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Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Equity Bottom-Up

We initiate coverage of <a href="https://www.smartkarma.com/entities/7658" target="_blank" data-smartkarma-citation="entities:7658:1">Yamazaki Baking Co Ltd (2212 JP)</a> with a fair value estimate of JPY 2,090, and assign it narrow moat and stable moat trend ratings. The stock is trading close to our fair value estimate although our operating profit estimates are 14% below the 2017 guidance and 2%-5% below the consensus. We expect rising logistic costs will erode margins while recovery in biscuit profits is unlikely to take place until 2018. We think management has been taking a conservative approach to logistic operations and Yamazaki has opportunities to improve profitability substantially by altering its production schedule and reducing delivery frequency. Until we see the sign that management will address the issue, however, we will not incorporate this into our base-case valuation.We consider the food business, mainly bakery products, has a narrow moat underpinned by intangible assets in its supply chain, namely entrenched retail relationships. As the only packaged bakery food manufacturer with a nationwide distribution capability to supply national retail chains, Yamazaki has attained retail penetration close to twice that of its second-placed rival. Its ability to offer an expansive product lineup with constant and timely new product launches is particularly valued by the national convenience store chains. The private-label exposure also reinforces the entrenched retail relationship which strengthens Yamazaki’s bargaining power of the name-brand confectionery and biscuit products.We project a 5% EPS CAGR over the next five years. We expect a steady low-single-digit organic growth in the core bakery food sales given Japanese consumers’ growing demand for bakery products in part resulting from the lifestyle change as demographics change and an increasing number of females entering the job market drives demand for convenience.On the other hand, rising labor and logistics costs are likely to erase some of management’s cost-saving efforts, which we expect to limit profit growth to the low-single digits over the next two years. After the completion of construction projects relating to the 2020 Olympics, however, we expect labour market pressures to subside somewhat, leading to 30 basis points of margin re-expansion. Logistic costs including labor costs of its own logistic arm accounts for 40% of SG&amp;A expenses or 14% of sales.Our fair value estimate implies a fiscal 2018 price/earnings of 23 times and enterprise value/EBITDA of 5.8 times, about the average of its historical range but at a 30% discount to the sector average on EV/EBITDA method due to a net cash position and high tax rates.We attribute Yamazaki’s 28% underperformance over the past 12 months to the Topix Food Index to disappointment over a profit decline resulting from margin contraction and lost sales caused by the unraveling of a partnership with Mondelez. The negative impact of this will fade from the fourth quarter. Streamlining logistic operations by reorganizing the production process and reducing delivery frequency will be the most effective means to lift margins over the short term, in our view, although no restructuring action is in sight yet. Any attempts to optimize logistic efficiency poses potential upside to our estimates.Analyst: Jeanie Chen

We initiate coverage of Yamazaki Baking Co Ltd (2212 JP) with a fair value estimate of JPY 2,090, and assign it narrow moat and stable moat trend ratings. The stock is trading close to our fair value estimate although our operating profit estimates are 14% below the 2017 guidance and 2%-5% below the consensus. We expect rising logistic costs will erode margins while recovery in biscuit profits is unlikely to take place until 2018. We think management has been taking a conservative approach to logistic operations and Yamazaki has opportunities to improve profitability substantially by altering its production schedule and reducing delivery frequency. Until we see the sign that management will address the issue, however, we will not incorporate this into our base-case valuation.We consider the food business, mainly bakery products, has a narrow moat underpinned by intangible assets in its supply chain, namely entrenched retail relationships. As the only packaged bakery food manufacturer with a nationwide distribution capability to supply national retail chains, Yamazaki has attained retail penetration close to twice that of its second-placed rival. Its ability to offer an expansive product lineup with constant and timely new product launches is particularly valued by the national convenience store chains. The private-label exposure also reinforces the entrenched retail relationship which strengthens Yamazaki’s bargaining power of the name-brand confectionery and biscuit products.We project a 5% EPS CAGR over the next five years. We expect a steady low-single-digit organic growth in the core bakery food sales given Japanese consumers’ growing demand for bakery products in part resulting from the lifestyle change as demographics change and an increasing number of females entering the job market drives demand for convenience.On the other hand, rising labor and logistics costs are likely to erase some of management’s cost-saving efforts, which we expect to limit profit growth to the low-single digits over the next two years. After the completion of construction projects relating to the 2020 Olympics, however, we expect labour market pressures to subside somewhat, leading to 30 basis points of margin re-expansion. Logistic costs including labor costs of its own logistic arm accounts for 40% of SG&amp;A expenses or 14% of sales.Our fair value estimate implies a fiscal 2018 price/earnings of 23 times and enterprise value/EBITDA of 5.8 times, about the average of its historical range but at a 30% discount to the sector average on EV/EBITDA method due to a net cash position and high tax rates.We attribute Yamazaki’s 28% underperformance over the past 12 months to the Topix Food Index to disappointment over a profit decline resulting from margin contraction and lost sales caused by the unraveling of a partnership with Mondelez. The negative impact of this will fade from the fourth quarter. Streamlining logistic operations by reorganizing the production process and reducing delivery frequency will be the most effective means to lift margins over the short term, in our view, although no restructuring action is in sight yet. Any attempts to optimize logistic efficiency poses potential upside to our estimates.Analyst: Jeanie Chen

Launching Coverage of Yamazaki With Narrow Moat and Stable Moat Trend Ratings; FVE of JPY 2,090