EUR 850.00 For Business Accounts Only

Morningstar | Resilient Foreign Tourist Demand Boosts Same-Store Growth; Higher Costs Depress Donki's Margins

Narrow-moat Donki’s first-quarter profits were largely in line with our expectations. Management has raised its first-half guidance as we had expected. While the revised sales target (up to 10.6% year on year from 8.7%) is catching up our forecast, revised growth in operating profits (up to 2.6% from 0.9%) remains lower than our projection of a double-digit growth. Despite the negative flood and quake impacts in Western Japan and Hakkaido, it posted a solid 1.6% growth in same-store sales thanks to robust growth in sales to foreign tourists. While the China-U.S. trade tensions may depress Chinese tourists’ spending in Japan and dent Donki’s near-term sales, we expect Donki’s price leadership and rich assortment, derived from its cost advantage and sourcing capability, will sustain its market share gains through store expansion and increased customer traffic.

FamilyMart will start tender offer for Donki’s shares on Nov. 7. Given that FamilyMart will borrow shares from Donki’s founder Yasuda if it fails to acquire a 20.17% stake, it seems unlikely that FamilyMart will raise the tender offer price over the short term. We intend to review our fair value estimate currently set at JPY 5,600 after discussing with Donki’s management Uny’s long-term strategies including potential closure of the 90-plus stores not scheduled for conversion to Donki or Mega Donki formats.

Like-for-like total sales grew 6.5% excluding impact of QSI acquisition (11.9% reported) thanks to continued new store openings in addition to a healthy 1.6% same-store sales growth and 33% growth in sales to foreign tourists (about 8.7% of Don Quijote retail sales). Sales to foreign tourists remained buoyant during the first quarter despite the closures of Kansai airport (representing 27% of inbound tourists) and Hokkaido’s New Chitose airport (5% of inbound tourists) caused by typhoon and earthquake.

Indeed, out of the 1.6% same-store sales growth, sales to foreign tourists contributed 1.5 percentage points. While growth has slowed to mid-20% in October from nearly 40% in July in part due to a larger denominator, growth in customer traffic rebounded to 15% in October from 10% of September.

While gross margins expanded 20 basis points, increased personnel expenses associated with seven new store openings and wage hike in the U.S., rising logistic and utilities costs as well as employee social welfare boosted selling and administrative, or SG&A, expenses as a percentage of sales by 90 basis points, leaving a mere 1.4% growth operating profits. However, we expect SG&A expenses as a percentage of sales will fall gradually quarter on quarter along with a pickup in sales of new stores.

It appears that the inventory level of imported watches and fashion accessories has returned to a right level and the issue of inventory buildup has resolved during the first quarter. Inventory turnover has improved after management has centralized procurement of imported fashion accessories and removed the products from 80 stores.