Morningstar | Lowing Yamazaki Profits and FVE After a Sizable Guidance Miss; Rising Labor Costs Burdening Profits. See Updated Analyst Note from 14 Feb 2019
Narrow-moat Yamazaki Baking’s fourth-quarter profits came in significantly below its revised guidance and our forecasts. The miss is attributable to a sizable cost increase in the moaty bakery business while profits contributed by the subsidiaries improved during the quarter. Management has taken a more cautious stance after missing the guidance for two years in a row and guided a more conservative outlook for 2019, indicating a 17% growth in operating profits with a 1.4% growth in the top line albeit a low base and potential benefits of price hikes. We have lowered our profit forecasts by 6%-12% given a significant increase in the labor and personnel costs specifically in 2019, wiping out a sizable portion of profits driven by price hikes. We therefore lowered our fair value estimate to JPY 2,000 from JPY 2,100, implying an 8% downside. Our profit forecast for 2019 is 3% above the guidance.Fourth-quarter sales were nearly flat while profits plunged 24% as a result of increased raw material, utility, and labor costs, leading to a nearly 80-basis-point drop in gross margins. Logistic costs continue rising but seem under control. The increased raw material costs seem to be boosted by intensifying competition, forcing the company to increase the size of some bakery products for promotional purposes. Volume of the bread loaf and sweet bun categories of which Yamazaki raised prices of some products by an average 3% and 4.5%, respectively, continued to fall at a pace of 3%-4% during the fourth quarter. Apart from the price hike of the name-brand products, it appears slow sales of the C-store channel where Yamazaki supplies the private-label products also depressed sales volume.
Due to the guidance miss over the past two years, management intends to enhance its forecast accuracy and has factored in a substantial rise, roughly JPY 2.2 billion, in labor and personnel costs. Despite rising hourly pay of part-timers, Yamazaki has been converting some part-timers to permanent employees and increasing recruiting of new graduate students to reduce risks of employee turnover and quality control. As a result, the increased costs are likely to remove a significant portion of profits driven by cost savings. We have estimated a JPY 5 billion profit increase for a period of 12 months if the price hikes fully kick in.
On the other hand, the food manufacturing and bakery subsidiaries that suffered margin contraction over the past two years appear to have seen a sign of improvement from the fourth quarter. Profit recovery of these subsidiaries will contribute nearly JPY 2 billion addition profits out of JPY 4.2 billion profit increased in 2019. Yet, Daily Yamazaki, its C-store operation, will stay in red due to increased system investment. With fierce competition in the space and investment required for updating the stores, there is no sign of the business turning into profitability over our explicit forecast period.
Management has maintained its dividend at JPY 20 for 2019. However, management may reconsider raising the dividend if profits meet or beat its guidance.
Yamazaki Baking is a baking company. Co. is engaged in the manufacture of bread, Japanese and western confectionery and the sale of its products to retailers; the manufacture and sale of bakery products; the operation of bakery cafes and bakeries; and the manufacture and sale of sandwiches, packed meals, rice balls, Japanese crackers, snacks and rice crackers. Co. is also engaged in the operation of convenience stores and food supermarkets; the logistics business; the design, supervision and construction of food manufacturing facilities; the office work entrusted business; the non-life insurance agency business; and the manufacture and sale of cleaning agents for baking equipment.
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