By Ritsuko Shimizu
TOKYO (Reuters) – Japan’s Seven & i Holdings is betting it can boost value by divesting underperforming businesses and focusing on key 7-Eleven stores. The outcome of its strategy will determine whether it can outmaneuver a $47 billion Canadian takeover bid.
Much depends on the retailer’s ability to roll out a new store format in Japan and improve profit margins abroad, analysts and industry insiders say.
Seven & i plans to spin off its supermarket operations and around 30 other ‘non-core’ units into a holding company, York Holdings. It will rename itself 7-Eleven Corp to emphasize its new focus and aims to bring in strategic investors for York and eventually list it on the stock exchange.
The shake-up shows Seven & i’s determination to ditch the conglomerate discount that has weighed on the shares for years. Poor performance in the supermarket sector hasn’t helped either, making the Japanese company a ripe target for a takeover bid from Alimentation Couche-Tard Inc, owner of Circle-K.
The Canadian company announced a preliminary offer for Seven & in August and sources said last week that it has since increased its offer by 22% to about $47 billion. If the deal goes through, it would be the largest foreign acquisition of a Japanese company ever.
Given pressure from Couche-Tard, Seven & i have made an “inevitable decision” to split the company, according to veteran independent analyst Akihito Nakai.
“It’s the only thing they can do,” he said.
Seven & i has said it is “confident” it can unlock shareholder value through a number of strategic actions and has set near-term growth targets, including an EBITDA profit target of 100 billion yen ($670 million) in the next fiscal year . the York Unit.
Still, it is unclear how long shareholders will be willing to wait. Shareholders Artisan Partners (NYSE:) and ValueAct Capital previously called on Seven&i to refrain from what they said was unnecessary bloat. The Japanese giant employs around 157,000 people worldwide across a business that includes clothing stores, supermarkets and restaurants.
The change in portfolio strategy underlines Seven & i’s “urgency to unlock shareholder value,” Jefferies analyst Shunsuke Kuriyama said in a note.
In Japan, 7-Eleven stores have become a cultural touchstone, known for their ready-made supplies of fresh food and everything from toothpaste to socks.
The Japanese stores are also very profitable: the operating margin is 27%, well above the 3.5% of 7-Eleven stores outside Japan.
Of 7-Eleven’s 85,000 stores worldwide, approximately 21,000 are in Japan, most of which are franchises. The Japanese supermarket market is also saturated: 7-Eleven also faces fierce competition from rivals FamilyMart and Lawson.
Same-store sales fell slightly in the six months to September compared to the previous year.
Reuters reported last month that some 7-Eleven owners are dissatisfied with the company’s current strategy, partly because of concerns about competition from rivals.
FAST EXECUTION
One area ripe for growth is mini-supermarkets, which are larger than convenience stores and stock more fresh food.
Rival Aeon has rolled out more than 1,100 of its ‘My Basket’ stores, focusing on urban areas where there is demand for the format from single and older shoppers. Aeon has indicated that it wants to double the number of My Basket stores.
7-Eleven introduced its own mini-supermarket, “SIP”, in February.
“Testing of the SIP format for mini-supermarkets is ongoing and will ultimately lead to the creation of a second domestic growth division for the company,” said analyst Michael Causton of consultancy JapanConsuming.
“The test results are promising and once everything is ready, it will roll out quickly,” he said in a note on the Smartkarma investor research platform.
The focus on SIP stores shows that Seven & i will have to maintain some sort of relationship with the supermarket company that will be spun off into York, said veteran analyst Nakai.
“If they completely break away from the supermarkets, they will not be able to implement the new strategy,” he said. “Regardless of capital ties, they must continue a cooperative relationship.”
FOREIGN AFFAIRS
Fixing 7-Eleven’s larger foreign operations could prove more difficult.
Seven & I cut its full-year profit forecast by a quarter last week. That reflects “a more challenging environment with customers reducing purchases,” Morningstar analyst Lorraine Tan said in a note after the earnings report.
Seven & i appears unable to cut costs quickly enough to ease pressure on margins, she said, adding that cost cuts are central to plans to boost returns from its US supermarket business.
So far, the company has announced plans to close approximately 444 underperforming stores abroad. It also increases the supply of fresh food in the United States.
It targets a return on invested capital (ROIC), a measure of profitability, of 10% by fiscal 2030, up from 6.5% last year.
The question now is whether it can deliver results quickly enough for investors, mainly due to the perception that the company is slow to respond to calls for change.
Converting foreign convenience stores into higher-margin businesses like those in Japan will take a lot of work, including in merchandising, locations and marketing, as well as logistics, JapanConsuming’s Causton said.
“In three years we might see some nice improvements, but five years is the minimum buy-in before the real gains start to show,” he said.
($1 = 149.2800 yen)
