EUR 850.00 For Business Accounts Only

Morningstar | Cutting JR East’s FVE to JPY 9200 on Medium-Term Margin Pressure; Cautious on Rising OPEX. See Updated Analyst Note from 31 Jan 2019

We reduce our fair value estimate for JR East to JPY 9200 from JPY 9500, driven by a less positive outlook on the profitability of the transportation business in the medium term. While the company posted solid top-line growth of 3.2% year over year in the fiscal third quarter (for the fiscal year ending March 2019), operating margin fell slightly to 19.4% from 19.6% a year ago. JR East has seen margins grow over the past five years, but we think this trend is reversing. We see cost pressure in the transportation business, which accounts for 68% of revenue. More specifically, higher unit labor and business consignment costs have had a negative impact, driven by personnel shortages. Sales growth was strong across all segments, especially transportation sales, which saw 1.3% increase in the first nine months versus the same period last year. Given rising operating expenses, we have reduced our fiscal 2018 operating income to JPY 481 billion from JPY 498 previously.

JR East continues to pivot its business away from the slower-growing railway segment by expanding its lifestyle business (retail, real estate, and Suica), which is expected to account for 37% of sales in fiscal-year 2027 (versus 32% in fiscal-year 2017). While we anticipate growth across all segments to be resilient in the medium term, driven by the Tokyo Olympics and ongoing real estate and retail expansion, we think that this will be achieved at the expense of a lower operating margin. We expect the transportation segment’s margin to steadily decline to 15.8% in fiscal-year 2021 from 16.9% in fiscal-year 2017 as JR East enhances security across railway facilities in the lead-up to the Olympics. Thereafter, margins are expected to stabilize and recover to a normalized 16.2% in fiscal-year 2027, driving operating income CAGR of 2.0% between fiscal-year 2017 and fiscal-year 2027.

We don’t expect transportation margins in fiscal-year 2027 to recover to fiscal-year 2017’s level of 16.9%, as we think that JR East will face longer-term challenges in containing operating costs. Due to the shrinking working population in Japan, supply-side shortages have pushed labor costs up. That said, JR East plans to mitigate this labor issue with the greater use of technology, such as introducing monitoring devices for track facilities and driverless operations.