EUR 850.00 For Business Accounts Only

Morningstar | Yamazaki Failing to Expand Margin Despite Price Hikes; Reducing Our Fair Value Estimate. See Updated Analyst Note from 25 Apr 2019

Narrow-moat Yamazaki Baking reported another disappointing quarter with a 1.3% decline in sales and 23% plunge in operating profits, compared with our expectations of flat sales and a low-single-digit growth in profits. While rising overhead and personnel expenses are well expected, sales weakness in the moaty bakery business and subsidiaries including Fujiya and Yamazaki Biscuit further weighed on profits. We have lowered our profit forecasts by 5% and fair value estimate to JPY 1,900 from JPY 2,000 given a delay in margin recovery and time required for solving the issue of food additives and rolling out new products. We view the shares as moderately undervalued with an 11% upside to our fair value estimate.

Our profit cut reflects lowered gross margins in the bakery business. Despite price hikes, the gross margin continued to dip, falling 72 basis points during the quarter. Apart from increased overhead of the bakery business, a deteriorated mix caused by a 2.4% decline in sales of higher-margin bread loaf products, combined with rising input and logistic costs facing the subsidiaries, is responsible for the margin contraction. It is unclear whether price hikes caused the volume decline as we saw mixed performance of the items with price increases.

On the other hand, sales appear to have picked up in the C-store channel that suffered sales declines since the second half of 2018. Sales of sweet buns rose marginally in March after Yamazaki improved offerings at the C-store channel. While management considers the improved sales a sign that its efforts to enhance product quality are starting to bear fruit, we think it will take at least another quarter to see impacts on the group level.

An issue concerning food additives labeling also is attributable to sales decline in core bakery items including bread loaf and sweet buns. Yamazaki reckons that its sales might be affected by rivals’ marketing claims that their products are free of “yeast food” and emulsifier, the additives often used for mass-produced bakery foods but deemed potentially harmful for health. Yeast food is an aggregate term referring to 18 chemicals used for activating dry yeast and accelerating fermentation during the baking process. While management discovered the issue a few months ago and has been working on new products employing Levain yeast, there were few new products launched during the first quarter. Management is hoping that the members of the industry association of packaged bakery goods will reach an agreement soon to solve the labeling issue, which could help repair Yamazaki’s reputational damage and boost sales.