positives for uniqlo: strong management, untapped u.s ...based fast retailing, with its trademark...

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EQUITY RESEARCH

November 30, 2012

The post-2008 shift to budget-minded consumerism has had enormous im-

pacts on fashion and the retail industry. Consumers that once aspired to pur-

chase exclusive labels now embrace the “cheap-chic couture” that reveres

affordability and uniqueness. And it’s not just ordinary consumers, either. A

simple look at the tabloids will show Kate Middleton wearing the latest piece

from Zara, or First Lady Michelle Obama openly embracing J. Crew.

In fact, this shift in consumer mindset has settled into something more sus-

tained, producing a trend that is searching for a new leader. In a booming

retail industry, saturated with good fundamental names, who will it be? At

William O’Neil, we believe past is precedent, and our models of the best-per-

forming stocks steer us continually toward emerging leaders. Right now, we

see compelling similarities between the rapidly growing, global Japanese

retail company, Fast Retailing (RETA.JP or 9983.T), and the ascendance of

GAP (GPS) in the 1980s.

Though the name may be unfamiliar to most American shoppers, Japan-

based Fast Retailing, with its trademark Uniqlo stores, is the fourth-largest

clothing retailer in the world. Catering to both men and women of all ages,

Uniqlo sells socks, underwear, t-shirts, jeans, and blazers in 12 countries. It has

only five stores in the U.S. now, but the Company will soon embark on a rapid

U.S. expansion plan.

Uniqlo. If You Don’t Know It Yet, You Will.Julian del Rosarioequity [email protected]

Positives for Uniqlo: Strong management, untapped U.S. market, growing presence in

China, and strong sales forecasts

In This Report

Uniqlo has just opened its first west coast

store in the U.S., bringing the total number

of American locations to five. But its Japan-

based parent company, Fast Retailing, has

plans to become the largest fashion retailer

in the world. Here is our analysis of why it just

may happen.


EQUITY RESEARCH

November 30, 2012

Uniqlo vs. The Gap circa 1985

GAP (GPS), formerly known as The Gap, is perhaps the most ubiquitous and

time-tested name in American fashion. Begun in 1969 by Don and Doris

Fischer, the brand developed its identity in the 1980s, under the leadership

of the now-renowned Mickey Drexler. Not long after he took the helm in

1983, GPS had a run of 505% in 40 weeks. So our question is: What company

characteristics precipitated this run, and how many of those characteristics

does Uniqlo exhibit today?

Uniqlo(RETA.JP)

The Gap (1985) (GPS)

Market Japan U.S.

Market capitalization $24 billion $14 billion

Shares outstanding 106 million 9 million

Sales $12 billion $ 647 million

P/E 25 12

Store count 1137 6131

RS 78 92

Pretax margin 13% 4%

ROE (approx) 20 10

Visionary Leadership

Although Drexler inherited a company that was financially prosperous, he

adamantly began implementing policies that dramatically changed The

Gap’s identity. He immediately got rid of all public-label brands (which had

accounted for nearly half its revenue) and consolidated its private brands

into one single brand, The Gap. The culture of the stores transformed, too,

from a price-driven, youth-focused atmosphere into a self-branded, qual-

ity “experience” store catering to all demographics.2 This transformation ex-

tended to the Company itself, with revenue rising from $400 million in 1982 to

more than $14 billion when Drexler left the company in 2002.

Tadashi Yanai, CEO of Uniqlo, also has a clear, ambitious vision. Reminiscent

of Steve Jobs, he is a man who carries a profound sense of self-confidence

and relentlessness, a style that contrasts sharply with the conformity often

associated with Japanese culture.3 That relentlessness is apparent in Yanai’s

long history. He opened the first Uniqlo store in Hiroshima in 1984, just about

the time The Gap broke into its heyday. It may have taken him 30 years, but

he succeeded in becoming the biggest clothing retailer in Japan. Having

sustained dedication to his goal for that long, conquering global competi-

tion—moving from fourth place to first—seems plausible.

Julian del Rosarioequity [email protected]


EQUITY RESEARCH

November 30, 2012

Game-Changing Strategy

Both Drexler and Yanai implemented contrarian strategies in their stores.

Drexler not only laser-focused on The Gap brand, but he was in touch with

American consumer tastes. Drexler accurately believed that those tastes

were shifting upscale, and The Gap’s new stores, full of casual yet classy and

affordable clothing, quickly took off.

Today’s fashion culture is fast and reactive. Companies like Zara and H&M

are quick to “copy” any mini-fad that emerges. They also push to turn over

inventory quickly enough to get new clothing onto the sales floor within two

weeks. By contrast, Yanai, again taking a page from minimalist Steve Jobs,

believes stores should create fashion trends—not the other way around—

and that shopping at Uniqlo should be an educating fashion experience.

Indeed, Uniqlo’s model for its retail stores follows the same format as Apple

(and Drexler’s Gap, too). One feels the intense control of not only the brand

but the entire user experience. Yanai’s inventory strategy also contrasts with

his competitors, as the Company purchases its inventory a year in advance,

allowing it to save on cost. This enables Uniqlo to offer clothing in a wide va-

riety of colors and sizes, leaving no consumer excluded.4, 5

Uniqlo(RETA.JP)

Zara (IND.ES)

GAP (GPS)

H&M (HMBF.SE)

Home country Japan Spain U.S. Sweden

Market cap $23 bil $83 bil $17 bil $48 bil

Stores in home country 845 333 1011 173

U.S. / China Stores 5/145 44/114 1011/35 233/101

Countries 13 88 47 54

Classic Denim $49-$89 $49-$89 $59-$89 19-$99

P/E Ratio 24.31 29.11 17.49 22.12

Most recent FY revs $11.2 bil (4th) $18 bil (1st) $15 bil (3rd) $16 bil (2nd)

2 yrs revs grwth est. +12%, +14% +16%, + 11% +6%, 4% +9%, +8%

2 yrs EPS growth est. +16%, +13% +23%, +14% +46%, +12% +8%, +11%

Market Status Rally Under Pressure Attempt Attempt

Aggressive Expansion

The Gap had only 200 stores at the beginning of 1980s, but it grew that num-

ber to 1,092 stores by the decade’s end.6 From 1983 to 1990, sales grew 335%.

Uniqlo’s CEO has no less ambitious goals. As of November 2012, there are

only five Uniqlo locations in the U.S.: three in New York, and one each in San

Francisco and New Jersey. Having recently opened its first west coast store

(in San Francisco) to much hype and fanfare, the Company plans to open

two to three dozen stores in the country over the next couple of years, even-

tually reaching 200 by 2020.



EQUITY RESEARCH

November 30, 2012

Yanai’s plans for the U.S. are only part of a larger goal of becoming the big-

gest fashion retailer in the world by 2020, projecting revenues of $10 billion in

the U.S. and $50 billion worldwide (Uniqlo’s FY12 revenues were $12 billion).7

Because Uniqlo already has a strong global presence, Yanai’s vision is not

far-fetched. For context, the U.S. retail market is a $199 billion industry, having

grown 4% in 2011 (manufacturer-owned stores grew 15%).8 Additionally, to

accommodate its growth and brand exposure in the country, Uniqlo opened

its online commerce site to U.S. customers in November 2012. (Even H&M,

which has 233 stores in the U.S. has not opened up its online presence to U.S.

shoppers.) 9

Another key part of Uniqlo’s expansion plans involve China. Despite a politi-

cal conflict that caused Uniqlo to temporarily close some of its Chinese stores

in September, Uniqlo’s China sales have been strong and the Company still

plans to open 80 new stores by the end of the year (adding to the 145 al-

ready present in China), with expansion growing to 100 stores per year over

the next several years. With its burgeoning middle class, China and its $94

billion apparel industry present huge market potential.10,11

Closeup on Fundamentals

Preceding its run in the 1980s, The Gap did not possess all the character-

istics of what we call a “model” stock. That was mostly because Drexler’s

transformational rebranding of The Gap’s clothing and stores involved huge

expenditures, resulting in narrow operating margins in the year preceding the

stock’s big run. However, the Company quickly turned things around, show-

ing strong earnings and sales growth from its pivot-date going forward (see

chart below and on p.5)

Source: The New York Times, April 6, 1986



EQUITY RESEARCH

November 30, 2012

Preceding its pivot in 1985, GAP traded sideways, and broke-out of a long

consolidation on heavy volume. Uniqlo is forming more of a cup-with-handle

pattern, and it will be important to see it break out of its prior resistance level

(around ¥238) on heavy volume.

Current chart for Fast Retailing (Uniqlo)

Source: PANARAY

GPS Pivot: Aug 19, 1985 Top: May 30, 1986 Bottom: Aug. 7, 1986

Gap acquires Banana Republic

Mickey Drexler joins Gap as president

Pivot Point:Breakout on heavy volume

First GapKids stores open

Historical chart for The Gap

Source: PANARAY

RETA.JP

Resistance

Company’s 5th U.S. Store open in San Francisco

USA e-commerce website goes live

Rising earningsestimate line

Low overhead OH - 3%



EQUITY RESEARCH

November 30, 2012

Pretax margins

Although Uniqlo has favorable pretax margins (+13%, +11%, and +14% in the

past three years), it does trail below competitors H&M and Zara. GAP’s re-

branding strategy also gave it relatively low pretax margins of 4% and 9% in

1985 and 1984, respectively. Although Uniqlo’s store expansion plan will also

come with significant costs, its strong revenue and earnings forecasts suggest

that Uniqlo could follow GAP’s trail to success.

P/E Ratio

Studies of our model stocks have shown that a P/E ratio is not the strongest

indicator of future stock performance. As a result of its marginal earnings

per share ($0.02 per share in 1984 and 1983), The Gap had a tremendously

high price/earnings ratio. (Limited Brands, for example, then had a P/E ratio

of 27.25.) From 1984 to June 1986, however, GPS’s price grew 114%. Today’s

retail landscape shows a lot more similarity among the top companies, and

Uniqlo’s P/E ratio of 24.31 is in line with Zara, H&M, and present-day GAP.

Return on Equity

The greatest stock winners historically have had a return on equity of at least

17%, with the stronger winners showing even bigger numbers. Despite oper-

ating struggles before its pivot, The Gap still managed a return on equity of

20%, 10%, and 21% in 1986, 1985, and 1984, respectively. With return on equity

of 20%, 18%, and 23% in the past three fiscal years, Uniqlo nicely fits the return

on equity criterion for a model stock.

Can Uniqlo Move from Fourth to First?

Ultimately, Uniqlo is a company that has many of the characteristics of a

model stock: it has good fundamentals, management, and potential for

growth. Relative to its competitors, it has a special opportunity to monetize

both the Chinese and U.S. markets, the latter of which many of its main com-

petitors have already saturated. Given the landscape of today’s U.S. econ-

omy, its “cheap-chic” model will not go away any time soon. And looking

globally, we like that Uniqlo trades in the relatively stable Japanese market.

More important, in order to sustain growth, the Company must continue to

be strategic in its expansion, and we will be closely monitoring its fundamen-

tals. Fast Retailing’s stock price dropped heavily on October 11, 2012 after

disappointing earnings. However, the news had more to do with industry-

wide bad seasonal weather than with the Company’s larger fundamental

picture. Uniqlo has the assets, resources, and capabilities to compete, but it

must do so strategically. With its strong leadership and clear vision, we look

forward to seeing if its promise as a model stock will be fulfilled.



EQUITY RESEARCH

November 30, 2012

William O’Neil + Company, IncorporatedOffers the world’s leading institutional investment managers a distinct blend

of quantitative, fundamental, and technical expertise in global stock buy-

and-sell recommendations. Its core method profiles stocks displaying the

characteristics of outperformance proven persistent over market history —

drawn from the firm’s industry-leading database. William O’Neil + Co., Incorporated is a Registered Investment Advisor with the State of California and certain other states. The firm and its affiliates may now or in the future have positions in the securities mentioned in this or other publications. Charts are intended to be used as tools to assist institutional investors in identifying equity ideas worthy for further review. Charts provide certain current and historical information, but are not a substitute for comprehensive analysis of the individual stocks. For further information about our business and legal policies, please see williamoneil.com/legal.

ENDNOTES: 1 http://www.fastretailing.com/eng/group/strategy/tactics.html 2 http://www.referenceforbusiness.com/businesses/G-L/Gap-Inc.html3 http://www.thememagazine.com/stories/tadashi-yanai-retail-warrior/4 http://www.forbes.com/sites/kerryadolan/2012/10/05/uniqlo-how-japanese-billionaire- tadashi-yanai-plans-to-clothe-america/5 http://www.wired.com/business/2012/08/upending-fashion-steve-jobs-style-10-questions- with-uniqlos-yasunobu-kyogoku/6 http://ajw.asahi.com/article/views/AJ2012110100797 http://www.fastcompany.com/1839302/cheap-chic-and-made-all-how-uniqlo-plans- take-over-casual-fashion8 http://www.commodityonline.com/news/china-clothing-store-industry-revenue-expect ed-at-$1826-billion-in-2012-50260-3-50261.html9 http://www.businessweek.com/articles/2012-10-23/uniqlo-dot-com-to-the-rescue-of- middle-america10 http://www.fastretailing.com/eng/ir/library/pdf/faq20120412_en.pdf11 http://ajw.asahi.com/article/views/AJ201211010079


positives for uniqlo: strong management, untapped u.s ...based fast retailing, with its trademark...

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