Brief Japan: FANCL: Playing the Long Game and more

In this briefing:

1. FANCL: Playing the Long Game
2. Pepper Food Services 4QFY2018 Results: Burnt, But a Lesson Learnt

1. FANCL: Playing the Long Game

• The declining and ageing population in Japan has been a major cause for concern to many Japanese companies.
• Fancl Corp (4921 JP), is a relatively small player in the Japanese cosmetics and nutritional supplements space who is expected to benefit from the declining and ageing population.
• Compared to the peer average, EV/Sales discount narrowed down significantly over the course of the last year. But we believe the discount remains the same on a growth adjusted basis.
• Still too small for institutional investors to notice. But we expect them to start noticing the company over the coming years.
• One of the cheapest stocks on a long term forward multiple, as we expect FANCL to sustain its high growth over a long period of time.

We are not sure if Fancl Corp (4921 JP) can ever be in the same league as Shiseido or Kao, but we certainly believe the company doesn’t deserve to be about 10% of the size of Shiseido. Thus, we have a very long-term bullish view on FANCL and expect to see the company’s market cap to double over the next 5-7 years

2. Pepper Food Services 4QFY2018 Results: Burnt, But a Lesson Learnt

On Thursday the 14^th Feb 2019, Pepper Food Service (3053 JP) announced its results for FY2018 and the guidance for both 1HFY2019 and FY2019. The company managed to grow its revenue by an impressive 75.3% YoY outperforming its own estimate by 6.4%.

However, the gross profit only grew by 69.9% during the year as the gross margin slipped 137bps in FY2018 driven by higher energy prices and wages. Higher wages were due to active recruitment of foreign workers within the food service industry which created a supply shortage. To tackle increasing costs, towards the end of the year, Ikinari Steak restaurants increased the prices of its steak. We believe the margin recovery witnessed in 4Q2018 was a direct result of this price increase.

Gross Margin Showing Signs of Recovery

Pepper Food Services saw its EBIT margin decline by 20bps to 6.1% in FY2018, as revenue growth offset most of the gross margin drop through gains from operating leverage. However, its restaurants in New York City continued to underperform. The company expected those restaurants to turn a corner and start contributing to the overall EBIT from FY2018, however, those restaurants failed miserably and continued to drag the overall EBIT margin down. Hence, the company failed to meet its EBIT margin forecast with EBIT falling 4.6% short of company guidance.