Morningstar | Who’s Riding the Train? We Cut JR East’s FVE to JPY 9,500. Factoring in Weaker Long-Term Ridership
East Japan Railway, or JRE, is Japan’s largest railway network operator running both long distance bullet trains (shinkansen) and shorter municipal train routes around and from the Greater Tokyo metropolitan area. JRE has been able to extract additional value to its regulated train transportation returns through redeveloping its stations into mixed commercial centers, with the most significant being Tokyo Station. We think being in Tokyo enables the company to garner attractive commercial rental returns above its peers in Japan and as a result its earnings are more diversified with 71% coming from its rail operations relative to main peer Central Japan Railway, where around 94% of operating profit is from rail. JRE’s management views its main challenge as being the secular population headwinds which will gradually reduce ridership on the trains. As a result, it is looking to reinvigorate growth by leveraging its rail footprint to accelerate expansion into adjacent businesses, such as retail, real estate, and Suica and IT services. The aim is to build an ecosystem of lifestyle services around its core rail assets. JRE will complete its redevelopment of its Shinagawa station in 2024 and we expect this to be the midterm driver of earnings. However, it’s harder for us to share JRE’s vision for the stickiness of its Suica card as it can be offered by the other rail companies. In addition, it remains relatively small contributor to the company’s earnings. We think the company will benefit in the next few years from tourist arrivals with the Tokyo Olympics in 2020 followed by the probable introduction of integrated casino resorts in Japan thereafter. Hence, we believe the current spending by JRE on its stations and hotels are warranted. For the next five years, however, free cash flow will be negative. As a result, net debt will rise and we expect dividends to be flat.East Japan Railway is mainly engaged in the transportation business. Co. operates railway routes covering mainly in the Kanto area and the Tohoku area totaling of 7,457.3 km of railway with 1,665 stations, 11,506 standard rolling stocks and 1,370 bullet Train rolling stocks as of Mar 31 2017. Co. establishes commercial space in the railway stations and operates restaurants, retail stores, cafes, convenience stores and shopping centers; and leases office buildings located in the railway stations and surrounding areas. Co. is also engaged in hotel business, advertising agency, travel operations, wholesale, truck delivery, information processing, cleaning, as well as credit card business.
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