Jul 2004

LONG ONLY JAPANESE EQUITIES

Most Japanese are private and reserved. Vanity is not a characteristic that one would immediately associate with them except when it comes to hair.

The majority of Japanese men die their hair; older men from grey to black and younger men black to brown, with a tiny minority prepared to consider the many other colours of the rainbow. We own shares in a business that specialises in selling hair care products and cosmetics for men called Mandom. It is family business that has been around for 75 years although its biggest selling brand ‘Gatsby’ is only 26 years old. Gatsby products account for 40% of all sales, a figure almost double the sales of the nearest competing male cosmetics brand. Altogether its product range is small but well focused, unlike other cosmetics companies in Japan, which have a plethora of offerings. At the same time the company is strict on inventory control especially with the distributors and it shies away from the practice of accepting returns. Most sales are through supermarkets and convenience stores. The company’s 60% owned subsidiary is one of Indonesia’s leading toiletry companies. It was established in 1971 and now accounts for almost 30% of total company sales, and, although on the surface is not yet as profitable as the parent, has more growth potential. Business in Japan is tough reflecting ongoing poor retail spending but Mandom’s niche is better than most. When valuing the company we forecast no growth but judge that, on purchase, a 7% free-cash flow yield and an 11% free cash flow/enterprise value was more than adequate compensation. The dividend yield was 2.5% when we bought it. Dividends have increased 67% since 2000, suggesting that the company is not shy of sharing rewards with investors. As a business it has all the durable characteristics that we seek, buffered by lasting brands in a niche market the company understands.

In Japan, one worse than going grey is becoming bald. Baldness used to be a sign of lechery. As a result, men afflicted wore wigs to preserve their honour but many of them were so badly made, usually of synthetic material, that one always wondered whether if it wasn’t better not to bare the crown instead. We invest in Aderans a company that specialises in making be-spoke wigs and providing solutions for baldness. In assessing the business we regard this as an essential service. Although today, the label of lechery is less relevant in modern society, the desire for elder women to preserve their modesty has provided the company with a rich new vein of business. Now the majority of sales are orientated to women in there 50’s and 60’s. Once a customer always a customer, as aging and use requires replacement wigs that fetch hefty margins, a marvellous dynamic for the business. Unfortunately the price of a be-spoke wig is approximately the equivalent of £1,500, which in the current deflationary climate is a disincentive for growth in new customers at the moment. Over the last 2 years sales and profits have fallen, as has the share price which trades at 38% of its peak in 1999. At this level the shares trade on 20x this years depressed earnings with the company retaining 25% of its market capitalisation in cash on its balance sheet. In addition the company has initiated a policy of raising distributions to shareholders though increased dividends and share buybacks at accretive prices. Since profits peaked, dividends have risen 36% and the yield today is 1.6%. Earlier this year the company bought out the minorities of a subsidiary, Fontaine, which sell women’s ‘fashion’ wigs ‘over the counter’ to younger customers. This investment represents a good allocation of capital in a subsidiary that is similarly profitable and has better growth prospects in the current environment. Today the shares are not outrageously cheap but they provide us as investors with a stable stream of earnings that could recover materially backed by a growing dividend.



Michael Lindsell

10 Jan 2004 LTL 000-024-7