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Morningstar | FamilyMart Growth to Decelerate Substantially After Benefit of Store Closure Cycles; Overvalued. See Updated Analyst Note from 11 Apr 2019

No-moat FamilyMart’s profit guidance for 2019 was better than our estimation given better-than-expected revenue from C-store franchisees. On the other hand, a more than 50% increase in capital expenditure driven by fixture upgrade at existing stores will depress its free cash flow. While we expect cost savings derived from the closure of unprofitable stores will pump up its profit growth in 2019, we expect growth to decelerate while sales stay fairly flat beyond 2019 when the benefit of store closure fully cycles. We have raised our fair value estimate by 5% to JPY 2,100 after lifting operating profits of the explicit forecast period by 10%-15%. Our revised profits and earnings for 2019 are a touch below the company’s guidance.

Despite a more than 17% price correction since late February, the shares remain overvalued with an 22% downside to our fair value estimate. We prefer narrow-moat Seven & i Holdings among the C-store players for its attractive valuations and the competitive edges in its private label products and prepared foods. We do not expect a drastic change in the 24-hour business model over the midterm as C-store operators will need to either raise prices of products or franchise charges to cover increased costs driven by shortened store hours. Such change will eventually jeopardize franchisees’ income. Yet, the C-store operators are facing an escalating risk of deteriorating investment returns after being forced to step up investment in labor-saving equipment and technologies. How to capture the returns through growth in same-store sales is a key challenge facing all the C-store operators.

While FamilyMart has seen same-store sales growth turn positive since August, we believe it is in part lifted by the large-scale cashback campaigns launched by a couple of operators of QR payment systems. The timing of campaigns coincides the months that FamilyMart saw growth customer traffic. FamilyMart was the only C-store chain offering QR payment of Paypay and Line Pay which give 20% cashback on purchase at FamilyMart. We intend to watch the longer-term sales trend beyond the campaign period to make judgment on the sustainability of sales improvement.


To tackle the labor shortage issue, FamilyMart will raise capital expenditure by more than 50% to JPY 140 billion, with nearly half of amount being allocated to existing stores. The investment includes about 25 billion in labor-saving equipment/ fixtures and JPY 37 billion for new coffee machines and freezers of which FamilyMart expects improved product quality and assortment will boost sales. Additionally, it plans to spend JPY 7 billion on digit payment services. Capital expenditure is unlikely to fall back if further investment in cashless or staffless stores are required for solving the issues of labor shortage and labor cost inflation.


Moreover, the company also announced unwinding of its holding company structure after divesture of Uny and appointed a new management team heading by Sawada, the president of C-store operations, while Takayanagi, the current president of the holding company, will serve the new company’s chairman role. The new structure will help reduce headquarter overhead while Takayanagi will continue to represent the parent company Itochu to oversee FamilyMart’s C-store operations as well as new businesses. It also hiked the dividend for 2018 to JPY 144 from JPY 127 (before 4-for-1 stock split) and plan to pay a dividend of JPY 40 for 2019, maintaining the payout ratio at 40%. Additionally, the company has maintained its net profit target of JPY 60 billion for 2020 as the deal of acquiring a 20% stake in Donki (Pan Pacific) remains on the table.