EUR 850.00 For Business Accounts Only

Morningstar | Pan Pacific's Profits Growth Depressed by Increased Expenses; Uny Turnaround a Midterm Driver

Narrow-moat Pan Pacific International Holding’s (previously Don Quijote) third-quarter operating profits were slightly below our expectation but seem largely in line with its guidance. A profit decline in the moaty discount store business is attributable to the shortfall as increased personnel and utilities expenses depressed profits. We have marginally lowered our profit forecasts to reflect increased staff hiring for supporting the top-line growth but raised our earnings estimate for 2019 after incorporating a lower tax rate and minority interests. The changes do not affect our fair value estimate of JPY 6,500.

While we are convinced that Pan Pacific will be able to lift Uny’s profitability by leveraging its low-cost operation and sourcing strengths, it appears that speculation on a new offer launched by FamilyMart has bumped up the share price. We consider the shares modestly overvalued with a 9% downside to our fair value estimate. Our profit forecasts remain a touch above the guidance. The company has revised its full-year sales and recurring profit guidance given the accounting change in the reporting method of Uny’s sales and less-than-expected non-operating expenses associated with Uny, which do not affect our fair value estimate.

Same-store growth of the Don Qujote format rebounded during the quarter, up about 1.8% (1% from domestic consumers and 0.8% from foreign tourists), thanks to strong demand for daily necessities including foods and daily sundries as well as one additional weekend day. Sales contribution from foreign tourists has decelerated to an estimated 10% compared with 27% growth achieved during the first half as a result of adverse impacts of China’s new e-commerce regulations that depressed demand of individual online sellers.

Likewise, same-store growth of the Mega Donki, the large-scale stores offering perishable foods and serving mostly domestic consumers, also improved to an estimated 0.7% compared with a marginal decline of the first half. The newly consolidated Uny sales also achieved a 0.2% same-store growth.

Despite a nearly 9% top-line growth achieved by the existing Donki business, profits fell 6% during the quarter as a result of increased personnel and utilities costs in addition to expenses associated to new store openings. Due to deteriorating consumer sentiment from October 2018, management has strategically lowered prices of frequently purchased items to lure consumers. It is determined to maintain the top-line growth momentum at the expense of gross margins without hurting gross profits, a strategy allowing it to take shares after the tax hike in 2014. Thus, margin contraction is likely to last through the next two to three quarters until early 2020 when adverse impacts of the sales tax hike scheduled for October 2019 cycle and Olympic euphoria lifts consumer sentiment.