EUR 850.00 For Business Accounts Only

Morningstar | Fast Retailing’s Downward Revision Expected; a Surge in Gu’s Profit a Surprise

Narrow-moat Fast Retailing revised down its full-year profit guidance as we had expected. The revised profit target, lowered by 3.7% from the initial guidance, is now a touch above our forecasts. Despite a sizable profit decline in the domestic Uniqlo business, the Gu business achieved a surprisingly robust growth.

We have maintained our fair value estimate of JPY 47,000. While we believe its cost advantages and intangible assets will sustain the group’s growth fueled by Uniqlo’s global expansion, specifically in Asia, the shares remain overvalued. The stock is trading at an 18% premium to our fair value estimate. We would be a buyer when it offers sufficient margin of safety.

The 10 billion shortfall in operating profits was attributable to a 24% decline, or JPY 21 billion drop in domestic Uniqlo’s profit. Although its same-store sales managed to grow 2.8% during the second quarter compared with a 4.3% decline posted in the first quarter, the growth was in part lifted by increased discounting. Therefore, gross margins of the domestic Uniqlo continued to contract by 330 basis points during the quarter. On the other hand, growth through the online channel remains health at more than 30% during the quarter (online growth included in the same-store growth). Despite management’s efforts to improve accuracy of demand forecast and supply chain efficiency, the longer lead-time required by large production lots per items makes inventory adjustment more challenging. Yet, unlike the trend-driven fast-fashion apparel, Uniqlo’s products are mostly basic items incorporating few latest trends. Thus, it faces lower inventory risks because it does not have to mark down unsold stock substantially to get rid of the inventory.

On the overseas front, Uniqlo saw sales growth accelerate to nearly 17% during the quarter although profit growth shrank to 5% compared with a 12% growth posted in the first quarter. It appears that Uniqlo’s sales in mainland China are not affected by the economic slowdown. Profit growth in China seems to have accelerated to more than 20% as a result of strong demand for winter clothes. Growth in Southeast Asia, Australia, and Russia were healthy with many countries posting a double-digit same-store growth. In a contrary, sales in Hong Kong and Taiwan remain sluggish. While the U.S. business managed to turn a profit, it fell short of the target.

To our surprise, Gu saw a nearly 15% growth in sales with profit reaching JPY 5.5 billion, compared with merely JPY 144 million of the same quarter last year. It appears that the marketing investment made in the first quarter contributed to a pick-up in sales during the second quarter while the core fashion items were well received. It seems that Gu’s sales performance is largely dependent on its ability to predict the trends in addition to speed in the supply chain management. Gu’s profits are likely to stay choppy unless it is able to produce consistent results in creating new fashion items meeting the latest popular trends.