EUR 850.00 For Business Accounts Only

Morningstar | Seven & i's Guidance Disappointing; C-store 24-hour Operating Model Staying Intact

Narrow-moat Seven & i’s fourth-quarter profits came in a touch below our expectation and the company’s guidance target given continued weakness in the superstore and department store businesses, although the moaty C-store business posted a healthy growth. The guidance for fiscal 2019 is somewhat disappointing, with operating profits JPY 30 billion or 7% short of our forecast of JPY 450 billion and the company’s midterm guidance. We have trimmed our profit projections by 2%-7% for the explicit forecast period, bringing the 2019 estimates close to the level of the guidance after cutting profits of the domestic C-store business to reflect expectations of increased costs in marketing and store renovations. Yet, we have maintained our fair value estimate of JPY 5,250 after taking increased time value of money into consideration.

Seven & i’s share price has corrected more than 15% after the trouble concerning the 24-hour operation with a franchisee became a social issue. We expect the majority of stores will continue 24-hour operations although management may allow franchisees to shorten business hours under certain circumstances. Nevertheless, retaining the 24-hour operations would imply a sizable investment in staff-free or cashless technologies in the future. The sustainability of the business model will depend on the C-store franchisors being able to capture investment returns by raising franchise charges. We intend to review the impact and potential solutions after the discussion with the management.

The results of the restructuring of underperforming superstore and department store businesses have been unsatisfactory. Despite the market’s frustration toward management’s lack of action in divesting the struggling businesses, management plans to inject more than JPY 60 billion into store remodeling in 2019. The decision is likely to be taken negatively as the market had been hoping that management would channel resources to the C-store business to combat the challenging operating environment.

Apart from the profit shortfall in the superstore and department stores businesses, the marginal profit growth in Seven-Eleven Japan, or SEJ, is also responsible for the lackluster outlook of 2019. SEJ plans to beef up promotional spend along with the launch of its cashless service 7 Pay in the coming summer. Furthermore, increased costs to upgrade the credit card service to the IC chip cards will also depress profits of its financial services.

Management has been accelerating store closure of SEJ’s directly operating stores to reduce costs. Moreover, it will curtail new store openings, limiting the net increase in store count to 150 (including 50 in newly entered Okinawa) compared with more than 600 in 2018. The strategy will allow more resources to be channeled to the existing stores, potentially lifting the same store growth and franchisees’ income. On the other hand, the U.S. C-store business is expected to achieve a double-digit profit growth through a solid same-store growth (up 2%) and improved operational efficiency despite deceleration in gasoline growth. Gasoline sales are likely to drop year on year on falling crude oil prices after the growth driven by Sunoco acquisition cycles.

Seven & i has appointed a new president to lead Seven-Eleven Japan to handle the controversy over its 24-hour operations. We do not expect the C-store operators will risk a sizable sales decline to offer franchisees choices in the operation hours, although they will need to step up recruiting support to franchisees amid a labor shortage. Based on experiments carried out by the rivals in the past, shortening the late-night operating hours will likely affect day-time sales, causing daily sales to drop as much as 30%. Moreover, as C-stores’ supply chain is built upon a 24-hour operation model, to shorten store hours will not only boost logistic costs but also vendors’ costs of the read-to-eat food products, turning the current business model unfeasible. According to SEJ’s survey, only 96 out of more than 20,876 stores wish to shorten operating hours.