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Morningstar | Fast Retailing Beat Guidance as Expected; 2019 Guidance Somewhat Optimistic

Narrow-moat Fast Retailing’s fourth-quarter results came in largely in line with our expectations. We have lifted our fair value estimate to JPY 47,000 from JPY 45,000, mainly to reflect a modest 1%-3% lift in our profit projection over the explicit forecast period and lowered tax-rate assumptions, given increased overseas contribution and reduced risks of future impairment of goodwill. While we are convinced that Uniqlo’s cost advantage and intangible assets will sustain group growth, fueled by the potential in Asia, we view Fast Retailing’s shares as overvalued, trading at a 22% premium to our fair value estimate, in part because of its low free float and its sizable weight in the Nikkei Index. We would prefer to own the name when it offers a sufficient margin of safety.

As we had expected, the firm beat profit guidance by 3%-5%, thanks to the heat wave that boosted demand for summer clothes in August.  To our surprise, management announced a 10% dividend hike for 2018, raising the dividend to JPY 440 from JPY 400, to bring the payout ratio close to 30%. It expects to raise the dividend by another JPY 40 in 2019, maintaining a 30% payout ratio. A significant increase in inventory (up 60%) was mainly caused by a change in the timing of inventory recognition.

Management guided an 8% growth in the top line and 9% growth in core business profits (14% growth in operating profits) for 2019, compared with our forecasts of 5% and 4%, respectively. Although management has taken the comparison hurdles caused by favorable weather in 2018 into consideration, its assumptions seem optimistic, factoring in 2% same store-sales growth, including 30% growth in the online channel for domestic Uniqlo, compared with our estimate of a 1% decline. This difference explains the gap between our projection and guidance.

On the overseas front, it will maintain a pace of 100 store openings in Greater China while accelerating expansion in Southeast Asia and Australia, boosting new openings to 50 from 35 in 2018. Given increased overseas contribution, we project a slight increase in gross margins for 2019, as we expect the higher gross margins earned by overseas markets will offset the adverse yen weakness on domestic Uniqlo’s gross margins.

Fast Retailing also announced the appointment of four new members to its board of directors, including CFO Takeshi Okazaki, Yanai’s two sons, and an external member. Yanai has explicitly denied the possibility of making his sons his successors and clarified that the appointment is aimed at reinforcing the group’s corporate governance. The approval will change the structure of Fast Retailing’s board, which includes just one internal director, an issue we cited in our recent report transferring coverage, and will bring a different voice from other internal members who are familiar with the company’s operations.