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Clayton Young
Clayton Young
Articles (12)  | Author's Website |

Is Japan's Population Problem Due to Fertility or Framework?

A closer look at Japan's child care infrastructure suggests there is more to its problem than childless couples

August 24, 2017 | About:

Japan’s population problem is common knowledge these days. The fertility rate required to sustain a population is generally considered to be somewhere around 2.1 births per woman. Japan’s fertility rate has remained below this level since the mid-1970s:

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Source: World Bank / Google

Sure enough, Japan’s population started declining around 2011. In a world where GDP growth to infinity seems to be the favored measure of every country’s economic future, Japan’s situation is not good. I have my own views on this topic, like how population growth to infinity is not sustainable, but that is a discussion for another day. Today, I will present a watchlist-worthy company with a side of what I like to call “fact-based speculation.”

The chicken or the egg

First, take a look at this:

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Source: Japan Ministry of Health, Labour and Welfare

This is a map of Japan. The areas highlighted in light pink have 1,000 ~ 2,000 children ages 0 to 5 on a waitlist for child care services. Dark pink areas have 3,000 ~ 5,000 children waiting, red areas have 5,000-plus. To simplify things, the one and only red area is Tokyo, the largest metropolitan area in Japan. The light pink all the way to the west of Tokyo is the Osaka/Kinki metro, which is the second largest in Japan. The pink area all the way southwest is my hometown  Okinawa.

Why are children on a waitlist for child care services in a supposedly childless Japan?

According to data from Japan’s Ministry of Health, Labour and Welfare, approximately 93% of child care capacity is used in Japan. To put this into context, the Japanese population started favoring cities. It’s likely that the remaining 7% of capacity is in areas where child care services are not in big demand. In fact, seven out of 47 prefectures account for almost 75% of Japan’s child care shortage. These seven prefectures are in and around the two largest metropolitan areas mentioned earlier.

So maybe some Japanese men are marrying fictional characters, but I think there is more to the Japanese population story. Even from a media standpoint, sexless Japanese men marrying anime characters probably make a better headline than a shortage in child care facilities. My fact-based speculation is that Japan’s population problem might be a boring infrastructure problem. Maybe Japanese couples want to have children, but child care infrastructure in cities is insufficient and expensive.

How to go from coffee carts in gambling parlors to largest child care facility operator in Japan

Hiromi Yamaguchi, an avid pachinko player and founder of JP Holdings (TSE:2749), was figuring out how to expand his office coffee delivery business. The lightbulb lit up: coffee carts inside pachinko parlors. In case you’re not familiar, pachinko is a form of gambling popular in Japan. Here’s a picture of a pachinko parlor:

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Source: BBC

The mechanics of pachinko don’t matter (it’s like pinball on steroids but without the flippers). The coffee carts were a hit. The company started expanding all over the country. Most of the coffee cart attendants were women. In Japan, it’s common for women to quit their jobs after marriage or starting a family. Soon enough, the company was faced with a problem: keeping female employees. The solution? Open a child care facility for employees.

The first JP Holdings child care facility commenced operations in 2001. Today, the company operates 271 facilities. In fact, the entire company operation exclusively revolves around child care today.

The Japanese government isn’t easy

Japan has several classifications of child care facilities. First, facilities are divided into two categories: day cares (ages 0 to 5) and kindergartens (ages 3 to 5). This is where it starts to get crazy and confusing. Day cares are governed by the Ministry of Health, Labour and Welfare while kindergartens are governed by the Ministry of Education, Culture, Sports, Science and Technology. Furthermore, the two facilities require different certifications. The main difference is that day cares are basically baby-sitting facilities while kindergartens are more like a school.

JP Holdings primarily operates under the day care domain. Now, there are three subdomains to day cares: federally approved, municipally approved and private. Generally speaking, federally approved facilities are most affordable, which is followed by municipally approved and finally private facilities. As you might imagine, this is due to government funding. To be sure, getting federally approved is a work of art. Companies need to meet certain child/caretaker, floor space, play area, etc., ratios to gain approval. About 60% of JP Holdings’ facilities are either federally or municipally approved.

The financials aren’t easy, either

The curious challenge that JP Holdings faces is the intense pressure on margins. There are several parts to this child care problem, which I will describe in a highly reductionist fashion. First, wages for day care teachers are so low that (literally) half of the people who get their day care teacher’s license don’t actually pursue a job at a day care. Next, child care is expensive, which is probably part of the reason Japanese couples aren’t having kids. Finally (and again), federal approval of a day care is incredibly difficult.

Essentially, revenues are forced to stay where they are or even go a little lower per head. Combine this with the government’s push for higher day care teacher wages and JP Holdings’ initiative to stay ahead of the wage race. The result is margin compression. This has become particularly apparent over the past few years:

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To be sure, JP Holdings is a high growth company, just not in a meaningful way for investors (yet). Revenue CAGR was 14.2% over the past 10 years while EBIT CAGR was 12.4%. This looks good, but the government push for wage increases and expanded affordable child care infrastructure started in the past few years. Shrink the timeline to five years, and we have a revenue CAGR of 6.8% while EBIT CAGR was at a 1.3%. Basically, revenue doubled while EBIT increased only marginally.

What to think of JP Holdings’ situation

Presumably, Japan’s fertility rate will not hit 2.1 next year (or in the next decade). Frankly, I’m not so sure that 2.1 is even the target. At this point, I can only guess that the Japanese government is mostly just interested in softening the blow for the younger generation. Three things are glaringly obvious here:

  1. The Japanese government will continue working on the fertility problem.

  2. Someone needs to operate child care facilities (even with the margin compression).

  3. Scale tends to reduce cost.

So child care facilities aren’t a hugely scalable platform in Japan, but someone still needs to operate it. Wages for day care teachers are rising, and the idea is to keep child care costs low. That means cost efficiencies need to happen elsewhere, whether it be admin cost reduction through scale, large volume purchases on educational materials, etc.

This isn’t to say that JP Holdings has no competition. Success Holdings and Global Group (TSE:6189) are the main competitors. Though Success Holdings operates more facilities than JP Holdings, the facilities tend to be smaller. On a revenue basis, JP Holdings is a little shy of Success Holdings and Global Group combined. More important, JP Holdings operates the highest number of federally and municipally approved facilities. Summarily, the company is best positioned for continued expansion.

It’s impossible to say where margins will “normalize.” The investor’s best defense is to pay a lower price. I’d find JP Holdings interesting at 170 yen ($1.55) per share, which would be about 17x EV/EBIT. That clearly accounts for a lot of growth, but it is not unreasonable. This is primarily because JP Holdings already started vertically integrating. The company leverages its industry-leading scale to make volume purchases on day care supplies, offers training programs for day care teachers, food cooking and training services, etc. At this point, financials aren’t broken out by segment on the company’s annual reports.

Going forward, the key macro drivers to pay attention to are:

  • Fertility rate.
  • Child care infrastructure capacity.
  • Child care cost.

The micro drivers to pay attention to are:

  • Margins for child care facilities.
  • Value-added business.
  • Emerging scale advantages.

In conclusion, there is a lot going on in Japan’s child care industry, and JP Holdings is well positioned. That said, today’s price seems to account for a considerable amount of growth with sustained/better margins (trading at EV/EBIT is 25x). Given the uncertainties, especially with the margin compression, JP Holdings is not an actionable investment today. I’ll be taking another look at JP Holdings if share prices came down to 170 yen.

Disclosure: I do not own shares in any of the companies mentioned in this article.

About the author:

Clayton Young
I grew up in Japan and completed an MBA in the U.S., but learned more from reading Howard Marks. I apply an American value investing approach to Japanese companies that are often inscrutable to outsiders who lack fluency in the unique cultural context.

Visit Clayton Young's Website


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