Logistics in Crisis? the 2024 Problem (Free)
Part 2: one related stock idea at 4.9x EBITDA and close to 40% of market cap in cash
Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. It may include some errors, please make sure to do your due diligence. The opinions expressed are those of the author and are subject to change without notice.
Disclosure: The author currently owns shares in the company as of 8 October 2024. The security could be sold at any point in time without prior notice.
One Idea in Logistics DX
Welcome to Part 2 of my logistics series. (You can find Part 1 here) I’ll briefly talk about a nanocap that could benefit from the shake-up in the logistics industry. This particularly interested me because it covers 2 themes I like which are: the 2024 Problem but also the 2025 Digital Cliff (in other words, DX). This is more like a shallow-dive so for the sake of brevity I’ll more or less highlight the main things I like + don’t like.
The company is Logizard $4391.JP, which is not a Pokemon (You’re thinking about Charizard) but probably the only listed pure-play Warehouse Management System (WMS) SaaS company in Japan. I guess one of the closest comparables in the US is Manhattan Associates MANH 0.00%↑ although they’re much, much bigger.
Market Cap: ¥4.1b
NTM P/E: 14.6x (9.2x ex-cash)
NTM EV/EBITDA: 4.9x
NTM EV/EBIT: 6.4x
NTM EV/Sales: 1.1x (1.4x ARR)
ROCE: 21.3%
To summarise the opportunity set for this company:
Logizard will see strong demand for digital/automation in the logistics industry given increasing constraints. This could continue for years to come, leading to a steady growth of earnings in the teens.
E-commerce and more complex consumer purchase behaviors will also likely require more oversight over inventory management which adds to that need.
The business is still early in terms of adoption but has steadily grown, since they hired more aggressively last year margins fell. I think this could lead to better growth looking-out and earnings to accelerate as margins recover.
The quality of revenue is going to improve as they now focus more on B2B customer segment > B2C. To that end, understanding the complex requirements of customers + competitors relatively late to the party = an expanding moat for Logizard.
40% of the market cap is cash which provides downside protection for an already predictable business model.
I’d add this is still a small position for me as there are things to be mindful of which I discuss below. I’m happy to miss out on the initial ‘pop’ if that means I can de-risk some of the concerns I have. On the other hand, as time slowly reveals the opportunity for this business, I’d expect to own it for many years as earnings compound.
The business
They provide several inventory management SaaS solutions. Their main solution is Logizard Zero which is their core Warehouse management solution or ‘WMS’ (90% of solution sales), which they launched in 2012. They’ve also more recently released Logizard Zero Store which is a complementary store inventory management solution useful for retail chains.
The solution is a SaaS native based on a subscription and volume-based fee structure. As part of their offering, Logizard also sources hardware and sells/leases them out to customers. Things like handheld terminals/scanners and small warehouse robots used for sorting. More recently their customers have become larger and this resulted in need for higher value items like material handling machines (Which is…$$$) Today, Logizard serves more than 1700 accounts.
They have 2 main customer segments.
1)B2C: These customers are smaller e-commerce shops. Logizard usually doesn’t contract with them directly but rather, they contract with warehouses which handle such customers. Fees for the shops involve a fixed minimum shipping volume component (¥10k/month) plus a variable fee based on volume above that threshold. There is usually no initial fee.
2)B2B: These can be larger retail chains, 3PLs and other logistics companies. Fees here are mostly based on a fixed fee per location. If for instance, a customer has multiple warehouses, they are charged for each warehouse. In addition to that, there might be additional fees based on customization
. This customer segment is currently around 60% of Logizard’s sales. These customers have way more complex logistics needs and order sizes can be larger compared to B2C. It’s also getting more complicated because these customers are shifting towards an omnichannel format. Given the nature of these customers, this market is much larger. Based on GMV about 50x larger than their B2C market. These are the customers that might need to connect inventory to their ERP for instance, so it quickly becomes a critical function. The absolute revenue is much larger.
This distinction will be important as you’ll see later.
The WMS solutions are annoying to switch once it’s running. There is a degree of customisation involved for each customer meaning that they will have to do this all over again if they go for a new solution. In addition to that, while the whole backend is being replaced, the warehouse will stop functioning for a period of time so the opportunity cost of switching can also be expensive. This is why customers are extremely careful at the initial RFP stage. Some customers have been with them for close to 20 years which is telling. Monthly customer churn hovers around 0.9-1.2% though revenue churn is much lower given that the customers that mainly churn are the small EC shops categorised under B2C customers. (sadly they don’t disclose the exact figure). Churn is naturally higher for EC shops as they only have to cancel their agreement with their warehouse provider.
The conclusion here is that the B2B segment is the more interesting opportunity for Logizard and IMO the quality of revenues is higher, given the scale of the customers, lower churn, fixed pricing, size of the market, and Logizard’s competitive positioning. Ultimately the value logizard can potentially provide for them is higher.
Growth
The business doesn’t directly solve the truck driver problem in Japan, but the knock-on effects from this are real and the 2024 problem should be captured as a ‘logistics industry problem’. Many industry participants are affected. Warehouses too are also suffering from a labor shortage as I mentioned and the working conditions in these places are harsh. So hiring is becoming more expensive and this is why we need even more DX and automation.
The business itself claims to see a very strong pipeline of demand to implement their solutions. This is no real surprise given the latent pressure coming from these regulatory changes. It’s not just that, the level of digitalization in Japan is still too low.
This can be broken down into 2 layers in my view.
Operational DX
Many companies in the logistics supply chain (much like the rest of Japan really) are late in adopting IT solutions into their operations. Trucking for instance is a fragmented market and limited resources can be put towards that. Larger firms have historically created a highly customized solution via a system integrator but these are also starting to get too old. This calls in the ‘other problem’ which is the 2025 digital cliff, where we’re expecting a huge demand for system replacement across corporate Japan.
Change in consumer behavior through E-commerce.
As it becomes more convenient to purchase whatever online for consumers this introduces more complexity into the logistics supply change. People buy things more frequently but also from multiple places and may also need to return items. An additional layer of complexity is now apparent because more mid to large-size enterprises are aiming to have an OMO (online merges with offline) type customer journey where physical stores are used as a showroom and contact point. So you can imagine, trying to track inventory without any digital aid is going to be a tall order. This can be a real bottleneck to scaling businesses and the solutions if implemented well can be highly value accretive. One of Logizard’s clients for instance was able to 5x their shipping volume. (Obviously, this is best case, but you get the point!)
Furthermore, another demand push likely will come from the digital cliff. Many of the systems that are in use today including in logistics is getting super, super old and its a matter of time before we see an influx of demand driven by replacement needs. At this juncture, some customers are likely to opt for more scalable solutions that aren’t highly tailored and/or clunky. So there is some potential for these companies to approach logizard for their solutions.
So now you might be thinking “oh yeah, huuuge business, very exciting” but here’s the catch, this is not a hyper-growth software biz. Given these have to be installed in physical sites (warehouses) as a mix of software and hardware with varying needs, Logizard’s ability to digest demand largely depends on the number of engineers they are able to hire and deploy. Increased hiring has been what Logizard has been doing the last 2 years and this could start becoming more visible. Although they are nowhere near done with hiring. I actually think hiring engineers will be the main growth driver of this business. So where I could be wrong here, is if they manage to hire faster than expected at which point throughput to install their systems can be higher. They’ve shown willingness to do so as mentioned in their recent earnings calls.
That said growth rates won’t increase to 20%+ all of a sudden.
They’ve been a ‘boring’ steady grower over the last few years, and they may as well be in the future. Which is fine at the right price. So overall the base case is that it’ll sustainably grow at revenues at high single digit but as they start shifting to larger clients I expect revenue to slowly accelerate somewhat to teens growth. Overall with some margin expansion, we could expect a teens growth in earnings for some time. So what we want here is ‘boring but predictable’
Their headcount (below) has grown over the years and now houses 81 engineers. The company is looking to reach 150 sooner rather than later. The more engineers they can hire earlier, the more projects they can take on = more sales. The company reports employee attrition of 2-3 people a year so this is sufficiently low.
Competition:
Smaller SaaS players are struggling because many of them are targeting small-scale E-commerce bizes, which tend to have a higher churn rate as many don’t succeed. Budgets are also tighter and therefore revenue scale per customer is small. Combining this it’s difficult to make money. Many tried to enter at the height of covid with a low price offering but did not work too well. There’s no denying in any case that the B2C side is more competitive as the needs of small EC shops are fundamentally easier to fulfill and in the future, the competition will likely only increase. Therefore, I think it is worthwhile for the company to focus on the B2B market, where the value added can be much higher and Logizard can become an incumbent. In fact, their solutions were originally aimed at B2B and not B2C (but got kind of distracted at the height of Covid)
It’s worth noting that Logizard is seen as the industry benchmark for pricing so that means customers will always try to undercut them. Though ultimately it’s not just about the price for a critical function in your business. Logizard wins contracts because of their extensive experience in the industry (again, there’s just not that many players here), their track record over 2 decades, and their strong customer service. They understand the small details that may cause problems when installing such a system and they can install in a relatively short time (still a few months) but much faster than a system integrator in many cases. Logizard provides support 365 days/year and customers really appreciate their high-touch customer service which can often respond within 30 minutes. This has been a key to customer loyalty.
One notable competitor would be Kantsu $9326.JP, which developed an in-house solution that they’ve decided to sell to 3rd parties. Their main strength is that they’re a logistics service provider themselves so have extensive operational knowledge. Moreover, customer/supplier relationships may even help them in client acquisition. Logizard notes that they sometimes meet them at biddings in the Kansai (Western Japan) region where Kantsu is based. To be fair, whilst Kantsu’s IT biz is only half of Logizards (although they’re reporting faster growth), I think they can be interesting as well as their IT portion is growing much faster than their core business and given the higher margins driving overall profits - which doesn’t seem appreciated. What’s of note here is that they’ve reported operating margins for their IT business of 40-50%. This is interesting to think about when you consider the margin potential for Logizard which is only in the high teens.
US folks like Manhattan Associates are present in Japan, but product acceptance has been limited. It sounds like they’ve not been good at tailoring their solution to the very particular needs of Japanese Corporates (and they can be particular alright!) which makes sense, at the granular level even Japanese Logistics is done differently to the US! Overall Japanese corporates seem to prefer using home grown ‘Made in Japan’ software providers here as a result.
The other type of competition is system integrators known as “SI-ers” in Japan. There are quite a few of these also in the stock market. These are the guys that produce highly customized (read: Totally not scalable) systems for customers. The issue here is that many customers can’t afford it unless you are an enterprise. So especially in the mid-size business segment, Logizard has an edge.
This can be a lucrative business but given the unit economics here, they’re disincentivized to switch to a SaaS-type model as it can take years before they can break even - and their SI model can effectively lock customers in for a loooong time. So many take the route of ‘if it ain’t broke, don’t fix it’.
Management
Logizard was founded by Kanazawa-san who is still the CEO today. His first job was at the Apparel Company Adastria $2685 working in IT, back office and operations. He was given the responsibility to manage inventory where he would frequent warehouses. This was in the 90s and pre-internet let alone any efficient data management (in Japan..) but he realised how impactful improving inventory management can be to cashflows. He eventually realizes that there’s an opportunity to use IT to improve this and founded his company in 2001. What’s remarkable is that he already started his business as a SaaS company back then - a concept that wasn’t widely recognized - nor did it get customer acceptance initially.
But come the rise of e-commerce, more and more businesses needed efficient supply chain management to keep up with their growth. On-prem IT vendors would typically take a year to build something for you and this wasn’t fast enough. This was when Logizard’s SaaS solution came in handy thanks to the shorter lead times. E-commerce was where they saw their first success. The founder directly owns 11.26% today. Future Corp $4722.JP invested early in 2012/2013 and also owns 27.86% and is now considered a ‘parent’. Future is an IT consulting firm and can be partners in some areas/projects. In a recent filing where Logizard disclosed their relationship with Future, they’ve mentioned (at least..) they have full autonomy to go about their business.
Nonetheless, Future Corp themselves have been a great performer in recent years, and does not hurt to have their backing.
Capitalizing R&D
One thing that didn’t sit too well with me is that they aggressively capitalized R&D expenses last year compared to previous years. Capex was 11% of sales versus the typical 3-4% in line with depreciation. This of course would make the margins look better, it is a little cheeky isn’t it? To be fair to them they break out capitalised vs Expensed R&D clearly and are pretty open about it.
The 2 rationales seem to be that 1) they had to previously expense client customisations of their old module Logizard Plus which is now reaching the end of service (EOS) after a 20-year run. These customizations were highly individualized so couldn’t justify capitalizing them and engineers’ resources were therefore directed more towards that. 2) Now that they are focusing more on B2B customers as their core opportunity, the R&D can be effectively shared. That is, whenever a customer requests an additional feature that doesn’t exist, Logizard develops it and adds it to their platform for others to use. This is why they can capitalize this - and depreciate over 5 years. In short, this is an investment into their B2B opportunity. As more functions get built out, they’ll be able to have a solution that can solve most general issues a client may have. This in itself would lead to further product competitiveness.
Ultimately the elevated capex isn’t bad, since it’s a direct investment into their competitiveness for the future, just know that this will affect free cash flow at least in the short term. This was 11% of sales in fiscal year 24. It sounds though that while they’ll keep investing, as a % of sales it’ll likely fall making the 11% a peak. It seems plausible that their underlying capex needs are lower in reality and their true ability to generate cash, at scale, is much greater. R&D capex is expected to decrease slightly from ¥174mn to ¥154mn this year.
Valuation:
The company trades at a NTM EV/FCF of roughly 10x and a NTM ex-cash P/E of 9.2x which I feel is cheap. Even with the elevated capex last year, that should moderate somewhat this fiscal year and FCF should start growing again. We’re talking about a business that has a predictable revenue stream, a mission critical piece of tech that could grow earnings and FCF double digits. Remembering that there’s a wave of demand for such solutions in the logistics industry, the odds can be in our favor. I don’t think a re-rating (in addition to earnings growth) is out of the question. Clients/Order Sizes are becoming larger which again could surprise the market positively.
The cash, which is 40% of market capitalization is unlikely to be paid out dramatically to shareholders any time soon as buybacks seem unlikely given how illiquid it is, (surprisingly they do pay out dividends!) But this provides a margin of safety on the downside should things fall apart.
Now will it trade like how MANH 0.00%↑ does? Doubt it… I mean those guys look pretty darn expensive ( 15x Sales, >50x EBITDA and >50x FCF? WTF?) but I’d point out that their Gross margin, Revenue CAGR, and Operating Margin all look pretty similar to the tiny peer that is Logizard. All to say that the market seems to like this type of business quite a bit overseas (albeit at a much larger scale) and I think Logizards looks attractive from a risk/reward perspective. As they solve some of their issues, I think there’s a good chance it’ll be trading at a multiple higher than what it is today - whilst being able to grow earnings from low to mid-teens. Coming from a combo of high single-digit revenue growth + some margin expansion.
Why its cheap:
SaaS Shitco Deathtrap: Sold off with the other SaaS names
There was hype late last year by the nikkei after highlighting the ‘2024 problem’ Market likely anticipated faster growth but didn’t realize that the sales cycles for this product are longer than a typical SaaS implementation. (Causing disappointment) and likely got longer since they focus on bigger B2B customers.
Small Mcap and low liquidity.
Margin declined since they started hiring engineers aggressively in the last 2 years.
Limited coverage/English disclosure (more of a bonus if they can fix this)
FCF declined in FY24 because R&D Capex increased.
What could change:
Quality of revenues: Logizard is starting to see strong growth from its B2B customers, which is the better cohort of customers given their stickiness, pricing structure (not volume-based), and order size. Today 60% of their revenues come from their B2B customers. I think the portion of this will likely increase going forward. Apparently, 80% of their pipeline currently are B2B customers.
Revenue/customer size: The market for B2B is estimated to be 50 times larger than the B2C market. Customers in these segments are likely to have larger budgets and therefore the revenue opportunity could be huge for Logizard. This in turn could lead revenues to ‘jump’ more than expected versus their previous trajectory. CEO recently mentioned they’re seeing strong demand for fiscal year 2025. However you’ll have to balance this with the fact that the revenue cycle will likely be longer since the projects are larger and makes it prone to delays.
Margin Expansion: With last year being the toughest in terms of growth spending on the P&L, margins are expected to normalize and expand further in the coming years. There are quite a bit of fixed costs involved making it easier to benefit from operating leverage. Currently, quite a bit of R&D depreciation weighs down on gross margins but as they scale I expect this to be alleviated and provide quite some room for margin expansion from their current sub-20% levels enabling double-digit earnings growth.
R&D Capex is Logizards growth investment which I welcome and good for their future competitiveness. That said I do think the spend will moderate as a % over time and thus FCF should improve again this year onwards.
SaaS is no longer hated: Could also finally play out… but this one is more of a ‘hopefully’. *tears roll down my face*
What I don’t like/Risks
Logizard capitalised more R&D this year which makes the profitability improvements somewhat less impressive. I’d like to see Free Cash Flow inflect before I become comfortable adding more to this position and have a better sense of their Capex plans going forward.
The risk of potential changes in revenue cadence as they move to bigger customers on the B2B side. The opportunities are larger but sales cycles tend to be longer, and the needs more complex. So with a risk of delay, this may push back revenues by an entire fiscal year.
They hold on to a lot of cash - the odds of this being paid out for shareholders is currently questionable (it’s not feasible to buy back shares either) so I only see this as a protection to the downside. Tbf they are saying they want to bring their ROE back up to 20%.
In Q4 last year they had to compensate some customers who had an issue accessing their platform - whilst they mention it was more to do with the infra/network and not an issue with the software itself, as a critical piece of the logistics puzzle you want to make sure to minimize such hiccups. This seems to be sorted already but it’ll be good to just double check on how order behaviour of customers might change near term.
This is still ultimately a sub-scale business, their SaaS model + competitive positioning are neat but execution risk is real - especially as they start winning larger customers as mentioned above. It’s still a small business after all and as they scale, management will also have to adapt their management style that suits the larger scale at that point in time - this, I don’t think, is as easy as it sounds. IMO, If they execute and the opportunity set is really that large, I think there will be opportunities to enter while avoiding some of these initial risks in the future.
Beyond their own engineer base, I’d like to see more partnerships with IT companies (like system integrators) and have partners that could help implement the systems so the throughput of new customers can be higher. Of course, this will also help offset some of the employee retention risk - which can impact growth quite a bit if it sours. In any case, given the opportunity set, perhaps management has been too conservative with their growth plans.
To conclude
This business is thematically interesting as it covers not one but two! issues facing Japan. It’s in an exciting category (SaaS) but boring because of steady growth. I’m totally fine with that, at the right price. With the stock trading at quite depressed multiples I think that’s the case, especially at a point where logistics providers are having to seriously reconsider getting more efficient!
With some of the shortcomings they’ve had (hiring, IT infra) and shift to the B2B segment (more complex, execution risk), I’m taking the careful approach of not entering too aggressively here and look to add as they ‘prove’ themselves with some of these changes, because If the opportunity is really as large as I think it is, I expect the business to compound steadily for quite some time.
Finally there are some case studies you can check out on their website which should translate so go have a look!
Even if you don’t find this idea interesting, I guess you can use this as a comp on your Short Thesis for MANH? Lol.
Disclaimer: The content on this website is for informational and educational purposes only. Nothing should be considered as investment advice or as a guarantee of profit. It may include some errors, please make sure to do your due diligence. The opinions expressed are those of the author and are subject to change without notice.
Disclosure: The author currently owns shares in the company as of the publishing date. The security could be sold at any point in time without prior notice.