EUR 850.00 For Business Accounts Only

Morningstar | Raising Fast Retailing's Moat Rating to Narrow from None; Overseas Growth Potential Fully Priced in. See Updated Analyst Note from 25 Sep 2018

After taking a fresh look of Fast Retailing, we have raised its moat rating to narrow from none and maintained the stable moat trend rating and the fair value estimate of JPY 45,000. Brand equity and a cost advantage in functional fabric and raw material procurement derived from its scale, form its moat sources. Despite our optimistic view on Uniqlo’s growth potential in Asia, we view Fast Retailing’s shares as overvalued, trading at a 25% premium to our fair value estimate, and prefer to own the name when it offers a sufficient margin of safety. Dips on negative one-off events may create good buying opportunity.

We consider the Uniqlo business, representing 80% of the group’s sales and 90% of profits, to have a narrow moat. Specifically, its good-quality, value-for-money products underpinned by a cost advantage, combined with consistent marketing investment, reinforces its brand equity. Unlike its western fast fashion peers focusing on trend-driven items which require fast product turnovers, Uniqlo sells products in large qualities, often more than a million units per item for core products. The scale enables mass procurement of raw materials and partnership with leading textile companies to jointly develop innovative, functional fabric for Uniqlo’s proprietary products.

While competition in the apparel space is fueled by new entrants including online retailers such as Amazon and the domestic rival Zozotown, we do not think the online retailers lacking product development and manufacturing expertise will be able to replicate Uniqlo’s cost competitiveness, offering products matching Uniqlo’s quality and prices, over the next decade. The key suppliers are unlikely to risk their long-term relationship with Fast Retailing and turn to new players lacking proven track records.

To accelerate online growth and improve inventory quality, Uniqlo has been stepping up investment in e-commerce and supply chain management. Online growth has picked up to more than 30% in Japan after it introduced the click and collect service, leveraging its store locations to enhance customer convenience and reduce shipping costs. It is aiming to double Uniqlo’s global online sales contribution currently at 9% by 2022. globally with the U.S. market’s 20%.

Our fair value estimate of JPY 45,000 implies a fiscal 2019 price/earnings of 30 times and enterprise value/EBITDA of 13.5 times. Despite Uniqlo’s rosy growth prospects in Asia, the stock is trading at a substantial premium, more than 60% above the sector average. We attribute it to: 1) a considerable weight, nearly 9%, in the Nikkei 225 Index; 2) the Bank of Japan’s ETF buying; 3) low free float to Fast Retailing’s rich valuations. Given its weight in the Nikkei, it is one of the few stocks often used for replicating market performance. Moreover, the Bank of Japan’s, or BoJ's, ETF buying further reduced the stock’s liquidity. The BoJ has become the second-largest shareholder with an estimated 17.5% stake in Fast Retailing, representing more than one third of the free float. The valuation premium might be unwound if the BoJ decided to exit the massive stimulus program.