiple compression. In addition, investors should also consider that Fast Retailing can extend is growing streak well beyond the next four years.
As such, despite the company trading near all-time highs, and with the existence of some execution risks, I believe there is enough positives to warrant picking up shares of Fast Retailing today.
If you enjoyed this article, I wrote a similar article on another apparel brand, Lululemon.
Disclaimer: The Good Investors is the personal investing blog of two simple guys who are passionate about educating Singaporeans about stock market investing. By using this Site, you specifically agree that none of the information provided constitutes financial, investment, or other professional advice. It is only intended to provide education. Speak with a professional before making important decisions about your money, your professional life, or even your personal life.