Financial Summary

(Source: Company, Keyakigaoka)

Recent Updates

Highlights

On November 29, 2011, Grandy House announced it would be promoted to the TSE First Section.

(For original Japanese-language only release in PDF format, please click here. )

On November 7, 2011, the company released 1H/Q2 FY03/12 results: click here to go direct to the 1H FY03/12 results section.

(For original Japanese-language only release in PDF format please click here)

On October 31, 2011, the company announced an upward revision to its 1H FY03/12 forecast, the revision was as follows:

• Sales: 15.2 billion yen (vs. previous forecast of 14.6 billion yen)
• Operating profit: 820 million yen (vs. previous forecast of 790 million yen)
• Recurring profit: 834 million yen (vs. previous forecast of 780 million yen)
• Net income: 461 million yen (vs. previous forecast of 440 million yen)

The company noted that while orders fell following March 2011’s earthquake in the Tohoku region they soon rebounded to solid levels. For example, orders for its large-scale development in Tochigi prefecture continued to be robust and sales in new areas, such as northern Tochigi prefecture, were progressing well. The company left its full year FY03/12 forecast unchanged for the time being.

(For original, Japanese language only release in PDF format, please click here.)

For corporate releases and developments more than three months old please refer to the News & Topics section.

Trends & Outlook

Quarterly Trends

1H/Q2 FY03/12 Results (Announced on November 7, 2011; please refer to table above)

Sales were up 12.8% YoY at 15.2 billion yen driven by new home sales as the company pushed into new geographic areas (northern Tochigi prefecture, and southern Ibaraki prefecture). Due to competition in the Real Estate Sales segment and increased prices for raw materials, the gross profit margin declined YoY by 1.4% to 17.2% from 18.6% and the sales-to-SG&A ratio rose/fell to 11.8% vs. 12.8% in 1H FY03/11 (due to a higher proportion of fixed costs) with operating profit rising 4.9% YoY to 820 million yen.

The performance for each segment during 1H FY03/12 was as follows:

• Real Estate Sales: (Sales: 14.0 billion yen, +12.8% YoY; Operating Profit: 696 million yen, +4.2% YoY)

(New Homes)

New home sales were up 62 units YoY to 454 for the period, underpinned by solid sales in both existing and new operational areas, such as northern Tochigi prefecture and southern Ibaraki prefecture. As a result, sales increased 16.3% YoY, to 12.4 billion yen.

Gross profit margin declined for the segment due to a downward trend in selling prices in the Gunma area on the back of increased competition and higher prices for raw materials.

Increased Competition:

In order to address competition in Gunma, the company has been establishing its own in-house development team to independently locate and purchase land, which allows it to streamline the entire process up until the sale of a house. Using this system, the company had been able to avoid competition relatively easily by targeting different areas to those targeted by rivals. As it started operations in Gunma comparatively recently though it had been in the midst of establishing this development framework and thus was involved in competition that it had been able to avoid in other locales. However, its development platform had become operational in Gunma as of spring 2011, and the company believed competition would ease going into 2H as it continued to replenish its product offerings. (The company requires an average of seven to eight months from the purchase of a plot to the completion of a unit.)

Higher material prices:

The company remarked that while the price of plywood remains high, the prices of other materials, such as laminated wood, have already peaked and were falling. As a result, it was not concerned about material prices for 2H.

The company significantly reduced its inventory of completed subdivided lots, from 453 lots as of end-March 2011 to 317 lots as of end-September 2011. This was the result of company efforts to cut long-term inventory (inventory for which six months or more have passed since completion). The company noted its moves to accelerate inventory turnover and disperse risk by focusing mainly on medium-scale projects (of 10 to 30 lots) rather than large-scale projects (of 100 lots) as an example of these efforts.

As of end-September 2011, the company employed 159 sales staff and planned to increase this to 180 by end-September 2012.

(Used homes)

Used home sales increased by 3 units YoY, to 93 units and, as a result, sales increased 3.3% YoY to 1.6 billion yen. The company, however, failed to achieve its sales target, which was based on a sales assumption of 100 units. Grandy remarked the cause for this was it was unable to purchase all the properties it had targeted. The company’s policy to address this has been to establish specialist departments for purchases and product planning and to increase inventory.

• Pre-Cut Parts (Sales: 1.0 billion yen, +14.0% YoY; Operating Profit :31 million yen, +137.2% YoY)

The company passed on higher raw material costs from FY03/11, increased production capacity and engaged in an active sales drive, which all contributed to the improved figures.

• Real Estate Leasing: (Sales: 142 million yen, +1.2% YoY; Operating profit: 93 million yen, +6.4% YoY)

The company focused on cutting administrative costs and acquiring new tenants amid the ongoing stagnant demand for office demand and the departure of some tenants.

Q1 FY03/12 Results

The company released FY03/12 results on August 3, 2011 (see the table above).

Sales were up 21.4% YoY at 7.5 billion yen driven by new home sales as the company pushed into new geographic areas (northern Tochigi prefecture, and southern Ibaraki prefecture). Due to competition in the Real Estate Sales segment and increased prices for raw materials, the gross profit margin declined YoY by 0.5% to 17.3% from 17.8% and the sales-to-SG&A ratio declined to 11.6% vs. 13.2% in Q1 FY03/11 (as measured by a higher proportion of fixed costs) with operating profit rising 48.0% YoY to 428 million yen.

The company maintained its 1H and FY03/12 forecast. The performance for each segment during Q1 FY03/12 was as follows:

• Real Estate Sales: (Sales: 7.0 billion yen, +22.5% YoY; Operating Profit: 361 million yen, +61.4% YoY)

The company has aimed for an average order rate of approximately 70 units per month in the newly constructed home market during FY03/12, and as of Q1 FY03/12 they have been moderately ahead of forecast, the company noted. The company had forecast order levels would be depressed due to the impact from March’s earthquake, however, in Tochigi and Gunma prefectures orders returned to pre-quake levels after only about two weeks after the quake. The company also said that among the three prefectures it operates in Ibaraki was the most affected by the quake, and while order levels have recovered relatively slowly they were still in line with projections.

While gross profit margin was down YoY due to competition with large residential construction firms over land acquisition and increases in raw material prices, the gross profit margin was still on a recovery path vs. 2H FY03/11.

The company also commented sales of second-hand homes were around 15 to 20 units per month, which was also in line with projections.

• Pre-Cut Parts (Sales: 470 million yen, +10.0% YoY; Operating Profit :16 million yen, +90.6% YoY)

The company made efforts to secure its supply chain amid concerns about shortages of material, such as plywood, following March’s Tohoku earthquake, but by mid-May these concerns had been laid to rest, the company said. The price of insulation materials also rose rather significantly, but the company appeared to have been able to absorb the price rises by cost-controls. The company was affected by higher raw material costs in 2H FY03/11, but they were able to able to pass on these higher costs smoothly as they entered FY03/12.

• Real Estate Leasing: (Sales: 70 million yen, +0.6% YoY; Operating profit: 47 million yen, + 4.7% YoY)

By focusing on cutting administrative costs amid stagnant demand for office rentals in the Kanto area (Tochigi, Ibaraki, and Gunma prefectures) the company was able to boost profitability.

Full Year (FY03/12) Outlook

The company was expecting its fourth consecutive FY of higher sales and profits. It forecasted a 7.4% increase in sales YoY, to 29.4 billion yen, and a 5.0% increase in operating profit YoY, to 1.6 billion yen. In 1H FY03/12, the company achieved 51.9% of both its full-year sales and operating profit forecast.

Real Estate Sales:

The company anticipated an 8.2% YoY increase in sales to 27.2 billion yen, and operating profit to rise 1.0% YoY, to 1.3 billion yen. Specifically, it expects sales of new homes to increase 8.3% YoY to 743 million yen (driven by sales of 880 units, or an 8.5% increase YoY). Meanwhile, used homes sales were forecast to rise 14.1% YoY, to 3.5 billion yen (underpinned by sales of 200 units, or a 16.3% increase YoY). In 1H FY03/12, the company achieved 52.1% of its full-year sales forecast for new homes and 48.1% of its sales forecast for used homes, meaning that it had achieved 51.6% of its total sales forecast for the Real Estate segment.

The principal factor behind the higher new-homes sales figures is the company was expecting its efforts to bolster its operational footprint in southern Ibaraki and northern Tochigi prefectures, where it launched operations in March 2011, to result in higher orders during the period.

The company believed that its entry into these new market areas had expanded the scope of its existing market in Tochigi by around 12% and Ibaraki by 24.0%. As the company began operations in northern Tochigi in March 2011 and southern Ibaraki in January 2011, it expects earnings contribution from these new operations to fully kick in during FY03/12.

New home sales forecasts by subsidiary were as follows (note these effectively represent area sales forecast as well, given the separate geographical footprints of these units):

• Grandy House (based in Tochigi) +8.3% YoY to 14.7 billion yen (570 unit sales; +7.1% YoY)

• Ibaraki Grandy House +5.6% YoY to 5.7 billion yen (200 unit sales; +9.9% YoY)

• Gunma Grandy House +14.0% YoY to 3.0 billion yen (200 unit sales; +13.4% YoY)

SR Inc. understands that Ibaraki Grandy House forecasts take into consideration effects of the Tohoku earthquake.

In 1H FY03/12, Grandy House (Tochigi) sold 304 units, Ibaraki Grandy House sold 100 units, and Gunma Grandy House sold 50 units, giving a sales total of 454 units. This means that Grandy House (Tochigi) achieved 51.5% of its full-year sales forecast; Ibaraki Grandy House 50.0%; Gunma Grandy House 45.5%; and the overall segment achieved 50.4% of its total full-year sales outlook.

Used Home Sales:

The company was also forecasting used home sales to grow following the FY03/11 opening of a new Ota city branch in Gunma prefecture and an increase in sales staff. Operating profit, however, is expected to only rise 1.0% YoY, the company explained this was due to a combination of anticipated higher SG&A expenses, including personnel and advertising-related expenses, and the impact of increases in some material prices.

Pre-Cut Parts:

The company expected sales to grow 0.2% YoY to 3.9 billion yen while operating profit is forecast to increase 212.5% YoY to 50 million yen. The company said it was aiming to improve performance at the segment by speeding up the pace at which it can pass on price increases in underlying materials to customers.

Impact from the Tohoku earthquake:

(Short-term impact) In the immediate wake of March 2011’s Tohoku earthquake the company noted it witnessed a dramatic fall in orders due to factors such as gasoline shortages limiting the number of people able to visit its branches. But by the latter part of March, order volumes had returned to pre-quake levels and orders for April and May were in line with its forecasts.

Many plants producing plywood, insulation, and other materials for home construction were located in Tohoku and as a result there has been general industry concern over the adverse impact the earthquake may have on procurement of materials and whether it may also lead to price hikes for materials.

However, the company said its procurement of materials was hardly affected by events. In addition, while plywood and some other material costs did rise, prices in general settled down immediately after the quake and the company expects any increase in material prices to remain within a range it can absorb by implementing cost controls.

(Medium to long-term impact)

The company believes that one consequence of the Tohoku earthquake will be that homebuyers become more safety conscious. The company's sales process for individual detached homes is to build first then sell them. Given none of its properties were destroyed in the earthquake, the company pointed out this was an actual demonstration of their properties’ earthquake-resistance capabilities. The company believes this should actually have a gradual feed through effects for its sales and result in improved financial performance.

Future Outlook

The company does not release mid-term targets but it is aiming for sales of 1,000 units in its core Real Estate new homes business by FY03/14. This represents an 11% increase on its FY03/12 forecast of 900 units. New homes constitute the majority of the company’s sales (about 80%), so simply calculated, an 11% increase on its FY03/12 forecast equates to sales of 32.5 billion yen in FY03/14.

If the company continues with a sales strategy that prioritizes fast turnover of medium-scale projects, as has been its focus in FY03/12, then SR. Inc. believes the company can exceed its FY03/12 operating profit margin target of 5.4%. If it is able to increase its operating profit margin by 1.0%, to 6.4%, then achieving the above-described sales forecast would result in operating profits of approximately 2.0 billion yen.

The company is likely to continue focusing its resources on core detached home business and core markets of Northern Kanto. Sales of used houses through its network of specialized offices should continue to grow as The company leverages its real estate and construction expertise to acquire used homes and refurbish them and sell at competitive prices.

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Business

Summary

The company’s core business is building and sales of detached homes (87.3% of total revenues in FY03/11).

Other significant businesses are used-home sales, manufacturing and sales of pre-cut wooden parts for construction, and lease of rental apartments and commercial buildings. Grandy reports three consolidated segments: Real Estate Sales (detached homes, custom built houses, land sales, used-home sales), Pre-cut parts (production and sales of building materials) and Real Estate Leasing (rental buildings and management of parking lots).

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Business Description

Main Business Segments
Real Estate Sales

Source: Company, Private Court Tsuruta

• Detached Homes for Sale, company's main business, is one of the most common types of housing in Japan, especially in suburbs and regional areas. As a typical developer, company acquires land and builds standardized homes for sale. Such developments target average income earners, in most cases first time buyers (for more detail see Market & Value Chain section below). The company specializes in wooden structures, by far the most typical material for detached dwellings in Japan. The average size of the house built by the company is 110-125 sq. m and the average price in FY03/11 was 25.9 million yen. The house size changes depending on-location. Due to uniformity of income distribution, especially for younger people, first time buyers tend to have similar incomes and therefore similar credit profiles. Initially a real estate developer, historically the company tended to put little emphasis on differentiation in terms of quality and variety of options but the company started pursuing more differentiated niche approach in recent few years. The company raised the quality of furnishings and number of available style and equipment options. It is now offering specialized designs for DIY and motorcycle enthusiasts, piano owners etc. This approach could help the company restore sales growth and profitability in the saturated and long term stagnant market. (see Market Overview and Strategy section for detailed discussion).

The process from land acquisition to delivery of the finished house to the customer typically takes about 8 months. Houses are often built before concluding the contract, the customer can “window shop” finished homes. She then chooses kitchen equipment, built-in furniture, and optional equipment to be installed. After the house is handed over, the company would provide structural insurance for the period of 10 years, 5 years of termite insurance, and perform 3-month, 1-year, and 2-year check-up visits. Assistance in obtaining financing is also provided.

• Custom Built Houses. The company started offering custom built (built-to-order) houses in 1996, before it started selling detached subdivided homes. This business is profitable but is unlikely to expand substantially. The company competes with national brand house makers and local builders.

• Land Sales. An opportunistic extension of the main business. The company will sell both large plots and subdivided individual plots if profitability and asset turnover of such transactions is attractive compared to building-for-sale. The company tried to grow large land transactions as a standalone business in 2006 but appears to have deemphasized it since.

• Used Houses. A relatively new business for the company, and is growing fast from a low base. Grandy House uses its local real estate knowledge to capture customers looking for used housing. The used housing market in Japan is substantially underdeveloped compared to other countries but will likely grow in coming years. The company buys a house, refurbishes it, and then sells to clients. The entire process takes approximately 3 months.

According to the company, there is little cannibalization of new homes by used home activities. Many used home buyers are drawn first to properties that are close either to work or relatives – new homes outside of a particular radius aren’t considered. Illustrating the ‘local’ nature of the market, the company’s advertising policy for used homes is heaviest within a 2 kilometer perimeter of the property. Further ensuring a separation of new and used buyers, used homes are sold under a different brand (“Sumikaekan”). SR Inc. expects this segment to grow in importance for the company.

As of FY03/10, Tochici was the main area for the Used Houses businesses, but it seems reasonable to conclude that expansion at some point is likely.

Source: Company, Pre-Cut Factory

• Pre-Cut Parts, Other. around half of factory production is consumed internally. Pre-cut business is likely to continue growing thanks to reasonable quality/price equation for customers, mostly smaller builders. As of end-FY03/11 the business was a small contributor to the company’s overall profitability.

Real Estate Leasing

• Rental Buildings & Parking Management Grandy House owns and manages buildings and parking lots primarily in the vicinity of Utsunomiya railway station.

Main Facilities

In total, company operates 19 offices in various locations.

Business Model

The company acquires land and builds detached houses for sale. Customers are introduced to a project through advertising or direct sales visits. Many customers live in the vicinity of the company’s properties; according to the company, in 80% of cases customers live within a 5km radius of their previous home. The customer chooses a property after it is actually constructed or selects a plot and has a house built for them based on a standard project. The company will normally assist customers in obtaining a mortgage.

According to the company, average sales prices of built-for-sale houses remained stable throughout the economic cycles of the past decade. The company's average selling price has been actually steadily climbing, from 25.4 million yen in FY03/04 to 26.3 million yen in FY03/11, due to increased proportion of more affluent customers. As such, changes in revenues are driven almost entirely by changes in the number of units sold. The company targets the highest volume zone of the mass market with reasonably priced (value zone but not low price discount zone) standard houses.

The business is low gross margin in absolute terms (18.2% in FY03/11), turnover focused, with high degree of variable and semi-variable costs. Land is a semi-variable cost. Once bought it has to be absorbed (sold) but the inventory cycle is less than one year (average of 8 months according to management) in the toughest of times, and the amount of new land acquired can be corrected continuously. Detached home builders in general tend to have less earnings volatility than condo developers that they are often compared to, and tend to be more stable financially.

For the company, the main components of costs of goods sold (COGS) in order of importance in FY03/11 were as follows (FY03/10 data in brackets):

Contracting expenses - 69% (51%)

Building Materials - 29% (18%)

Land acquisition expenses - 37% (45%)

Direct Labor - 6% (6%)

Overheads - 1% (1%)

(Parent Basis; Source: Company Yuho)

According to management, residential subdivided land prices in Tochigi are relatively stable across an economic cycle and do not exhibit volatility typical for metropolitan areas. Land acquisition cost as a percentage of total cost per house has been declining at a slow rate over past few years. (See more discussion of land prices in Market Overview). Contracting expenses, i.e. costs that the company is paying to outside contractors such as carpenters, are also stable and are purely variable costs. The company sees an opportunity to squeeze contracting costs by increasing efficiency of allocation of workers across all job sites. Direct labor and direct overhead are a small input. Building material costs have been rising rapidly in 2006 to early 2008 creating cost pressures but those pressures subsided in the second half of 2008 due to world economic crisis. Overall, it would appear that by far the major factor affecting gross profitability is the inventory turnover, i.e. how quickly the land cost is absorbed. Therefore, business is about how to sell as many units as quickly as possible while differentiating itself from competition and sustaining positive brand image.

In terms of Selling, General & Administrative costs (SG&A), (approximately 58.7% of FY03/11 SG&A), followed by advertising (11.4%). The company has some flexibility in controlling advertising spending but the bulk of costs can be considered fixed. It is probably hard to cut staff costs, management feels that in recent years it went too far in terms of introducing tough pay-for-performance schemes and cutting costs. Those measures had a negative effect on employee retention and satisfaction. The company now strives to make itself more balanced and attractive as a place to work and that means that labor cost cuts are unlikely in the near future. Indeed, the company raised base salaries for its employees in 2008 to bring them closer to the nationwide average. Advertising costs are discretionary. Grandy House uses flyers as the main means of advertising, about 50% of total.

Other businesses are marginal contributors to both overall profits and profit volatility.

Profitability Snapshot, Financial Ratios

Strengths, Weaknesses

Strengths:

While detached home building is a competitive business in which it is hard to achieve much differentiation, the company has several strengths that support its position as a major player in Tochigi which should allow it to grow presence in adjacent prefectures:

• Combining real estate development and home building expertise. The company's origin is in real estate development and land trading and it therefore has skills in sourcing land, financing, and timing of transactions. The company never lost money at a recurring level despite volatility and harsh environment of last few years highlighting its prowess in managing real estate exposure. At the same time, the company has 15 years of architectural and building experience allowing it to provide high quality housing and control the entire process itself.
• Leading local player. Compared to smaller local competitors it probably has more stable financing from local banks and enjoys higher brand recognition among consumers. Compared to large nationwide competitors it may have better local knowledge of and access to land information, finer understanding of customer needs and pricing opportunities in the mass market zone.
• Independent. Not having a large nationwide corporate umbrella means that the company can stay more entrepreneurial and flexible. Management has less of a salarymen mentality typical for large corporate groups and is likely more focused on sustaining growth compared to large nationwide “house makers” (Sekisui House, Daiwa House) or builders operating as a part of a large group (e.g. some Toyota Home group companies).

Weaknesses:

• Historically, little focus on product development (with limited range of house types and equipment options). That prevented the company from differentiating its offering from aggressive low price competitors. Customers were choosing Grandy-built homes based on price and location. While successful in good times, this approach backfired when Central Kanto based competitors, condo developers and “power builders”, brought price competition to Tochigi. The company found that its products and “value-for-money” message were no longer sufficient. Grandy House has since worked to develop more varied and clearly positioned product, however its perceived positioning as “not as good quality as house makers, not as cheap as low price builders” might remain a weakness. The company will need to continue efforts in becoming a niche player that understands local needs and provides product that is comparable in quality to national housing brands but is attractively priced and therefore represents a true value for first time buyers.
• Size. Compared to large nationwide companies such as “house makers” the company has limited economies of scale in procuring materials.
• Brand recognition is limited. Grandy House has a limited ability to utilize national TV stations for branding. It makes it more difficult and expensive for the company to expand outside of Tochigi.

Geography of Operations

Real Estate Sales breakdown by prefecture (as of end FY03/11):

Tochigi – 59.8%

Ibaraki – 27.9%

Gunma – 11.4%

The company operates in five prefectures: Tochigi, Ibaraki, Gunma, Fukushima, and Chiba. The “home market” is Tochigi where the company was originally established.

Operations in Ibaraki and Gunma, two most strategically important markets for company after Tochigi, are coordinated via separate subsidiaries. Tochigi, Fukushima and Chiba markets are served by the parent company.

The company derives the bulk of its revenues from Tochigi. There seem to be sufficient growth opportunities in prefectures of Ibaraki and Gunma, as they have similar demographic and economic profiles as Tochigi and Grandy House has experience in those markets. Growth in Tochigi has been historically sufficient for the young company and that explains more than any other factor, lower penetration in Ibaraki and Gunma.

Post-IPO the company started expanding more aggressively in adjacent prefectures but economic turbulence and a sudden deterioration in profitability (discussed in Historical Financial Statements) forced management to cut its ambitions. With limited local offices in Ibaraki and Gunma, SR Inc. believes that simply gradually adding sales offices and salespeople in those regions could create future growth opportunities.

Group Companies

Group consists of parent company and 5 fully-owned subsidiaries (as of FY03/11):

• Ibaraki Grandy House and Gunma Grandy House are core regional subsidiaries, through which strategy at a prefecture level is implemented.
• “Chukojutaku Johokan” (formerly “Sumikae Johokan”) is a subsidiary running the used homes sales business.
• General Livtec (formerly Grandy Pre-Cut) is a manufacturer of pre-cut construction materials.
• Grandy Reform runs group “reform” (reconstruction of old houses) business and performs building maintenance.

Group Strategy

Management stresses its area strategy as key to future success. Regional subsidiaries have large degree of autonomy and are run as standalone companies - that allows deeper penetration of local niches and better servicing of local market needs.

M&A does not seem to be a priority. Organic growth allows for better strategy implementation. Differences in corporate cultures are often quite pronounced at Japanese firms and potential market share gains would be likely offset by turmoil of integration. Local companies tend to be family run and are generally reluctant to sell unless deteriorating financial position forces them to choose between sale and bankruptcy.

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Market & Value Chain

Market Overview

The size of the Japanese housing market in fiscal 2010 (housing starts base) was 819,000 units, of which 306,000 were standalone (order-built) houses and 211,000 were condominiums and subdivided-detached houses. This is 33% less than the number of housing starts in fiscal 2009 and 36% less compared to fiscal 2006, the peak year of the past 10 years. There has been a clear shift away from order built houses towards condominium types. This reflects population movement to large urban areas away from regional areas and remote prefectures.

The market of Northern Kanto, the company's core market, also peaked in fiscal 2006, with pronounced declines in individual house construction occurring ever since. However, a closer look at the government data reveals a glut of condo starts in three Northern Kanto prefectures (Ibaraki, Tochigi, Gunma) in fiscal 2005 and 2006. This was particularly pronounced in Ibaraki, influenced by real and speculative demand growth due to commencement of service of Tsukuba Express connecting city of Tsukuba with Tokyo. In Tochigi, fiscal 2006 condo supply was 2-3 times larger compared to the long term trend. That caused supply/demand imbalances that, combined with a weak economy, negatively impacted the Tochigi market.

It seems likely that the number of new houses for sale will remain unchanged on average for Northern Kanto. The number of households should continue to increase very slightly (junior baby boomers marrying and leaving parents' homes; at the same time death of one of spouses doesn't impact the household count). Incomes, being a function of economic conditions and the demographic pyramid, should decline slowly as higher earning baby boomers begin retiring from the workforce. It seems therefore reasonable to expect more robust performance at the low end of the market (first time buyers of detached homes, the company's core market). Availability of land and dominance of cars as the main means of transport in regions will mean that detached dwellings will remain the main type of housing.

Land price in Northern Kanto prefectures have been declining steadily over past several years but the rate of decline slowed from FY03/07-FY03/09. Price trends are very stable in Ibaraki, Tochigi and Gunma compared to volatility of prices in metropolitan areas. That reduces risks of getting stuck with overpriced inventory and write-offs. SR Inc. believes that the average selling price of a home is more a function of income (a primary determinant of the size of a mortgage) than the land price. When land is expensive, consumers tend to buy smaller houses (i.e. the total of land + house is always roughly the same). When land price declines, buyers can afford a larger house and a larger plot of land. It is possible to speculate that land price trends of the past 10-15 years were a blessing in disguise for detached home builders. If the land prices were stable, it would be reasonable to expect the secondary market to evolve more rapidly. However, declining land prices pushed the overall quality curve (better house + larger land plot) for new houses while making older detached houses structurally less attractive (the size is too small and cannot be increased).

Market Growth Potential & Cyclicality

Source: Company

Source: Company(Yu-Yu Jizai)

The housing cycle is driven by the overall economic cycle and demographics as discussed above. Overall, the market is in a structural decline stage. SR Inc. believes that the current cycle has bottomed as inventories in Northern Kanto peaked in 2007 and is likely to stage a mild recovery over next few years. The business appears to have low seasonal variation from one quarter to another, although temporary factors like weather can substantially impact monthly orders.

Customers

Grandy House's typical customers are first time buyers: a household with two parents and one child. The husband is under 40 years old and earns more than 5 million yen a year. He works at a listed or large unlisted (more than 300 million yen in capital) company (55% and 32% respectively). There has been a small shift towards more affluent households among the company's customers. According to management, such a shift is likely due to worsening credit availability for lower income families. The demographic profile of the company's customers is one of a typical Japanese young family. Usually, the family lived in a rental apartment before buying their first house and they were looking to buy close to one of the parents' house. They did not want to move out of a familiar area and most likely had to buy because they needed more space for their growing child.

Buyer access to credit has become complicated with the adoption of the Bank for International Settlements (BIS) risk measurement practices in recent years. According to the standards, loans in excess of assessed collateral value are given a substantially reduced value on banks’ balance sheet, impacting the lenders weighted asset/liability mix. Detached homes and condominiums valuations are based on land value, thus assessed values are normally below-market.

Suppliers

There are two main types of suppliers for the company. One type concerns building materials and there are numerous suppliers of such materials. There are multiple and fragmented suppliers and their power vis-a-vis home builders is limited. The company is a large firm and probably enjoys better pricing than smaller competitors but not to the extent that it would give it a sustainable competitive advantage. The second type is manufacturers of equipment, such as kitchens, bathroom fixtures etc. Those are large nationwide companies but they too operate in a highly competitive environment and do not exert any material power over their clients. Again, the relatively large size of Grandy's operations probably means it has an advantage in buying power over smaller competitors but not big enough to be material.

Barriers to Entry

Barriers to entry to start a detached home building business are exceptionally low. However, highly competitive nature of the industry and a mature state of the market means that it is hard for the smallest competitors to make money and grow. Branding is also expensive and therefore actual barriers to entry are higher than they appear. Larger competitors have better access to capital and enjoy some economies of scale. Regional differences also constitute barriers to entry making a regional company model more sustainable. For detached home builders, they have to find a combination of land plot size and the house size that is optimal for a particular market, and those tend to differ from region to region. While this probably means that it can be difficult for the company to grow outside 3 Northern Kanto prefectures, it also means that its position in this particular region is probably better protected than it might appear. House makers do not have the issue of buying the land and matching its price to the price of their houses at the lower end of the market. They can therefore charge very similar (and higher) prices across the nation and this seems to be the reason why there are several nationwide house makers but no nationwide detached home builders.

Competition

It is difficult to provide direct comparison among various companies as they tend to have various business mixes. The main competitors of the company, according to management, are regional firms such as Toyota Woodyou Home (Unlisted), KI Star (Unlisted), Aida Sangyo (Unlisted), and to some extent Iida Home Max (TSE 8880) and Hajime Kensetsu (Jasdaq 3268). It appears that the company is enjoying a relatively dominant position in Tochigi but one cannot say the same for other prefectures. In Tochigi, the company enjoys benefits of persistent multiyear branding campaign. There are multiple small builders (koumuten), small family owned business that compete with the company in particular local markets but mostly focus on smaller subdivided and individual plots. Nationwide house makers historically were not direct competitors as their homes are on average 10 million yen more expensive than Grandy's. However, the competition with those firms has been increasing marginally as the company is slowly moving upscale and poor economic conditions force house makers to move down market.

In terms of comparable listed companies, a possible list of reference comparisons includes: Fuji Corp (TSE 8860) Hajime Construction (Jasdaq 3268), Iida Home Max (TSE 8880), Sala House (TSE 1405), Tact Home (TSE 8915), Touei Housing (TSE 8875), Wood Friends (Jasdaq 8886).

Substitutes

Degree of substitution is limited due to a strong consumer preference favoring detached houses, that tends to be particularly pronounced in regional areas. “Reforming” is a stronger substitute especially in times of economic hardship. However, small size and poor quality (particularly when it comes to earthquake safety) of older dwellings mean that new homes are preferred over refurbishment whenever financial situation allows. Despite those preferences, company business was hurt in 2007-2008 by aggressive condominium sales by competitors from outside of Northern Kanto. Real estate financing became very easy resulting in higher prices in metropolitan areas, and many developers started building low cost condos in regional markets, an unusual situation which proved unsustainable but showed that low prices and novelty factor can reinforce a normally weak substitution level and cause lasting damage.

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Strategy

Impacted by recent weak performance the company is focused on gradually returning to peak profitability (previously achieved in FY03/06). Maintaining financial stability throughout the business cycle is management's highest priority. The company feels that they perform an important social function of providing people a place to live and customer satisfaction is an important focus area since firm's foundation. Housing companies often call their industry a “claim industry”, meaning that customers are sold their houses only once but service provided in the form of housing continues for many years, impacting a builder's long term brand equity. In terms of growth strategy, Grandy House aims for low double digit growth in earnings, a lower rate compared to one that management tried to pursue immediately after exchange listing in 2005. The company quickly realized that aggressiveness also meant more financial risk and lowered its growth ambitions. Grandy maintains that it will continue to focus on its core business of detached built-for-sale houses and expand peripheral businesses, such as used home sales. The custom built home business is expensive to grow and it requires more sales effort and is therefore a lower strategic priority.

Increased focus on higher quality and more variety highlights a more mature and customer-focused company compared to a few years ago. Management stresses importance of building homes that customers would want to buy while before it focused more on land development and price side of the equation. Generally speaking, the company is pursuing a mix of differentiation and cost leadership strategy, focusing on the mass segment of the market. It is trying to increase brand recognition and offer more differentiated products, positioning itself as a leading and trusted supplier, particularly in Tochigi. Stronger execution supported by more stable and better incentivized sales force allowed the company to maintain relatively healthy order flow in what has been an extremely depressed market in FY03/09. Another strategic theme through FY03/11 is reducing construction costs without impacting quality. The key area of this incremental effort seems to be in lowering contracting costs. Grandy aims to increase efficiency of allocation of workers among its building sites through better control and planning.

In terms of geographic strategy, growth in Gunma and Ibaraki will likely be the main driver but the company believes that it can achieve further market share gains in Tochigi. (See also Group Strategy)

In terms of expanding to prefectures outside of Tochigi, Ibaraki, and Gunma, it seems that the process will be more gradual. Given highly competitive nature of the business and how difficult it is to differentiate oneself from competition, successful expansion requires slow accumulation of experience and local knowledge. Access to capital could be an important advantage but such advantage can only be made possible by a strong recovery in equity prices for listed companies, lowering their cost of capital. Such a recovery is a matter of speculation and cannot be currently regarded as a part of a viable strategy.

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Historical Financial Statements

Summary

Earnings Results Discussion for the Year Preceding Current Fiscal Year (For Reference Purposes)

FY03/11 Results

The company released FY03/11 results on May 9, 2011.

Sales were up 23.2% YoY at 27.2 billion with operating income climbing 70.3% YoY to 1.5 billion yen for FY03/11 driven by the company’s expansion into new geographies (northern Tochigi prefecture, and southern Ibaraki prefecture) plus a sales campaign to celebrate the 20th anniversary of its founding.

Sales came in slightly below the company forecast as the Tohoku earthquake caused delays in the handing over of some homes (the company was expecting 27.3 billion yen in sales for the period). Operating profit figures, however, exceeded expectations. (The company upwardly revised its FY03/11 projections on October 4, 2010, operating profit forecast was revised to 1.2 billion yen, recurring profit to 1.4 billion yen; and net income of 750 million yen). The company booked an extraordinary loss of 100 million yen relating to damages and repairs stemming from the Tohoku earthquake (out of a total extraordinary loss of 109 million yen for the period).

Business performance and summary per segment for FY03/11 follows below:

Real Estate Sales (Sales: 25.1 billion yen, +22.7% YoY; Operating Profit: 1.3 billion yen, +125.3% YoY):

The company sold 811 units at its core new homes construction business (+27.9% YoY). It cited the following factors behind the higher figures:

• Proactive focus on new property sales: the company launched sales at its NijinoMori New Town development, a large-scale development of 136 lots for sale adjacent to Utsunomiya, the prefectural capital of Tochigi

• Company-wide promotional events to attract new customers: examples, included a sales campaign to mark the 20th anniversary of the company

• Expanding its area of operations: this expansion included opening a facility in Yaita city in northern Tochigi prefecture, and launching a branch in Ushiku city in southern Ibaraki prefecture.

Sales of its new homes were up 27.9% YoY at 811 units, while sales volume for used homes increased by 28.4% to 172 houses.

Sales volume for used homes increased by 28.4% to 172 houses. In order to improve the purchasing and sales efficiency of this unit the company intends to consolidate and integrate its 14 Tochigi prefecture stores into ten. In addition, the company launched its first facility outside of Tochigi prefecture with a branch in Ota city, Gunma prefecture.

Pre-Cut Parts (Sales: 1.8 billion yen, +36.4% YoY; Operating Profit: 17 million yen, - 84.2% YoY)

The increase in top-line was driven by an expansion of its production line and external sales since October 2010. However, a surge in material price costs into summer 2010 and the lag in passing these costs on to customers ate into operating profits.

Real Estate Leasing: (Sales: 280 million yen, -4.1% YoY; Operating Profit: 175 million yen, +6.8% YoY)

There were no major acquisitions or sales of properties by this segment and as a result, performance remained flattish YoY.

Q3 FY03/11 Results

The company released Q3 FY03/11 results on February 3, 2011.

Sales and operating profit increased YoY. Grandy started selling new homes in more areas vs. FY03/10 and sold a large number of Detached Homes in the Tochigi area.

Business performance and summary per segment for cumulative Q3 FY03/11:

• Real Estate: (Sales: 18.8 billion yen, +19.6% YoY; Operating Profit: 1.1 billion yen, +151.2% YoY)

Performance in the company's core segment, new home construction, was strong across the board with a 31% increase in sales over the previous year. By region, sales were +25% YoY in Tochigi, +50% YoY in Ibaraki, and +28% YoY in Gunma.

The company commented that the strong order trend continued into Q3 FY03/11 and kept its plan to increase the sales staff to 200 in FY03/12 in place. The company said that it opened a branch in the Ushiku area (in southern Ibaraki) in January 2011, and was moving into the Yaita area (in northern Tochigi) with plans to open a branch there in March 2011, and that it strengthened operations in Gunma. Regarding the 200-person increase in sales staff, the company has already finished adding core employees (team leaders, etc.) and now plans to recruit support staff as needed. Highly capable core employees have already been dispatched to Gunma offices, and the company expects business in the region to grow during FY03/12.

Used home sales averaged 15 homes per month in 1H FY03/11, but the pace picked up to roughly 18 homes a month in Q3 FY03/11. The company commented that it started to increase land purchases in early 2011 and will continue to do so into FY03/12. The company also said that by increasing its supply of homes, it hopes to meet its existing goal of 25 home sales per month.

• Pre-Cut Parts (Sales: 1.4 billion yen, Operating Profit: 12 million yen)

In September 2010, the company increased its manufacturing facilities and sales are increasing as an expansion of direct sales is underway. However, the company commented that profitability in the segment is low due to the continued high price of materials. Therefore, the company will review pricing structure and hopes to increase sales to the builders who yield high profits.

• Real Estate Leasing: (Sales: 212 million yen, -4.7% YoY; Operating Profit: 134 million yen, -3.8% YoY)

Q2 (1H) FY03/11 Results

The company released Q2 FY03/11 results on November 4, 2010. As a percentage of the full year company estimate 1H FY03/11 results were as follows:

• Sales: 49.3% (vs. FY estimate of 27.3 billion yen )

• Operating profit: 65.1% (vs. FY estimate of 1.2 billion yen)

• Recurring profit: 55.1% (vs. FY estimate of 1.4 billion yen)

• Net income: 58.5% (vs. FY estimate of 750 million yen)

Sales improved in all areas following an increase in the number of sales people, and both cost reductions and tighter inventory control helped improve OPM.

Business performance and summary per segment for 1H FY03/11:

Real Estate Sales: New Homes (Sales: 10.6 billion yen, +30.4% YoY)

Performance in the company’s core segment, new home construction, was strong with sales of 9.7 billion yen, a 35.5% increase over the previous year (units increased to 362 homes, +35.6% YoY). By region, sales in Tochigi totaled 5.7 billion yen (+24.3% YoY), in Ibaraki – 3.2 billion yen (+44.6% YoY), and in Gunma – 1.2 billion yen (+59.3% YoY). There were large increases in sales in almost every region, but the company commented that it was somewhat dissatisfied with sales levels in Gunma. The company said that it was gradually becoming more widely known in Ibaraki, which was having a positive effect on land purchasing, sales activities, and hiring.

The sales force stood at 160 people at the end of Q2 FY03/11, an increase of 43 people compared to the end of Q2 FY03/10. The number of orders received for new home construction grew in proportion to the number of sales staff – 420 orders in the 1H FY03/11, a 36.4% increase YoY.

The company expected the strong order trend of the 1H FY03/11 to continue into the 2H FY03/11 and kept unchanged its plan to increase the sales staff to 200 in the near future. It planned to open branches in Ushiku (in southern Ibaraki) in January 2011 and in Yaita (northern Tochigi) in March 2011. Once the Yaita branch opens, the company will be operating in nearly all areas of Tochigi.

Real Estate Sales: Used Homes (Sales: 1.6 billion yen, +34.9%YoY)

Grandy House attributes its substantial increase in revenue to the effects of government policies put in place to respond to market conditions (which seem to be improving) and internal reorganization. Policy changes included expanding non-taxable home loan finance gifts, simplifying mortgage applications, reducing home loan taxes, “Flat 35S” preferential interest rates, etc. Structural reorganization included subdividing the company’s areas of operation and increasing the number of sales staff from three to four per team. Team size was also revised in FY03/11 so that six rather than five people would be in charge of larger regions (similar to the new home sales teams). However, the company sees substantial potential for this segment to grow and commented that it was not yet satisfied with performance. Sales averaged 15 units per month during the 1H, but the company hopes to reach a pace of 25 sales per month in the near future. The company said it planned to use the know-how it gained in Tochigi Prefecture to enter neighboring markets. In September 2010 it opened a branch in the city of Ota, in Gunma (the first one outside of Tochigi for the used homes business).

The company commented that the trend of increased orders during the 1H FY03/11 could be sustained into 2H FY03/11, similar to the New Home sales segment.

Pre-Cut Parts (Sales: 896 million yen, +45.0% YoY)

Sales in 1H FY03/11 were as follows: sales to external customers – 896 million yen, sales to group companies – about 1.1 billion yen. Only about 1.1 billion yen worth of parts was produced, not enough to meet demand, and the company had to outsource some production to third parties (similar to FY03/10).

In September 2010, Grandy House expanded its manufacturing facilities and increased capacity by 1.5 times. As of 2H FY 03/11, it could handle up to 2.5 billion yen (annualized) worth of parts in-house. To improve profitability, the company plans to raise the proportion of more profitable smaller contractors among its clients. As of the beginning of Q3 FY03/11 such smaller contractors accounted for only 20%-30% of external sales.

Q1 FY03/11 Results

The company released Q1 FY03/11 results on August 3, 2010. As a percentage of the 1H company estimate, Q1 numbers were as follows:

• Sales: 51.7% (6.2 billion yen vs. 1H estimate of 12 billion yen )

• Operating profit: 72.3% (289 million yen vs. 1H estimate of 400 million yen)

• Recurring profit: 69.8% (279 million yen vs. 1H estimate of 400 million yen)

• Net income: 68.0% (150 million yen vs. 1H estimate of 220 million yen)

There was no change to the 1H or full year forecasts.

Both sales and operating profit were up YoY. Grandy started selling new homes in more areas vs. FY03/10 and focused on growing orders by adding more salespeople.

Sales of built-for-sale homes in the Tochigi and Ibaraki prefectures drove performance, while business in Gunma was softer than the company had initially expected. SR Inc. suspects that an improving macro environment as well as other factors (tax-exempt real estate gifts, a shortened application process, mortgage tax deductions, and attractive Flat 35S mortgages) could be stimulating demand. The company mentioned that the order flow in Q1 was encouraging, similar to internal expectations. In discussion with SR Inc., the company commented that it was targeting 70 unit sales per month (total) for the year, vs. 60 units per month in FY03/10.

The used homes business continues to grow, but it seems that management would like to see the pace improve. Grandy sold about 15 used homes per month in Q1, more than the 11 per month in FY03/10, but less than the 25 per month expected capacity mentioned following Q4 FY03/10. The company commented that it would try to address what it identified as the problem: a lack of the “right” properties (location, price, etc.), and improve supply channels (using internal resources vs. outside property agents). Management sounds convinced that used home sales will be an important piece of the business, with sales growth potential of about 10 billion yen within 4 or 5 years.

Costs appear to be under control; the company commented its fixed costs matched the needs of current business and were unlikely to rise further. Average gross profit had improved by about 500,000 yen following the new inventory turnover policy (aggressively sell homes that are unsold after six months), which should improve overall cash flows.

Although it is arguably too soon to call a return to normal, SR Inc. notes that there are signs of life - Kanto housing starts were +2.7% YoY in Q1 vs. large double-digit declines for most of FY03/10. SR Inc. speculates that if strength in the core built-for-sale business continues, a forecast revision could be a possibility.

FY03/10 Full Year Results

The company released FY03/10 results on May 6, 2010.

• Sales for the year were 22.1 billion yen (up 12.0% YoY), 0.5% over initial estimates.

• Operating profit was 884 million yen (up 13.6% YoY), 1.6% over initial estimates.

• Recurring profit was 854 million yen (up 18.8% YoY), 6.7% over initial estimates.

• Net income was 469 million yen (up 26.8% YoY), 17.3% over initial estimates.

FY03/10 Results Report Card

Revenues

Target: 22.0 billion yen (+11.4% YoY)

Result: 22.1 billion yen (+12.0% YoY)

Operating Profit

Target: 870 million yen (+11.8% YoY; 4.0% OPM)

Result: 884 million yen (+13.6% YoY; 4.0% OPM)

Recurring Profit

Target: 800 million yen (+11.3% YoY; 3.6% RPM)

Result: 854 million yen (+18.8% YoY; 3.9% RPM)

Net Income

Target: 400 million yen (+8.1% YoY; 1.8% NPM)

Result: 469 million yen (+26.8% YoY; 2.1% NPM)

FY03/10 sales exceeded the company’s forecasts. Sales in all three of the company’s core markets (Tochigi, Ibaraki, Gunma) grew YoY, with relatively stronger recovery in Ibaraki (+27.9% YoY) and Gunma (+11.1%) than Tochigi (+5.2%). The sales were, as expected, dominated by the built-for-sale homes, 69.9% of the total. The new homes sales recovered but the pace was still slow – only 6.3% increase in built-for-sale units from the low level of 536 to 570 units. The second hand units grew strong 61.4% to 134 units.

The company said that the market was showing clear signs of improvement, helped by tax benefits and other measures (described in FY03/11 Outlook sub-section).

Gross profit margin improved YoY, from 15.9% to 17.0%.

Both operating and recurring profit rose YoY, continuing the recovery trend, but profit margins were flat vs. FY03/09 on higher SG&A expenses. SG&A-to-sales ratio increased by 1% to 13.0% due to higher labor costs as the company continued investing in the used homes business, growing headcount and expanding offices.

Q3 Results

Grandy House released Q3 results on February 3, 2010. Cumulative results were: sales were 15.93 billion yen (up 8.6% YoY); operating profit was 559 million yen (down 6.4% YoY); recurring profit was 523 million yen (down 4.3% YoY); net income was 296 million yen (up 12.2% YoY).

The company indicated that overall market conditions were improving in key areas of operation, and that consumer demand is starting to increase. The largest contributor to sales during Q3 was sales in Ibaraki (increase of 359 million yen YoY, or 32.4%); driven by detached home sales of 1.35 billion yen (versus 970 million yen during Q3 FY03/09). Total sales in Tochigi increased approximately 10.1% YoY; weakness in detached home sales (down 10.8% YoY) was offset by more sales of land and custom homes.

In Ibaraki, the company seems to be benefiting from relatively low competition as local players tended to focus on custom homes. This makes it easier for Grandy to buy the land and offer detached homes at attractive prices to consumers who previously were faced only with the more expensive custom home option.

Used home sales continue to be an area of focus and growth for the company. The company sold 31 used homes during Q3, bringing the cumulative number of used home sales to 94 units through Q3 FY03/09. Cumulative Q3 sales levels represent an approximate 50% increase YoY (63). Given the progress thus far, SR Inc. estimates that the company should be able to meet the company’s estimate of 120 used home sales for the full year plan.

Various cost cutting measures are beginning to make an impact. The company indicated that gross profit per house recovered few percentage points in Q3 form the previously depressed levels. SR Inc understands that along with efforts being made in sourcing, the company has also realigned internal incentives to focus on gross profit margins.

SR Inc. received the impression that the company is cautiously optimistic with respect to its ability to meet full year forecasts. In SR Inc.’s opinion, this sentiment seems reasonable once considering improvements in the company’s cost structure, the improving economy, and the competitive situation in the company’s core prefectures. The recent trends also give some reasons to be optimistic about the outlook for FY03/11.

The company announced a change in top-level management closely timed with the release of Q3 FY03/10 results. Kunio Iso was appointed as the successor to COO Akira Fukuda, who will assume the role of President at Ibaraki Grandy House Corporation. Iso joined the company in 1996 from Toyota Woodyou Homes, increasing the company’s architecture and construction expertise (the company was then more focused on real estate). SR Inc. wonders if this change could mean that the leadership of the company becomes more concentrated with CEO Kikuchi giving the company more unified sense of direction and streamlining the executive decision making.

Q2 (1H) Results

On November 6, 2009, Grandy House announced cumulative 1H consolidated results: sales were 10.25 billion yen (up 2.5% YoY) vs. an original forecast of 10.5 billion yen; operating profit was 326 million yen (down 22.8% YoY) vs 430 million yen forecast; recurring profit was 310 million yen (down 20.2% YoY) vs. estimate of 400 million, and net income was 203 million yen (up 3.2% YoY) vs. original estimate of 200 million yen.

The company’s new home sales of 296 units during 1H represented a 5.7% increase YoY; a notable result given market conditions: 29% decrease in detached home starts in Tochigi and similar declines in Ibaraki (-28% YoY) and Gunma (-32%).

According to the company’s earnings report, weak consumer sentiment and continued strict mortgage application reviews by banks caused deterioration in housing demand, and as a result housing starts remained depressed. In the Northern Kanto area, detached home starts for the April-August period were down by more than 30% YoY. The company managed to secure the same number of orders for its new homes as it did in Q1 of FY03/09 and it also increased sales of used homes. However, intensifying competition and some delays involving land sales meant that Company estimates have not been achieved. The full year forecast was not changed at the time of the announcement.

Accounting changes related to the timing of sales recognition resulted in 1H sales figures being higher by 81.79 million yen; net income, operating and recurring profit were all higher by 22.43 million yen (specifically related to recognizing the percentage of completed construction for pre-order homes). The accounting change applies to all firms; adoption was not management discretion.

Q1 Results

The company reported Q1 results on August 5, 2009. Sales increased 15.1% YoY to 5.18 billion yen; operating profit was up 13.4% to 220 million yen. Gross profit margin stayed flat compared to the previous year at 17%. Overall results appear to be neutral to SR Inc., with the numbers likely clearing the contribution hurdle towards the official 1H target. At the same time, Company commented that the numbers were somewhat weaker than the internal targets.

Market conditions remain challenging according to the management. While the economy of Northern Kanto seems to be performing better than many of Japan’s remote areas, the weak labor market, uncertainty about future incomes, and expectations of lower prices among consumers mean that selling houses is not an easy task. Company is working to solidify its local dominance and to improve profitability by approaching the market one house, one customer at a time.

The number of new homes sold in Q1 was 147 units, including 32 custom built houses. This is a 27.8% YoY increase. SR Inc. estimates that the number was somewhat below the internal budget. Used homes business is continuing to grow. Company sold 28 units in Q1, in line with initial projections. SR Inc. believes that this business will continue to grow and should become an important contributor to earnings recovery and growth over 2-3 year horizon.

Overall Real Estate Sales segment recorded 15.8% YoY increase in sales to 5.1 billion yen and 28.7% jump in the operating profit to 168 million yen. In Real Estate Leasing segment sales and earnings declined due to a sale of a number of properties in FY03/09.

The company kept its full year estimates unchanged.

Income Statement

Historical Earnings Forecasts

The company had a tendency to present aggressive guidance since listing and revise down the original forecast later, however this trend has reversed itself since FY03/09. The company revised up the original guidance in September 2008 and achieved new target at the fiscal year end. According to management, they always try to stay realistic and conservative in terms of forecasts. SR Inc. believes that the official published forecasts are generally similar to internal company targets.

Actual Results
The company started as a real estate operator, buying and selling land to individuals. It later moved to sell built-to-order houses and then started selling detached built-for-sale houses. The ability to buy land and understanding of real estate locations gave the company a significant boost when it focused on home building business.

While the company’s business was impacted by the previous recession in 2002, it achieved remarkable growth, tripling earnings in the period from FY03/01 to FY03/07. Focus on growth, internal management issues following exchange listing, and increased competition from condo developers driven by easy credit led to a slowdown in FY03/07 and a sharp earnings drop in FY03/08 when RP fell to 400 million yen, the lowest level in several years. Following unexpectedly weak performance in FY03/07, the company tried to aggressively address sales costs by linking a higher ratio of pay to performance. That led to a decline in morale amid growing economic woes in the region creating, by management's own admission, a “vicious cycle”. The company has since adjusted its approach to labor costs and employee morale. Rising labor costs are partly due to management's realization that the company needs to rebuild itself as a nicer and more balanced place to work.

The drop in sales and RP in FY03/08, -33% YoY and -87% YoY respectively, was due to a combination of following factors:

• Deterioration of supply/demand situation in the core market of Tochigi due to a significant increase in supply of condominiums for sale.
• Problems associated with unsafe condos scandal (“Aneha scandal”)
• Poor consumption impacted by rising prices of gasoline
• Competition from non-traditional rivals, Kanto based builders

FY03/09

Grandy's earnings recovered in FY03/09, with original full-year guidance revised up in September 2008 due to better than expected sales on the back of order trend recovery since December 2008 (Source: Upward revision news release of September 17, 2008). This was achieved despite high material costs driven by global commodity bubble.

The company then proceeded to achieve revised guidance, resulting in 32% YoY sales growth, 57% growth in operating profit (OP), 80% recurring profit (RP) growth. According to management, this was driven by better performance of sales companies, improved training of sales force, and more focus on improving individual sales office efficiency. The company sold 117 more detached homes and 14 more built-to-order homes for the total of 565 units in FY03/09. Sales of used houses also contributed positively in FY03/09 (increasing by 45 to the total of 83 units). SR Inc. expects growth in sales of used homes to outpace growth in other segments in the future.

Highlights in FY03/09 were strategic focus on popular areas such as Utsunomiya and Mito (Ibaraki Prefecture) and more focus on more affluent consumer. This latter resulted in higher unit price per customer (26% of houses sold were priced at 30 million yen or more compared to 20% in FY03/08). Order trends have been in a recovery trend since Q4 of FY03/09.

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Balance Sheet

Assets

Current assets increased by 588 million yen in FY03/10 due to cash and accounts receivable.

Inventory stayed at more than 1 year worth of houses for sale at the end of FY03/10 (10.5 billion yen).

Company balance sheet has negligible amounts of accounts receivables and accounts payable. As with any real estate business, it is all about inventory and how quickly can a firm turn it.

In terms of fixed assets, as of FY03/10 end the company had 6 billion yen worth of land and 3.3 billion yen worth of buildings on its balance sheet.

Liabilities

Total debt as of FY 03/10 end was 10.3 billion yen, second lowest level in the last 7 years. Total liabilities increased by 168 million yen to 13.1 billion yen as of FY03/10 end. Debt-to-equity ratio stood at 1.1x at FY03/10 end (1.16x in FY03/09), reasonable level both historically and from the interest payment burden perspective. Majority of interest bearing liabilities is short term, matching the inventory cycle. Therefore a substantial increase in unsold inventory would present financial risk, however this is not the case with the company whose financial situation seems to be stable.

The company lowered its overall level of indebtedness in FY03/10, probably partly due to a conservative (reluctant) stance of banks regarding financing of new projects. This situation seems likely to persist in the near future as banks work through their problem loan books and will probably be reluctant to increase their real estate exposure.

The relationship with banks has been an area of focus for any real estate related company in 2008 and early 2009. Being a dominant regional player, the company enjoys more stable relationship with its main banks, Ashikaga, Gunma and Joyo compared to Tokyo based real estate firms that are more dependent on city banks and foreign lenders. The company commented that it did not feel pressure from banks to restructure or aggressively lower its level of indebtedness. The company commented at the analyst results meeting on May 25, 2009 that the attitude of banks was very nervous in the aftermath of the financial crisis in 2008, in Japan referred to as the “Lehman shock”. However, that attitude started normalizing in FY03/10, and the company was able to re-start land purchases.

Development projects are financed on an individual basis by each subsidiary and SR Inc. estimates that it is generally harder for subsidiaries located in Ibaraki and Gunma to obtain new project financing.

Shareholders’ Capital

Shareholders' equity increased by 2771 million yen in FY03/10 (+469 million yen net income increase, -192 million yen of dividends).

Per Share Data

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Cash Flow Statement

Operating Cash Flow

Operating cash flow was positive in FY03/10 at 1.3 billion yen compared to 2.7 billion yen a year earlier. The decrease was due to a decline in inventory of houses for sale that boosted FY03/09 operating cash flow.

Investment Cash Flow

Investment cash flow was also positive in FY03/10 at 53 million yen compared to 485 million yen in FY03/09. FY03/09 investment cash flow was due to disposals and a low level of new property acquisitions.

Financing Cash Flow

Financing cash flow was negative at 745 million yen as of FY03/10 end, compared to negative 2.9 billion yen in FY03/09. Grandy repaid both short-term and long-term portions of its debt in FY03/09, and further reduced overall borrowing levels in FY03/10.

In total, cash and equivalents increased by 576 million yen at the end of FY03/10.

Simple Free Cash Flow

The company’s simple free cash flow was 1.3 billion yen vs. 2.1 billion yen in FY03/09. The company had a higher pre-tax income in FY03/10 vs. a year earlier, but inventory reductions in FY03/09 weren’t duplicated in FY03/10. Higher levels of payables in FY03/10 were the main factor of lower working capital needs.

Source:Company, Hakomori New-Town Development

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Other Information

History

April 1991. Established as Shin Nihon Kaihatsu KK in Utsunomiya, Tochigi prefecture to sell subdivided land.

September 1999. Started “Grandy” brand for detached built-for-sale houses.

November 1999. The company name changed to Shin Nihon Grandy.

January 2004. Name changed to Grandy House.

December 2005. Listed on the 2^nd Section of Tokyo Stock Exchange, exchange code number 8999.

Initially Grandy House was selling subdivided plots of land later moving into built-to-order home building and then detached home (“bunjo ikkodate jutaku”) building business, currently the main pillar of operations. The company is offering homes in several standard series with projects designed to blend into environment with individual houses being different from one other. In built-to-order segment Grandy offers differentiated Yu-Yu Jizai series. It is now also involved in used home sales, pre-cut wood parts manufacturing, real estate development, and house refurbishing (“reform”) businesses.

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News & Topics

August 2011 On August 3, 2011, the company released Q1 FY03/12 results: click here to go direct to the Q1 FY03/12 results section.

(For original Japanese-language only release in PDF format please click here)

May 2011

On May 9, 2011, the company released FY03/11 results.

(For original Japanese-language only release in PDF format please click here)

April 2011

On April 18, 2011, the company revised its financial forecast for FY03/11. Details of the revision are below:

• Sales: 27.2 billion yen (vs. previous forecast of 27.3 billion yen)
• Operating profit: 1.5 billion yen (vs. previous forecast of 1.2 billion yen)
• Recurring profit: 1.5 billion yen (vs. previous forecast of 1.4 billion yen)
• Net income: 798 million yen (vs. previous forecast of 750 million yen )

The company noted that its sales forecast was revised slightly lower as the Tohoku earthquake caused delays in the handing over of some homes. However, operating profit was upwardly revised due higher profit margins driven by improved turnover rates and cost controls.

March 2011

On March 14, 2011, the company made an announcement regarding the March 11 Tohoku earthquake.

• All of the company’s plants and facilities were operating normally.
• There was only minor damage related to the company's core new home construction segment (including homes under construction).
• The company thought that effects of the earthquake on FY03/11 earnings would be minor.
• The company would release details as necessary if it became clear that FY03/11 earnings would be impacted by effects of the earthquake.

February 2011

On February 3, 2011, the company released Q3 FY03/11 results. The company also announced a change in management with an effective date of March 1, 2011.

• Hiroyuki Murata (New role: President of Grandy House, previously Vice President of Grandy House)
• Kunio Iso (New role: Vice President of Grandy House, previously President of Grandy House)

November 2010

On November 4, 2010, the company released Q2 FY03/11 results.

October

On October 4, 2010, the company announced an upward revision to 1H and full year FY03/11 forecasts. The revised figures were as follows:

1H FY03/11 forecasts

Sales: 13.4 billion yen (previous forecast: 12.0 billion yen)

Operating profit: 610 million yen (previous forecast: 400 million yen)

Recurring profit: 710 million yen (previous forecast: 400 million yen)

Net income: 400 million yen (previous forecast: 220 million yen)

FY03/11 forecasts

Sales: 27.3 billion yen (previous forecast: 26.0 billion yen)

Operating profit: 1.2 billion yen (previous forecast: 1.0 billion yen)

Recurring profit: 1.4 billion yen (previous forecast: 1.0 billion yen)

Net income: 750 million yen (previous forecast: 500 million yen)

The company mentioned that the combination of higher sales and lower than anticipated costs were the basis for the revision. Sales improved in all areas following an increase in the number of sales people, and both cost reductions and tighter inventory control helped improve OPM.

August

The company announced Q1 FY03/11 results on August 3, 2010.

February

The company announced a change in management on February 2, 2010, with an effective date of March 1, 2010.

• Akira Fukuda, President and COO of Grandy House, assumed the role of CEO at Ibaraki Grandy House Corporation
• Kunio Iso (on the Board of Grandy House and the President and CEO of General Livtec) became Fukuda’s successor.

Industry News and Topics

• Implementation of Law of execution of Warranty Against Housing Defects (In force from October 2009) will lead to a cost increase of approximately 100,000 yen per house. At the same time tax subsidies for housing loans and “eco” subsidies, such as assistance in acquiring solar panels should help housing demand, according to the company.

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Top Management

Short biographies of the key members are provided below:

Born in 1950, Toshio Kikuchi, is the founder and chairman of the company. He became a chairman in 2006. While he is currently involved only with the most important decisions such as capital allocation and major strategy issues, Mr. Kikuchi remains the key figure at the company. His background as a real estate developer shaped the company's aggressive ascent. Before starting Grandy he was a senior executive in charge of land procurement at Woodyou Homes (currently Toyota Woodyou Homes, a competitor).

Hiroyuki Murata, born in 1960, he became the President of the company in 2011. Murata joined the company in 1998 and became a director in 2000. He was previously with Subaru Housing.

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Employees

As of end FY03/11 the company employed 516 people on a consolidated basis.

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Major Shareholders

As of end-FY03/11, the top ten shareholders collectively accounted for 53.36% of shares outstanding. Foreigners increased to 10.1% as of end-FY03/11 from 9.0% as of end-FY03/10. The number of shareholders was 3,191 as of end-FY03/11.

Number of shareholders: 3,294 as at the end of FY03/10.
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Dividends and Shareholder Benefits

The company maintained the dividend of 2,000 yen from its listing in FY03/06. The same amount is planned for FY03/11. The company will continue to pay the dividend once year. In addition to the normal dividend the company flagged its intention to reward shareholders more generously by paying special dividends when it can be justified by operating conditions. The company paid a special dividend of 333.33 yen (split adjusted; the company split 1:3 on March 28, 2006) in FY03/06 to commemorate its exchange listing.

The company also performed a buyback of 3,699 shares in FY03/07. Management does not rule out future buybacks as a part of its shareholder return policy but has not announced any concrete programs as yet.

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Investor Relations

Result meetings are held in Tokyo after the announcement of interim and fiscal year end results.

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By the Way

Latest Q&A

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