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Morningstar | Cost savings and Third-Party Cash-Back Campaigns Driving FamilyMart's Profit Growth

No-moat FamilyMart’s profit came in above our expectations mainly because of a delay in marketing spending during later quarters in conjunction with the launch of its cashless payment app FamiPay. We still believe the cost savings it has made after  closing unprofitable stores will boost its profit growth in 2019 but the organic profit growth will decelerate beyond 2019 when the benefits of store closures and C-store integration reach full cycle. We maintain our forecasts and fair value estimate of JPY 2,100. Despite a 17% correction over the past six months, FamilyMart’s shares remain overvalued, trading at a 28% premium to our fair value estimate and 80% premium to moaty 7&I Holdings.

FamilyMart’s same-store sales grew 1.7% during the quarter, with the growth in cigarettes, including electronic cigarettes and other vaping devices, contributed one percentage point. Gross margins at the C-store business fell 30 basis points, partly because of a deteriorated mix, with an increased contribution from low-margin cigarettes. In addition to closure of more than 560 stores, mostly underperforming shops, we believe cash-rebate campaigns offered by third parties boosted its same-store sales by one percentage point, with half of the growth coming from sales of cigarettes. Given that cigarettes are sold at fixed prices across the channels, smokers have been taking advantage of 20% cash-back campaigns to buy at a discount. As the rival 7-Eleven starts offering QR code payment services with cash-back campaigns, it may help gauge the effects of cash-back campaigns on sales in same-store sales and whether the current pace of growth is sustainable.

Cost savings achieved by closing underperforming stores and associated to the C-store integration remain the profit driver. Management expects to achieve roughly JPY 5 billion cost savings per quarter during 2019. On the other hand it is making provisions for subsidies to franchisees, in preparation for issues associated with the 24-hour operations. It appears the stores that introduced shorter operating hours are seeing a drop in sales, although the final results will not be available until the end of summer. Management might have to beef up subsidies to encourage franchisees to continue 24-hour operations. Moreover, it may increase its marketing spend on FamiPay, given the recent system troubles caused by network congestion after customers downloaded the app. While FamilyMart achieved nearly three million downloads in just 10 days after the service was launched and is on track to achieve its goal of 10 million downloads for the year, how to monetize consumers’ purchase data is a challenge for the retailer.