EUR 850.00 For Business Accounts Only

Morningstar | Cost Savings to Boost Near-Term Profit Growth, Yet Underlying Sales Growth Remains Soft. See Updated Analyst Note from 28 Aug 2018

We have increased our fair value estimate for no-moat FamilyMart Uny to JPY 8,000, up from JPY 7,050, after becoming slightly more optimistic about potential cost savings generated from the closure of underperforming stores and system integration over the next two years. While we remain skeptical about the outlook of the underlying C-store and general merchandise store businesses and foresee limited profit growth through top-line expansion, we expect cost savings from store restructuring to sustain FamilyMart’s profit growth momentum over the next two years. We have raised our profit forecast beyond 2018 by 5%-8% for the explicit forecast period ending 2022. Despite a nearly 30% correction in its share price from the recent peak, we still view the stock as overvalued with 20% downside. Soft same-store sales of the C-store business and low gross-margin expansion are our key concerns regarding the company’s long-term growth prospects. Our profit forecasts for 2019 and 2020 are a touch above consensus but remain 5%-10% below the company’s targets.

FamilyMart’s shares more than doubled over the past 12 months before Itochu’s tender offer ended on Aug. 16, 2018. Apart from Itochu’s tender offer, the Bank of Japan’s exchange-traded fund purchasing of Nikkei Index also lifted FamilyMart’s share price. According to Nikkei, the BoJ is estimated to hold a 15%-plus stake in the name, accounting for about 38% of the free float. As a result, FamilyMart is trading at a 40%-60% premium to its C-store peers on a price/earnings valuation metric.

We anticipate that cost savings including cost reduction through closure of underperforming stores and reduction of directly operated stores, as well as system integration, will serve as a major profit growth driver over the next two years. The firm plans to close 741 stores, including 143 Circle K Sunkus, or CKS, directly operated stores, out of 16,313 stores. Specifically, reductions in rent, personnel costs, and other selling, general, and administrative expenses are expected to lead to approximately JPY 17 billion savings in 2018. We estimate that nearly half of these savings will contribute to profits in 2018. Given that store closures will continue through the year, we expect this to add another JPY 3 billion to profits in 2019. Additionally, we have factored in about JPY 5 billion in savings through decreased system costs and subsidies extended to the converted stores.

On the other hand, we project limited profit contribution through top-line growth. Despite sales expansion of converted CKS stores, whose per-store sales are catching up to the level of FamilyMart’s, the majority of FamilyMart’s same stores are struggling to increase sales. Increased investment in dedicated production facilities for ready-to-eat foods by vendors and consolidation of logistic centers have not borne fruit, given marginal increases in gross margins. We think increased labor and raw material costs, along with soft same-store sales, may have curtailed returns of investment endeavors. The benefit of the expanded scale through mergers is less clear after a large-scale store closure, given that the difference between the number of stores of FamilyMart and that of Lawson will be down to 2,000.

FamilyMart and its parent company Itochu are apparently considering creating their own ecosystem through setting up a reward point program and entering the financial services business. The retailer is hoping that the massive database regarding consumers’ purchase histories will allow it to better predict demand and develop new products and services, as well as generating new income sources by distributing data or analysis to third parties. While there are no details regarding the new financial business, we expect FamilyMart to offer the mobile payment service integrated with its reward point program.

Nevertheless, as all of its rivals are focusing on similar strategies, we foresee fierce competition in gaining partners and acquiring consumers to participate in its ecosystem, and we are concerned that the investment may not yield positive returns if price wars heat up. Despite Itochu’s technology support and a network of nearly 16,000 stores, we do not find that FamilyMart possesses a strong competitive edge in forming its ecosystem among C-store players, as FamilyMart is lagging rivals in the loyalty programs. FamilyMart and Itochu's ability to secure attractive partners and incentivize consumers will be critical to their success.