Deep-dive 2021-5: Sanrio Company, Ltd

Sanrio Company, Ltd (8136 JP) is a designer, licensor and producer of cute ("kawaii") consumer products. Its most popular brand name is "Hello Kitty".

The company has three segments: direct product sales (with inventory risk), licensing of characters to third-parties as well as running two theme parks in Japan. The company has about 450 characters in its current portfolio. After designing a new character, it then markets them through its theme parks and own products. If it becomes a success, it finally licenses it out to third parties - collecting further, high-margin revenue.

The company has suffered over the past few years as the founder's son Kunihiko Tsuji passed away in 2014, causing a vacuum in the top leadership. The founder's grandson Tomokuni Tsuji has been groomed to take over the business and finally took the reins in late 2019.

The problems were manifold. Kunihiko Tsuji had been the driving force behind Sanrio's overseas licensing business in Europe and the US, the two primary contributors to Sanrio's operating profit. Once he passed away, the overseas business was handed over to senior managing director Rehito Hatoyama, but Rehito mismanaged it and ultimately resigned in 2016. Another problem was increased competition from Disney following the runaway success of Frozen and other Disney franchises. Sanrio has also struggled with the shift to online and with COVID-19 in 2020.

We think that Sanrio represent an asset that hasn't yet been fully monetised. It is difficult to value the asset with any kind of precision. But the fact that Hello Kitty is the second-most successful media franchise of all times hints at what Sanrio can achieve under the right leadership.

While Tomokuni Tsuji is young, his turnaround plan makes perfect sense. Whereas each character previously had its own marketing department, the company will now coordinate marketing resources across the company. New digital initiatives such as the Sanrio+ app have been launched to collect customer data after each new initiative, to quickly respond to any successes in a trial-and-error fashion. A new animation and gaming business has been established to collaborate with Netflix and Hollywood studios to create product releases that increase character brand awareness. New collaborations with Levi's, Razer, Uniqlo, Balenciaga and other fashion brands have put Hello Kitty on the radar of many consumers yet again. Tomokuni's 2021 plan that will be announced in May is likely to put a greater focus on China as a growth market.

The turnaround is visible from alt-data across platforms such as Google, Instagram and Reddit. Google search queries have rebounded sharply, especially in the key US and European markets where Sanrio enjoy high-margin licensing revenue. Spikes in user activity on YouTube and Instagram also suggest an increased consumer focus on Hello Kitty. This is especially evident in markets outside of Japan.

Like many other consumer brands, Sanrio has suffered during COVID-19. Its theme parks were shut down in early 2020 and are still operating below capacity. Its direct stores are suffering from low foot traffic at offline retail establishments. Japan's vaccination program is now on track however, with initial plans to vaccinate the entire population in anticipation of Tokyo Olympics in July / August 2021. While that plan has been delayed a number of months, we believe COVID-19 will become much less of a problem as we go through the second half of calendar year 2021.

It is difficult to value Sanrio, since the outcomes are highly skewed to both the upside and the downside. But in a base case scenario, we believe that Sanrio will make close to JPY 14.3 billion in FY2025, representing a partial recovery vs 2014 levels. Such a scenario would imply a forward EV/EBIT of 9.2x and an upside of +44% to our target multiple. But instead of trying to guess exactly where Sanrio's stock price will end up in a turnaround, we recommend buying the stock, follow the progress on a half-yearly basis and sell at whatever price has been achieved once product momentum turns more neutral.

For literature on Sanrio, we highly recommend Shared Research 80-page report on Sanrio available here and also alt-data focused Twitter account @AstutexAi, which has been tweeting about Sanrio recently.

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The above article and PowerPoint presentation constitutes the author’s personal views only and is for entertainment purposes only. It is not to be construed as financial advice in any shape or form. Please do your own research and seek your own advice from a qualified financial advisor. The author may from time to time hold positions in the aforementioned stocks consistent with the views and opinions expressed in this article. Disclosure – we hold a position in Sanrio Company, Ltd at the time of publishing this article (this is a disclosure and NOT A RECOMMENDATION).

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