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Morningstar | High Expectations on Profit Growth Driven by Yamazaki's Price Hike Could Disappoint

We have examined the impact of narrow-moat Yamazaki’s price hikes on its bakery products and adjusted our operating profit forecasts by 4%-6%, mainly for 2019 and beyond. We thus lifted our fair value estimate to JPY 2,300 from JPY 2,100, assuming that the price hikes will be fully passed through six months after implementation. We think Yamazaki's ability to pass on higher costs in a tough retail environment is supported by its moat source stemming from distribution capabilities, although the price hikes are unlikely to take place on a regular basis. Still, we reckon the market has factored in a much greater profit increase than the degree implied by the price hikes, and we see the share price as overvalued. Our fair value estimate indicates 18% downside. We consider improvement in logistics efficiency a long-term solution to rising logistics costs.

Yamazaki has hiked the price of bread loaf items by an average of 3.1% and that of sweet buns by 4.5% from July 1, in order to reflect increased costs in labor, energy, and raw materials. The target items comprise 60% of bread loaf and 20% of sweet buns, and we estimate sales of these items account for roughly 12% of group sales and 13% of food sales. As a result, the price hikes might add up to JPY 5 billion in operating profits over a span of 12 months if sales volume stays intact.

During the last round of the price hike implemented in 2015, volume sales fell around 3% in the first six months after Yamazaki raised prices of 170 items by an average of 2.6%. But sales turned positive when the negative impact on volume faded within six months after the price hike. Given that peers followed suit in both rounds of price hikes, we expect volume will be depressed slightly during the first six months (second-half 2018), but the price hikes will be fully passed through in the later six months (first-half 2019).

On the cost side, increases in logistics costs have advanced at a faster pace than the company had expected. Logistics costs rose JPY 700 million during the first quarter, compared with the company’s expectation of JPY 1 billion for the full year. Therefore, we expect a sizable portion of profit contributed by price hikes will be offset by the cost increase in the second half of 2017, and we project 30%-plus profit growth during the period. On the other hand, we lifted our 2019 profit forecasts by JPY 2 billion to reflect the benefit of price hikes.

Nevertheless, we do not think Yamazaki will be able to meet its full-year profit guidance, which is nearly 5% above our 2018 estimate and consensus, given that 1) profits in the first half are likely to lag its interim guidance, and 2) a profit recovery in Yamazaki Biscuit, a key profit driver for the year, remains slow. Upside risks to our profit forecasts include a significant drop in input costs or an improved product mix if consumers trade up to the higher-margin premium products.

We do not think price hikes are a sustainable countermeasure to address logistic cost inflation. It is unlikely that Yamazaki can pass on higher costs regularly when logistics costs are on the rise. We believe there is room to slash costs by cutting back on delivery frequency, although reorganizing delivery routes and negotiating with retailers will be a time-consuming process.