rockdrigo68/iStock Editorial via Getty Images

rockdrigo68/iStock Editorial via Getty Images

Yamato Holdings (OTCPK:YATRY) offers a potential upside of 50%-70% from the current stock price of ¥2,186 under the ticker of 9064 on the Tokyo stock exchange or $18.98 for OTC’s ticker of YATRY. The market significantly underprices the company due to a temporary jump in subcontracting expenses in the last quarter of FY 2022, which resulted in a decline in profitability and produced a subsequent plunge in the stock price. Given the company’s dominant market position in the parcel delivery market and strong record in identifying and solving its operating problems in the past, I expect that Yamato will be able to restore profitability to 5%+ operating margin within the next one or two years.

Also, the market significantly underprices the strong secular positive trend in Japanese ecommerce, which is expected to show strong growth within the next five years and serves as a tailwind for the company’s delivery business. The market also overlooks Yamato’s strong bargaining power to raise parcel unit prices and ability to take market share from its competitors in the future as it continuously builds out and improves its delivery network in Japan. Finally, the company is working to diversify away from a pure play on parcel delivery to a fully integrated logistics company by providing various fulfillment services to ecommerce merchants. All of this will serve as a strong positive for Yamato’s top line growth and, together with margin improvement, will yield a closure of the gap between the current stock price and my estimated intrinsic value.

Yamato is one of the leading transportation companies in Japan that specializes in door-to-door deliveries for business-to-business (B2B), business-to-consumer (B2C) and consumer-to-consumer (C2C) segments of the ecommerce market. The company is known for its flagship service called TA-Q-BIN (“remarkable and convenient”) launched in 1976 that delivers a wide range of parcels in Japan, including golf kits to golf courses, luggage from/to airports, ski gear to ski resorts. Besides the standard TA-Q-BIN, Yamato offers “Cool TA-Q-BIN”, which is refrigerated delivery of frozen food for businesses and individual consumers.

In 2021, Yamato reformed its business structure and currently discloses two main business segments: retail and corporate. The retail segment handles small-lot transportation services (e.g. parcel delivery, moving services) for small businesses and individuals. The corporate business primarily handles large corporate clients and provides not only ecommerce parcel delivery, but also supply chain management services, including customs clearing and fulfillment services for ecommerce clients. Large corporate customers, such as Amazon, Rakuten and Mercari are handled through Yamato’s corporate segment.

Table 1. Revenues and Operating Profits for Yamato’s reportable segment for Q1-Q3 FY2022 on the unconsolidated basis (¥ millions)

Source: Company’s materials. Numbers above are on the unconsolidated basis and include intersegment numbers.

Yamato holds the largest share of 43.8% in the courier and parcel delivery market in Japan. The delivery market in Japan is highly concentrated and geographically fragmented. Together with its other two competitors, the three leading transportation companies control over 90% of the delivery market in Japan.

Table 2. Major Delivery Companies in Japan based on FY 2021 Results (1,000 parcels)

Source: Company’s website. Excludes airfreight.

Recognizing the limits of the Japanese market, Yamato is also developing its delivery and logistics businesses in foreign markets, such as China, Singapore, Malaysia, Thailand, Hong Kong and Taiwan. Unfortunately, Yamato does not disclose how much revenue is generated outside Japan, but the number is likely at or below 10% of its consolidated revenues.

The coronavirus pandemic brought a strong shift in Japanese consumer purchasing behavior and forced many consumers to rely on the online channel to get their daily necessities and other products. In my view, the market largely discounts the Covid-19 bump in ecommerce sales as a one-time event and significantly undervalues the tailwind for Yamato from the future strong growth in ecommerce.

Table 3. Ecommerce in Japan and Parcel Delivery (100 billion yen)

Sources: e-Stat for Japan parcel delivery volumes growth rates. Ministry of Economy, Trade and Industry for Ecommerce data (2006 – 2019 and 2020 data sources). Yamato’s 2020 annual report for delivery revenue data. Note: Yamato’s delivery revenues growth rate and Japan’s delivery growth rates are for fiscal years (e.g. 2020 is from 4/2020 through 3/2021), while Ecommerce data is for calendar years. Conversion rate represents a percent of ecommerce purchases of total purchases (online and offline) for a particular category.

Japan is one of the largest ecommerce markets in the world with total B-to-C ecommerce sales of ¥19.8 trillion in 2020. B-to-C ecommerce is generally divided into three major categories: merchandise, digital content and services. B-to-C merchandise ecommerce is the most important metric for Yamato since it involves physically sending, picking and delivering products by couriers from businesses to consumers. From 2013 to 2019, the B-to-C merchandise market demonstrated the CAGR of 9%. But when Covid-19 struck, the annual rate jumped to 21.7% as consumers huddled down at home and switched to shopping online.

There is also a consumer-to-consumer (C-to-C) ecommerce market, where individuals trade and send merchandise to each other via online platforms, such as eBay and Mercari. Although this is a rapidly growing segment of Japan’s ecommerce market, it is largely irrelevant for Yamato due to its relatively small size. Also, there is business-to-business (B-to-B) ecommerce, where companies make orders online for various merchandise and couriers make deliveries (e.g. a restaurant ordering fresh produce from a local farm). The size of the B-to-B market is very large. Although there is no breakdown of how much revenues Yamato earns from B-to-B/B-to-C/C-to-C ecommerce sales, it is possible to deduce that the B-to-C market is the most important one as evidenced by 2020 numbers. While B-to-B ecommerce declined by 5.1% in 2020, Yamato’s deliveries jumped in line with the B-to-C trend.

While the 2020 annual growth rate of 21.7% for B-to-C merchandise ecommerce is not a sustainable number, online retail will likely continue showing a strong growth trend over the next 5 years. According to GlobalData, overall B-to-C ecommerce sales are expected to grow further by CAGR of 5.9% up to 2025. The Digital Market Outlook by Statista projects that the growth in the B-to-C merchandise market in Japan will be around 6.2% from 2021 to 2024. This continued growth trend will be sustained due to several powerful factors. First, more people in Japan got accustomed to online shopping due to pandemic emergency curbs on brick-and-mortar stores operations. This habit has a high probability of persisting even after all Covid-19 restrictions are lifted. While online shopping is the norm for many customers, senior people in Japan prefer shopping in physical stores due to certain cultural aspects (preference to use cash, human contact, high density and close proximity of convenience stores in urban areas). However, after trying online shopping, many Japanese consumers discovered its convenience. Same-day deliveries with customizable delivery time and place are becoming a standard in Japan thanks to the innovation/digitalization of parcel courier services. While the Japanese society is still largely using cash (cashless transactions account for a mere 20%, compared to 96% in South Korea and 66% in China in 2019), the trend of using electronic means of payments is picking up. The Japanese government is planning to double cashless transactions to 40% by 2025 by providing various rewards and incentives for using electronic payments. Moreover, a higher demand for online shopping is incentivizing traditional Japanese retailers to invest in digital infrastructure to stay competitive and attract customers, making ecommerce even more convenient.

Available statistic confirms these trends. For example, the share of households with two or more people shopping online in Japan jumped from 42.8% in 2019 to 48.8% in 2020, the highest number on record, according to Statista. Also, the internet usage rate jumped even before Covid-19, as the rate increased from 79.8% in 2018 to 89.8% in 2019 according to Japan’s Ministry of Internal Affairs and Communications. Especially notable was an increase in internet usage rate among senior people (60+ years) from an average of about 50% in 2018 to about 74% in 2019. This trend only strengthened during the pandemic. With numbers of first-time ecommerce buyers likely increasing, especially among the senior cohort, there will be more online consumers in Japan after the pandemic is over.

With all this, ecommerce in Japan will continue trending up not only with the overall private final consumption in Japan, but also as a result of the conversion from offline to online. According to eMarketer, the global B-to-C ecommerce retail sales (please see notes to Figure 1 for eMarketer’s definition of ecommerce sales) conversion rate was 19% in 2021 and will likely reach 23.6% by 2025.

In contrast, Japan recorded an ecommerce sales conversion rate of 9.3% in 2019 according to eMarketer. Based on my calculations using Japan total retail sales of ¥150.5 trillion and ecommerce sales of $144.1 billion according to eMarketer, Japan’s ecommerce conversion rate reached 10.5% in 2021. With the world’s average conversion rate being almost twice as much as that of Japan, Japanese ecommerce has a long runway of future growth.

Another important aspect of ecommerce for Yamato is the size and growth in cross-border trade between Japan and other countries. According to Japan’s Ministry of Internal Affairs and Communications report on ecommerce, the global cross-border B-to-C ecommerce market size in 2019 was $780 billion and is expected to grow 30% annually and will reach $4.82 trillion in 2026. USA and China are two main countries for Japan’s cross-border ecommerce. In 2020, B-to-C cross-border ecommerce from Japan to China amounted to $18.2 billion, while cross-border ecommerce from Japan to the US was $9 billion. Also, Japanese consumers bought products worth $2.9 billion from American ecommerce sites. According to Grand View Research, total Japanese cross-border ecommerce (B-to-C/C-to-C/B-to-C) is projected to grow by CAGR of 7.5% from 2020 to 2030. Yamato has a presence in the US with 25 branches and strong exposure to Chinese ecommerce market through a partnership with JD.com. Yamato handles international shipping from Japan to China, including fresh food, and uses JD.com's network for home delivery since Yamato has its own delivery network set up only in Shanghai and Hong Kong. Although cross-border is a promising growth area for the company, it is difficult to ascertain the prospects of the company’s overseas expansion due to lack of Yamato’s sales/profits data for foreign markets. Thus, the Japanese ecommerce market will likely remain the cornerstone of Yamato’s value for the foreseeable future.

Looking at table 3, there is some positive association between B-to-C merchandise ecommerce and Yamato’s delivery units, although it is not perfect for reasons that will be discussed later. However, this positive link is especially evident in 2020, when merchandise ecommerce sales jumped by 21.7% and Yamato logged a parcel unit growth of 11.6% and delivery sales growth of 8.3%. Compared to its competitors, Yamato has the largest exposure to ecommerce corporate clients, such as Rakuten, Amazon Japan and Yahoo Japan, which together control over 50% of the total ecommerce market in the country. As this clientele grows, so will Yamato’s deliveries. On average, B-to-C merchandise sales grew by a CAGR of 10.7% from 2013 to 2020, while Yamato’s delivery units increased by a CAGR of 3.3%, or about a third of the ecommerce growth rate. In my valuation analysis, I assume that Japan’s ecommerce market will grow by about 6% for the next five years and this growth will produce about a 2% annual growth rate for Yamato’s delivery units.

Potential for Market Share Gain

The market underestimates the potential for Yamato to take market share from its rivals, as it expands and enhances its services during the ecommerce boom. Table 4 summarizes the dynamics for the parcel delivery market for the past 10 years.

Table 4. Market Share in Parcel Delivery Market of Japan

Source: Company’s Delivery Report and market overview webpage

Yamato was able to increase its market share substantially from 42.2% in 2011 to 46.9% in 2017, as ecommerce took off in Japan. First, Yamato has a competitive advantage over its competitors with a strategic control over its distribution network. The company has 100% coverage of parcel delivery in Japan with about 3,700 pickup centers and 200 logistics bases. Unlike Yamato, other Japanese couriers do not have such a vast coverage and must rely on other companies, such as Yamato and other regional couriers, to deliver parcels to certain locations for them. Yamato also rely on subcontractors when it is unable to handle volume surges, but to a lesser extent compared to its competitors. But most importantly, this sophisticated control over its logistics allows the company to better identify, test and implement new services, such as time-definite delivery, same-day delivery, extensive pick-up services, temperature-controlled delivery and other services. While the company’s extensive network results in higher costs, Yamato effectively offsets them by leveraging its dominance in highly-populated urban areas through economies of scale and offering unique value-added services with delivery anywhere in Japan.

Also, Yamato differentiates itself from its competitors by focusing on a customer-centered business strategy and working primarily in the B-to-C and C-to-C delivery. The company devotes a lot of time to provide its customers with excellent services in an efficient and convenient manner. Among major delivery companies in Japan, Yamato ranked number one for 13 consecutive years in the courier services category based on the 2020 Japanese Customer Satisfaction Index survey, which is one of the largest and leading polls in Japan. Overall, Yamato was ranked in the top ten among 79 leading brands of Japan in 2020.

The key factor behind such a high customer satisfaction is Yamato’s superior training and execution by its employees. The company’s personnel primarily consist of so-called sales drivers. Sales drivers may or may not necessarily drive delivery vehicles themselves, but they are the face of the company when it comes to interaction with customers during delivery. Sales drivers are trained to learn about customers’ needs and communicate their insights to upper management. This can later lead to logistical improvements or even creation of new services. There is a prominent story of how Yamato’s sales drivers took notice of the difficulty consumers faced logging their golf and ski equipment while on vacation. After communicating it to local managers, a new successful delivery service was developed specifically for ski and golf equipment.

Around 2017-2018, Yamato’s delivery network got stretched to its limits. Typically, Yamato handles unexpected surges in demand by asking its employees to work overtime or subcontracting deliveries to third-party logistics operators. However, around 2017-2018, there were difficulties with hiring part-time workers. Close to 30-40% of part-time workers at Yamato are Japanese housewives, who typically work in the mornings to handle early deliveries. In 2017-2018, Japan amended its tax laws that affected thresholds for social health insurance when one of the spouses in a household is a part-time worker. This led to a temporary adjustment and smaller numbers of hours worked by part-time employees. Also, due to increasingly higher overtime work, Yamato’s labor union demanded to curtail the volume of deliveries to relieve the stress from its workers. Finally, the Japanese government fined Yamato for not paying overtime to its workers. All of this led to lower deliveries and consequently a loss of market share by Yamato in FY2018-2020.

However, this motivated the company to improve its logistical processes, hire more part-time workers and utilize its labor force more efficiently. Hence, when the Covid-19 pandemic-related surge in online purchases began, Yamato was well-prepared to handle such a high volume and its market share went up to 43.8% for FY2021.

Many of Yamato’s rivals are simply unable to handle the surges in volume and some of them even exited business with certain large B-to-C customers. For example, Sagawa Express was unable to cope with large volumes from Amazon profitably and withdrew from the delivery deal with Amazon around 2015. The main problem for smaller Yamato’s competitors with handling large clients such as Amazon and Rakuten is the seasonal surge in deliveries that comes along. To make such deliveries, a courier must either require its workers to work overtime or hire third-party subcontractors to do this job for them. Hiring subcontractors can be very expensive and nullify profit potential from large clients. Because many couriers in Japan do not have 100% country coverage for timely parcel delivery, hiring subcontractors is a must for them. Yamato, on the other hand, bulked up its labor force, especially its part-time worker, leading up to the 2020 pandemic crisis after the 2017-2018 fiasco. This gave the company a necessary flexibility to handle large volumes when they came without resorting too heavily to subcontractors:

Source: Company’s financial facts

Moreover, Yamato was able to continue innovating during the pandemic. As more and more customers were requesting non-contact delivery, the company introduced EAZY service for its large B-to-C corporate clients in June 2020. EAZY supports various receiving methods, including gas meters, bike baskets, garages, front door and custodian/reception. This service also allows customers to change the receiving method right before delivery. The service was an instant hit with consumers and now accounts for about 50% of parcel deliveries for the corporate segment and continues growing.

However, the most important news came out in 2020. Yamato made an agreement with Z Holdings (an owner of Yahoo! Japan Shopping and PayPay Mall) to provide a complete specter of fulfillment services from receiving products, inventory management, managing consumer orders and shipping products on behalf of Z Holdings’ third-party sellers. This is a very important development, as the company is gradually transforming itself from a pure play on Japan’s delivery industry to a provider of full range of logistics services.

All this leads to the following conclusion: as Japan’s ecommerce continues expanding, Yamato is strategically well-positioned to not only grow alongside it, but also take market share from its competitors, which are unable to provide reliable “last-mile” delivery services, something Yamato excels at. Based on my estimates, Yamato’s market share for the trailing 12-month period ending on November 30, 2021 increased even further to about 46% compared to 43% for the previous period based on total parcels delivered. In my valuation I assume that Yamato will be able to take an additional 1-2% market share from its competitors, reaching 47%-48%, as the B-to-C ecommerce market expands further. This will add an additional 1% growth rate for Yamato’s delivery units for the next five years.

The biggest determining factor for Yamato’s pricing dynamics is the size of the client. About 90% of Yamato’s deliveries originate from corporate clients, who typically negotiate volume discounts on delivery rates. The rest of 10% or so comes from individuals. The larger the client, the bigger the discounts it can negotiate by providing a large volume of business to Yamato. Also, prices vary by the size of the parcel, as well as the delivery distance.

Yamato’s willingness to raise prices depends on many factors. However, the main one is the competitive dynamics. Typically, major postal couriers in Japan charge somewhat similar prices for comparable services. While it is in the best interest of courier oligopolists in Japan to follow a similar pricing line, pricing wars can break out. Facing higher labor and fuel costs around 2014, major Japanese couriers began raising rates for corporate clients. In particular, Yamato raised its rates by a few percent for large clients and by over 10% for smaller businesses. Similarly, Sagawa and Japan Post have been raising their rates for the past 5-7 years.

However, in 2017, large volumes of ecommerce deliveries overwhelmed Yamato’s network and the company was forced to increase its rates even more dramatically. Specifically, the company increased its rates by 5-20% for individual customers, something that has not been done since 1990. Also, Yamato imposed even steeper rate increases on its corporate clients, who typically pay ¥280 per package or about half of the average rate that individual clients face. According to Nikkei Asia, Yamato was negotiating with Amazon for a ¥400 base rate per package. Unfortunately, around that time, Yamato also began limiting and eventually withdrew from same-day deliveries deal with Amazon. Based on my research, it seems that Amazon refused to accept much higher rates for same-day delivery and Yamato was forced to turn down same-day delivery to relieve pressure from its overwhelmed employees. This prompted Amazon to start developing its own delivery network in major metropolitan areas, something that I address later as a major risk for Yamato’s future growth.

Based on this development, unit prices indeed went up substantially during the FY2018-2019 period, as can be learned from table 6.

Table 6. Yamato’s Average Unit Prices per Service (in ¥)

Source: Company’s website. TA-Q-BIN/TA-Q-BIN Compact/EAZY are typical delivery services provided to the majority of Yamato’s clients. Nekopos is a service that delivers parcels to mailboxes with stringent limits on size and weight. Kuroneko DM-Bin is a service for delivering promotional leaflet material to mailboxes in Japan.

While the average unit prices trended downwards from FY2011 to FY2017, the unit price inflations picked pace in FY2018. The main reasons behind this trend are rising labor costs and a necessity to invest and optimize the delivery network. Yamato noted on its earnings call Q&A for Q2 FY2018:

We are making progress in negotiations with our low-profit clients with respect to establishing more adequate unit pricing when contracts come up for renewal. Note that we intend to continue such efforts to review pricing on an ongoing basis next fiscal year and beyond.

While the CAGR for unit price from FY2011 to FY2021 was barely 0.5%, I assume that Yamato will be cautiously aggressive with price increases going forward to maintain its profitability levels. Specifically, I assume that the annual unit price growth will be around 0.5% for the first five years in my valuation.

Yamato’s adjusted operating margin fluctuated around 5% over the past 10 years.

Table 7. Yamato’s Operating Margin

Source: Company’s filings, author’s calculations. The retirement benefit adjustment includes any non-operating costs related to retirement benefit assets and liabilities.

As was mentioned earlier, Yamato suffered a setback in 2017-2018 due to part-time labor shortages and curtailments on delivery volumes. In this regard, this period was unusual, as the company’s profitability plunged. While in 2019 Yamato was on a recovery trajectory, 2020 was another unusual year, as starting on October 1, 2019, the Japanese government hiked sales tax rate from 8% to 10%. This negatively affected the company as its revenues barely grew in FY2020 and profitability declined due to a fixed nature of certain expenses. On the other hand, the period from FY2021 to Q3 FY2022 was an exceptional time for Yamato, as it was able to effectively leverage the surge in ecommerce sales and its profitability increased substantially. Looking further at the TTM period, the adjusted EBIT margin declined by 1% compared to 2021. The main reason behind such a decline was a jump in subcontracting expenses, which becomes evident after looking at table 8.

Table 8. Yamato’s Expenses as % of Unconsolidated Revenues

Source: Company’s filings, author’s calculations.

While most of the expenses remained stable in the TTM period, the subcontracting expenses margin jumped from around 32% in 2020-2021 to 35.8% relative to unconsolidated revenues. Such a high percentage is not typical for the company by historical comparison. Yamato’s management explained such an increase by its inability to finish the initiative to improve its ecommerce logistics network. In 2021, the company announced plans to separate and have a dedicated network that will focus primarily on ecommerce logistics in urban areas. At the center of this ecommerce network is EAZY crew, which is a digital and physical system for allocating work and necessary resources to deliver ecommerce orders to consumers. Besides Yamato’s own personnel, other delivery partners can join the EAZY crew network with an option of leasing vehicles from Yamato. The company also provides a wide range of digital support tools to EAZY crew workers, such as route planning and pickup support through a dedicated mobile app. In essence, EAZY crew will allow Yamato to cope better with seasonal fluctuations in ecommerce delivery volumes at a lower cost compared to traditional subcontracting and make ecommerce delivery a variable expense. However, as parcel delivery surged further in the TTM period and this initiative was a work-in-progress, Yamato was unable to handle increased delivery volume itself and had to resort to subcontracting some of the work to traditional external logistics partners, rather than handling the volume either itself or through EAZY crew. Hence, the surge in subcontracting costs occurred.

Based on my research I conclude that this TTM increase in expenses and decline in margins is very likely a temporary event. In January 2021, Yamato unveiled a new medium-term management plan "One Yamato 2023", which will significantly improve its operating cost structure and strengthen even further its already dominant position in Japan. First, the company is undergoing a complete digitalization of all of its delivery processes. Despite handling a vast number of deliveries in the past, a lot of Yamato’s information from operations has not been digitalized and many of its personnel conducted deliveries based on experience and intuition rather than available data. By digitalizing its processes, the company will be able to improve the forecast accuracy for demand volume, work scheduling and vehicle allocations substantially in the future. This will allow Yamato to improve the productivity of its network and expand pickup and delivery capabilities.

Also, there are a couple of initiatives that Yamato is undertaking to reduce expenses by FY2024 in comparison to FY2020. Specifically, the company is in the process of improving its sorting and transportation operations with the goal of increasing network sorting capabilities by 50%. Yamato plans to achieve this through automating its facilities and consolidating collection and delivery to reduce frequent use of transportation. Additionally, the company set a goal to reduce administrative work load by 40% through standardization and digitalization of administrative operations.

Another cost area that is plaguing courier providers in not only Japan, but around the world are redeliveries. Because the customer is not at home and it is culturally unacceptable in Japan to leave parcels at doorsteps, drivers must make several delivery attempts. Also, customers in Japan are provided with driver phone numbers that they can call to reschedule deliveries. All of this wastes a lot of time and costs money for Yamato. According to Statista, the average redelivery rate fell from 16% in October 2019 to 8.5% in April 2020, as people were forced to stay at home. Since then, the rate went up to 11.9% in October 2021. According to the Japanese government’s 2015 estimates, every 1% redelivery rate translates to roughly 9 million of wasted man-hours (not counting fuel/vehicle costs). Assuming an hourly wage of ¥1,160 and the current redelivery rate of about 12%, this translates roughly to 108 million of wasted man-hours for the whole courier industry or about ¥125.3 billion a year (equivalent to about $1.1 billion). Assuming the market share of 46%, Yamato can optimize about ¥58 billion, if it can lower its redelivery rate (in comparison, Yamato’s TTM operating income is ¥81.5 billion). This estimate is approximate and it is very likely that the cost of redeliveries is even higher now, because the number of parcels increased dramatically since this report from 2015. Yamato is implementing several measures to combat redeliveries. First, the company introduced the above-mentioned EAZY delivery, which allows a customer to change the receiving method at the last hour. Second, in 2020, Yamato partnered with the ecommerce solutions provider Doddle to establish a proprietary nationwide pick-up/drop-off (PUDO) network in Japan. The PUDO network will allow Yamato’s customers to pick up their parcels from around 240,000 Yamato partner shop network facilities, including convenience stores, department stores and train stations. Also, customers will be able to change the delivery method from one PUDO collection point to another on-the-go. Finally, while still at the experimental testing stage, Yamato partnered with DeNa to provide on-demand delivery services at a particular time of the day using self-driving cars. While the details and approvals from the local authorities are still being worked out, this could be a viable delivery option for Yamato in sparsely-populated residential areas.

As these cost initiatives take hold, Yamato’s profitability is likely to improve significantly going forward. While the company aims to achieve an operating margin of 6% by FY2024, I assume that the margin will likely land somewhere between 5%-5.5% in the base case scenario by the fifth year in my valuation, given the uncertainty surrounding labor force sourcing and subcontracting.

To value Yamato’s common stock, I use free cash flow to the firm DCF with a ten-year time horizon to reflect the abnormal growth rate for ecommerce in Japan for the next five years.

Table 9. DCF Valuation Assumptions (in ¥ millions except for stock price and share count)

To calculate the weighted-average cost of capital, or WACC, I use the 10-year Japanese Treasury yield of 0.23%. I assume that Yamato’s tax rate consists of the federal tax rate 30.6% and the combined tax rate of about 8.5% for local Tokyo levies and differential foreign taxes. I obtain an unlevered industry beta from Pr. Damodaran's database of industry betas for Japanese companies. I then lever this beta with Yamato’s debt to market capitalization ratio to obtain a levered beta of 0.93. I also obtain the average Japan’s equity risk premium (ERP) of 4.7% using Pr. Damodaran's data. I also estimate the company's debt cost by using Pr. Damodaran's synthetic rating tool, producing the cost of debt of 0.92% for a 10-year horizon. Given these parameters, I derive the cost of capital of 3.82%.

As was explained above, the company’s revenue growth of 3.5% for the first five years will be driven by parcel volume growth of 2%, plus an additional 1% coming from taking market share from its competitors and 0.5% growth rate in unit prices. After the fifth year, the company’s revenue growth rate will converge to the nominal growth rate of Japan’s economy, which is approximated by the long-term risk-free rate of 0.23%.

As for the operating margin, I assume that Yamato’s adjusted EBIT margin will increase to 5.25% by the fifth year and stay the same for the remainder of the valuation.

To calculate Yamato’s reinvestment needs, I use McKinsey & Company's valuation methodology to calculate invested capital, net operating profit less adjusted taxes, or NOPLAT and return on invested capital (ROIC). This methodology separates operating assets/liabilities from non-operating ones and provides the true economic picture of a company.

Table 10. Invested Capital, NOPLAT and ROIC (in ¥ millions)

Source: Company’s filings and author’s calculations

Because Yamato’s cash/revenues ratio is below its industry median cash/revenues ratio of 0.12, the company’s entire cash balance is classified as operating cash and will not be added to its estimated intrinsic value. After calculating Yamato’s invested capital, the average sales/capital ratio comes out at about 2.70, which I will use in my DCF valuation.

As mentioned above, the terminal year revenue growth rate will approximate the nominal Japanese government yield of 0.23%, as advocated by Pr. Damodaran. The cost of capital will gradually increase to about 4.5% in the terminal value, which assumes that the equity risk premium will go up to 5% and Yamato’s levered beta will gravitate to the market’s beta of 1. As for ROIC, I assume that Yamato will maintain its dominant competitive position and will earn a ROIC of 9%, which is approximately what the company will earn by the tenth year in the valuation.

Table 11. Yamato’s Discounted Cash Flows model (in ¥ millions)

Based on the assumptions above, Yamato’s common equity is undervalued by 70%.

To compare Yamato to its peers, I use data from Morningstar.com for a selection of Japanese companies that operate in the trucking/integrated freight and logistics industries. In my data selection, I discard companies that have negative EBIT or whose key financial data is absent. Based on these criteria, I compile the following financial and valuation data for 50 companies using simplified calculations for enterprise value (market capitalization + book debt + preferred stock + minority interest – excess cash) and ROIC data from Morningstar, which may slightly differ from my estimates due to differences how NOPLAT and invested capital are calculated:

Source: Morningstar.com and author’s calculations. Enterprise value (EV) is calculated as market capitalization + book debt + preferred stock + minority interest – excess cash. Excess cash for each company was estimated based on the median industry cash/sales ratios. Net debt is book debt less total cash. Growth rates are for the period ending on the most recent published fiscal year-end data. ROIC numbers are from Morningstar, which differ from my ROIC estimates in table 10 due to how invested capital and NOPLAT are calculated.

Based on median EV multiples, Yamato is about fairly valued (based on EV/Sales ratio, it is about 20% undervalued). However, because Yamato’s ROIC of 7.10% is about 20% higher than the peers’ median one, it can be said that the company is undervalued.

At the same time, Yamato exhibited much higher growth rates in both sales and operating profits, especially on a 5-year and 3-year time horizon. Assuming that past historical growth provides some insights into future growth and given that Yamato’s sales and EBIT grew 1.5x – 2x faster than those of its peers, it can be said that Yamato is significantly undervalued compared to its peers. As I argued above, Yamato is very likely to experience steady growth in sales and much faster growth in its earnings due to near-term margin expansion.

Also, compared to its peers, Yamato is less risky with a negative net debt to market capitalization ratio due to a large cash balance.

Overall, the conclusion from table 12, depending on which factors are looked at, is that Yamato can be anywhere from 20% to 50%+ undervalued compared to its peers. However, it is also worth looking at how Yamato’s valuation multiples and its profitability compare historically.

Table 13. Yamato’s Historic Valuation Multiples

Source: Author’s calculations. Enterprise value is calculated based on McKinsey & Company's valuation methodology using detailed reclassification of Yamato’s balance sheet.

The most import metric to look at here is EV/NOPLAT and EV/EBIT together with ROIC. Historically, Yamato exhibited a lower ROIC compared to its TTM ROIC of 8.10%. The company is also currently showing much better profit margins, sales and EBIT growth rates. However, in the past, the market gave the company a multiple that is from 50% to 100% higher compared to the TTM enterprise value multiples. This also suggests that based on the historic comparison, Yamato is undervalued at least 50%+.

Although Yamato maintains a dominant position in the oligopolistic delivery market, the company still faces competition. In September 2021, Sagawa Express and Japan Post announced a partnership in package deliveries to divide pick-up/delivery and share logistics networks to better compete with Yamato in light of labor force shortages. Both companies acknowledged that they will cooperate only in certain areas, while they will compete in others. In particular, Sagawa will outsource small parcels delivery to post boxes to Japan Post, while Japan Post will outsource the delivery of cold items to Sagawa. Sagawa will also use Japan Post’s express mail services for international deliveries. This will allow the two companies to reduce redundant costs and outsource deliveries to a partner with a better cost structure. This is not the first time Japan Post and Sagawa announced a partnership, although this time it is somewhat broader compared to the one in 2004.

However, because this is not a capital tie-up or a corporate merger, but only a partial cooperation with respect to very specific types of deliveries, I do not view this cooperation as a threat to Yamato’s dominant position. Moreover, Yamato went on the offensive and increased its small parcel deliveries of ecommerce items and lowered Nekopos (a small parcel service that delivers packages to post boxes and directly competes with the services outsourced by Sagawa to Japan Post) delivery fee from ¥195 to ¥175 according to Toyo Keizai.

Another threat to Yamato may come from its major ecommerce customers, such as Rakuten and Amazon Japan, in particular.

Table 14. Japan’s Ecommerce Gross Merchandise Value, or GMV, by Vendor (in ¥ billion)

Source: Statista. Values above may include not only merchandise, but also digital services for B-to-C and B-to-B customers.

In 2020, Amazon Japan generated ¥4.7 trillion in gross merchandise value, while Rakuten came as a second with about ¥4.7 trillion. Yahoo Shopping came third with ¥1.4 trillion. While Yamato continues providing delivery to many customers listed above, some of them are actively building their own distribution network or forging alliances with Yamato’s competitors. In particular, Rakuten announced a strategic partnership with Japan Post, whereas Japan Post took an 8.3% equity stake and invested ¥150 billion in Rakuten. In exchange, Japan Post will work with Rakuten to build a certain number of shared logistics/pickup centers and delivery stations. Japan Post also hopes to utilize Rakuten know-how in the digital realm to better forecast demand and improve operating efficiency. On top of this, Rakuten has been working to develop its own fulfilling logistics network since 2018 called Rakuten Super Logistics.

After Yamato declined to provide same-day delivery service to Amazon in 2017 due to its overwhelmed delivery network, Amazon Japan picked up the pace in developing its own delivery, primarily in dense urban areas. In November 2018, Amazon Japan launched "Amazon Flex", which uses contract drivers to deliver parcels around Tokyo, Sendai, Sapporo and some other areas. Amazon Japan also uses delivery services from other affiliated regional operators, such as Maruwa Unyu Kikan, SBS Sokuhai Support, among a few other companies.

While all this sounds like a threat to Yamato, in the worst case scenario it will only slow down its revenue growth by 1% to 2%. As mentioned previously, Yamato strategically aligned itself with Z Holdings, who is the owner of Yahoo Shopping, Yahoo Auction, ASKUL Corporation and Zozotown ecommerce platforms, to provide a full range of fulfillment services for Yahoo Shopping merchants. It is possible that such a logistics agreement may extend to all of Z Holdings’ platforms. Also, Yamato is working to lock in other large customers, according to Toyo Keizai, and offers its fulfillment services as a value-added product for online platforms and ecommerce stores.

While it may seem that Amazon Japan can develop its own logistics network and replace Yamato and other delivery companies, it will be close to impossible. Japan’s delivery networks offered by major couriers are very well-developed, efficient and very competitively priced. Another factor is a shortage of drivers that I will discuss later. According to a 2019 interview, Jeff Hayashida, VP of Amazon Japan operations in charge of building the delivery network, acknowledged that it is difficult for Amazon to build a cheaper delivery system compared to those offered by Yamato or other delivery couriers. Instead, Jeff Hayashida said that Amazon will still use Yamato and compete in certain areas, such as dense urban locations.

Yamato’s innovative EAZY delivery system is very popular among many ecommerce corporate clients as well as its offerings of fulfillment services. Moreover, Yamato continues expanding its cooperation with Amazon. In 2021, Yamato joined Amazon FBA (Fulfilled by Amazon) Partnered Carrier Program, along with Japan Post. The program enables Yamato to get business from Amazon sellers by offering discounted rates for shipping products to Japan’s Amazon fulfillment centers. Also, Yamato USA joined Amazon Service Provider Network, which allows the company to support Amazon sellers from various countries by providing international shipping, delivery of Amazon inventory to fulfillment centers and consulting for customs clearance and import regulation for many Asian countries. Therefore, I deem the risk of significant sales decline from ecommerce players building their own logistics network reasonably low.

Labor shortages remain a major risk area for Yamato that may disrupt its operations and prevent the company from taking advantage of ecommerce growth. First, the delivery driver job itself is not particularly attractive, as it is physically demanding and the hourly pay of about ¥1,200 is average in Japan. This is reflected in persistently high job vacancy to applicant ratio for courier drivers, which fluctuates between 2.5 and 3.0, more than double of the national average. Also, based on table 5, it is evident that Yamato heavily relies on part-time force. Hence, Yamato’s success largely depends on the willingness of workers to engage in part-time work. As the Japanese population shrinks and ages, the problem becomes even more acute. Also, there is a law that will gradually limit the amount of annual overtime hours for drivers to 960 hours, or 80 hours a month, by 2024.

Yamato is fully aware of these challenges and is constantly working to improve the productivity of its workers through different means, such as improving route efficiency, using trucks that are better suited for loading/off-loading and doing team delivery from a particular location rather than making frequent stops. As a result, the company’s productivity, as measured by operating revenue per employee, has been improving for the past 10 years by 1% on average.

Figure 2. Operating Revenues per Employee (in ¥ thousands)

There is no denying that labor shortages are the biggest risk for Yamato not only for profits, but also revenues. Without proper staffing, revenues will stagnate and the company will lose its market share. As labor shortages will continue getting worse, Yamato will be pressured to raise wages to make its job offerings attractive. However, all players in the delivery industry will be facing similar challenges and will likely pass along higher labor costs to customers to secure proper profits. Given Yamato’s high efficiency and dominant position, it will likely be at the forefront of these price increases going forward.

One can argue that as Covid-19 restrictions are relaxed in Japan, buying habits will normalize and people will come back to shopping in stores instead. With this, the ecommerce demand will likely normalize and may even plateau for a few years. However, as mentioned above, Covid-19 exposed first-time consumers to online shopping and showed how ecommerce can prove to be a convenient and efficient way to get products to your doorsteps. This was especially true among seniors, who were reluctant online shoppers before the coronavirus outbreak. But since first-time online shoppers tried new online services, it is very likely that they will become loyal customers for the foreseeable future.

Also, looking at table 3, there was a significant decline in B-to-B ecommerce deliveries during the coronavirus, as corporate offices got closed. However, as office life is gradually normalized, B-to-B deliveries will likely rebound. While there is no data available for how much sales Yamato is generating from the B-to-B segment, it is likely that some of the stagnation in the B-to-C ecommerce segment will be partially offset by B-to-B’s rebound.

Japan’s shrinking population is a very well-known problem among developed countries. According to the country’s census, Japan’s population declined to 126.14 million in 2020 or 0.7% compared to 2015.

Compared to 2015, the working-age population (between 15 and 64) declined by 3% to 75.08 million in 2020. At the same time, the senior population (65+) rose 7% to 36.02 million. This underscores the problem that Japan is facing with the falling birthrate and aging population. Extrapolating these trends, the Japanese government estimates that the country’s population will fall to about 111 million by 2040. This decline will yield not only labor shortages, but also a gradual decrease in the number of potential consumers in the country. Also, as certain regions get depopulated, this will likely result in declining delivery efficiency and higher costs. Yamato is aware of this problem and working with local governments to optimize its supply chain to reflect Japan’s aging population. It remains unknown if these trends are reversible, but a very low growth rate in my valuation’s terminal year is likely already reflecting the stagnant and non-existent growth expected of Japan’s economy.

To assess the above-outlined negative factors, I change various levers in the DCF model, such as target revenues and margins for Yamato to determine where the company's intrinsic value stands.

The worst case scenario assumes that Yamato’s competitive position will deteriorate, revenues will grow by 1% for the first five years and the company’s margin will decline to 4.5% by the fifth year. Despite this, Yamato still shows an upside of about 32%. For the best case scenario, I assume that Yamato will realize its guidance with an operating margin of 6% by the fifth year and sales growth of 3.5%, producing revenues of ¥2 trillion by the third year. These assumptions yield a 97% upside from the current stock price of ¥2,186 in the best case scenario.

Assuming subjective likelihoods for each scenario in table 15, the weighted average value shows an upside of 67%. Of all the factors, the profit margin assumption produces the greatest variation in the intrinsic value. Hence, to grow its value, Yamato must keep its logistics network efficient despite growing labor costs pressures.

Overall, the above sensitivity scenario shows that Yamato’s stock price is substantially undervalued with a very low risk of losing on the investment. In fact, to lose on the investment in Yamato’s stock, the company must have not only non-existent revenue growth, but also operating margins that are way below its historic norm. I deem this scenario very unlikely in the long term.

In my opinion, Yamato’s current market price will very likely converge to my estimated intrinsic value with about 50%-70% upside within one to two years. The biggest catalyst for this would be optimization of subcontracting expenses, which significantly reduced Yamato’s profitability in the trailing twelve-month period. In its latest quarterly presentation, the company disclosed the following chart:

Figure 4. Yamato’s Q3 FY 2022 Subcontracting Costs for Sorting and Transportation

In this graph, the company acknowledges that there were about ¥20.3 billion of expenses (red rectangles) related to outsourcing sorting and transportation that Yamato is working on optimizing. As explained above, this happened due to Yamato’s efforts to build a dedicated ecommerce delivery network. Given the company’s stellar record in identifying and correcting its weak areas within several years, there is a very high likelihood that these expenses will be indeed optimized, which will lead to a reset in the market’s expectation towards an upside.

The company’s stock is primarily traded on the Tokyo Stock Exchange. While Yamato’s stock is traded on American OTC markets under the tickers of YATRY and YATRF, the volumes are very low or non-existent. Therefore, it is best to purchase Yamato’s stock in blocks of 100 shares on the Tokyo Stock Exchange. Many U.S.-based brokers allow their customers to get approval for trading on foreign stock exchanges.

Investing in Yamato will inevitably expose investors to foreign exchange risk. Over the last twelve month, the Japanese yen depreciated by about 10% in relation to the U.S. dollar. One way to mitigate this risk is to not use currency conversion, but rather obtain a margin loan from your broker for your investment in Japanese yen. For more details, please see this presentation on the mechanics about the foreign trades from Interactive Brokers. By doing so, you will avoid foreign currency risk on your cost basis, but you will still be exposed to currency fluctuations on your realized gains and certain fees/interest on margin loan in a foreign currency.

As Yamato works on optimizing its ecommerce network within the next one to two years, I expect the next several quarters may turn out to be volatile. I got exposure to the company at around the stock price of ¥2,200. In the absence of strongly negative fundamental developments, I plan on adding more to my position if the stock price declines below ¥2,000. If the stock price declines to ¥1,500 for no apparent reason, I will substantially expand my exposure to Yamato in my portfolio. I will be updating my thesis in the comment section below, if any material developments occur.

Yamato’s dominant market position that it was able to maintain for decades by innovating and constantly adapting to changing market conditions indicates that this current undervaluation is unusual and will likely not last long. Given strong tailwinds from Yamato’s significant exposure to B-to-C ecommerce, the company will continue showing strong top line growth. Also, I deem the recent jump in subcontracting expenses as a temporary phenomenon. As the company is optimizing these and other expenses through its cost reduction initiatives, the market stock price will likely converge towards my intrinsic value within the next one to two years, producing an upside of 50%-70% from the current stock price levels.

This article was written by

Disclosure: I/we have a beneficial long position in the shares of TSE:9064 either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.