EUR 850.00 For Business Accounts Only

Morningstar | Margin Expansion in Moaty-C-Store Business Lifted 7&I's Profits

Narrow-moat Seven&i’s first-quarter profits came in a touch above our expectation thanks to healthy growth in the moaty overseas C-store business 7-Eleven Inc (SEI). The moaty domestic C-store business SEJ also saw profits improve during the quarter as a result of a sizable drop in promotional spending, partly because of a shift of marketing investment for the roll out of 7 Pay cashless payment service in July. On the other hand, profits of the struggling superstore and department store businesses continued to slide. Management will announce the new restructuring plans for the underperforming business in early October. So far, the market has been disappointed by the speed of restructuring and the expected announcement could be a positive step if the restructuring scale is significant. We have marginally adjusted our forecasts, which do not affect our fair value estimate of JPY5,250. We see a healthy 40% upside to our fair value estimate.

Disputes over C-stores’ 24-hour model has weighed on 7&I’s share price. 7&I plans to release the testing results of shorter store hours by the end of September and we expect the majority of stores will continue 24-hour operations. However, management will allow franchisees to shorten business hours under certain circumstances. 7&I needs to boost investment in staff-free or cashless technologies if it decides to retain the 24-hour model over the long term. The C-store operator could transform the business model once the staff-free technologies are established because it will be less dependent on franchisees to manage the store staff.

Over the near-term, we believe that offering discounting on prepared food in the form of reward points to reduce food disposal could be a win-win solution. It could boost both franchisees' income with little cost to the headquarters if the strategy does not affect the sales of full-price items. The testing results of 10 directly operated stores indicate per-store sales increased while disposal decreased in February when the stores offered 3% reward points. SEJ shoulders 15% of the disposal costs while franchisees are responsible for the remaining 85%.

The credit card fraud linked to the recently launched mobile payment service 7 Pay appears to have affected about 900 customers at a JPY 55 million loss. Management has decided to suspend the charging service and might stop accepting new user registration before identifying the cause. The incident may have minor effects on 7&I’s digital strategies, but we expect the company will be able to resume the service quickly after altering the security system. 7&I introduced 7 Pay on the 7-Eleven app on July 1, 2019 and plans to roll out 7 Pay app at third-party retailers in October 2019. Alongside the roll out of 7 Pay, 7-Eleven also started offering five third-party QR code services including Paypay, Line Pay, Meri Pay, Ali Pay and Wechat Pay. The introduction of the third-party payment services may help close the gap between 7-Eleven and its rivals, including FamilyMart and Lawson, which took advantage of the cashback campaigns offered by the QR code payment service providers to drive same-store sales over the past few months.

A lift in gross margins was another driver behind the quarter’s profit growth. Gross margins of SEJ expanded 10 basis points despite a deteriorated mix as a result of the increased contribution of tobacco sales (minus 20 basis points). SEJ managed to raise the prices of some products in conjunction with the product renewal, and grew sales of the renewed items. Likewise, gross margins of the SEI rose by nearly 130 basis points, owing to the improved product mix of merchandize sales and a more than 6% increase in gross profits of gasoline per gallon. Solid sales of lucrative soft beverages and private label and write-down of liabilities of unredeemed reward points helped lift SEI gross margins. Margin improvement in SEI should continue, although rising gasoline prices may slightly depress gross profits per gallon.