EUR 850.00 For Business Accounts Only

Morningstar | Donki's Results and New Guidance Largely in Line; Uny Restructuring a Midterm Growth Driver

Narrow-moat Pan Pacific International’s, or PPI's (previously Don Quijote) second-quarter profits were in line with expectations although sales trended slightly above the company’s target and our estimate. The revised profit guidance incorporating Uny’s contribution from the third quarter is 2% below our forecasts but given management’s tendency for guiding to a conservative outlook, we maintain our forecast and fair value estimate of JPY 6,500. While we are convinced that PPI will be able to raise Uny’s profitability by leveraging its low-cost operation and sourcing strengths, shares have priced in the upside and we prefer to wait for an attractive entry point to own the name.

Management also provided some guidance on the strategies to revamp Uny and profit targets. It inclines to abandon Uny’s exiting chain-store model, meaning unified operations controlled by the headquarters, and to introduce Donki’s operating model of granting autonomy to managers of individual stores to all Uny stores. It expects conversion of 100 Uny stores to the Donki format combined with restructuring of the remaining 80 stores operated under the same Apital/Piago banners will lift the retail profits by JPY 20 billion by 2023. However, it is unclear how the rental income, the main profit contributor to Uny’s retail business, will be affected if Donki’s management takes back primary space currently rented to tenants for its retail operations. We expect the consolidation of Uny to add about JPY 35 billion in profits by fiscal 2023.

We estimate like-for-like total sales are estimated to grow 4.5% excluding impact of QSI acquisition (10% reported) thanks to continued new store openings although same-store sales growth was down to nearly flat, depressed by warm weather, during the quarter. While sales contributed by foreign tourists remain resilient, contributing an estimated 1.3% growth to the same-store sales, sales to local consumers appeared to drop by 1.7%. The subsidiary Nagasaki-san operating the Mega Donki format also experienced the same negative trend, seeing same-store sales decline 1.6% compared with a 1.2% growth posted during the first quarter. Given the slowdown in same-store sales, management guides a 1%-2% same-store growth as a sustainable level over the midterm.

Meanwhile, Donki intends to continue the pace of new store openings, adding about 20 stores per year, but will focus on smaller Don Quijote and Picasso formats. Given growing the size of gross profits is its priority, Donki may not slowdown the pace of new openings even though same-store sales have been underperforming its targets. It plans to take advantage of the increasing vacant premises previously occupied by other formats of retailers including book stores, pachinko parlors, and video rental shops, to grow shares. We usually consider such a strategy a risk to retailers but given that Donki’s management operates in an agile manner and opening costs tend to be lower than the average as many are converted from other retail formats, we do not think such store opening strategies will pose risks to the organization but expect the company to scale back expansion given limited resources available for new stores.

Management has hiked the dividend by JPY 5 as special dividend for Don Quijote’s 30-year anniversary, lifting the full-year dividend to JPY 38. Given earnings contribution from newly consolidated Uny business, we do not think management will cut back the amount of special dividends next year and expect a steady rise from the JPY 38 level, leaving the payout ratio largely unchanged at merely 11%-12%.