Arcland Service Holdings (3085)asiaresearch.daiwacm.com/eg/cgi-bin/files/3085_16Sep06F.pdf- 3 -...

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Share Price Chart

Source: Compiled by Daiwa.

Market data

12-month range (Y) 2,030-3,550

Market cap (Y mn; 5 Sep) 47,832

Shares outstanding (000; 9/16) 15,917

Foreign ownership (%; 12/15) 21.2

Investment Indicators

12/15 12/16 E 12/17 E

P/E (X) 26.7 24.4 20.4

EV/EBITDA (X) 12.7 11.0 9.2

P/B (X) 3.80 3.37 2.97

Dividend yield (%) 0.67 0.83 1.00

ROE (%) 15.1 14.6 15.5

Net debt/equity (X) -0.5 -0.4 -0.4

Income Summary

(Y mn) 12/15 12/16 E 12/17 E

Sales 20,942 23,700 26,600

Op profit 2,923 3,390 4,020

Rec profit 2,985 3,430 4,060

Net income 1,792 1,960 2,350

EPS (Y) 112.6 123.1 147.6

DPS (Y) 20.00 25.00 30.00

See end of report for notes concerning indicators.

Arcland Service Holdings (3085)

Target price: Y3,700

Share price (5 Sep): Y3,005 | Up/downside: +23.1%

Restaurant operator undergoing significant changes

Operates Katsuya restaurant chain

Rollout of Karayama to accelerate as second major brand

Coverage initiated with 2 (Outperform) rating

What's new: We initiate coverage on Arcland Service Holdings with a

2 (Outperform) rating.

Company overview: Arcland Service Holdings is mainly engaged in

the operation of the Katsuya chain of tonkatsu (pork cutlet) and

katsudon (pork cutlet rice bowl) restaurants. As of 1H FY16 (year

ending Dec 2016), the firm had a total of 405 locations (139 directly

managed, 266 franchise). Katsuya has an average monthly revenue of

roughly Y8mn and an average ticket price of around Y750. Its strengths

include the high efficiency of store operations and relatively stable

same-store sales.

We think the following points warrant attention: (1) prospects for

accelerating new store openings, with Karayama, a karaage (fried

chicken) restaurant chain firmly positioned as the firm’s second major

brand after Katsuya, (2) potential for sustained same-store sales

growth (unfavorable weather brought same-store sales into negative

territory in August), and (3) the firm’s increasing willingness to expand

operations in order to achieve its revenue target of Y100.0bn in 2025.

We expect the firm to gradually expand the Karayama chain, opening 12

new locations in FY16, 24 in FY17, and 40 in FY18.

Outlook: We estimate operating profit at Y3.39bn (company projection

Y3.25bn) for FY16, Y4.02bn for FY17, and Y4.94bn for FY18. We expect

profit to exceed the company’s projection in FY16, driven by higher-than-

expected same-store sales. We expect earnings growth to continue

thereafter, driven by the expansion of both the Katsuya and Karayama

chains.

What we recommend: We initiate coverage on Arcland Service Holdings with a 2 (Outperform) rating and a six- to 12-month target price of Y3,700.

To derive the target price, we applied a P/E of 30X, or the peak current-FY multiple, to our FY16 EPS estimate of Y123.1. We believe that such a high P/E valuation is justified given (1) prospects for the firm accelerating the rollout of new stores with Karayama solidly positioned as the second major brand after Katsuya, and (2) the firm’s increasing willingness to expand its operations,

following the shift to a holding company structure in July 2016.

Japan

Retail trade 6 September 2016 Japanese report: 6 September 2016

Outperform

(new)

Satoshi Sakae 81-3-5555-7139

[email protected]

- 2 -

Arcland Service Holdings (3085): 6 September 2016

Table of contents

I. Investment summary .............................................................................................. 3

1. Investment opinion ................................................................................................................... 3

2. Fundamentals ........................................................................................................................... 3

3. Valuation ................................................................................................................................... 4

II. Key points .............................................................................................................. 6

1. New store openings to accelerate fuelled by store expansion for second brand Karayama ........ 6

2. Same-store sales growth to continue at relatively steady pace ............................................... 7

3. Extra emphasis put on store expansion to achieve revenue target of Y100.0bn in 2025 ....... 8

III. Company outline .................................................................................................. 9

1. Business activities .................................................................................................................... 9

2. Company history....................................................................................................................... 9

IV. Earnings trends .................................................................................................. 10

V. Financial strategy ................................................................................................ 11

VI. Risk factors ......................................................................................................... 12

Arcland Service Holdings (3085): Income Summary (Y mn; y/y %)

Year to Sales Op profit Rec profit Net income EPS (Y) DPS (Y)

12/13 14,986 (17) 2,323 (18) 2,359 (17) 1,353 (22) 95.9 12.50 12/14 17,623 (18) 2,592 (12) 2,624 (11) 1,597 (18) 105.7 15.00 12/15 20,942 (19) 2,923 (13) 2,985 (14) 1,792 (12) 112.6 20.00 12/16 E 23,700 (13) 3,390 (16) 3,430 (15) 1,960 (9) 123.1 25.00 12/17 E 26,600 (12) 4,020 (19) 4,060 (18) 2,350 (20) 147.6 30.00 12/18 E 30,300 (14) 4,940 (23) 4,980 (23) 2,900 (23) 182.2 35.00

12/16 CP 23,800 (14) 3,250 (11) 3,300 (11) 1,900 (6) 119.4 25.00

E: Daiwa estimates. CP: Company projections.

Note: Per-share figures retroactively adjusted to reflect 2-for-1 stock split on 1 Jan 2016.

- 3 -


Coverage initiated with 2 rating

I. Investment summary

1. Investment opinion

We initiate coverage on Arcland Service Holdings with a 2 (Outperform) rating and a six- to

12-month target price of Y3,700. To derive the target price, we applied a P/E of 30X, the

peak current-FY multiple, to our FY16 EPS estimate of Y123.1. We believe that the stock

has not fully priced in the following changes: (1) prospects for the firm accelerating the

rollout of new stores with Karayama solidly positioned as the second major brand after

Katsuya, (2) the firm’s increasing willingness to expand its operations, following the shift to

a holding company structure on 1 July 2016.

2. Fundamentals

Arcland Service Holdings is mainly engaged in the operation of the Katsuya chain of

tonkatsu (pork cutlet) and katsudon (pork cutlet rice bowl) restaurants. As of 1H FY16, it

had a total of 405 locations (139 directly managed, 266 franchise). Katsuya’s average

monthly revenue has risen to roughly Y8mn and its average ticket price is around Y750.

Katsuya has both suburban and station front locations, with the former accounting for more

than half of its store network. Its strengths include the high efficiency of store operations

and relatively stable same-store sales.

Chart 1: Overview of Major Brands

Katsuya Karayama, Karaage Yukari

Subsidiary in charge of ops Katsuya Ever Action

Format Tonkatsu (pork cutlet),

katsudon (pork cutlet rice bowl) restaurant Karaage (fried chicken) restaurant

Store concept High-quality tonkatsu at affordable prices Specialty restaurants offering karaage, ranked as a favorite dish among Japanese consumers,

at affordable prices

Avg. ticket price Around Y750 Around Y750

Avg. monthly sales Y8mn Y12mn

Initial investment Y50-60mn Y60-75mn

Store appearance

Source: Company materials; compiled by Daiwa.

We think the following points warrant attention: (1) prospects for the firm accelerating new

store rollouts with Karayama, a karaage (fried chicken) restaurant chain solidly positioned

as the firm’s second major brand after Katsuya, (2) the high likelihood of sustained

same-store sales growth despite a planned change in store hours, and (3) the firm’s

increasing willingness to expand operations in order to achieve its revenue target of

Y100.0bn in 2025. We expect the firm to gradually expand the Karayama chain, opening 12

new locations (eight directly managed, four franchise) in FY16, 24 (12, 12) in FY17, and 40

(20, 20) in FY18.

We estimate operating profit at Y3.39bn (company projection Y3.25bn) for FY16, Y4.02bn

for FY17, and Y4.94bn for FY18. We expect profit to exceed the company’s projection in

FY16, driven by higher-than-expected same-store sales. We project earnings growth will

continue thereafter, driven by new store rollouts for both the Katsuya and Karayama chains.

Coverage initiated with 2

(Outperform) rating,

Y3,700 target price

Operates Katsuya chain

of tonkatsu & katsudon

restaurants

Focus on rollout of new

Karayama stores

Earnings growth to

continue on store

expansion for both

Katsuya, Karayama

- 4 -


3. Valuation

We set our six- to 12-month target price at Y3,700. To derive the target price, we applied a

P/E of 30X, or the peak current-FY multiple, to our FY16 EPS estimate of Y123.1.

We believe the stock is undervalued given (1) prospects for the firm accelerating new store

rollouts with Karayama, a karaage (fried chicken) restaurant chain solidly positioned as the

firm’s second major brand after Katsuya, (2) sustained same-store sales growth, and (3) the

firm’s increasing willingness to expand operations in order to achieve its revenue target of

Y100.0bn in 2025. Given the changes under way, we believe that the stock should trade up

to at least 30X, the peak current-FY multiple marked in 2015.

Arcland Service Holdings enjoyed P/E expansion to the restaurant industry average

multiple after the firm’s reassignment to the first section of the Tokyo Stock Exchange in

June 2014. Thereafter, the stock was afforded a higher multiple of around 30X, with

earnings growth from new store openings at Katsuya and solid same-store sales growth

attracting much investor attention. Beginning in 2016, it has experienced multiple

contraction to the mid-25X range, apparently reflecting a slowdown in new store openings

and concerns that shorter store hours could lead to a decline in same-store sales.

Chart 2: Prospective Current-FY P/E (X)

Source: Astra Manager; compiled by Daiwa. Note: Based on Nikkei estimates.

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Weighted avg. P/E for top 40 restaurant names by market cap

Weighted avg. P/E for Nikkei Stock Average

Weighted avg. P/E for Arcland Service Holdings (3085)

Target price set at Y3,700

- 5 -


Chart 3: Valuations of Restaurant Names

Code Company Rating FY-end Share price (Y)

Market cap (Y mn)

Operating profit growth (y/y %)

P/E (X)

P/B (X)

Div. yield (%)

1 Sep 2016 Current FY E Next FY E Current FY E Next FY E End-previous period Current FY E

* 2294 Kakiyasu Honten Feb 1,818 19,827 2 3 17.0 16.4 1.53 2.48

2675 Dynac Dec 1,549 10,894 22 18 22.2 17.0 2.69 0.65

2695 Kura Corporation Oct 4,990 98,518 21 9 20.0 18.0 3.74 0.40

2752 Fujio Food System Dec 2,458 23,841 23 23 17.3 13.3 3.52 1.22

2753 Amiyaki Tei Mar 3,610 24,724 2 6 11.3 10.6 1.41 2.77

* 2789 Karula Feb 421 2,529 6 3 21.2 20.2 0.80 2.38

* 2910 Rock Field Apr 1,381 36,680 10 7 21.7 20.0 2.94 1.99

* 3030 Hub Feb 1,732 6,503 11 2 12.8 12.3 2.11 1.85

3068 WDI Mar 1,169 7,401 7 14 14.2 10.4 3.43 0.86

* 3069 Asrapport Dining Mar 438 12,827 47 13 20.4 18.1 2.22 1.14

* 3082 Kichiri Jun 628 6,195 30 27 20.1 15.8 3.91 1.19

3085 Arcland Service Holdings 2 Dec 3,190 50,776 16 19 25.9 21.6 4.03 0.78

3087 Doutor Nichires Holdings 2 Feb 1,846 88,958 12 10 15.3 14.1 0.93 1.52

3091 Bronco Billy Dec 2,994 45,120 20 17 23.0 19.3 3.66 0.73

3097 Monogatari Corporation Jun 4,490 26,955 26 24 13.5 10.8 2.33 1.56

3175 AP Company Mar 706 5,085 71 22 8.1 6.7 1.44 Nil

3193 Torikizoku Jul 1,827 21,163 30 26 28.2 22.3 4.54 0.33

3196 Hotland Dec 869 15,951 9 16 19.9 17.2 3.46 0.58

3197 Skylark 2 Dec 1,283 249,834 11 5 14.1 13.4 2.42 2.96

* 3317 Flying Garden Mar 900 1,301 20 3 8.7 8.2 1.05 3.33

* 3329 Towa Food Service Apr 1,917 7,813 0 7 22.4 21.2 1.66 0.89

3387 Create Restaurants Holdings Feb 967 91,275 13 18 21.7 17.6 5.22 1.34

3395 Saint Marc Holdings Mar 2,676 59,444 0 7 13.7 12.6 1.41 2.32

3397 Toridoll 2 Mar 2,199 95,320 13 10 15.2 13.5 3.18 1.27

* 3399 Maruchiyo Yamaokaya Jan 1,220 2,969 16 10 8.9 8.1 2.02 1.15

7421 Kappa Create Mar 1,207 58,682 6 17 25.4 24.5 3.34 Nil

7550 Zensho Holdings Mar 1,776 263,281 43 20 38.2 30.6 4.31 0.90

* 7561 Hurxley Mar 907 8,511 33 8 9.1 8.3 0.45 4.96

7581 Saizeriya 2 Aug 2,169 110,086 18 9 22.1 20.0 1.52 0.83

7611 Hiday Hidaka Feb 2,247 53,935 10 10 18.0 16.4 2.85 1.60

7630 Ichibanya May 3,190 101,843 3 4 29.0 27.8 3.60 1.72

8179 Royal Holdings Dec 1,677 64,168 13 2 23.9 24.0 1.40 1.19

8200 Ringer Hut Feb 2,286 48,844 14 12 34.6 29.8 4.37 0.66

* 9828 Genki Sushi Mar 2,007 17,719 3 13 21.7 18.2 2.88 0.70

9861 Yoshinoya Holdings Feb 1,406 90,720 87 35 47.3 49.3 1.58 1.42

* 9887 Matsuya Foods Mar 2,890 55,074 17 7 29.0 27.1 1.58 0.83

* 9936 Ohsho Food Service Mar 3,990 74,704 0 5 22.1 21.1 1.74 3.01

* 9942 Joyfull Dec 1,081 31,790 21 2 31.4 30.0 2.12 1.85

* 9943 Coco's Japan Mar 1,900 32,247 3 6 22.6 21.4 1.40 1.26

9945 Plenus 3 Feb 1,733 66,316 3 12 16.8 14.8 1.03 3.46

Simple avg. (excl. names with P/E over 50X) 20.7 18.6 2.50 1.58

Source: Company materials; compiled by Daiwa. Notes: 1) Toyo Keizai estimates used for firms marked with *, Daiwa estimates for other firms.

2) Share price as of 1 Sep close. 3) Per-share figures adjusted for stock splits.

E: Daiwa estimates.

- 6 -


II. Key points

1. New store openings to accelerate fuelled by store expansion for second brand Karayama

The company has nearly completed store format development for Karayama, which it

positions as its second major store format after Katsuya. Going forward, the firm will likely

step up new store openings, centered on the Katsuya and Karayama brands.

Chart 4: No. of Stores

Source: Company materials; compiled by Daiwa. E: Daiwa estimates.

With Matsunoya (rival tonkatsu chain run by Matsuya Foods [9887]) and other restaurant

chains, as well as convenience stores and drugstores, also stepping up new store openings,

it has become increasingly difficult for the firm to find suitable locations for new stores in

recent years. Even when suitable locations were found, the firm has often had to refrain

from opening a store there due to another Katsuya being located nearby. Going forward, the

firm plans to open a Karayama restaurant in such cases. We believe that the firm has room

to expand the Katsuya chain to around 500-600 locations, since there is still room for new

store openings in less developed sales territories (areas outside Kanto and Tokai regions

and in Tokyo metropolitan area along private railway lines). We see room for around

200-300 new store openings for Karayama, which largely targets the same sales territories

as Katsuya.

Whether the firm can step up the rollout of Karayama stores will depend on the firm’s

capacity for store development. Arcland Service Holdings has around five store

development staff and is apparently capable of opening more than 20 directly managed

stores a year. At this juncture, the company seems to lag competitors in developing new

locations. As such, we believe the key challenge for the firm will be to improve its ability to

obtain property data by assigning more staff to store development.

Karayama has an average ticket price of around Y750 and average monthly sales of

roughly Y12mn (vs. around Y8mn for Katsuya). We suspect that it also has slightly lower

food and labor costs as percent of sales than Katsuya and attracts somewhat more families.

With karaage restaurants, it is difficult for restaurant operators to differentiate themselves in

terms of menu offerings and operations. Still, Arcland Service Holdings has succeeded in

introducing to Karayama the highly efficient store operations it has developed for Katsuya.

Meanwhile, store expansion for Karayama should allow Katsuya to pursue a healthy pace

of new store openings. Notably, we have recently witnessed robust new store openings by

competitors near Katsuya locations. The firm would be able to avoid intensified competition

87 93 116144

193228 252 276 300

77 8493

103

109

112119

127135

7

19

43

83

20 1510

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0

100

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FY10 11 12 13 14 15 16 E 17 E 18 E

Other Karayama Katsuya directly managed stores Katsuya franchises storesKatsuya Katsuya

New store rollouts to

accelerate for both

Katsuya, Karayama

Establishment of

Karayama to open up

more opportunities for

new store openings

Store development key

to accelerating new

store openings

Karayama to help avoid

price war, intensified

competition with peers

- 7 -


or a tough price war if Karayama opened new stores, not competitors. By establishing

strategic dominance within a territory with Katsuya and Karayama, Arcland Service

Holdings will be able to improve efficiencies in store development and procurement.

Chart 5: Breakdown by Region (FY15)


2. Same-store sales growth to continue at relatively steady pace

Katsuya has a high percentage of repeat visitors (with predominantly male customers), and

thus has more stable same-store sales than other restaurant chains. In recent years, the

firm has begun to offer breakfast and box lunches for takeout (mainly at directly managed

stores), leading to sustained same-store sales growth.

With Katsuya’s average monthly revenue consistently exceeding the Y8mn mark, the firm

plans to change its store hours from 2H at an increasing number of stores. Previously, we

had been concerned that the shortening of late-night store hours could lead to a decline in

same-store sales. However, the few stores that have adopted the new store hours on a trial

basis have apparently managed to maintain monthly sales at roughly Y8mn.

Whereas the store hours at most locations were previously around 10:30 a.m.-1:00 a.m.,

the firm is changing its hours to 10:30 a.m.-12:00 a.m. or 7:00 a.m.-11:30 p.m. depending

on the location. The firm plans to maintain its average monthly revenue of Y8mn even with

the shorter late night hours (where hourly wages are high for part-time workers) by

increasing lunchtime revenue and offering breakfast hours. By adopting efficient store hours,

the firm aims to reduce personnel costs per store. We positively view the fact that the

company has adopted such a strategy ahead of its competitors, since recruiting sufficient

personnel will be a key issue for the restaurant industry over the medium to long term.

The firm has shortened the list of lunch menus as part of its efforts to boost lunchtime

revenue. In addition, it has shortened time for preparation, thereby increasing seat turnover

and customer traffic. At stores where the menu was adopted on a trial basis, lunchtime

customer traffic apparently increased by roughly 20% y/y despite the average price of lunch

items being slightly lower (Y500-650). Thus, the new lunchtime menu has been positive for

revenue.

In August, same-store sales dived 3.8% for the first time in the last 17 months, with

customer visits down 3.1% and the average ticket price down 0.7%. Calendar effects and

unfavorable weather such as typhoons negatively affected customer traffic. The fall in the

average ticket price is attributable to a lower proportion of families with children, which

Kanto44%

Hokkaido4%Touhoku

5%

Shinetsu4%

Hokuriku3%

Tokai15%

Kinki11%

Chugoku3%

Shikoku1%

Kyushu4%

Overseas6%

Same-store sales

growing y/y

Stores with new hours

have apparently

managed to maintain

revenue

Lower personnel cost

ratio per store to be

pursued through more

efficient store hours

Shorter lunch menu list

to drive revenue growth

Aug same-store sales

plunge mainly due to

poor weather

- 8 -


typically have higher ticket prices, mainly in the Obon holiday season. In our view,

September could stage a recovery to around zero growth in same-store sales on an easy

y/y comparison, depending on the weather.

Chart 6: Same-store Sales at Directly Managed Stores (y/y)


3. Extra emphasis put on store expansion to achieve revenue target of Y100.0bn in 2025

The firm has set a revenue target of Y100.0bn for 2025, which we estimate breaks down

into Y50.0-60.0bn from Katsuya, Y20.0-30.0bn from Karayama, and Y10.0-20.0bn from

corporate acquisitions. At this juncture, these targets look difficult to achieve for both brands,

but it is possible that earnings may surge with the addition of more store development staff

or acceleration in new store openings by franchisees. The firm’s willingness to expand its

operations via M&As appears to have increased, following the shift to a holding company

structure on 1 July 2016.

We give the company some credit for its growth strategy, including external growth, since

M&As will be essential to achieving more rapid growth in the already mature domestic

restaurant market. However, it seems that potential prime targets have grown scarcer in the

industry and deals have become more expensive. As such, any future deals will need to be

considered very carefully.

Another alternative for accelerating growth would be to acquire a meat processing plant. At

present, the processing of pork for use by Katsuya is handled by subsidiary Arcland Maruha

Meat. To expand its Karayama operations, the firm may also need to acquire a poultry

processing plant. Such a plant may be able to accelerate revenue growth by not only

processing meat for the firm’s own use but also engaging in sales to outside the group.

90%

95%

100%

105%

110%

Same-store sales Customer traffic Avg. ticket price

Focus on store expansion

in pursuit of Y100bn in

revenue for 2025

- 9 -


III. Company outline

1. Business activities

Arcland Service Holdings is mainly engaged in the operation of the Katsuya chain of

tonkatsu (pork cutlet) and katsudon (pork cutlet rice bowl) restaurants. As of 1H FY16, it

had a total of 405 locations (139 directly managed, 266 franchise) including 355 Katsuya

locations (110 domestic directly managed, 219 domestic franchise, five directly managed

overseas, 21 franchise overseas). Katsuya’s monthly average revenue has risen to roughly

Y8mn and its average ticket price is around Y750. Katsuya has both suburban and station

front locations, with the former accounting for more than half its store network.

Katsuya’s strengths include the high efficiency of its store operations and relatively stable

same-store sales. Being a pioneer in the tonkatsu and katsudon restaurant chain market, it

also appears to have improved efficiency in various aspects of store operations such as

food preparation and customer service. The company has also made continuous

improvements to fryers and other cooking equipment through joint development with

manufacturers. Katsuya has a high percentage of repeat visitors (with predominantly male

customers), which has allowed stable same-store sales growth.

Having begun franchise operations in 1999, Arcland Service Holdings has around 70

franchisees (incorporated entities only). It generally seeks five-year contracts that call for an

initial franchise fee of Y5mn and royalties of 5% of monthly sales (lower for multi-store

franchisees). While the initial outlay is relatively large, at Y50-60mn, there has been strong

interest among franchisees in expanding existing stores and opening new stores, given the

chain’s stable same-store sales. Recently, franchisees seem to have shown especially

strong interest in opening new Karayama locations. The first Karayama franchise store

opened in spring 2016.

Outside Japan, Arcland Service Holdings operates directly managed locations in South

Korea and franchise stores in Hong Kong, Thailand, and Taiwan, with plans to advance into

the US market in the future. However, with only 26 stores overseas in 1H FY16, foreign

operations have little impact on overall revenue or operating profit, in our view. Although

revenue is brisk in certain regions, further expansion overseas will require the firm to further

establish its store format and review store locations.

Chart 7: Conditions of Katsuya’s Franchise Agreement

Term of contract Earlier of either five years from new store opening or 5 ½ years from contract date

Initial franchise fee Y5mn on contract date

Deposit Y2mn due 10 days prior to new store opening

Renewal fee Y1mn due 80 days prior to contract expiration date

Royalties 5% of monthly sales (for three stores or fewer)


2. Company history

Focusing on healthy growth potential of the restaurant industry amid changing consumer

lifestyles, Arcland Sakamoto (9842), the parent of Arcland Service Holdings, established a

restaurant division in April 1986. The restaurant operations were transferred to Arcland

Service, which was established as its wholly owned subsidiary in Sanjo City, Niigata

Prefecture, in March 1993. In August 1998, Arcland Service opened the first Katsuya

restaurant. In July 1999, it began franchise operations. In October 2014, it expanded into

meat processing operations by establishing subsidiary Arcland Maruha Meat, a joint

venture with Maruha Nichiro (1333). Thereafter, it expanded into karaage restaurant

operations by launching the new Karayama brand. In December 2015, subsidiary Ever

Action acquired Karaage Yukari chain operator Ban Family. On 1 July 2016, it shifted to a

holding company structure and renamed itself Arcland Service Holdings. With lasting

prosperity, performance-related pay, being an elite group, and achieving the impossible as

its guiding principles, the firm is steadily working toward achieving its revenue target of

Y100.0bn in 2025.

Operates Katsuya

tonkatsu, katsudon

restaurant chain

Strengths include high

efficiency of store

operations

Strong interest in

opening new stores

among Katsuya and

Karayama franchisees

Expanding overseas, but

earnings impact limited

- 10 -


IV. Earnings trends

1H FY16 results

In 1H FY16, revenue grew 13% y/y to Y11.2bn and operating profit rose 19% to Y1.57bn.

The profit figure exceeded both our prior estimate of Y1.5bn and the company’s projection

of Y1.37bn. The overshoot vs. the company’s projection was mostly due to

higher-than-expected same-store sales. Same-store sales grew 3.3% y/y at directly

managed stores and 0.1% at franchise stores. This difference was apparently due to (1)

more directly managed stores offering breakfast and take-out lunch boxes, and (2)

problems with staff recruitment at some franchise locations. As of end-1H, the total number

of stores came to 405, up 13 from end-FY15. New store openings for directly managed

stores fell short of the company’s target due to fewer-than-expected locations earmarked

for new store openings, especially in city centers. Meanwhile, new store openings by

franchisees exceeded the company’s estimate, driven by strong franchisee interest in

opening Karayama stores. Fixed costs were not as high as we had expected, due to

fewer-than-expected directly managed stores being opened, as well as success in lowering

rents at some stores.

Chart 8: Long-term Earnings (Y bn)


FY16 forecasts

For FY16, we expect revenue to rise 13% y/y to Y23.7bn (company projection Y23.8bn) and

operating profit to increase 16% to Y3.39bn (Y3.25bn). The main difference with the

company forecast is due to our more bullish forecast for same-store sales. We believe

same-store sales will rise 1.7% y/y (customer traffic up 1.9%, avg. ticket price down 0.2%),

vs. the company’s forecast of no change. Our estimates assume a net increase of 39 stores

(49 new store openings, 10 closings) from a year earlier to 431 as of end-FY16. The new

stores break down to 21 Katsuya locations in Japan, 13 Katsuya locations overseas, 12

Karayama locations, and three for other store formats. We expect the number of store

closings to be higher than usual due to some Karaage Yukari stores being removed from

the group. Although pork prices are likely to decline, we believe the gross margin will narrow

by 2.9 percentage points due to higher rice prices and a higher percentage of franchise

stores at Katsuya.

FY17 forecasts

For FY17, we see revenue growing 12% y/y to Y26.6bn and operating profit rising 19% to

Y4.02bn. We expect earnings growth to be driven by store expansion for Katsuya and

Karayama. Our estimates assume a net increase of 56 stores (58 new store openings, 2

0

1

2

3

4

5

6

0

5

10

15

20

25

30

35

FY06 07 08 09 10 11 12 13 14 15 16 E 17 E 18 E

Sales (left) Operating profit (right)（

（

（億円）

Revenue up 13% y/y, op

profit up 19%

Op profit to rise 16% y/y

on 13% revenue growth

Op profit to rise 19% on

12% revenue growth

- 11 -


closures) from a year earlier to 487 stores as of end-FY17, with new store openings

expected to break down to 22 domestic Katsuya locations, 12 overseas Katsuya locations,

and 24 Karayama locations. We expect new store openings to accelerate for Karayama,

driven by growth in both directly managed and franchise stores. We foresee same-store

sales flat with the year-earlier level. We expect the gross margin to drop 1.6 points y/y,

mainly due to a higher percentage of franchise stores at Katsuya.

FY18 forecasts

For FY18, we forecast revenue growth of 14% y/y to Y30.3bn and an operating profit

increase of 23% to Y4.94bn. We see earnings growth driven by accelerated new store

openings for Katsuya. Our estimates assume a net increase of 72 stores (74 new store

openings, 2 closures) to 559 locations. New store openings should break down into 22

domestic Katsuya locations, 12 overseas Katsuya locations, and 40 Karayama locations.

We foresee flat same-store sales.

V. Financial strategy

Cost of accelerating new store openings to be financed by cash on hand

The firm has been stepping up store expansion for Katsuya in recent years, keeping related

costs within the range of free cash flow. Given the prospect of robust new store openings for

Karayama going forward, we expect free cash flow to decrease in FY16. Further

acceleration in new store openings by Karayama could bring free cash flow into negative

territory with related costs to be financed by cash on hand and proceeds from the sale of

investment securities. We believe the firm may sell Y1.5bn in investment securities in FY17

and FY18 combined. The firm aims to keep its dividend payout ratio at around 20%, while

adopting the policy of maintaining steady dividends.

Chart 9: Cash Flow (Y bn)


-6

-5

-4

-3

-2

-1

0

1

2

3

FY11 12 13 14 15 16 E 17 E 18 E

Cash flows from investing activities Cash flows from operating activities Free cash flow

Op profit to rise 23% on

14% y/y revenue growth

Cost of accelerating new

store openings to be

financed by cash on

hand

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VI. Risk factors

Potential risks include (1) risks associated with the short list of shareholders, (2) risks

associated with M&As, (3) risk of competition from new market entrants, and (4) risk of

ingredient price fluctuations.

(1) Short list of shareholders

Arcland Sakamoto owns a little under 53% of the firm’s shares. It is not likely to sell the

shares, given that the subsidiary is a key growth driver. If the parent should implement a

secondary offering, this would have a meaningful of impact on buying/selling pressures in

Arcland Service Holdings shares.

(2) Risk associated with M&As

The firm may pursue M&As going forward as part of its efforts to achieve its revenue target

of Y100.0bn for 2025. However, given the company’s lack of significant experience with

major M&A deals, we see this as a risk to earnings.

(3) Risk of competition from new market entrants

In our view, the firm has benefited from the growth of the fast casual market, including

Katsuya (positioned between family restaurants and fast food) in recent years. However,

the entry of newcomers in the tonkatsu restaurant chain market, including Matsuya Foods’

Matsunoya, may become a threat for both same-store sales and new store openings.

(4) Risk of ingredient price fluctuations

Significant changes in the price of ingredients (pork, rice, vegetables) would have a

meaningful impact on earnings. However, since ingredients are generally procured through

trading firms and wholesalers, the impact of less severe fluctuations should be negligible.

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Chart 10: Consolidated Income Statement (Y mn; y/y %)

FY14 15 16 E 17 E 18 E 16 CP

Sales 17,623 (17.6) 20,942 (18.8) 23,700 (13.2) 26,600 (12.2) 30,300 (13.9) 23,800 (13.6)

Katsuya directly managed stores 9,494 (9.4) 10,367 (9.2) 11,210 (8.1) 12,330 (10.0) 13,790 (11.8)

Katsuya franchises stores 6,942 (34.0) 8,552 (23.2) 9,030 (5.6) 9,780 (8.3) 10,420 (6.5)

Other restaurant businesses 931 (6.0) 1,559 (67.5) 2,490 (59.7) 3,560 (43.0) 5,130 (44.1)

Other business 254 (2.2) 463 (82.3) 970 (109.5) 930 (-4.1) 960 (3.2)

Gross profit 9,694 (12.4) 11,082 (14.3) 11,840 (6.8) 12,875 (8.7) 14,241 (10.6)

Gross margin (%) 55.0 52.9 50.0 48.4 47.0

SG&A 7,101 (12.7) 8,159 (14.9) 8,450 (3.6) 8,855 (4.8) 9,301 (5.0)

SG&A ratio (%) 40.3 39.0 35.7 33.3 30.7

Operating profit 2,592 (11.6) 2,923 (12.8) 3,390 (16.0) 4,020 (18.6) 4,940 (22.9) 3,250 (11.2)

Operating profit margin (%) 14.7 14.0 14.3 15.1 16.3 13.7

Non-operating income/expenses 32 62 40 40 40

Recurring profit 2,624 (11.2) 2,985 (13.8) 3,430 (14.9) 4,060 (18.4) 4,980 (22.7) 3,300 (10.6)

Recurring profit margin (%) 14.9 14.3 14.5 15.3 16.4 13.9

Extraordinary gains/losses 36 -127 -130 -119 -118

Pretax income 2,660 (20.2) 2,858 (7.4) 3,300 (15.5) 3,941 (19.4) 4,862 (23.4)

Pretax income margin (%) 15.1 13.6 13.9 14.8 16.0

Net income 1,597 (18.0) 1,792 (12.2) 1,960 (9.4) 2,350 (19.9) 2,900 (23.4) 1,900 (6.0)

Net income margin (%) 9.1 8.6 8.3 8.8 9.6 8.0

No. of stores

All stores 316 (22.5) 392 (24.1) 431 (9.9) 487 (13.0) 559 (14.8)

Katsuya 302 (22.3) 340 (12.6) 371 (9.1) 403 (8.6) 435 (7.9)

Other (Karayama) 14 (27.3) 52 (271.4) 60 (15.4) 84 (40.0) 124 (47.6)

Same-store sales at directly managed stores (%) 101.5 102.3 101.7 100.0 100.0

Source: Company materials; compiled by Daiwa. E: Daiwa estimates. CP: Company projections.

Chart 11: Consolidated Balance Sheet (Y mn)

FY14 15 16 E 17 E 18 E

Cash and cash equivalents 8,817 6,310 6,210 6,740 7,490

Accounts receivable 801 1,054 1,250 1,450 1,650

Inventories 210 273 350 430 510

Current assets 10,190 7,972 8,320 9,230 10,360

Tangible fixed assets 2,213 2,536 2,840 3,330 4,010

Intangible fixed assets 7 332 330 330 330

Investments and other assets 2,208 5,809 6,930 7,630 8,320

Fixed assets 4,429 8,679 10,100 11,290 12,660

Total assets 14,620 16,651 18,420 20,520 23,020

Accounts payable 1,017 1,165 1,370 1,570 1,770

Short-term borrowings 0 0 0 0 0

Other 1,682 1,795 1,790 1,790 1,790

Current liabilities 2,699 2,960 3,160 3,360 3,560

Long-term borrowings 0 0 0 0 0

Other 809 963 960 960 960

Long-term liabilities 809 963 960 960 960

Total liabilities 3,509 3,923 4,120 4,320 4,520

Total net assets 11,110 12,727 14,300 16,200 18,500

Total liabilities and net assets 14,620 16,651 18,420 20,520 23,020


- 14 -


Financial Statements

(Y mn) 12/13 12/14 12/15 12/16 E 12/17 E 12/18 E

Income statement

Sales / Revenue 14,986 17,623 20,942 23,700 26,600 30,300

Operating profit 2,323 2,592 2,923 3,390 4,020 4,940

EBITDA 2,583 2,872 3,269 3,790 4,480 5,460

Recurring profit 2,359 2,624 2,985 3,430 4,060 4,980

Net income 1,353 1,597 1,792 1,960 2,350 2,900

Balance sheet

Liquidity on hand 4,529 8,817 6,310 6,210 6,740 7,490

Fixed assets / Non-current assets 4,050 4,429 8,679 10,100 11,290 12,660

Total assets 9,737 14,620 16,651 18,420 20,520 23,020

Interest-bearing debt 0 0 0 0 0 0

Total liabilities 2,922 3,509 3,923 4,120 4,320 4,520

Total net assets / Total equity 6,815 11,110 12,727 14,300 16,200 18,500

Shareholders' equity 6,815 11,065 12,602 14,200 16,100 18,400

Cash flow statement

Cash flows from operating activities 1,855 2,256 2,219 1,390 1,600 1,850

Net income 1,353 1,597 1,792 1,960 2,350 2,900

Depreciation and amortization 260 280 346 400 460 520

Cash flows from investing activities -926 -5,762 -1,083 -1,090 -590 -540

Free cash flow 929 -3,506 1,136 300 1,010 1,310

Cash flows from financing activities -11 2,780 -138 -400 -480 -560

Increase (decrease) in cash and cash equivalents 922 -712 992 -100 530 750

Accounting standards JGAAP JGAAP JGAAP JGAAP JGAAP JGAAP

Financial indicators

Growth

Sales / Revenue (y/y %) 17.1 17.6 18.8 13.2 12.2 13.9

Operating profit (y/y %) 18.4 11.6 12.8 16.0 18.6 22.9

Profitability

Operating profit margin (%) 15.5 14.7 14.0 14.3 15.1 16.3

EBITDA margin (%) 17.2 16.3 15.6 16.0 16.8 18.0

ROE (%) 21.8 17.9 15.1 14.6 15.5 16.8

ROA (%) 15.2 13.1 11.5 11.2 12.1 13.3

Financial leverage/dividend policy

Net debt-to-equity ratio (X) -0.7 -0.8 -0.5 -0.4 -0.4 -0.4

Equity-to-assets ratio (%) 70.0 75.7 75.7 77.1 78.5 79.9

Total dividends / shareholders' equity (%) 2.6 2.2 2.5 2.8 3.0 3.0

Dividend payout ratio (%) 13.0 14.2 17.8 20.3 20.3 19.2

Per-share data

EPS (Y) 95.9 105.7 112.6 123.1 147.6 182.2

DPS (Y) 12.50 15.00 20.00 25.00 30.00 35.00

Book value per share (Y) 482.7 695.2 791.7 892.1 1,011.5 1,156.0

Valuations Share price: Y3,005; market cap: Y47,832mn (5 Sep 2016)

P/E (X) 31.4 28.4 26.7 24.4 20.4 16.5

EV/EBITDA (X) 16.8 13.6 12.7 11.0 9.2 7.4

P/B (X) 6.22 4.32 3.80 3.37 2.97 2.60

Dividend yield (%) 0.42 0.50 0.67 0.83 1.00 1.16

Source: Company materials; compiled by Daiwa. Note: Per-share figures retroactively adjusted to reflect 2-for-1 stock split on 1 Jan 2016. E: Daiwa estimates.

Company Outline

Arcland Service Holdings is mainly engaged in operation of the Katsuya chain of tonkatsu (pork cutlet) and katsudon

(pork cutlet rice bowl) restaurants. Katsuya has average monthly revenue of roughly Y8mn and an average ticket price

of around Y750. Its strengths include high efficiency of store operations and stable same-store sales amid a high

percentage of repeat visitors among predominantly male customers. We expect new store openings to accelerate going

forward with the Karayama format solidly established as the firm’s second major brand.

Translation: Research Production Department Style check: K.R. Accuracy check: H.M.

- 15 -


Notes concerning market data, investment indicators, and income summary on pages 1-2

Estimates on page 1 by Daiwa Net income is that attributable to shareholders of parent Shares outstanding: Common shares outstanding (excl. treasury stock) Market cap: Based on shares outstanding and closing price as of indicated date EV: Market cap + interest-bearing debt – liquidity on hand EBITDA: Operating profit + depreciation & amortization ROE: Net income / average of start-FY and end-FY shareholders’ equity (figures based on net income attributable to shareholders of parent) Share Price Chart and per-share figures retroactively adjusted to reflect stock splits/reverse stock splits

- 16 -


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The views about any and all of the subject securities and issuers expressed in this Research Report accurately reflect the personal views of the research analyst(s) primarily responsible for this report (or the views of the firm producing the report if no individual analysts[s] is named on the report); and no part of the compensation of such analyst(s) (or no part of the compensation of the firm if no individual analyst[s)] is named on the report) was, is, or will be directly or indirectly related to the specific recommendations or views contained in this Research Report. The following explains the rating system in the report as compared to relevant local indices, based on the beliefs of the author of the report. (Criteria below apply to rating assignments or updates from Jan 2015. For ratings assigned or updated prior to Jan 2015, criteria refer to performance vs. TOPIX/benchmark index over six months.) "1": the security could outperform the local benchmark index by more than 15% over the next 12 months. "2": the security is expected to outperform the local benchmark index by 5-15% over the next 12 months. "3": the security is expected to perform within 5% of the local benchmark index (better or worse) over the next 12 months. "4": the security is expected to underperform the local benchmark index by 5-15% over the next 12 months. "5": the security could underperform the local benchmark index by more than 15% over the next 12 months. Additional information may be available upon request.

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