CFA Institute Research Challenge hosted by CFA Society of Japan Tokyo Institute of Technology [Tokyo Inst. of Technology] Student Research [Wholesale Industry] This report is published for educational purposes only by students competing in the CFA Institute Research Challenge. Sanrio Co. Ltd. Date Ticker: TSE: 8136 (Japan) Recommendation: SELL September 30th, 2013 Price: ￥ 6,030 (as of 9/30/2013) Price Target: ￥ 4,998 Exchange: 98.87JPY/USD Earnings/Share (EPS) Mar. Jun. Sept. Dec. Year P/E Ratio 2010A ￥13.00 ￥17.46 ￥42.83 ￥31.47 ￥104.76 23.5 2011A 32.09 30.79 65.29 34.39 162.56 19.9 2012A 32.96 30.38 41.55 37.22 142.09 29.5 [Tokyo Inst. 2013E 29.90 30.56 59.15 41.51 161.12 37.4 of Highlights Sanrio is a company of character business which runs mainly product sales, licensing business and theme Technology] park business. Sanrio is popular to own famous character, Hello Kitty and My Melody and so on (Exhibit5). ・Overestimated price compared to fundamentals even adopting bullish estimate : Target price based on DCF is 4,998 JPY, 17% downside from the current price. We adopt bullish EPS estimate of 161.12 JPY in FY03/13 compared to the Sanrio’s guidance of 150.87 JPY, and predict Sanrio’s operating profit will be 23.7 billion JPY in FY03/14, 30 billion JPY in FY03/16, and will reach to 40 billion JPY in FY03/21 as Sanrio increases revenue from character licensing. However, we believe that current price, which is more than double of 2,754 JPY as of January 2013, has already reflected above scenarios. Besides, the market has become overly optimistic, due to the expectation of Sanrio’s theme park business becoming profitable for the first time and x-date interim dividend was in the end of September, followed by the exciting news in September that Tokyo will host Olympic games in 2020. ・Gradual expansion of sales and profit by licensing business: Sanrio’s value driver is the character licensing ,especially in overseas segment . Revenues from licensing will continue to increase with growth of the number of licensee although sales per license will remain largely unchanged. For the next ten years, Sanrio will expand its licensing deals to 3,600 in FY2022 from 2,700 as of FY2012. Total sales of Sanrio will gradually increases 110 billion JPY FY2022 in 3.9% CAGR, OP margin will be 44 billion JPY FY2022 in 6.6% CAGR. ・High profitability and cash pile: Sanrio has been improving its profitability by expanding licensing business. The current ROE is 32.1%, which is about two times higher than its competitors. Sanrio will accumulate cash as the licensing business grows, which will lead to deterioration of capital efficiency, since licensing does not require much additional expenditures. Consequently, current ROE will not be sustained unless allocating ample cash for appropriate investment opportunities such as acquisitions, or distributing the excessive cash to shareholders. Volume (Millions) Price (JPY) Market Profile 1.80 6,500 6,000 1.60 52 Week Price Range (JPY) 2,301-6270 Sanrio (8136) 5,500 Average Daily Volume 556,900 1.40 5,000 Beta 0.753 1.20 4,500 Dividend Yield (Estimated) 1.00% 4,000 1.00 Shares Outstanding 89,065,301 3,500 0.80 Market Capitalization (million JPY) 537,063 TOPIX 0.60 3,000 Institutional Holdings 29% 0.40 Insider Holdings 4% 2,500 0.20 Book Value per Share ¥533.33 0.00 2,000 Debt to Total Capital 49.9% Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct サンリオ 8136 TOPIX (Indexed to 8136) Return on Equity 32.1% Important disclosures appear at the back of this report CFA Institute Research Challenge Date Figure 1 Business Description consolidated sales, OP, OPM Sanrio is a character business company. Sanrio has designed more than 400 characters including the world famous “Hello Kitty” (Exhibit5). Sanrio has expanded character business by owning character copyright. The company was established by Mr. Shintaro Tsuji, the President and CEO of Sanrio, in 1960 with the concept of “Small Gift Big Smile” which means that small gift makes people happy. Sanrio established the subsidiary in US in 1974, and in Germany in 1980, and has expanded overseas business. In fact, overseas sales constitutes around 45% of consolidated total sales. Main businesses are character licensing (In Japan and overseas), product sales (In Japan and overseas), theme park (In Japan) and others (rental robots, making movies and so on). Profitability has become higher by having shifted business model, from product sales to licensing business mainly in Europe and in America. This has been led by Mr. Rehito Hatoyama, ex-Mitsubishi Corp. since 2008, and he has responsibility for strategy for overseas business. As a result in FY03/13, the consolidated operating profit reached 20.1 billion JPY (+6.8% YoY). It was historical record.(Figure 1) Licensing business (In Japan and Overseas): Character copyright licensing is the profit driver of Sanrio, Source: the security report and its royalties constituted 42% (31 billion JPY, Figure2) of consolidated total sales in FY03/13. Sanrio licenses its character copyright to 2699 companies which mainly are in apparels (Exhibit7). The operating Figure 2 profit margin is very high because Sanrio doesn’t bear costs for redesigning, producing and selling. Licensee Sales breakdown by business pays these costs. And Sanrio allows licensee to redesign their character almost freely. For this reason, Sanrio can license multiple companies in the same industrial category. Therefore Sanrio’s potential market size is unlimited in theory. In overseas, because the subsidiaries of Sanrio have master license, they can license the copyright of Sanrio characters to local companies. This makes character’s design suitable for the area rapidly. For this reason, sales is growing. The growth of royalties in overseas is remarkable. Especially in North-America, Asia and South-America, total sales grows over 30% YoY. Although debt crisis in Europe and not good economy in Japan, total sales remains high (Figure3) . Sanrio has contract with many companies, for example with ZARA (INDITEX Group) and H&M (They are the top2 in apparels) in Europe, with Walmart in America, with KT Company and KT Shanghai Company (they are one of Li&Fung Group which is big trading company in Hong Kong). Product sales (In Japan and Overseas): Product sales constitutes 64% of total sales in Japan (21.2 billion JPY), and in Japan, there are 209 Sanrio shops, including a department store, and 929 wholesale shops. In overseas, Sanrio discontinued to operate a directly managed store but spread shops through the local agency. From now licensing is main business of Sanrio. In Japan and Asia, after closes down unprofitable stores and cuts costs, shops will be selectively operated to increase awareness of their characters. Source: the security report Theme park (In Japan): Sanrio operates the Sanrio Puroland (Suburb near Tokyo) and the Harmonyland (Oita-prefecture). In FY03/13, total theme park sales was 5.3 billion JPY (-0.6% YoY) and operating loss Figure 3 Licensing sales in was 0.5 billion JPY (+13 million JPY YoY). Theme park business has been making losses, but operating each region (bn JPY) loss has become smaller by reducing costs while the number of visitors and per-visitor spending decreases. Sanrio business model is shown in Figure4. Figure 4 Business model Source : the security report Source: company documents 2 CFA Institute Research Challenge Date Figure 5 Industry Overview & Competitive Positioning Retail market size of character products (bn JPY) Industry Overview ・Environment of market will be severe. Due to economic slump and decline of birthrate in Japan, the retail market size of character products is scaling down from 2000s (Figure5). In overseas market, there have already been many popular local and global characters (ex: Mickey Mouse, The Walt Disney Co.; NYSE: DIS). Additionally because existing contents from Japan and others are going to entry overseas character market in earnest, the competition among characters becomes more severe. Difference between Sanrio and competitors is taking media-mix strategy which promote their characters by TV animation, books, movies, Internet media and try to diversify and maxim of revenues. It is said that media-mix strategy is essential to create new popular characters. However, Sanrio don’t have strength of these strategies. SWOT Analysis (Figure 6) Sanrio’s operating profit is mainly from licensing business. But, product sales and theme park business is Source: CharaBiz DATA 2011 closely connected to licensing. By owning these business, Sanrio can provide pleasure of customers by CharaBiz DATA 2013 playing with characters, research trend by directly contact with customers and to induce customers to buy Figure 6 SWOT analysis licensing products. So we think these businesses are combined, therefore we don’t do SWOT and 5 Force analysis of every business but “Sanrio” which includes all Sanrio businesses. Strength ・“Hello Kitty”, stable income resource (Exhibit9): “Hello Kitty”is a character popular enough to take the top spot in the character ranking not only in Japan but also in overseas. Hello Kitty is very popular especially among Japanese women irrespective of age. There are only few characters which are popular among that age range. Therefore, “Hello Kitty” is stable income resource. ・Highly flexible redesign of Sanrio’s character : Most of character’s license contracts have strict condition about design and usages. Licensee cannot redesign the portrayal of original based on their promotion strategies, and licenser can contract only one licensee in one product category. Because most of licensers don’t own copyrights of their characters (generally characters from animation).