ZOZO Inc

TSE:3092

Earnings Call Analysis

ZOZO Targets Higher Shareholder Returns

In a nod towards heightened capital efficiency and increased shareholder returns, ZOZO Inc. posted a solid second quarter with a 3.0% year-on-year growth in GMV to JPY 258.7 billion, and a 6.3% increase in operating profit to JPY 28.9 billion, maintaining a strong operating margin of 12%. The company has committed to enhancing shareholder value through increased dividends and buybacks, aiming for a total return ratio above 80% over the next five years. The fiscal year ending March 2024 will see a raised dividend of JPY 98 per share. Despite climatic impacts on sales, cost reductions led to overachievement in operating profit. Noteworthy too is the expansion of their active customer base to 10.51 million, complemented by the introduction of 70 new shops in the quarter.

Strategic Emphasis on Shareholder Returns Amid High ROE

ZOZO Inc. delivered its FY 2023 second quarter earnings call with executive leadership including EVP and CFO Koji Yanagisawa outlining the financial results and strategic priorities. A highlight was the company's solid Return on Equity (ROE) of 60.1% for the fiscal year ending March 2023, well above their stated minimum target of 30%. Surfacing a commitment to shareholder value, the company is focusing on returning surplus funds through a mixed strategy of increased dividends and share buybacks, aspiring to an average total return ratio above 80% over the next five years.

Raising Dividends and Implementing Share Buybacks

ZOZO has raised its consolidated dividend payout ratio target from 50% to 70%, indicating a more generous return to shareholders with a dividend set at JPY 98 per share for FY ending March 2024. Additionally, the company plans buybacks with an upper limit of JPY 10 billion or 5 million shares and will cancel over 11 million treasury shares by November 9, 2023, as part of its capital return strategy.

Consistent Growth in Gross Merchandise Value

The company reported a 3.0% year-over-year growth in Gross Merchandise Value (GMV) to JPY 258.7 billion, with a particular strength in GMV excluding other GMV, which surged 6.2% year-on-year. Operating profit also saw an uptick of 6.3% from the previous year, maintaining an operating profit margin of 12%. Despite challenges from climate impacts delaying seasonal sales, efficiency improvements, including lower costs, have enabled the company to achieve 45.2% of its GMV target and 48.2% of its Operating profit (OP) goal for the year.

Expanding Product Range and Strategic Partnerships

ZOZO continues to enrich its platform with a broader product assortment and high-profile brand partnerships. The company saw a marked increase in the styles available through its 'introduced by ZOZO' service, as well as a steady expansion of accounts for its sales support tool 'FAANS'. In addition to onboarding respected brands such as Muji and luxury fashion houses like Versace, ZOZO is also proactively boosting its technologically driven offerings like ZOZOFIT, which has shown a threefold increase in daily sales in the U.S.

Stable Increase in Active Buyers Despite Guest Buyer Decline

ZOZO's active buyer base experienced a healthy growth, incrementing by 80,000 to 11.55 million. This growth is reflected in an increase by 160,000 in active members, though it was offset by an equivalent decrease in guest buyers, signifying a shift to more consistent and engaged customer relationships.

Investments in Technology and Infrastructure

The company has made significant advancements in operational capabilities, most notably through the development of the new logistics center 'Tsukuba 3', which effectively utilizes automation to reduce manpower requirements. Moreover, investments in such assets are indicative of the company's commitment to future growth and efficiency.

Enhancements in Average Order Value

ZOZO's continued focus on optimizing customer purchasing behavior has been successful, with the average order value (AOV) increasing by 4.3% year-on-year to JPY 7,894. This has been partially attributed to a campaign offering free shipping for orders over JPY 10,000, encouraging customers to increase the number of items per order, demonstrating effective sales strategy implementation.

Moderation in Advertising Spending

The EVP CFO, Koji Yanagisawa highlighted that unlike the previous year where advertising spending was heavier in the first half, this year's strategy is to evenly distribute advertising spend across quarters. This approach implies a steady continuation of marketing efforts, including promotions equivalent to 3.8% against the GMV.

Uncertainty in Consumption Trends

The company acknowledges challenges in forecasting future consumption trends, a sentiment underscored by the volatile climate impacting sales cycles. ZOZO remains cautious about the effects of weather on their product sales, stating that a colder winter could positively affect sales of winter apparel, a significant component of their GMV.

Shareholder Q&A Highlights

During the Q&A session, analysts inquired about the rationale behind the balance of dividends and buybacks, operational strategies in response to consumer spending, and expectations for AOV in the second half of the year. ZOZO's management detailed their forward-looking strategy on capital returns while acknowledging that forecasting AOV can be challenging due to unpredictable factors like weather and market dynamics.

Earnings Call Transcript 2024-Q2

[Yusaku Kobayashi, executive]

[Interpreted] At this time, we would like to begin, good evening everyone. My name is Kobayashi from ZOZO. Thank you for taking the call in the conference call for FY 2023 second quarter for ZOZO Inc. So from our end, we have the Executive Vice President, CFO, Koji Yanagisawa as well as myself Kobayashi. And we would like to jump right in and we will ask Mr. Yanagisawa to take us through the earnings results.

[Koji Yanagisawa, executive]

[Interpreted] Good evening, everyone. My name is Yanagisawa and I will be presenting our financial results for the second quarter of the fiscal year ending March 31, 2024. First, please turn to Page 6 of the presentation material. I would like to take you through the 3 [ timely ] disclosures that we announced today. With respect to our profit sharing with our shareholders, in principle, our group takes into consideration the trends in our business performance, financial situation, the future of our business, investment plans as well as the internal reserve balance. Now March 31, 2023, the Tokyo Stock Exchange published action to implement management that is conscious of cost of capital and stock price, and they asked companies to address this. And in response, we have analyzed the current situation and forecasted our future. At the moment, although our external minimum ROE target is 30%, we have maintained a high ROE of 60.1% for the fiscal year ending March 2023. On the other hand, we have continued to accumulate internal reserves. Therefore, even if we take into consideration our future business and investment plans indices that represent our return on capital, such as ROE are expected to worsen.And please turn to Page 7. As such, we have determined that the improvement of our financial soundness beyond current levels would worsen the future capital efficiency. Hence, we have made a decision to start getting back the service funds to our shareholders more accurately than ever before. In addition to raising the consolidated dividend payout ratio, we will also bear in mind the liquidity of our shares and share prices to regularly consider the buyback of our shares. Going forward, we will aspire to achieve an average total return ratio of over 80%, including share buybacks over the next 5 years. Next, on the following page, I would like to talk about the 3 specific measures we will be implementing. First, we will be raising a dividend payout ratio. The consolidated dividend payout ratio target will be increased from 50% to 70%. As a result, the dividend for the fiscal year ending in March 2024 will be JPY 98 per share. Second is share buybacks with an upper limit of JPY 10 million or 5 million shares, we will be buying back our shares from the market. This will take place between November 1 of this year to March 1, 2024. Third is cancellation of treasury stocks. We will be canceling 11,170,104 shares on November 9, 2023. And when we implement all of these measures, the ROE for the fiscal year ending March 2024 will be 53.1%. From here, I will take you through the details of this quarter's performance. During the second quarter of this fiscal year, the GMV grew 3.0% year-on-year to JPY 258.7 billion. Gross merchandise value, excluding other GMV increased 6.2% year-on-year to JPY 241.6 billion, Operating profit increased by 6.3% year-on-year to JPY 28.9 billion, and the operating profit margin remained the same at 12%. As was the case in the first quarter, the GMV during the second quarter and is slightly behind plans due to impact from climate. However, the costs have decreased, so we have overachieved on the OP. In terms of our progress against plans, we have achieved 45.2% of our GMV, excluding other GMV and 48.2% of the OP.Please turn to Page 11 for the trends in consolidated business performance. During the second quarter, GMV, excluding other GMV increased by 6.1% year-on-year. Due to the lingering summer heat, the sales during the launch of the fall/winter season remains sluggish. However, as was the case in the first quarter, we have continued to receive higher levels of inventory. With respect to OP, we saw an increase in acquisition costs and promotional costs in comparison to last fiscal year. And [indiscernible] costs have been reflected in the books. However, the growth of GMV and the advertising business resulted in higher gross profit. Therefore, the OP increased by 1.3% year-on-year. Next on Page 12, we have the increase, decrease analysis of the OP. The OP went from JPY 27.2 billion to JPY 2.93 billion, increasing by JPY 1.72 billion. There are 3 factors that contributed to increasing OP. First is the increase in gross profits from increasing GMV of ZOZOTOWN and Yahoo! shopping businesses, resulting in an additional JPY 4.49 billion. Advertising business resulting in an increase in sales of JPY 0.78 billion. Increase in shipping income due to rise in GMV resulting in additional JPY 1.06 billion. On the other hand, there are 4 factors that decreased OP. Versus the higher fixed costs due to increasing the number of employees and logistics centers, resulting in minus JPY 1.04 billion. The second is increase in variable costs to fluctuate and proportion to GMV resulting in JPY 1.01 billion. The third one is increase in actual promotional-related expenses resulting in minus JPY 2.02 billion. And lastly, increase in other expenses due to transfer of some outsourcing commissions to other accounts, resulting in minus JPY 0.53 billion. On Page 13, you will find the balance sheet in comparison to last fiscal year, tangible fixed assets have increased, and this is due to the purchase of machinery, et cetera, for the new logistics center.Next, please turn to Page 24 for a breakdown of the SG&A expenses. The SG&A expenses as a percentage of GMV was 22.9%, increasing by 0.2 points year-on-year. There are 2 key reasons why the SG&A expenses decreased. First, the average order value was higher in comparison to the same period previous fiscal year. So the packing and shipping expenses decreased by 0.4 points. Second, we changed the accounting items for certain expenses, which brought the outsourcing fees down by 0.2 points. On the other hand, there are 3 reasons why the SG&A expenses increased. First, we saw an increase in web ads and advertising expenses for ZOZOFIT, which we did not have the previous fiscal year and expenses related to the niaulab located in Omotesando, which resulted in an increase in advertising expenses by 0.4 points. Second, the rent increased by 0.1 points with the launch of the new logistics center. And the remain depreciation and material handling equipment began with the launch of new logistics center, increasing the depreciation and amortization expenses by 0.1 point. Next on Page 27, you'll find the trends in the actual promotion-related expenses. In the second quarter, we spent 3.8% against the GMV for actual promotion expenses, which includes advertising and point related expenses. As was the case in the first quarter, point initiatives and web advertising have increased in comparison to the same period previous year. And on Page 25, you will find the trends in OP and OPM. In the second quarter, we tend to see lower ARP and AOV. So this season, it's harder to secure OPM. This quarter, we have increased our spending on acquisitions and promotions in comparison to the same period last year, and we have also started to incur costs in relation to the new logistics center Tsukuba 3. Thus, the OPM was 0.6 points lower year-on-year, landing at 11%. On Page 29 onwards, I would like to take you through the KPIs for ZOZOTOWN. The annual buyers increased by 80,000 to 11.55 million. If we break this down, active members increased by 160,000 to 10.51 million and the gas buyers decreased by 80,000 to 1.03 million since the last quarter. We have continuously undertaken point work campaigns for new members. Therefore, we have seen a downward trend in guest buyers, but we have seen a steady rise in active members. Aside from new acquisition campaigns, we have strengthened our efforts targeting specific audience segments. In the first quarter earnings briefing, we did mention that we were concerned about the decreasing light users, but we are trying to address this issue being more targeted promotions. On Page 30, you'll find a number of shops. As of the end of the second quarter, we saw a net increase of 70 shops. And in the second quarter, we welcomed 34 shops. The brands include Muji, as well as Versace and Prada Beauty. And on Page 35 and 36, you will find the average retail price and the average order value. First, starting with the average retail price, it was JPY 3,500, up 3.0% year-on-year. The ARP has trended up due to the rise in prices of some goods and the decrease in the products sold or the discount rate of products, which pushed up the prices of both goods sold at full price and at a discount. The average order value was 7,894, up 4.3% year-on-year. In addition to rise in ARP, the number of items purchased per order has also increased, resulting in higher AOV year-on-year. The key reason why the items purchased per order has increased is due to the year-on-year increase in the free shipping over 10,000 campaigns, and this has resulted in more items being purchased together on the day of these campaigns. On Page 38, you will find that our consolidated business forecast remains the same. But in terms of the dividends, as I mentioned in the beginning, this will be JPY 98 per share for the fiscal year. Next, I would like to briefly take you through some of the topics, our President, Sawada, to go through during the earnings briefing. First, starting with produce made by ZOZO, we have talked to you about introduced by ZOZO before, and we just wanted to give you an update. This is a service where if somebody places an order, we can manufacture and ship these products within 10 days at the earliest. And we have seen a number of styles increase by 1.9x. In terms of the exact number of styles in 2022, we were making 461 million. But during the first half of 2023, this increased to EUR 878 million. Next, moving on to communicate. FAANS is a sales support tool that we offer for the brand's shop staff, and we have seen a steady increase in the number of accounts from April of 2023. The number of accounts have increased by 1.5x. And we've seen expansion in implementation to include clients such as Astoria, [ Pao ], Lacoste Japan and Adidas.Next is an announcement about a new shop. As I mentioned before, Muji has opened a large store on our platform. And at the time of the launch, we had some special initiatives. For example, Muji sold limited edition T-shirts on our ZOZOTOWN and we also did deliver Muji's products in a special movie-themed box. And next, as I mentioned before, Versace, a luxury brand in Italy has opened up the store on ZOZOVILLA . On ZOZOVILLA and we are seeing a steady increase of brands available on ZOZOVILLA. Next is Tsukuba 3, we showed a video during the earnings briefing. So please take a look when you have time, but we are the first company in Japan to implement the pockets order, which has significantly reduced the required manpower. Lastly, I would like to give you an update about ZOZOFIT compared to the daily sales earlier this year, we've seen the daily sales increased by threefold, and we are seeing a steady increase in demand, and we're seeing good traction. So we would like to continue to promote ZOZOFIT in the U.S. That was a brief overview of our performance. Thank you.

[Operator]

[Interpreted] We would like to move on to the Q&A session. [Operator Instructions] Tom, please go ahead.

[Tom Grew, analyst]

Hi, this is Tom from Alma Capital. Can you hear me?

[Koji Yanagisawa, executive]

Yeah.

[Tom Grew, analyst]

Okay. I was wondering, first of all, just about your change in capital policy and the buyback that you're going to do. Firstly, how did you decide to sort of balance of buyback and dividend? And then specifically with buyback and if there are future buybacks, how will it work with obviously Z Holdings holding a large stake in your company if you keep buying back stock that their stake will increase. So how will the mechanism work with them?

[Koji Yanagisawa, executive]

So in principle, as I mentioned earlier, we want to achieve an average total return ratio of over 80% in the next 5 years. And in order to do so, of course, we have taken into consideration the medium-term business outlook as well as the cash flow that we would need. And impressible the tool that we will use is the dividend payment. However, in supplement to that, we will be considering share buybacks. The buybacks next year onwards, we will decide based on the level of cash flow required. But in terms of scale, it's going to be similar to what we will be conducting this year around JPY 10 billion. It's not going to be significant, and it won't have a material impact on the shares that Lynn and Yahoo! hold.

[Tom Grew, analyst]

But if you keep doing buybacks over the medium term, their shareholding ratio will rise. So are they selling into your buybacks? Have you agreed with them to do that?

[Koji Yanagisawa, executive]

Of course, over the midterm, there is a possibility that we could start talking to the holdings about buying back their shares.

[Tom Grew, analyst]

Okay. And my other question is just more operational one. I was wondering, is it possible to talk about the outlook for consumption and consumer spending and what your view is on that in Japan? And then in response to that, what we should expect in terms of promotion in Q3 is obviously the big quarter for promotion. So could you just comment about your feel on the dynamics? And if you look into next year, do you think that consumption will remain strong? Or what do you think?

[Koji Yanagisawa, executive]

In terms of trends and consumption, we have not really seen a major change as we have this year. But in terms of fashion, it's more climate that concerns us. This summer was extremely hot and is still quite warm, and it's finally just becoming cool. So the fall/winter launch has been sluggish, and we are more concerned about the impact from climate. And in terms of promotional expenses like last year, we have organized the PGA golf tournament. So we will be seeing similar advertising expenses this quarter. Last year, the first half of the year, we raised in advertising spending, and we spent more in the third and fourth quarter. But this year, we have made a decision to more evenly allocate our advertising spend throughout the year. So like the previous quarters, we will be spending in the third quarter.

[Operator]

Thank you, Tom. And Tim, if you would like to go ahead.

[Unknown Analyst]

Yes. Thank you guys very much for the presentation. It's Tim from ClicktoGlobal. I just wanted to drill down on the previous comment that you made, on you saw us on the fall/winter trends so far. You mentioned that it only recently got cold in Japan and the fall/winter trends are sluggish to start. Can you just expand on that maybe in terms of what you're seeing for October shipments versus your expectation or versus last year?

[Koji Yanagisawa, executive]

So we can't really share details about the most recent performance. But as I mentioned, it is just starting to get cold, so we would like to take this opportunity to make sure that we're promoting the fall/winter products so that we can capitalize on the quarter weather. We believe that as long as it gets cold, we will be able to secure GMV.

[Unknown Analyst]

Understood. And my second question is in relation to the AOV. Q1, you continued to see strong year-over-year AOV at over 6%. And then this quarter, it seems to normalize slightly at 4.3% year-over-year. Can you just comment from here on what your expectation is for the full year AOV trend to be considering the second half of last year was much stronger than the first half. So yes, I'm curious what your expectations are for the second half of this year?

[Koji Yanagisawa, executive]

This is hard to forecast. But in the second quarter, the average retail price grew by about 3%. And this is a result of the sluggish fall/winter launch, the full winter price didn't sell as much as we expected. So the average retail price didn't grow as much, therefore it impacted the AOV. And in the second half, it is very hard to forecast. We don't know if the winter is going to be warm or cold. If it's cold, then we will be able to sell heavy items such as coats and denim jackets. But if not, then we might not see the level of sales that we expect, therefore, this would impact the AOV.

[Unknown Analyst]

Understood. And my last question is, this quarter, you seem to have a very large revenue increase in outright purchase stock. Maybe this is a one-off. I'm not sure. Can you just comment on what drove the outright purchase stock revenue to over $2 billion this quarter?

[Koji Yanagisawa, executive]

For now, we believe that it will be temporary. The healthy growth that we saw in the second quarter was due to the collaboration items with popular games and animation and content such as those. And whether this kind of popularity will continue going forward is something that we can't really say and commit to at this point in time.

[Operator]

Thank you, Tim. Glenn, if you like to go ahead?

[Unknown Analyst]

Good evening, Kobayashi, I think that was you referencing the birth of your baby.

[Yusaku Kobayashi, executive]

Thank you very much.

[Unknown Analyst]

Sure. Just a question of clarification first. Will the shares that are being bought back this fiscal year is the intent to cancel those shares? And then my real question is just if you could just talk about the performance you're seeing and the return you're getting for the promotion expense that you are making, have you seen any change in terms of customer uptake and customer redemption of the points and promotions? Or is what I'm seeing really just the weather impact that you spoke of? Thanks.

[Yusaku Kobayashi, executive]

So in terms of the share buyback or the cancellation of shares, these are going to be the treasury stocks that we actually had already acquired and is currently reflected in our books. And so we will be canceling the past shares that we acquired through buybacks. And the percentage in terms of the total amount of shares is going to be about 3.58%. And in terms of advertising and promotions, we haven't really implemented any new initiatives. We are showing or offering personalized discounts. And in terms of the points that we've awarded, we are seeing very high usage rates from our users. So we would like to continue to utilize this tool.

[Unknown Analyst]

Okay. And just to come back to my first question. So the new shares that will be repurchased under the newly announced repurchase program. Will those treasury shares also be canceled?

[Yusaku Kobayashi, executive]

Yes, we don't really see the necessity or a reason to utilize those shares, they will be canceled. And generally speaking, when we buy back shares, we will hold them for about a year. And if we don't have any use for them, they will be canceled.

[Operator]

Thank you Glenn. Does anybody have any other questions? [Operator Instructions] Thank you very much for taking part. It doesn't seem like we have any additional questions, so we would like to wrap up today's session. Thank you.

[Yusaku Kobayashi, executive]

Thank you very much.

[Operator]

[Foreign Language]