Seven & i Holdings Co Ltd

TSE:3382

Earnings Call Transcript 2020-Q1

[Junro Ito, executive]

Greetings, everyone. My name is Ito of the Corporate Development division at Seven & i Holdings. Thank you for your continued patronage at our various stores operated under the umbrella of the Seven & i Group. I would also like to thank you for your continued support and understanding. Thank you for taking the time off your busy schedules to attend today's financial results briefing.

Before delving into the company's financial results for the first quarter, I would like to offer an apology. There have been reports starting yesterday, so I believe many of you gathered here today are aware of this news. We have confirmed access by unauthorized third parties to a subset of 7pay accounts, referring to the company's smartphone payment system which became available to the public on July 1. We are currently in the process of investigating this security breach, so I would like to refrain from discussing the possible causes behind this incident. We take this issue very seriously and will be doing our utmost to determine the cause behind this incident and to enact measures to prevent future incidents of this kind. I would like to offer my deepest and sincerest apologies to all of you for any concern this may have caused.

Without further ado, I would like to give you an overview of Seven & i Holdings' financial results. Please turn to Page 2. I would like to start with a review of the company's consolidated financial results for the first quarter. Due primarily to the sale of subsidiaries last fiscal year, a decrease in Ito-Yokado store locations and a challenging existing store sales environment, et cetera, revenues from operations stood at JPY 1.5964 trillion. This represents a slight Y-o-Y contraction of 0.2%. Operating income stood at JPY 90.3 billion, which represents a Y-o-Y growth of 4.6%. Net income attributable to owners of parent saw an improvement in part due to a decrease in extraordinary losses and stood at JPY 52 billion. This represents a Y-o-Y growth of 21.5%. We have therefore delivered the best earnings performance in the company's history for all income metrics while meeting company targets.

Next, I would like to discuss the topic of operating income changes by segment. An increase in operating income led primarily by convenience store operations in Japan and overseas offset a contraction in other segments, allowing for Y-o-Y growth of JPY 3.9 billion. This represents a new all-time high for the third fiscal year in a row. I invite you to peruse the appendix for a more detailed overview.

I shall be providing an overview of each operating company of the Seven & i Group. I would like to start with Seven-Eleven Japan. Please turn to Page 5. We registered a Y-o-Y increase of JPY 4.4 billion for the first quarter in the metric of operating income at Seven-Eleven Japan. Operating income stood at JPY 60.2 billion. We saw an increase in existing store sales of 0.3% Y-o-Y. This fell below company guidance. However, an increase in store locations contributed partially to a sales increase of JPY 5.2 billion.

In terms of gross profit margins, an increase in fried product sales and a margin improvement for rice ball products translated into an operating income improvement of JPY 620 million. On the other hand, in terms of SG&A expenses and while we registered an increase in expenses associated with new store openings, we were able to keep other expenses under control. This allowed us to contain this increase in SG&A expenses to JPY 1.4 billion. The following page contains a more detailed explanation. These 3 factors combined translated into a Y-o-Y operating income increase of JPY 4.4 billion, allowing us to post the company's best operating income performance.

Please turn to Page 6. The graph on the left provides a visual representation of first quarter operating income margins and SG&A expenses margin trends over the past 5 fiscal years. SG&A expenses margins have been on an upward trajectory up until fiscal year 2019. However, they have dropped to 11.5% for fiscal year 2020. The optimization of sales promotions and a shift to 7-Eleven app-based sales allowed us to reduce advertising expenses by JPY 2.2 billion Y-o-Y. A reduction of directly operated stores with 76 fewer stores compared to the end of May of last year, among other factors, led to a Y-o-Y reduction of approximately JPY 400 million. While we registered an increase in rent costs and in depreciation and amortization, we were able to curb the overall increase in SG&A expenses to 1% Y-o-Y or a JPY 1.4 billion increase. This 1% increase is the lowest first quarter increase in the company's history. Going forward, we want to implement improvements to head office cost structure and deliver further profitability improvement.

Please turn to Page 7. The graph on Page 7 provides a breakdown of Y-o-Y changes in gross profit margins month-by-month. The dashed line represents gross profit margins including cigarettes, while the solid line represents the same metric excluding cigarettes. We saw the positive influence of the renewal of fried products in the fall of last year and of rice balls in February of this year, leading to a robust improvement in gross profit margins excluding tobacco. Going forward, we want to continue these renewal efforts while improving product quality and deliver further improvements in gross profit margins.

Please turn to Page 8. This slide deals with gross profit improvements we have made in the product category of rice balls. The vertical bar graph on the left deals with Y-o-Y changes in gross profit margins for rice balls. The red line represents Y-o-Y changes in gross profit amounts, while the blue line represents Y-o-Y changes in sale price. As you can see, we registered significant improvements following our renewal efforts. From February, we carried out the complete renewal of 5 hand-rolled rice ball items. We reviewed the rice, nori seaweed and fillings using these rice balls and delivered a significant quality improvement. We then changed the price point for these items following this dramatic quality improvement. This led to a gross profit margin improvement. As a result, while we raised prices by JPY 5 to JPY 10, consumer response was positive, leading to an increase in sales volume. This posed a significant contribution to an increase in both sales and gross profit margins for the product category of rice balls as a whole.

Please turn to the graph on Page 9. The graph on Page 9 represents Y-o-Y trends in existing store sales and customer numbers. Excluding extraordinary factors such as the influence of unstable weather conditions and a hike in the price of cigarettes, we registered a Y-o-Y sales increase. However, we have registered a Y-o-Y contraction for 20 out of the last 24 months. For this reason, we consider customer visits to be the biggest issue we must contend with. In particular, the trend starting with the current fiscal year shows a Y-o-Y decrease of over 1 point in terms of customer visits. We believe this to be partly due to a consumer shift to competitors offering barcode payment options like PayPay and LINE Pay, services which 7-Eleven hadn't offered until recently.

Please turn to Page 10. As I've mentioned earlier in this presentation, issues involving the unauthorized access to a subset of 7pay accounts have come to light. July 1 marked the introduction of 7pay and the introduction of a payment function to the 7-Eleven app. Our app has already been downloaded over 12 million times, allowing us to stand in a strong and effective starting position. Over 700,000 app users registered for 7pay on the first day and over 1.5 million people in the first 3 days alone. Simultaneous with the introduction of 7pay, we also made available barcode payment options at our stores. These include PayPay, LINE Pay, et cetera, for a total of 5 companies in and outside Japan. Starting July 11, we will have executed the first joint sales promotion initiative by PayPay, MerPay and LINE Pay. We are currently studying a variety of other sales promotion strategies, which we believe will lead to an increase in sales and customer visits.

Please turn to Page 11. Page 11 deals with our action plan to the 24-hour operation issue, which we announced on April 25. Our action plan involves measures to strengthen support for franchise stores such as strategies to respond to staff shortage issues and offer productivity improvements through personnel savings. We are in the process of strengthening communication with owners through store visits from directors and general managers and by carrying out owner surveys. We are also considering a shortening of operating hours by carrying out tests at select directly operated stores and franchise stores. Finally, we are accelerating the introduction of new store layouts and implementing measures to reduce food loss in an effort to expand sales and profits.

I would like to give you a progress update for some of these strategies. Please turn to Page 12. We have included several examples of equipment and furniture we introduced at our stores as part of our personnel saving efforts toward an improvement in operational efficiency. We started introducing these changes during the current fiscal year starting with new and renovated stores. The introduction of the 10 facility improvements shown on Page 12 leads to a theoretical operation improvement of 223 minutes or approximately 3 hours and 40 minutes. We are hopeful these will lead to a revision of work shifts and to the strengthening of customer service and stocking, which in turn should translate into a sales and profitability improvement.

I would now like to give you a progress update on the introduction of the new store layouts as part of our efforts to expand sales and profits. Please turn to Page 13. We are in the process of analyzing sales trends at the 411 stores that had introduced changes by December 2018. Results for the month of May show an increase of JPY 17,000 in APSD. We are seeing improvements derived from changes to store sales areas and in product categories for which we implemented changes. We introduced new store layouts at 1,200 stores during the first quarter. The cumulative number of stores that have already transitioned to the new layout stands at 4,600. During our financial results briefing back in April, we had previously announced a target of 6,000 stores. We have since then added 1,000 to this target. We therefore expect the cumulative number of stores with the new layouts to stand at 7,000 by the end of the current fiscal year. We are therefore in the process of strengthening existing stores.

Page 14 contains information about what we have termed our ethical program, a program designed to reduce food loss and improve profitability. We expect to be able to reduce food loss by granting extra nanaco points for the purchase of products a few hours away from the sell-by deadline. This is a sales promotion carried out by the head office, so there is no added burden on franchise stores. Through the sale of products that would previously be discarded, we expect to deliver an increase in sales and achieve improved profitability. The head office will bear the burden when it comes to granting these extra nanaco points. However, we believe we can offset these with higher franchise fees derived from improved store sales and from a reduction in the cost to franchisees related to food loss. Since nanaco points will be used as part of this initiative, we believe this will lead to greater adoption for 7pay and nanaco.

Page 15 contains results from an ethical program test we carried out in February at directly operated stores. We awarded 3% in nanaco points for the purchase of products sold 3 hours before the sell-by deadline. These are the average results for a sample of just 10 stores. However, as you can see from the rightmost column, we registered an increase in sales and a reduction in food loss. We are carrying out tests for other sell-by deadline times and point-of-work rates. Also based on these tests, we will be expanding the ethical program to all stores in the fall. We will be reducing food loss and improving profitability for franchise stores.

Next, I would like to go over our results in 7-Eleven, Inc. Please turn to Page 17. We registered a Y-o-Y operating income increase for 7-Eleven, Inc. of $31 million during the first quarter. Operating income therefore stood at $161 million in what was the best operating income performance in the company's history. In terms of merchandise, we registered a Y-o-Y improvement in United States existing store sales of 3.4%. This, among other factors, had a positive contribution of $39 million in sales. We also saw a significant improvement in terms of gross profit margins of 0.7%. This translated into a gross profit growth contribution of $24 million.

We saw a Y-o-Y contraction in terms of sales volume per store for the product category of gasoline. However, our acquisition of Sunoco, which we carried out on January 23 of last year, had a positive sales volume impact which translated into sales volume growth of $10 million. Gross profits, as shown by the metric of cents per gallon, were up $0.012 Y-o-Y. This translated into gross profit growth of $19 million. An increase in rents, et cetera, associated with the sale and leaseback of assets we acquired from Sunoco pushed down operating income by $61 million. Overall, 7-Eleven, Inc. delivered $161 million in operating income, allowing us to exceed guidance.

Please turn to the graph on Page 18. The orange line represents same-store sales growth, while the vertical bar graph represents gross profit margin Y-o-Y variance. Fresh food and 7-Select private brand products were sales drivers during the first quarter, as was the sale of alcoholic and nonalcoholic beverages and e-cigarettes. This led to a Y-o-Y existing store merchandise sales growth of 3.4%. We also continued to register strong sales after April. A sales increase for nonalcoholic beverages, which have high margins; a positive contribution from 7Rewards, our customer loyalty program; and the introduction of 7-Select products and other 7-Eleven products at Sunoco stores, led to a merchandise gross profit margin growth of 0.7% Y-o-Y.

Please turn to Page 19, which deals with gasoline gross profit. As you can see from the graph in the upper left corner, the price of crude oil saw a sudden decline in the months leading up to the end of last year, started reversing around the beginning of the year and is now on an upward trend. However, the price of crude oil was still lower Y-o-Y during the first quarter. As a result of this, the retail price of gasoline was lower Y-o-Y. However, as you can see from the graph in the upper right corner, gasoline sales volume per store was lower Y-o-Y due to unseasonable weather, among other factors. However, as shown on the graph at the bottom, the metric of cents per gallon was higher Y-o-Y. There was also an increase in store days for Sunoco. These factors resulted in a significant gasoline gross profit improvement of 9.7%.

Page 20 contains our results for Sunoco. As some of you might have some concern over our results for Sunoco, I would like to give you a more detailed breakdown for these. I would like to start with operating figures. Both daily merchandise and gasoline sales were lower Y-o-Y. However, this is due to the timing of our acquisition of Sunoco. We acquired Sunoco on January 23 of last year. Due to the timing of the acquisition, the figures for the current fiscal year include the first 3 weeks of the year, which is generally the worst sales period of the year. Figures for this period were absent in the previous fiscal year.

Next, I would like to go over the financial figures. Operating income in U.S. dollars for Sunoco saw a marked decline and stood at 12.8% of what they were the previous fiscal year. As I mentioned back on Page 17, this was mainly due to the impact of an increase in rents derived from sales and leaseback. The first quarter is the hardest quarter in terms of sales, and there was also the influence of higher fixed expenses as a result of an increase in store days. Our results for Sunoco have a negative impact on consolidated operating income. However, I would like to assuage your concerns by saying that these figures are in line with company estimates.

Please turn to Page 21, which deals with our new test store. We opened a new test store in March in Dallas. We are currently in the process of carrying out a variety of tests with an open mind in order to improve our understanding of customer needs and in order to gather information we can use for our future store designs. This new test store has an in-store bakery serving cookies and croissants. We also serve craft beers. We also opened a Laredo Taco location at the new test store. Laredo Taco is a Mexican restaurant chain which we took over following our acquisition of Sunoco.

We also introduced the Scan & Pay system at the store through which customers can scan and pay for items with their smartphones as part of our personnel saving efforts and in order to increase profitability. We will be studying ways to apply results we see at this new test store to existing stores. The development and improvement of fast food items is important and something which we will continue doing going forward. We also believe changing public perception of 7-Eleven in the United States to be important. In order to change public perception when it comes to buying food products at 7-Eleven, like is common in Japan, we will be strengthening store cleanliness and improving customer service quality. We also want to continue carrying out efforts towards the renovation of existing stores.

I would now like to go over our results for Ito-Yokado. Please turn to Page 23. During the first quarter, we registered a Y-o-Y operating income contraction of JPY 2 billion for Ito-Yokado. Operating income stood at JPY 370 million. Sales at same stores, including tenants, were down 0.1%, mostly unchanged Y-o-Y. However, we saw a decrease of 5 stores carried out within the scope of structural reform. This had a negative operating income impact of JPY 1.8 billion Y-o-Y.

Gross profit margins of directly operated sales remained unchanged Y-o-Y, while we registered a decrease in gross operating profit margins due to an increase in the tenant composition ratio. This negatively affected gross profit margins, leading to a JPY 770 million Y-o-Y contraction. A decrease in personnel costs and in rents due to store closings led to an improvement of JPY 600 million in terms of SG&A expenses. However, this wasn't enough to offset the deterioration of sales and gross operating profit margins, leading to a Y-o-Y operating income contraction of JPY 2 billion. We were also unable to meet company guidance targets for Ito-Yokado.

Page 24 outlines our store structural reform efforts. We carried out a strategy of reducing sales floor space associated with apparel and household goods, products which are characterized by low profitability. There has been a 10% area reduction compared to 2015. Despite accounting for over 70% of sales floor space, these product categories have gross profit margins of approximately 40%. This therefore remains a challenging profit structure. Starting with the current fiscal year, we consolidated the apparel and household goods division into the lifestyle division. We also formed a new specialty stores division from the exhibitions division within food and household goods.

In terms of the lifestyle division, we want to carry out not just a mere reduction of store sales space, but also merchandising reorganization. We have divided merchandising into 2 categories: basic merchandising common to all stores and optional merchandising in line with individual store characteristics. In addition to this, we are considering merchandising categories to abandon for all stores and narrow down the range of merchandising categories offered.

In the specialty stores division, in addition to exhibitions, we will also be developing new products to enhance the attractiveness of the venue as a whole. We are considering a shift to franchising for our restaurant businesses and services, which are tenants characterized by the ability to attract customers, but which also have problems related to personnel strategies. We will be recreating stores as commercial facilities aligned to local characteristics.

Page 25 provides a visual representation of operating income margins and SG&A expenses margin trends over the past 5 fiscal years. Operating income margins saw a significant contraction and are down to 0.1% for the current fiscal year. On the other hand, SG&A expenses margins were in a downward trend up until fiscal year 2019. For the current fiscal year, while we achieved a reduction in SG&A expenses of 0.8% Y-o-Y, this wasn't enough to offset a sales contraction. As a result, SG&A expenses margins stood at 25.2%. This represents a Y-o-Y increase. Several factors contributed to this such as store remodeling within the scope of the company's structural reform efforts and an increase in amortization associated with the opening of 3 new stores. We also carried out sales promotions for the 10-day extended Golden Week holiday, which resulted in an increase in advertising expenses. We will be announcing specific countermeasures during the company's financial results briefing in October. These include store policy, investment discipline, personnel allocation, et cetera.

Next, I would like to discuss our results for Sogo & Seibu. Please turn to Page 27. During the first quarter, we registered a Y-o-Y operating income contraction of JPY 660 million for Sogo & Seibu. We posted an operating loss of JPY 370 million. Our 5 key stores in the Tokyo metropolitan area were able to deliver a sales performance on par with last fiscal year. A Y-o-Y contraction for our regional and suburban stores as well as for the corporate outside sales division led to a sales reduction of JPY 240 million.

In terms of gross profit margins, growth in sales of low gross profit products such as luxury brands and food products, et cetera, led to a 0.4% reduction Y-o-Y. This negatively affected gross profit margins by JPY 380 million. In terms of SG&A expenses, while we saw a decrease in personnel costs, we saw an increase in depreciation and amortization due to a point-of-sales cash register changeover in the previous year. We also saw an increase in advertising expenses associated with our Golden Week sales promotion efforts, among others. These factors led to a Y-o-Y operating income contraction of JPY 40 million.

Please turn to Page 28. Page 28 provides a visual representation of operating income margins and SG&A expenses margin trends for the first quarter. After we announced our MTP, we closed 6 stores and carried out a call for voluntary retirement. We also carried out the transfer of Sogo Kobe and SEIBU Takatsuki while also guaranteeing the employment status of the people working at these stores. We carried out these initiatives in order to reduce our SG&A expenses margins. However, while it is only a slight change, our SG&A expenses margins registered a Y-o-Y increase for the current fiscal year. Sogo & Seibu's SG&A expenses margins stood at 22.7%, back to where they were 5 years ago.

During the second quarter and beyond, we will be introducing a low-cost operation structure at SEIBU Tokorozawa and Sogo Chiba. In addition to reviewing personnel allocation, we will be shifting human resources in the direction of the loyal customers division and the corporate outside sales division, which we consider to be growth areas in an effort to improve productivity. Further reform plans are to be announced following the same schedule as Ito-Yokado in October 2019 during Seven & i Holdings' financial results briefing for the first half of the year.

Lastly, I would like to discuss the company's digital strategy. Please turn to Page 30. We launched mobile apps for both 7-Eleven and Ito-Yokado in June of last year and started the Seven Mile program. We then launched an app for Sogo & Seibu in December of the same year and for THE LOFT and Akachan Honpo in March 2019. Through this, the number of 7iD members continues to grow steadily with over 15 million people joining the Seven Mile program in the 12 months since its launch. As you can see from the graph, app utilization rates are also on a steady growth trajectory.

The table to the left on Page 31 shows the comparison of 7iD and nanaco memberships. Compared to nanaco users who haven't yet transitioned to 7iD memberships, 7iD users have higher purchase amounts and purchase frequency. This holds true for both 7-Eleven and for Ito-Yokado. This indicates 7iD members are loyal customers. Also as shown on the graph to the right, the ratio of 7iD member purchase amount to total sales continues to grow at a healthy clip. This ratio has recently exceeded 11%.

Page 32 contains a recent example of a mutual customer referrals campaign between Sogo & Seibu and Seven-Eleven Japan. The graph in the upper-left corner shows sales for e.depart, Sogo & Seibu's online shopping site, and uses 2016 as a baseline for comparison. As you can see, sales for cosmetics continued to grow at a healthy clip. We have included in the upper right corner a breakdown of the Seven & i Group's strengths. We have what we call Kirei station at Sogo & Seibu stores where we offer individual consultation for all cosmetic brands. Customers who find a product they like through this process usually continue buying these products online through Sogo & Seibu's online shopping site. Customers can also pick up their orders at the nearest 7-Eleven store. This is a service that is convenient to use by leveraging the Seven & i Group's infrastructure and which we believe has been well received by the public.

In an effort to further promote mutual customer referrals, we carried out a joint campaign between Seven-Eleven Japan and Sogo & Seibu with female app users between the ages of 20 and 50 as the target demographic. Customers who purchase cosmetics through the e.depart site and who choose to pick up their orders at a 7-Eleven store are presented with a nanaco gift card. 7-Eleven app users can also receive a ticket entitling them to a free SEVEN CAFÉ and café latte. It has only been a week, but as you can see, we have registered an increase in cosmetic sales through e.depart compared to the period prior to the execution of this campaign.

In-store pickups in particular have increased significantly by 91% Y-o-Y. As shown on the bottom right corner, the overall in-store pickup ratio has shown significant growth. For the product category of cosmetics, more than 50% of customers make use of this in-store pickup option. This leads to the acquisition of new customers as many customers who use this in-store pickup option also make additional purchases at 7-Eleven stores. This in turn translates to a sales and profit improvement for franchise stores.

Page 33 contains an overview of mutual customer referral campaigns between Akachan Honpo and Ito-Yokado. Customers who visit Akachan Honpo are parents who are currently pregnant or have infant children. A large number of customers in this target demographic have difficulty leaving the house to do the shopping or in carrying heavy weights. I believe we can make life easier for our customers through the use of Ito-Yokado's Net supermarket. We carried out a campaign towards the end of April and into May through which we offered customers, who downloaded both the Ito-Yokado and Akachan Honpo apps, coupons they can use at both stores. This initiative was well received, and the number of members who are combining usage of the 2 company apps rose by 20% compared to the period prior to the execution of this campaign. The number of users with both apps rose to 41,300. By June 15, 670 people had made use of Ito-Yokado Net supermarket coupons. This translated into a sales increase of JPY 5.3 million. Going forward, we want to carry out these mutual customer referral initiatives between the various operating companies in an attempt to create group synergies.

Lastly, I would like to discuss future developments. As I mentioned earlier, the launch of 7pay was not without incident. However, the 7 app with 7pay payment functions is now available to the public. Soon it will be possible to use 7pay at external retailers. An expansion in the use of 7iD to entities outside the Seven & i Group will allow us to better and more accurately understand customer needs. By promoting the development and offering of products and services reflecting changes in customer needs, we will also expand both sales and profits. Also customers will be able to accumulate nanaco points through purchases made at stores outside the scope of the Seven & i Group, which they can convert into their 7pay balance. We believe this will lead to an increase in the use of stores belonging to the Seven & i Group. We want to pursue synergies between digital strategy and real business and create new value while providing products and services more tailored to customers' lifestyle needs.

Thank you for your time. As I mentioned at the start of today's financial results briefing, we apologize for the recent issue involving 7pay. We will look into the causes for this breach and take concrete measures to prevent a similar issue from arising ever again, for this particular incident but also in general, not just from a technical point of view, as we believe consumption trends will likely worsen going forward. Seven & i Holdings will be working as a cohesive unit towards this end. So for this reason, I would like to request your understanding and cooperation.

Thank you for listening.