Seven & i Holdings Co Ltd

TSE:3382

Earnings Call Transcript 2019-Q1

[Junro Ito, executive]

Good afternoon. My name is Junro Ito, Director and Executive Managing Officer at Seven & i Holdings. I would like to thank you all for taking the time off your busy schedules to participate in today's earnings briefing as well as for your continued support.

Starting with the first quarter, we have decided to implement some changes to the company's earnings briefing structure. I, alongside Seven & i Holdings IR Manager as well as the heads of each respective department, shall thus be announcing and discussing the company's earnings results for the first and third quarters in a teleconference format. Earnings reports for the second and fourth quarters shall be conducted as usual in a physical forum and will be headed by President and Representative Director, Isaka, alongside with the representative directors of each entity comprising the Seven & i Holdings Group. We ask for your understanding regarding these changes.

Without further ado, I would like to go over Seven & i Holdings' results for the first quarter of the fiscal year ending in February of 2019. Please turn to Page 2, which contains an overview of the first quarter. Despite adverse weather conditions during the month of May as well as a decrease in revenue derived from Seven-Eleven Japan franchise fees, we were able to meet our targets for each earnings metric. More specifically, we were able to realize JPY 2.851 trillion in sales for the Seven & i Holdings Group as a whole, which corresponds to a 6.6% increase Y-o-Y. Similarly, we registered JPY 1.599 trillion for the metric of revenues from operations and an all-time high for the second quarter in a row of JPY 86.3 billion in operating income. This translates into an annualized increase of 8.9% and 2.7%, respectively. Finally, we realized JPY 42.8 billion in net income attributable to owners of parent. This represents an increase of 27.5% Y-o-Y.

The chart on the right contains a sectional breakdown of the metric of operating income for each operational segment. As you can see from the chart, we saw an increase in operating income associated with the Overseas Convenience Store business and the Superstore, Financial Services and Specialty store segments. On the other hand, we registered a decrease in the Domestic Convenience store business as well as for the Department-store segment and the segment labeled Others.

I would like to comment briefly on the performance associated with several of these segments before providing a more detailed overview of our operations at Seven-Eleven Japan, 7-Eleven, Inc., Ito-Yokado and Sogo & Seibu. In the Superstore segment, we registered a contraction in both sales and profit at York-Benimaru due in part to a decrease in consumer consumption in the Tohoku region. Starting with the second quarter, however, we intend to implement concrete measures revolving around the addition of a new fresh delicatessen menu as well as an eat-in corner at York-Benimaru stores. We're currently running a pilot program in [ Yukutska ] in Fukushima prefecture, which we hope to expand to other areas in the region. Through this initiative, we hope to increase profitability during the first half of the year and reach our sales and earnings targets by the end of the fiscal year.

We registered a profitable quarter for the Financial services segment. Although we do expect an increase in capital expenditures associated with IT infrastructure modernization allowing for the use of integrated circuit cards, we are confident in our ability to meet our targets for fiscal year 2019.

Regarding the specialty store segment, Nissen Holdings continue to implement a range of measures towards restructuring its operations and increasing profitability. The same can be said about Seven & i Food Systems, LOFT, Akachan Honpo, all of which registered an increase in profitability during the first quarter.

I would now like to go over our results for Seven-Eleven Japan. Please turn to Page 4. As you can see from the waterfall chart on Slide #4, Seven-Eleven Japan registered a JPY 3.8 billion contraction for the metric of operating income. Several factors account for this, starting with a 1% reduction in franchise fees, which negatively affected the company's bottom line to the tune of JPY 3.8 billion. We also saw a 0.1% reduction in gross profit margins due to an increase in demand for low-margin products such as e-cigarettes and concert DVDs for the all-girls band, Nogizaka46. Similarly, and although we were able to reduce costs associated with advertising, we saw an increase in costs related to new store openings. All in all, costs associated with SG&A grew at an annualized rate of JPY 8.2 billion. We were able to offset these costs through an increase in sales for existing and new stores to the tune of JPY 8.5 billion. If one excludes the aforementioned 1% reduction in franchise fees, operating income does remain flat in comparison to the same period for fiscal year 2018, falling in line with company expectations.

The graph on Page 5 provides a monthly sales breakdown for the months of March through May. We were off to a moderately positive start, but adverse weather conditions in May, which was characterized by prolonged periods of rain, led to a contraction for the categories of soda, ice cream, beer, energy drinks and milk-based beverages. This, in turn, translated into a decrease in daily store sales volume for these 5 categories to the tune of JPY 8,000, down 1.2% Y-o-Y.

On the other hand, we were able to increase sales for a number of product categories by developing and marketing products fitting our customers' needs, especially in the categories of frozen meals, products marketed under the SEVEN CAFÉ brand, deep-fried food products, noodles and delicatessen products. We intend to continue our efforts into the summer and into the second quarter, which has historically been associated with higher sales volume.

Please turn to Page 6, which details the economic impact of Seven-Eleven Japan's new store layout strategy. As you can see, we intend to renovate a total of 600 existing stores during fiscal year 2019 as well as open 1,100 new store locations. Of these, we renovated 60 existing stores and expanded into 240 new store locations for a combined total of 300 stores using the new and improved layout.

We also made progress in the development of new products with special emphasis on frozen meals suited to the new layout, which allows us to display a selection of 81 products, up from 57 under the old layout. Of these, 25 account for newly developed products introduced during the first quarter. This translated into an annualized increase of 28% in sales volume for the category of frozen meals during the month of May, a trend which we expect to have accentuated further during the month of June. All in all and during the 10-month period since the implementation of the new store layout, we registered an average increase in sales of JPY 17,400 per store location using the new layout, exceeding the JPY 15,000 figure we reported back in April.

Please turn to Page 7, which details the company's strategy as it pertains to the sale of chicken skewers, deep-fried foods and other products at 7-Eleven store counters all across the country. We have developed a number of new products in this category, which have met with a positive reaction from our customers. As you can see from the graph on the right, sales for the category of deep-fried foods were significantly higher Y-o-Y than the national average for stores in the Eastern Osaka area, where we started offering new products such as chicken skewers in the month of May. There were 6,400 such stores as of May 31, and we further expect to expand the scope of this initiative to cover 9,200 store locations by the end of July. We expect to cover the entirety of domestic 7-Eleven franchises carrying deep-fried foods during fiscal year 2019, including stores in the Tokyo area starting in October. Currently, products like chicken skewers sell particularly well during nighttime, but we intend to further expand the range of products sold at 7-Eleven store counters to cover all times of day. We expect this strategy to lead to a 20% increase in sales for the deep-fried foods category.

Please turn to the next page. The graph on the left provides a visual representation of franchised store sales plotted against personnel costs with fiscal year 2011 as the baseline for comparison. As you're aware, we lowered franchise fees by 1% in September of last year. This allowed franchises to offset an increase in personnel costs and increase the average revenue per store. It also led to a more proactive stance by franchise owners who now order fresh delicatessen products more often, which in turn leads to a reduction in opportunity costs. We also provide employment training opportunities in an effort to improve customer service.

We're still facing a shortage in personnel, but I'd say our franchise owners are taking a proactive stance towards improving service and operational efficiency. Our strategy has paid off, allowing 7-Eleven to increase its market share, starting with the third quarter of last year. The company boasted over 20,000 store chain locations, but we plan to further increase this number by working closely and in cooperation with franchise owners.

This section deals with our operations at 7-Eleven, Inc., starting on Page 9. As you can see from the graph, the first quarter was positive for the merchandise and gasoline segments, allowing for increased profitability. This thesis holds true, even one excludes a boost in productivity associated with the acquisition of Sunoco. We thus registered an increase in sales in the merchandise category, with special emphasis on fast food and products sold under 7-Eleven, Inc.'s private label brand. The 7Rewards app has also been well received, which translated into higher sales volume. All in all, sales volume grew 1.9% Y-o-Y for existing store locations in the U.S.

Gross profit margins were down slightly by 0.2%, mostly due to the impact of a tobacco tax increase. The price of gasoline also went up during the same period, but this was offset by an increase in sales volume and higher margins. More sales translated into higher SG&A fees associated with credit card purchases, but still, and excluding the positive impact derived from the acquisition of Sunoco, we saw a $27 million increase in profitability during the first quarter. The inclusion of data associated with Sunoco brings the grand total to $41 million during the first quarter.

Please turn to Page 11. As you can see from the data on Page 11, the average daily sales volume for Sunoco stores stood at $4,660 for the first quarter or $150 above the average for 7-Eleven, Inc. stores. The same holds true for the metric of gasoline sales measured by the gallon, with 5,000 gallons on average for Sunoco store locations to 3,430 gallons for 7-Eleven, Inc.

The financials for Sunoco are also included in the slide on Page 11. Assuming an exchange rate of JPY 108.22 to the dollar, there is still JPY 1.88 billion in the amortization of goodwill, which in turn translates into a negative earnings impact of JPY 270 million. Despite this, 7-Eleven, Inc. as a whole contributed JPY 9.376 billion to Seven & i Holdings consolidated earnings, up 33.1% Y-o-Y. We expect Sunoco to have a positive earnings impact starting in the second quarter.

We are also ahead of schedule in our talks with Sunoco towards the transition of existing stores to the 7-Eleven brand as well as the creation of a franchise chain regime.

Next, I would like to go over our operations at Ito-Yokado. For Ito-Yokado, we saw a sales contraction during the first quarter. However, structural changes in an effort directed towards improving gross profit margins as well as reducing expenses associated with SG&A led to increased profitability to the tune of JPY 1.7 billion. Reduced store space surface dedicated to apparel as well as falling prices for fresh food items such as vegetables and fruits were among the main factors contributing to the slump in sales volume during the first quarter. This translated into a sales contraction of approximately JPY 900 million. We conducted an inventory optimization for apparel items, allowing us to improve gross profit margins and offset the negative impact of falling food prices. Furthermore, structural changes to our business allowed us to book an extra JPY 1.2 billion in operating income. Lastly, and as it pertains to expenses associated with SG&A, we implemented a cost reduction strategy towards the optimal allocation of resources. All in all, Ito-Yokado registered JPY 2.4 billion in operating income.

Please turn to Page 14, which outlines the company's strategy towards structural reform. For the first quarter, this involved the revamping of the tenant composition of our Ario store in Izumi Sendai and in Omori, the latter which also saw a reduction in store area surface dedicated to the sale of apparel items. We also redesigned our Oimachi store location to feature an ideal food, apparel and household goods sales composition. We also closed one store during this period.

As you can see from the graph, these efforts translated into the more efficient use of store space as expressed through the metric of sales volume per square meter. We also saw an improvement in gross profit margins.

I would now like to direct your attention to Page 15. Here, we have included 2 examples showcasing the efficacy of our two-pronged strategy involved a move away from a general merchandising store layout and towards Ito-Yokado's Ario layout as well as increasing the number of tenants at our stores. We thus reduced the store area surface dedicated to the sale of apparel and household items and introduced new specialty stores and a food court capable of driving footfall to our facilities. Customers reacted favorably to these changes, which in turn translated into a significant increase in sales as well as an improved gross profit margins per square meter.

Please turn to Page 16. Further corroborating this trend, data from 10 pilot store locations prominently featuring food products indicates an increase in both footfall and sales. We intend to optimize the ratio between food, apparel and household goods across Ito-Yokado store portfolio.

Please turn to Page 17, which contains a graphical representation of food product sales at Ito-Yokado plotted against the industry average as determined by the Japanese Chain Store Association and the Japan Supermarket Association on an annual basis. As you can see, Ito-Yokado has outperformed the industry benchmark.

Lastly, I would like to go over our operations at Sogo & Seibu. Regarding Sogo & Seibu, we registered a slight contraction in operating income during the first quarter on lower sales volume due to store closings and transfers. We similarly registered a slight decrease in sales of 0.4% for existing stores due to a slump in institutional demand for our products. On a retail level, demand remained mostly unchanged. We also saw a sharp contrast in sales between our flagship stores in Ikebukuro and Shibuya and stores in areas further removed from the major metropolitan centers. We were able to improve gross profit margins by cutting back on sales promotions as well as reduce costs associated with SG&A. But despite these efforts, we posted an JPY 80 million contraction compared to the first quarter of last year. This translated into JPY 290 million in operating income.

Please turn to Page 20. Similar to Ito-Yokado, we've also implemented structural changes at Sogo & Seibu. These changes are already starting to bear fruit in the form of a higher sales volume per capita to surface area ratio. We have similarly been successful in reducing the relative weight of Sogo & Seibu's point reward program when measured against sales for existing stores. Worthy of note is the fact that our discontinuing our point reward-based discount policy does not appear to have had a negative impact in terms of sales. Moving forward, we intend to continue unlocking structural and operational efficiencies at Sogo & Seibu, with special emphasis on renovating our flagship stores, among which, our Yokohama store location, with a full revamping of the cosmetics section by mid-August of this year.

Next, I would like to explore Seven & i Group's customer relationship management and digital content strategy. Please turn to Page 22. We had the opportunity to show you this diagram during our last earnings briefing back in April. It encapsulates our strategy of combining our existing physical store locations, our product lineup and excellent customer service, with the latest in information technology to gain a better, deeper understanding of our customers' wants and needs in order to provide a personalized service suited for the digital age. This involves, for example, the use of RFID and other technologies in inventory management and optimization; an expansion in the range of services we offer, allowing for direct product delivery to our customers through initiatives such as IY Fresh or net convenience store as well as through the creation of a dedicated 7-Eleven and Ito-Yokado app.

We debuted this app on June 1, so it's only been a month. But we already have 3.58 million registered users for the 7-Eleven app and 460,000 users for the Ito-Yokado platform for a combined total of 3.58 million users, more and more of which are starting to use these 2 apps at our stores.

For the 7-Eleven app, the data suggests a positive correlation between app usage and an increase in sales. We intend to integrate new insights obtained through the analysis of customer data into the further development of new apps suited to our customers' needs. Furthermore, Sogo & Seibu will be getting its own app in the fall, with LOFT and Akachan Honpo following suit in the spring of 2019.

Please turn to Page 24, which details Seven & i's data laboratory initiative. As previously announced in a press release dated June 1, it's an initiative geared towards the mutual sharing of data between Seven & i Holdings and ANA HOLDINGS, NTT DOCOMO and others, with the objective of building a new framework with which to address societal issues and improve people's quality of life. Moving forward, we intend to enlist the help of companies across a wide range of sectors and industries.

Last but not least, I would like to use this opportunity to announce 2 new partnerships. The first is a partnership with Zoshinkai Holdings, which operates the online learning platform, Z-kai, as well as Eikoh Seminar and several other cram school chains, serving a wide range of customers from preschool children to college students and even adults. We believe we can make use of Seven & i's strengths in the form of its physical store locations, customer base and product line to improve customer service and create new service solutions while, at the same time, helping households where both parents work and incentivizing education and learning. This will involve, for example, making use of the Seven-Meal framework to deliver bento boxes to children who attend said cram schools or through the use of the multifunction printer devices found at 7-Eleven stores to allow students to submit exam questions. Students will also have the option of purchasing textbooks through our online store. We're considering possibly using store space at Ito-Yokado to host events or have cram schools and English conversation schools as tenants in an effort to drive footfall to our physical store locations.

We've also entered a partnership agreement with Odakyu Electric Railway Co., Ltd. and Odakyu Shoji Co., Ltd. This partnership will cover the supermarket business, the transitioning of existing Odakyu SHOP and Odakyu MART convenience store chains into the 7-Eleven brand in a mutually beneficial logistics agreement. We are currently in the process of working out the details in implementing these initiatives. Moving forward, we intend to enter more of these synergistic partnerships in an effort to unlock value.

This concludes my presentation. Once again, I would like to thank you for your time today. We at Seven & i Holdings place tremendous importance in these quarterly earnings briefings as they allow us to interact directly with investors. We shall be sharing your questions and opinions with President and Representative Director, Isaka; and Vice President and Representative Director, Goto; as well as the head of each constituent part of the Seven & i Group as we believe your feedback to be vital in helping us come up with new initiatives and further improve the operational efficiency of the group as a whole.

Lastly, I would like to invite each of you to download and install the 7-Eleven and Ito-Yokado apps, if you haven't done so already. We really appreciate your feedback. Thank you for your time today and for your continued support.