[edit] Financial Summary

[edit] Recent Updates

[edit] Highlights

SR Inc. initiates coverage of BALS Corporation (“BALS”) with this report.

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[edit] Trends & Outlook

Monthly Trends

Quarterly Trends

FY01/11 Full Year Results

On March 4, 2011, the company announced FY01/11 full year results (see table above).

FY01/11 Results Report Card

The company’s results vs. forecasts were as follows:

Sales

Forecast: 34.4 billion yen (+0.6% YoY)

Actual: 33.3 billion yen (-2.5% YoY)

Operating profit

Forecast: 2.4 billion yen (+5.9% increase YoY)

Actual: 2.0 billion (-12.1% YoY)

Recurring profit

Forecast: 2.3 billion yen (+4.5% YoY)

Actual: 1.9 billion yen (-14.0% YoY)

Net income

Forecast: 1.1 billion yen (+26.1% YoY)

Actual: 941 million yen (+4.0% YoY)

Sales were -2.5% YoY, primarily due to removing subsidiary Real Fleet from consolidation and lower comparable store sales (-3.8% YoY). Gross profit margin improved from 59.7% in FY01/10 to 60.6% in FY01/11 after the company increased direct purchasing from manufacturers and removed Real Fleet’s performance (a lower gross profit margin). However, SG&A expenses increased due to higher advertising costs accompanying the company’s rebranding strategy and operating profit declined 12.1% YoY. Net income grew +4.0% YoY mostly due to lower extraordinary losses (201 million yen vs. 724 million yen in FY01/10).

Full year FY01/11 comparable store sales were -3.8% YoY; customer count fell -0.9% YoY and average customer spend was -2.9% YoY. The company said that lower interior goods sales (total contribution fell from 37.4% in FY01/10 to 34.8% in FY01/11) was main factor behind lower average spend. The downward trend in comparable store sales ended in December 2010 (+1.3% YoY).

Stores: During the year, the company opened 8 and closed 12 stores in Japan, and opened 4 overseas, bringing the total store count to 140 (8 overseas stores).

Q3 FY01/11 Results

On December 2, 2010, the company announced Q3 FY01/11 results (see table above).

Cumulative Q3 FY01/11 sales were 23.7 billion yen (-4.2% YoY), operating profit was 1.2 billion yen (-24.4%). The company left full-year forecasts unchanged.

Stores: Through Q3, the company opened 8 and closed 8 domestic stores, and opened 3 overseas, bringing the total store count to 144 (7 overseas stores).

Q2 (1H) FY01/11 Results

On September 2, 2010, the company announced Q2 (1H) FY01/11 results.

Sales during 1H FY01/11 were 16.0 billion yen (-5.4% YoY), operating profit was 843 million yen (-23.3% YoY). Sales were less than the 1H forecast of 16.5 billion yen; the main reason being comparable store sales of -5.9%, vs. the company's original forecast of -2.1%. Operating profit exceeded the 1H forecast of 720 million yen due to effective SG&A cost controls.

Following the 1H FY01/11 results, the company revised its full-year sales forecast from 35.6 billion yen to 34.4 billion yen. The earnings forecasts were left unchanged.

Stores: During 1H, the company opened 5 and closed 4 domestic stores, bringing the total store count to 142 (4 overseas stores).

Q1 FY01/11 Results

On June 4, 2010, the company announced Q1 FY01/11 results.

Sales during Q1 FY01/11 were 8.0 billion yen (-7.2% YoY), operating profit was 477 million yen (-23.1% YoY).

Stores: The company opened 4 and closed 3 domestic stores during the quarter, bringing the total store count to 142 (4 overseas stores).

Full Year (FY01/12) Outlook

The company’s assumptions for FY01/12 are as follows:

1. Comparable store sales: flat YoY.
2. Store network: opening 24 (23 in Japan, 1 overseas); closing 9 (all in Japan).
3. Gross profit margin: improve by about 1.5% from FY01/11, to 62.1%.
4. SG&A expenses: +8.6% YoY to 19.8 billion yen.
5. Extraordinary gains/losses: 450 million yen (vs. 201 million yen in FY01/11).

Although comparable sales have shown signs of recovery since December 2010, the company’s FY01/12 comparable store sales forecast is flat, and SR Inc. thinks that it might be considered conservative.

The company’s said that it may increase store openings (it has agreements in place for the forecast figures, but could open more if market conditions were positive). The company expects an improvement in the gross profit margin based on a higher proportion of PB products and an increase in direct purchasing from overseas manufacturers. The PB ratio in FY01/11 was about 65%, and the company’s FY01/12 forecast assumed it could rise as high as 70%. The company bought about 20% of its products directly from manufacturers in FY01/11 and expects this ratio to rise to 26% in FY01/12. The increase in SG&A spending includes costs relating to store openings, higher spending on advertising, and higher depreciation and amortization expenses. For extraordinary losses, the company expects 300 million yen of asset retirement obligations and 150 million yen of store relocation and closing expenses.

The company held its result meeting on March 7, 2011; main comments made by President Takashima were:

• The company aims to improve furniture sales in FY01/12 by expanding its product line up. Product development should last until fall 2011, with launches afterward.
• Moving the Procurement and Merchandise Development Division to Hong Kong sped up product development significantly: reducing prototype lead-time from a month to a week.
• The policy for future store openings will be to increase average sales per store by opening large-scale roadside stores and replacing existing stores. The company is also experimenting with a new format, such as its Francfranc Mini (unofficial name) concept - small-scale stores on train platforms or in train stations.
• The company will stop publishing print catalogues, instead display everything online. The company thinks that the Internet is effective for viewing single items like interior goods and accessories. In order to stimulate demand for interior goods, the company is considering publishing a magazine featuring different scenes using its interior goods and accessories.

Longer Term Outlook

The company does not publish a mid-term management plan but states a 100 billion yen sales target (50 billion yen in Japan and 50 billion yen overseas) and a 20% operating profit margin over the “medium term” (no period specified). In order to achieve those goals, the company aims to aims to grow both its merchandise offering (improving existing brands and launching new store formats) and its geographical presence (expanding into overseas markets).

In Japan, the driver of growth is likely to be higher customer traffic and better retail space efficiency of the core brands, especially Francfranc, as the company optimizes the existing stores and opens new ones in both large and small formats.

In terms of overseas growth, one avenue may be mainland China. While Chinese furniture and interior retailing markets are still developing, rapid economic development of large metropolitan areas like Shanghai will mean growing demand for interior goods. In response to this emerging demand, BALS has been working to intensify its development of interior goods and furniture for the Chinese market from fall 2011, aiming to aggressively expand the lifestyle offering of its core Francfranc format in large Chinese cities. The company signed an agreement with Shanghai Ruihong Xincheng Ltd., a company involved with the RXHC construction project (expected to produce 10,000 new condominium units at prices equivalent to about 30-40 million yen each). In Japan, they say that around 5% of a condominium’s purchase price is spent on buying furniture, and assuming an average spend of 1.5 million yen (5% of 30 million) for the new 10,000 units, the market opportunity is significant. It is hard to say how many families would purchase furniture from BALS, but to the extent that there are several similar projects underway, the potential impact is noteworthy.

The company is also exploring the possibility of entering markets in Europe and the United States and will conduct a feasibility study in FY01/12. The company commented that while Europe and the United States have large markets and seem to be a cultural fit for their products, there seem to be no clear competitors in the markets. As a result, the markets appear attractive, and probably have lower risks than entering the China market.

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[edit] Business

[edit] Business Description

The company is an interior goods retailer with an extensive network of Francfranc, its core format, and other retail stores. The company philosophy is represented by its credo, “Value by Design”. The merchandising offering centers on interior items (furniture, fabrics, and lighting) and home goods (tableware, stationery, and accessories). The company says that its design philosophy is to go beyond appearance and address feelings and experiences of people using the products. According to President Takashima, “we want to enhance the value of interior space through design, and offer both lifestyle and ‘rich moments’ to our customers”. While such statements may seem vague to many readers, it should be noted that design has been at the core of the company’s success over the years, making it into a large and reasonably profitable business.

Main Business

The consolidated company consisted of three entities as of March 2011: BALS Co., Ltd. (parent), BALS Hong Kong Ltd., and BALS Merchandising (Shanghai) (hereinafter BM China). The parent company operates stores in Japan while the other companies are involved with overseas operations.

BALS store formats are Francfranc, Francfranc BAZAR, About a girl, BALS Tokyo, J-PERIOD, and WTW.

Francfranc (65.0% of consolidated sales in FY01/11) - the main store format, based on a concept of “casual-stylish.” Since its inception, Francfranc’s target customer was a “25 year-old female office worker living by herself in a large city”. However, as discussed in Business Model, the company has moved away from focusing on particular age groups, and shifted its marketing emphasis to “emotional age”, addressing consumers who are perceptive to the changes around them, who think young.

Francfranc BAZAR (17.9% of consolidated sales in FY01/11) - a Francfranc outlet format. While the stores are in the outlet malls, the approach is different from a conventional outlet concept in that apart from the usual off-season merchandise, about 30% of the offering are full-price items. According to the company, gross profit margins are about 55%.

About a girl (4.8% of consolidated sales in FY01/11) - a store format derived from the original Francfranc concept. The first store was opened in October 2007, and was organizationally separated from Francfranc in FY01/09, becoming independent with respect to store development, merchandise selection, and sales promotions. The stores target women sensitive to trends and individualistic in their tastes, both at workplace and at home.

“BALS Tokyo” (4.1% of consolidated sales in FY01/11) - stores targeting “adults living true to themselves,” earning over 7-8 million yen per year. The stores are mix of cultures from different territories, offering designer interior goods and miscellaneous items thematically drawing on Tokyo’s evolving identity.

J-PERIOD (0.8% of consolidated sales in FY01/11) – stores with “Wa” (or “Japaneseness”) as its core theme (the ”J” in the name stands for Japan). Stores sell Japanese style dishes, lacquerware containers, chopsticks, soy sauce holders, placemats, tablecloths, etc. Items are mostly non-furniture.

WTW – a new store format to be launched during FY01/12 (the first 5 stores scheduled to be opened in 1H). The stores will have ‘Urban,’ ‘Surf,’ and ‘Natural’ as main themes. The target customers will be men and women from 30-50 years old. The product mix will be diverse, including tables, furniture, apparel, and fabrics. The company initially targets 10 stores providing total sales of 2 billion yen and store operating profit of 15%.

Store Network

The company had 140 directly managed stores at the end of FY01/11. Of those, 132 were in Japan (90 Francfranc, 18 Francfranc BAZAR, 17 About a girl, 4 BALS TOKYO, and 3 J-PERIOD). Overseas, there were 5 directly managed stores in Hong Kong (3 Francfranc, 1 About a girl, 1 BALS TOKYO), 3 directly managed stores in Shanghai (3 Francfrancs), and 8 Francfranc franchisee stores in Taiwan and South Korea.

Parent company. Geographically, sales in Kanto, Kinki, and Tokai make up about 79% of the total sales. Stores are primarily located in so-called “fashion buildings” (multistory boutique centers) or suburban shopping centers. Because Francfranc’s original target consumer was “young single urban professional females”, most stores were opened in or near major urban areas such as Tokyo, Osaka, or Nagoya. Similarly, as those customers tended to go shopping in centrally located fashion buildings, this was where BALS had been opening the majority of its stores in the early days. When suburban shopping centers started rising in prominence from 2004 onwards, the company moved aggressively to open its stores in those new locations.

Store Description

A description of the company’s typical Francfranc store is below. Note that details below describe stores the company had been opening in the past. Starting in FY01/11, the company shifted to new experimental formats, including both larger (around 660 square meters) and smaller (100 to 165 square meters) stores.

• Floor space: approximately 500 square meters (150 tsubo)
• Inventory investment: 20 million yen
• Facility investment: 50 million yen
• Monthly sales: 20 million yen (240-250 million yen p.a.)
• Average spend per customer: approximately 3,400 yen
• Store level operating margin: 20%
• Investment payback period: approximately one year
• Number of products (SKUs): About 7,000

All domestic stores are directly managed. The company believes it would be hard for franchisees to master the operating and service know-how BALS has accumulated over the years.

Group Companies

BALS HONG KONG LIMITED: Wholly-owned subsidiary established in September 2002; in charge of development of BALS Group business in Asia.

BM CHINA (BALS Merchandising (Shanghai)): A joint venture with the Mitsubishi Corporation, established in June 2010 (BALS 66.6%, Mitsubishi Corporation 33.4%); running retail and wholesale operations in China.

Business Model

Japan

The main store type, Francfranc, carries the entire range of interior goods - from small accessory items to furniture, from the most basic to the trendiest. Product displays at Francfranc differ from typical interior retailers where items tend to be grouped in categories (e.g. chairs with chairs, tables with tables, tableware with tableware, etc.). Instead, Francfranc has individual living spaces showcasing complete interior ideas (chairs around a table, tableware on the table, casually placed decoration or stationery items). Similar to trying clothes on when buying them, the company gives a customer an opportunity to imagine how things sold at the store would look in her own home.

Store environments are designed with a nod to a modern Western European style. Customers are not necessarily coming to the store with a particular shopping list in mind, but often simply stop by. The sales area is set up to have a fun and interesting feel, stimulating impulse buying. The company estimates that over half of the Francfranc customers are “browsing shoppers” who enter the store without a particular purchase in mind. At the same time, nearly 80% of the company’s customers are repeat shoppers. BALS CEO Takashima has said that from the beginning his idea was to build stores that offer not only items for sale but also entertainment, an opportunity to spend time. The data seems to suggest that the customers see the company stores this way.

As of FY01/11, the parent's sales breakdown was approximately 34% interior goods (furniture, fabrics, lighting, etc.) and 65% accessories (according to the company, the profit contribution is roughly 50:50 between the two). Furniture sales have been trending down as a percentage of total sales, but this is partly due to deteriorating salaries common to the company’s younger target demographic. The net result has been that sales of interior items, with their relatively high unit prices, have leveled off.

The company's product mix is about 65:35 divided between private brands (PB) and so-called “national brands” (NB; third party brands). The company intends to increase the proportion of PB products. However, management also feels that it needs third party products to represent emerging trends, and niche tastes, something hard to achieve with only in-house developed merchandise. It could therefore become counterproductive to keep pushing up that percentage. Gross profit margins stood at 65% for PB products and 57% for NB products (not including inventory losses) as of March 2011. The ratio of PB products tends to be high for furniture and fabrics, and low for electric appliances and accessories. The company does not have scale necessary to achieve meaningful gains producing appliances and other mass-produced accessories by itself. At the same, labor-intensive small lot furniture and fabric manufacturing tends to fit well with the needs and scale of BALS’ operations.

In order to keep the product offering in line with the current trends and customer needs, the company overhauls the inventory seasonally (twice a year, in spring and fall). On average, every item in the store is replaced with something new every two years. At the same time, it introduces new items almost monthly to keep stores looking fresh and appealing to repeat customers. Each season, the company selects a theme, choosing an appropriate color palette and materials, and then uses those as guidelines for product development, buying, and merchandising. In the past, the company tried to use “chase the winners” merchandising by focusing on hot-selling products and systematically eliminating slow sellers. However, such approach failed to boost sales. The company realized that it was the original merchandising mix and presentation that moved the popular items, not the items themselves, and shifted to evaluating the overall mix and looking at slow sellers as visual enhancements of the product offering.

Since November 2010, the company has been moving its Procurement and Merchandise Development Division (PMD) to Hong Kong. The goal is to accelerate and improve the product development cycle by building closer ties and communicating directly with the Chinese manufacturers who handle the bulk of the company’s products manufacturing. As of March 2011, the company had eight development merchandisers on the ground in Hong Kong, responsible for development and production control of their respective product categories.

In terms of splitting merchandising responsibilities between stores and headquarters, store managers choose what will be sold in their stores (picking about 7,000 SKUs out of 10,000 or so SKUs centrally purchased by the PMD). There are exceptions, such as when the PMD is promoting a specific thematic campaign, in which case store managers may be required to carry certain items.

Francfranc Rebranding

Starting in FY01/11, the company has been reviewing its main store format, Francfranc, including everything from merchandising to the management approach. This review was triggered by the financial crisis (a.k.a. Lehman Shock) and the decline in sales it brought about. However, there were more fundamental issues behind the decline that the company recognized and felt an urgent need to address. Items in Francfranc stores were gradually losing their freshness and unique appeal. The company saw it core target customers, 25-year-old single professional females, starting to decline driven by the prevailing demographic trends. At the same time, the trends towards an “ageless consumer” (where people of various age groups exhibiting similar buying behavior), rising fashion awareness of the male population, and shift towards more frugal consumption, were changing the underlying assumptions of who Francfranc’s customer should be.

Rebranding was the way to move the target consumer from the “25 year-old demographic” to the “25 year-old mental age”, in other words, expand the target demographic to include consumers who wanted to lead a youthful and fun lifestyle, irrespective of their actual age. BALS decided to change merchandising, store design, and store opening plans accordingly. An example of such change was the introduction of a series of new staple items in the merchandising mix, the off-white Standard line, a departure from the bright color schemes that used to characterize Francfranc store look. With the Standard, the company is trying to balance design, quality, price, and a fun factor, with the hopes of converting a wider range of consumers into repeat customers.

Store Interior. Source: Company Data Processed By SR Inc.	“Standard” Products. Source: Company Data Processed by SR Inc.

As discussed in the “Store Network” section, most of the company’s existing stores are in fashion buildings and suburban shopping centers. However, future store openings will concentrate on standalone locations where it is easier to draw in consumers of varying demographics, and train station buildings where high customer traffic means higher sell-through. The company hasn’t published the overall timetable, but mentioned at the FY01/10 results meeting that it wanted to increase the ratio of standalone stores from 16% in FY01/10 to over 40% in the medium term.

The Tokyo Aoyama Store, opened in May 2010, is a good example of the rebranding effort. The 1,000-square-meter “urban casual” style store, located in a prestigious Aoyama area, looks like a large house or possibly warehouse, with a two-story great room and a chandelier hanging from the ceiling. The aisles are wide and merchandise is arranged for easy access. The average price point is somewhat higher compared to conventional Francfranc stores, reflecting the upscale location.

Aoyama Francfranc. Source: Company Data Processed by SR Inc.	Aoyama Francfranc Interior. Source: Company Data Processed by SR Inc.

Overseas

Hong Kong

BALS HONG KONG LTD. was founded in Hong Kong in September 2002. The company opened two stores there in 2003. The timing coincided with the SARS outbreak in the territory. That and operational issues related to setting up overseas operations kept the stores in the red through FY01/05. In FY01/06, the stores turned profitable (the subsidiary BALS HONG KONG LTD. itself was still losing money due to overhead).

Taiwan

In December 2005, the company joined with Taiwanese firm Collins Co., Ltd., signing a franchise agreement covering the development of Francfranc stores in Taiwan. The company has been opening stores under this franchise since January 2007.

South Korea

In 2009, the company joined with South Korean firm Daeseong Industries, signing a franchise agreement covering the development of Francfranc stores in Korea. The company has been opening stores under this franchise since June 2009.

China

In June 2010, the company partnered with Mitsubishi Corporation (TSE 8058) and jointly created BALS Merchandising (Shanghai) (BM CHINA). The first store, the Shanghai Metro City store, opened in August 2010.

The majority of BALS products sold in overseas stores are manufactured in China, imported to Japan, and subsequently re-exported to Hong Kong, Taiwan, South Korea, or China. When various costs are taken into consideration (tariffs, transport costs, etc.) the price differential is about 1.3x that of Japanese merchandise. Correcting this pricing difference is a challenge to resolve as the company seeks to increase sales overseas.

Business alliance with Shanghai Ruihong Xincheng Ltd.

In December 2010, the company announced a business alliance with Shanghai Ruihong Xincheng Ltd., which is involved with the “Shanghai Ruihong Xincheng Project (RXHC Project)” in Shanghai, China.

The RXHC Project is a large-scale hybrid development project of approximately 450,000 square meters. The project calls for approximately 10,000 condominiums, commercial facilities, offices, etc. by 2018. The company plans on opening a flagship Francfranc store (approximately 2,680 square meters across three floors) at the RXHC Project site in 2014. The company hopes to sell merchandise to the condominium owners.

In addition to the project in Shanghai, Shui On Land Ltd. is working on other “Tiandi” developments in Hangzhou, Chongqing, and Wuhan Provinces. BALS said that the partnership with Shui On Land Ltd. could lead to more store openings in these other large urban development projects.

Strengths, Weaknesses

Strengths:

• Experienced, hands-on management team: It’s probably fair to say that President Takashima’s efforts have helped turn BALS into the company it is today. He has been involved in developing the merchandising methods, design themes, and led a persistent effort to create an image that customers can relate to. Over time, the company has developed its unique value proposition and strong brand identity. After creating the successful Francfranc store format, Takashima did not rest on his laurels, but instead channeled the momentum into new initiatives. In SR Inc.’s opinion, the combination of ambition and willingness to drive change provides the company with unique management resources necessary to finding future growth.
• Aggressively embracing change while maintaining a core identity. Although the company is unique, the persistent threat from imitators means that it must continuously strive to differentiate itself. Competitors’ use of looks similar to Francfranc (bright colors, etc.) in 2008 and 2009 is an example of this. However, the company seems to have developed an ability to change its stripes while staying connected to its target consumer. Francfranc's evolving “casual-stylish” concept illustrates how although looks changed, the core idea hasn’t (“French Country” in the 1990s, “modern Italian” from 2000 to 2005, and “colorful” (pink and yellow-green, etc.) from 2005 to 2009). In 2010, the company started to develop a deeper definition of its brand, refining the core identity and adding to its uniqueness.
• Strong brand image. In the home consumer goods (food, clothing, interior goods, etc.) market, interior goods had historically been the least sophisticated in Japan, and emphasis was on price & quality. However, the company took a new approach by proposing a specific “lifestyle experience” to customers and discovered hidden demand that reshaped the interior goods industry. The word “Francfranc” brings an immediate association with a dynamic urban lifestyle store. Creating such a clear brand identity is not easy, and the high proportion of repeat customers is evidence of the brand’s strength.

Weaknesses:

• Core market is shrinking: The company derives the majority of its profits from Japan, a market expected to contract over the longer-term, and its overseas businesses are still developing. The company has a number of challenges ahead to build supporting pillars of earnings growth. Such challenges include: strengthening overseas businesses, pushing ahead with new in Japan while rebranding its core stores, increasing share in Japan, and enhancing its capabilities to operate globally. Growing sales by increasing its geography of operations has significant potential, but the extent to which the company can execute on these multiple fronts remains an open question.
• Merchandising can’t be data driven. Many leading global retailers use sales data to drive merchandising decisions (Wal-Mart in the US is probably a famous example). BALS sells products which include both functional and emotional aspects (evoking certain lifestyles), finding “what works” means more than analyzing sales. Indeed, the company learned this when chasing hot-selling products and found that offering variety can be valuable, even if data suggests otherwise. Arguably, BALS has been successful because its offering was unique, something that customers appreciated. The downside of this approach is that it is difficult to capture the intangibles that make product development successful. In other words, BALS merchandising success seems to be more experience-driven than data-driven, leading to the question of how its experience can scale. Challenges in new product development mean challenges to growth - keeping a fresh image while appealing to new customers (tastes in Tokyo and San Francisco are different).
• “Soft” organizational structure. The company’s organizational structure seems to be relatively flat and flexible enough to rearrange itself as business needs dictate. Although flexibility might have been instrumental to surviving rapid changes in the market, it remains to be seen if it is the best choice to support global ambitions. As the company grows and operations necessarily become more complex, a more clearly defined management structure might be necessary.

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[edit] Market & Value Chain

Market Overview

The home fashion market, mainly made up of interior goods, has been shrinking along with a declining and aging population. Add to this falling bridal demand as people marry later in life, and in a word, the market environment is extremely harsh. At the same time, mass consumer behavior is shifting from focusing on price and functionality towards a more complex mix, with choices driven also by taste and design preferences. Consumers increasingly select what they see as fitting their own individual lifestyle. Amid those changes, there is an increasing number of companies trying to win customers by offering lifestyle-based retail spaces and diversifying the merchandising mix. It is probably fair to say that BALS has been and remains at the forefront of such movement.

In terms of sales channels for interior goods, the market has expanded from department stores, traditionally the main channel, to a wide variety of formats, including specialty furniture and interior retailers to apparel stores. Similarly, accessories, another traditional department store staple, are now sold all over the retail map, from 100-yen shops to apparel stores. The market is getting increasingly competitive and giving the customer something unique is essential to survival.

In order to understand the evolution of BALS’ target market, it helps to look at the overall Japanese demographic trends (see the table above). The company's main target, 25-to-29 year olds (or more broadly 20-to-39 year olds), grew in number in 1995-2000 and then trended downward. That declining trend is expected to continue into the future. The bold figures highlight the so called “junior baby boomer” generation (born in 1971-1974). The original baby boomers born in 1947-1949 had their children in 1971-1974, hence the “junior” wave. The lifestyle and consumption patterns of those two groups of the Japanese population have been shaping the economic and cultural life of the country.

It appears obvious that such demographic trends have been to some extent impacting BALS’ (and other retailers’) performance. For example, in the early 1990s, casual street fashion originating from the streets of Shibuya and Harajuku gained in popularity. Before that, fashion trends were to some extent driven by manufacturers employing the market-in approach (trying to figure out what consumers want, making the apparel based on those perceived needs, and then force-feeding the consumer through advertising and lack of mainstream alternatives). With street fashion (casual fashion born in the streets), young consumers create new styles forcing sellers and producers to follow. Young consumers of the early 1990s were the junior baby boomers, a group so large that the industry could simply not ignore. Interior retailing was several years behind emerging trends dictated by the new vocal consumer. It is probably not an exaggeration to say that BALS moved in to fill the gap and push the industry forward.

A turning point for the company was the opening of its Shinjuku Southern Terrace store in 1998 (when the junior baby boomers were about 24-27 years old, precisely the age BALS targeted at the time). As mentioned in the corporate timeline, the company expanded nationwide to the major metropolitan areas after seeing the success of the Shinjuku Southern Terrace store in Tokyo. (There were 15 Francfranc stores in 1997, growing to 50 by 2000.) For an average “office lady, 25 years of age, single, living in a city” (a representative image of the female part of the junior baby boomer generation), Francfranc brand became an inseparable part of their lives.

However, the junior baby boomer generation has been growing older. In 2011, junior baby boomers range in age from 37 to 40. They may still have the same mind-set that they had at 25, but are probably looking at merchandise and stores differently than when they actually were 25. And they keep aging, soon to reach their 40s. The marginal propensity to consume tends to be higher for those in their early 40s compared to any other population group. Indeed, the earlier and larger population “bump” has already demonstrated that – individual consumption growth rates in Japan reached a peak in 1991, just as the baby boomers were ages 42-44). It is probably reasonable to assume that the “juniors” would have a similar, if smaller, effect on consumption. Devising ways to draw in this demographic will be critically important for Japan's retailers. BALS started rebranding itself in January 2011. The company acknowledges the risk of losing some of its existing fans but sees an opportunity to bring in an even bigger market. Whatever the outcome, the results of these rebranding efforts will be the key to BALS’ domestic performance.

Suppliers

The company has around 560 suppliers. It sources some of national brand products through wholesale intermediaries, however the majority of the products it sells originate from Chinese manufacturers.

Customers

Women make up about 80% of the sales at Francfranc. By age, approximately 70% of purchases are made by costumers in their 20s and 30s.

Barriers to Entry

The barriers to entry are generally low although size and experience help with branding.

Competition

Considering that BALS sells everything from accessories to furniture, identifying the direct peers is not easy. In one sense, it does not have any. In another, it competes with any firm in a similar market. The closest comparisons could be Nitori (TSE 9843), Marui Group (TSE 8252; through its “in the ROOM” store brand), IKEA, Ryohin Keikaku (TSE 7453), Loft (subsidiary of Seven & i Holdings (TSE 3382)), Tokyu Hands (subsidiary of Tokyu Real Estate (TSE 8815)), Cassina IXC (JASDAQ 2777), and Otsuka Kagu (JASDAQ 8186).

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[edit] Strategy

The company’s strategy has been to differentiate itself from other competitors and in the process redefine how consumers perceive the market. Its first marketing effort (proposing products that fit a lifestyle vs. products that performed functions) is an example of this.

One challenge with pursuing a differentiation strategy is the threat from imitators. Although creating a unique product or concept is a necessary component to success, being able to maintain the edge is critical to turning a good idea into a good business. BALS’ rebranding effort in FY01/11 and its shift in new store opening strategy are example of how the company is trying to maintain its uniqueness. If the company can tap into consumers who identify with the 25-30 (vs. those who actually are), its brand could have increased staying power and also change its market opportunity. Increasing the variety of new stores (more larger and smaller sizes) could mean shops that feel more unique and genuine for customers trying to express their lifestyle.

BALS’ development strategy is also focused on creating differentiated products. Interior goods have historically been defined along two fronts: design and price. The company is trying to change how consumers perceive its products, and instead see them as combinations of fashion (how something looks, but also what it says about the owner) as well as price.

In terms of future growth, the company has its sights set on overseas markets (China, US, etc.). Shifting design, production, and logistics to China seems to be a move aimed at supporting global expansion.

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[edit] Historical Financial Statements

[edit] Income Statement

FY01/06

Sales grew +17.0% YoY to 22.2 billion yen, while operating profit increased 26.1% YoY to 1.4 billion yen. Comparable store sales grew +0.9% YoY and the company opened 11 new stores in Japan (92 total stores at the end of FY01/06), which contributed to the increase in earnings. Operating profits grew due to higher percentages of interior goods and Private Brand merchandise, as well as direct transactions with Chinese manufacturers (gross profit margins grew +0.9% YoY). Although the SG&A to sales ratio increased from new store openings (+0.4% YoY), operating profit margin grew +0.5% YoY.

FY01/07

Sales grew +11.8% YoY to 24.9 billion yen, while operating profit fell 5.7% YoY to 1.4 billion yen. The increase in sales was due to higher comparable store sales (+1.0% YoY) and 13 new store openings in Japan (106 total stores at the end of FY01/07). Operating profit declined due to higher SG&A costs related to new store openings. Non-operating income (foreign exchange gains) meant that recurring profit and grew +16.0% YoY to 1.6 billion yen.

FY01/08

Sales grew +22.1% YoY to 30.3 billion yen and operating profit grew +39.1% YoY to 1.9 billion yen, record highs. In addition to strong comparable store sales, +7.8% YoY, new stores helped earnings. The company opened 12 new stores in Japan and 3 stores overseas (122 total stores at the end of FY01/08). Operating profit grew due to performance of the company's Francfranc stores, and subsidiary Real Fleet (household appliance planning and wholesaling), becoming profitable. The company had some extraordinary profits resulting from sales of stock in subsidiary Seven Signatures and from land holdings (about 790 million yen).

FY01/09

Sales grew +21.2% YoY to 36.8 billion yen and operating profit grew +73.8% YoY to 3.3 billion yen, record highs. Comparable store sales were strong (+8.0%), and new store openings also contributed. The company opened 28 stores in Japan (143 total stores at the end of FY01/09). Operating profit grew mainly due to increased sales at Francfrac stores (with contributions from other formats as well).

FY01/10

Sales fell -7.0% YoY to 34.2 billion yen and operating profit fell 31.9% YoY to 2.2 billion yen. Sales at existing stores fell 12.4% YoY due to a tough economic environment, the main reason lower sales. With respect to the slump in comparable store sales, the company said that a large reduction of new product introductions exacerbated the effect of the sluggish Japanese economy. The company said that it introduced fewer new products because its theme for FY01/10 was a “massive expansion to improving quality.” This meant shifting product development to away from “easy” options (different sizes, colors, etc.) to more meaningful efforts that would appeal to more consumers. The company opened 5 new stores in Japan, but also closed 7 (141 total stores at the end of FY01/10).

Cost Structure Analysis

The parent company’s performance makes up the majority of consolidated profits, and it has a rather high SG&A to sales ratio. In the SG&A breakdown, personnel and rental expenses make up a significant portion of total SG&A spending (both items together account for approximately 60% of SG&A). Considering the fact that temporary employees make up a large part of the company’s workforce, personnel costs could be called "semi-fixed." Because most stores are located in fashion buildings and suburban shopping centers where rental expense is probably linked to sales (not including minimum guarantees), it could also be a "semi-fixed" cost. The proportion of SG&A spent on advertising is low. For Francfranc stores, visiting the stores themselves is the best way of advertising products, something the company incorporated into their design. According to President Takashima, "We let the shops to all the talking. The spread of information is best left to word of mouth by the ladies." Note however, that the company did boost advertising spending in FY01/11 to support the rebranding effort.

One conclusion from the discussion above is that not only is the SG&A to sales ratio relatively high, but the spending is almost, but not quite completely, fixed. Therefore, the company's profitability is significantly driven by sales trends at existing stores.

Profitability Snapshot, Financial Ratios

Inventory Management

Whether the products are Private Brands or National Brands, the company purchases all inventory outright, assuming inventory risk. For this reason, inventory turnover is important; any declines in the turnover ratio would mean liquidation selling and an obvious impact on gross profit and possibly the ability to invest in product development. The table above shows inventory turnover (sales /average inventory) for the parent company. Inventory turnover in FY01/08 was low, 6.5x, and the company subsequently took inventory valuation charges in FY01/09 and gross profit margin fell to 59.3% in FY01/09 from 60.2% in FY01/08. The company commented that the inventory increase during FY01/11 was intentional and brought about by sales-floor presentations and the launch of new products.

Results vs. Historical Earnings Forecasts

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[edit] Balance Sheet

Assets

Changes in the number of directly managed stores have driven working capital trends (mostly through inventory requirements for new stores). In FY01/07, total assets were 23.6 billion yen, an increase from 11.4 billion yen in FY01/06 (the change was due to consolidation of the Seven Signatures subsidiary). The following year, FY01/08, Seven Signatures was excluded from consolidation and total assets declined to 16.3 billion yen.

Liabilities

Interest-bearing debt increased in FY01/07 with the consolidation of the Seven Signatures subsidiary, but except for FY01/07, interest-bearing debt level was low. In FY01/11, the amount of cash exceeded total interest-bearing debt, making the company essentially debt-free.

Shareholders’ Equity

Shareholder’s capital and reserves each increased by 899 million yen in FY01/06 when the company went public. In other years, net assets fluctuated primarily with the acquisition of treasury stock or changes in net income.

Per Share Data

The company performed a 3-for-1 split on February 1, 2006.

Shareholder Returns

The company started targeting a consolidated payout ratio of 30% in FY01/08. The consolidated payout ratio (dividends / net income) was actually 6.3% in FY01/08, but that doesn’t include the acquisition of treasury stock. The total return ratio (dividends plus cash spent on buybacks divided by net income) was 47.5% in FY01/08, a relatively high amount. The consolidated payout ratio in FY01/09 was 17.8%, another year that the company bought back stock; the total return ratio in FY01/09 was 48.1%, also a relatively high return.

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[edit] Cash Flow Statement

Operating Cash Flow

Operating cash flows are typical – driven by changes in net income and working capital. Negative OCF in FY01/07 was due to consolidation of the Seven Signatures subsidiary, which increased inventories (pushing up working capital requirements). The subsequent removal of Seven Signatures from consolidation in FY01/08 was the reason behind the rebound. Although net income declined in FY01/10 vs. FY01/09, operating cash flow increased mostly due lower inventory levels.

Investment Cash Flow

Investment cash flows change mostly based on new store openings, other tangible asset acquisition, and security deposits for new stores. Investment cash flows in FY01/10 were slightly negative because there were few store openings.

Financial Cash Flow

Financial cash flows tended to be positive through FY01/08, when the company was using bank loans and bonds to support new store openings and fund working capital increases. In FY01/09 and FY01/10, however, this reversed with lower inventory levels and the subsequent repayment of corporate bonds and long-term loans.

Simple Free Cash Flow

The company’s working capital and capex spending (mostly changes in the store network) have been the main factors driving simple free cash flow.

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[edit] Other Information

[edit] History

Corporate Timeline

July 1990: BALS founded in Fukui Prefecture, to sell imported furniture and interior goods.

July 1992: Opened first Francfranc retail store at Tennozu Isle

September 1993: Started importing furniture and accessories from Europe, India and Southeast Asia.

1996: Became independent from Maruichi Selling through MBO.

July 2002: IPO on JASDAQ market.

September 2002: Founded BALS HONG KONG LTD for developing overseas operations of the group.

May 2003: Opened first overseas Francfranc store in Hong Kong.

February 2005: Listed on the Tokyo Stock Exchange (second section).

January 2006: Shares listed on first section of TSE.

August 2009: Sold subsidiary Tokyo Jutaku (Residence).

June 2010: Created BM CHINA to expand business in China.

The founder and current President and CEO of the company, Fumio Takashima, went to work for furniture manufacturer Maruichi Selling after graduating from college. After working in Osaka and Tokyo, he launched BALS in 1990 as an internal venture. At the time, BALS was mostly selling high-end imported furniture to golf courses and hotels. However, after the bubble burst, sales languished and losses mounted. He was asked if he would consider relocating his showroom to Seafort Square at Tennozu Isle in Tokyo (a popular spot at the time), so Takashima opened a store there. The store in Tennozu sold interior goods and accessories, a new concept. In July 1992 that store became the first Francfranc store.

With this entirely new business, BALS needed to start from scratch and figure out what to sell, and to whom. The initial merchandising target was defined as Miss A., a single city-dwelling office worker, 25 years of age. As Takashima went about asking his female staff about which magazines Miss A. would buy and her other tastes, the concept of “casual stylish” (cool, cute, fashionable) emerged, resonating with Takashima and his colleagues and was close to the original BALS concept. His staff came up with the Francfranc name, derived from the French word ‘franc’ (frank).

The company thinks that the secret to the success of its first store was combining furniture and home accessories, a revolutionary concept at the time when furniture stores sold furniture and accessories stores accessories. The original store did not have any private brand items, simply a conceptually consistent selection of products bought from various suppliers.

The second store was opened in the Landmark Tower in Yokohama (the tallest skyscraper in Japan). This store too, was a success. A third store, opened in Kotesashi Tokorozawa, in Saitama prefecture, was the first suburban Francfranc and the first failure. The company continued to grow hitting occasional road bumps, and in 1996 Takashima bought the company out from Maruichi. The real success came two years later with the opening of the Shinjuku Southern Terrace in 1998. The Southern Terrace store was an instant hit among consumers and media, and the company was swamped with requests to open new stores from shopping mall operators across Japan, leading to a rapid nationwide expansion.

In July 2002, ten years after opening Francfranc, the company listed on JASDAQ. This brought the advantages of more avenues for funding new stores and better recognition as a listed company. The company listed on the second section of the TSE in February 2005 and then moved to the first section in January 2006.

In June 2006, BALS bought Seven Signature, an exclusive Japanese distributor for a hotel condominium under development in Hawaii's Waikiki. In November 2006 BALS established Tokyo Jutaku, a builder selling designer homes. BALS subsequently pulled out of both businesses and also divested from Real Fleet (a home appliance designer and wholesaler) in 2010, fully focusing its resources on the core retail business.

The company started its overseas operations in 2002, establishing a Hong Kong subsidiary and opening a store there the following year. Subsequently, BALS expanded into Taiwan and South Korea via franchise agreements with local companies and created a subsidiary in mainland China in 2010.

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[edit] News & Topics

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[edit] Top Management

Fumio Takashima, President and CEO

Born in Fukui Prefecture in 1956, Takashima started his career working at Maruichi Selling. In 1990, he founded BALS as a subsidiary of Maruichi, opening the first “Francfranc” store in Tennozu Isle shopping area in 1992. In 1996, Takashima acquired BALS in a management buyout.

Hiroshi Nariki, Executive Vice President

Originally a bank executive working with BALS as a client, Nariki joined the company in July 2000. He worked as a Managing Director and Executive Director before being appointed to his current position in April 2007.

Nobukuni Taneya, Executive Managing Director

Taneya joined BALS in 2007 from Inabata Industries, where he held senior executive positions. In April 2008, he took over in his current position. He also works as Chairman of BM CHINA.

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[edit] Employees

The company had 1,764 staff as of the end of FY01/10 (547 full-time and 1,217 temporary employees), of which 1,143 were employed by the parent company.

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[edit] Major Shareholders

FT Planning Ltd. is an asset management company owned by President Takashima. Including that stake, he directly and indirectly controls about 30% of the shares. Mitsubishi Corporation, apart from being a large shareholder, is a joint venture partner of BALS in China and provides assistance in the company’s import operations.

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[edit] Investor Relations

The company holds analyst results meetings twice a year.

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[edit] By the Way

The company's name, BALS, is an acronym for “Basic Art Life Style”.

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[edit] Latest Q&A

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