Fast Retailing Q3 2024 Preview: The dual challenges of strategy adjustment and slowing demand growth

Let's take a look at the development of Fast Retailing in the third quarter under the circumstances of macroeconomic fluctuations and strategic adjustments in the market

Fast Retailing has a large number of brands, among which Uniqlo's overseas and domestic businesses in Japan account for 51.95% and 32.19% of the total revenue, totaling 84.14%. GU as the second largest brand revenue accounted for 10.67%, other smaller international brands accounted for 5.12%.

According to the regional analysis, Fast Retailing's market is mainly distributed in Japan and Greater China, of which the domestic business in Japan accounts for 43.67% of the revenue, the Chinese market accounts for 18.21% of the revenue, and other overseas markets, including other regions in Asia, Europe and the United States account for 38.11%.

As a clothing retail brand, Fast Retailing's UniqLO and GU have been gradually known to the public. Uniqlo's market share in the Japanese men's/women's market has reached 18.2% and 16.0%. According to BCG forecasts, Uniqlo's market share in China's mass clothing market is about 3.0%. Due to its extensive market penetration characteristics, Fast Retailing's revenue capacity is highly linked to the macroeconomic environment and consumer confidence in key markets. At the same time, as a fast-moving clothing brand, Fast Retailing's revenue is also linked to its quarterly product and environmental climate adaptation and store sales strategy.

According to the monthly report released by Fast Retailing, its main brand Uniqlo's Japanese market performed well in April and May compared with the same period last year, mainly driven by the Golden Week holiday and brand appreciation festival. The end of April to the beginning of May is the Golden Week in Japan, and sales are strong during the holiday; At the same time, from May 23 for the 40th anniversary of Uniqlo Japan thanks festival, a number of popular goods limited time promotion, summer merchandise sales strong. The increase in same-store sales was primarily driven by per capita purchases, with the number of customer visits in May 24 essentially flat year over year, while per capita purchases increased 8.2% year over year.

From the macro data analysis of Japan, the average consumer confidence index in 2024 rose slightly to 37.2 compared to the average of 35.7 in April and May last year. From September 23 to March 24, Japan's macro consumer confidence has continued to increase, and from March to May, consumer confidence has declined, but it is still better than the same period last year.

Japan CCI data

From the perspective of the clothing industry, the summer climate in 2024 is hotter than expected, so consumers respond well to UniQlo summer products, and the total sales, the number of customers, and the average purchase rate have increased year-on-year. According to the data, its same store sales in April achieved an impressive +18.9% year-on-year growth, and in May it also reached 8.4% year-on-year growth.

It should be noted that the rapid growth of sales in the short term is also due to the Golden Week holiday and the discount of the gratitude festival promoted by Uniqlo. The end of April to the beginning of May is Golden Week in Japan, a holiday that boosts consumption. From May 23, for the 40th anniversary of Uniqlo thanks festival, limited time promotion to stimulate consumption. It can be seen from the data that although the number of customers to the store in May was basically flat, the per capita purchase increased by 8.2% year-on-year.

Uniqlo Japan's total sales, including online sales, grew by 1% in March, 20.3% in April and 9.3% in May. Revenue driven by consumer confidence and promotional interactions is expected to exceed expectations. However, it should be noted that consumer demand for summer goods has also been released ahead of schedule with good results in the third quarter. This could have an adverse impact on fourth-quarter results.

At the same time, considering that the market share of Uniqlo in the Japanese men's/women's market in 2022 is 18.2% and 16.0% respectively, the brand awareness and market share are already at a high level, so its long-term incremental space is limited. The strategy of increasing the number of stores to drive revenue is no longer applicable to the Japanese market, and Fast Retailing needs to improve the efficiency of single store revenue through the strategy of "opening efficient large stores and closing inefficient small stores" to maintain long-term revenue growth. According to Bloomberg forecasts, its revenue will grow by 1.14 percent in 2024, 3.56 percent in 25, and 2.62 percent in 26, all of which are no more than 4 percent.

Although the Japanese market has performed well recently, the Greater China market, which also accounts for the certain proportion of revenue, is likely to face a double whammy from macro consumption weakness and corporate decision-making adjustments.

Consumer expectations in the Chinese mainland market, despite a slight increase in March, fell back to near record lows in April and May, and are expected to drop 2.04 percent year-on-year in May. In the first quarter of 2024, per capita consumption expenditure as a proportion of disposable has dropped to 63%, reflecting the marginal decline in Chinese residents' willingness to consume. Among them, clothing consumption accounted for only 6.7% of per capita consumption. Both will affect the market's consumer attitude towards FMCG apparel products. Although the social retail sales data from March to May picked up year-on-year, they were lower than expected. Among them, the garment and textile industry increased year-on-year in March and May, and the growth rate turned negative in April due to the warming temperature. Although the May Day holiday drove travel traffic and consumption in May, Uniqlo stores are mainly located in first - and second-tier cities, and according to social zero data, the average daily passenger flow of shopping malls in first-tier, new first-tier and second-tier cities fell by 0.7%, 0.8% and 2.4% year-on-year. Therefore, its Chinese market revenue is not optimistic.

Similarly, Fast Retailing has also begun to make strategic adjustments in the Chinese market, but it may not be conducive to improving corporate profitability in the short term. Uniqlo's development situation in China's first - and second-tier cities is similar to that in the Japanese market, where brand recognition is already at a high level. At the same time, considering the downturn in China's macro environment, in the second quarter earnings conference, Fast Retailing reduced the new store opening target in Greater China from 80 to 55, and also adopted the strategy of "opening efficient big stores and closing inefficient small stores" for its business. Although large stores can drive single-store efficiency through visual marketing and business efficiency, the strategy of centralized scrapping of small stores takes about three years to complete, so the revenue growth and operating profit of its Greater China business will take longer to stabilize. In the 2024 half-year results, the operating margin declined after excluding the impact of changes in the way it recognizes bonuses. Therefore, although the change in Fast Retailing strategy is conducive to the long-term growth of per-store revenue, its sustainability and profitability are still to be verified.

According to the data of the first half of Fast Retailing's fiscal year of 24, the performance of the European and American markets was strong, and the revenue and profit increased significantly. Its European market revenue grew 5.02% in the second quarter, while the North American market grew 17.02%. The significant increase in revenue was mainly due to the gradual acceptance of Uniqlo and its LifeWear concept in the European and American markets. The Atlantic pointed out that due to the difficulty of finding a job and the pressure of student loans, Uniqlo and other cost-effective clothing are gradually accepted by the younger generation. According to Bloomberg forecasts, its 2024-2026 U.S. and European market revenue will both grow in the high double and high single digits year-on-year.

Fast Retailing is steadily expanding in other parts of Asia and the Pacific, while also developing more targeted products to meet market needs. According to second-quarter data, Southeast Asia, India and Australia saw significant revenue and profit growth. Revenues and profits rose in South Korea. For Southeast Asia, India and Australia, Uniqlo will not expand into new countries at present, but will fully tap the growth potential of the markets where it has opened stores until its market revenue reaches 1 trillion yen. In order to reach its revenue target faster, the company will further increase the pace of store openings in Southeast Asia, India and Australia from 70 to 100 stores per year. At the same time, Fast Retailing will also take into account the differences in climate needs in Southeast Asia and the equatorial regions of Oceania. The company will increase its range of products designed specifically for the year-round summer to expand its business in the region, and according to Bloomberg forecasts, its third-quarter revenue in the rest of Asia and Oceania markets will increase by 3.67% year-on-year.

Overall, according to its monthly report, Fast Retailing's short-term performance in the Japanese market is good, and the recovery of the Japanese macro economy is conducive to the stable improvement of its revenue performance. However, its market share in the Japanese clothing market is already very high, and it needs to maintain its growth rate through the company's strategy adjustment and improvement of operating efficiency in the long run. It is estimated that the compound growth rate may be stable at about 2%. At the same time, quarterly demand may be released early in the special discount period, which may not be conducive to the development of next quarter's performance; Europe, the United States and Asia excluding Greater China saw rapid growth in the second quarter through rapid store expansion and successful marketing to attract new customers, and this momentum is expected to continue as Fast Retailing expands its growth rate and customizes its product portfolio to specific regions. The Greater China market faces the dual challenges of macroeconomic weakness and fluctuations in strategic adjustments, and revenue and profit margins may continue to decline year-on-year.

After 23 years of rising costs caused by the sharp depreciation of the yen and poor forecast of order volumes, Fast Retailing improved the accuracy of its product ordering process, reducing the need for additional production orders and thus reducing the cost impact of exchange rate changes. According to the forecast, Fast Retailing's operating expenses (cost of revenue) for the quarter will increase by 8.45% to 338.46 billion yen. However, due to strong demand for its summer products in Japan during the quarter, its expense growth was slower than its revenue growth of 9.65%. According to Bloomberg's forecast, its gross margin in the third quarter will rise to 54.52% year-on-year.

However, in its forecast operating expense for the third quarter, selling, general and administrative expenses increased by 9.98% year-on-year to 281.51 billion yen, and the forecast operating margin was 16.22%, down 1.3 percentage points year-on-year. As it adopts the strategy of closing inefficient stores and opening efficient large stores in Japan and Greater China, the centralized scrapping of small stores and the higher operating costs of large stores in the early stage will lead to the reduction of its short-term operating efficiency.

In terms of inventories, Japan, Greater China, South Korea, Southeast Asia, India and Australia all saw declines in inventory assets, benefiting from the release of excess consumer demand after the pandemic. While inventories in North America and Europe have increased, this is mainly due to the fact that business in the region is still in an expansion period. At the same time, the company's inventory turnover rate increased year-over-year for several consecutive quarters. Fast Retailing uses SKU (inventory unit of each product) as the management unit, and closely tracks the gap between actual sales and target sales on a weekly basis. If the gap between the actual sales volume and the target sales volume is too large, the company will set it as a discounted product next week in a timely weekly meeting to promote the actual sales close to the target sales volume, accelerate inventory turnover, and avoid a large inventory at the end of the quarter. As a fast-moving consumer goods brand, Fast Retailing has demonstrated its solid turnaround ability and flexible control of market demand. At the same time, according to its half-year earnings report, Fast Retailing expects to strengthen its inventory management by reducing the number of SKUs, making thorough STOP&GO decisions on SKU production, and using automated warehouses in SKU deliveries. According to company statistics, Fast Retailing inventory has declined for three consecutive months, and its inventory turnover has risen for four consecutive quarters.

In general, Fast Retailing can improve margins by accurately forecasting orders to reduce costs and strengthen its ability to turn around inventory. Its developing markets through rapid expansion and the entry of new customer groups will effectively drive product profit margins. However, fluctuations in operating costs caused by the adjustment of its strategy will have a negative impact on its profit margin. Meanwhile, according to Bloomberg forecast, Fast retailing's third-quarter revenue was 743.62 billion yen, YOY+9.98%; net income: 90.66 billion yen, YoY+6.5%; Earnings per share 271.32 yen, YoY-2.27%.

According to market forecasts and fundamental analysis, although the Greater China market may face the impact of declining consumption levels, Fast Retailing's revenue in the quarter was good under the active promotion of its Japanese market and European and American markets, the cost growth rate was less than the revenue growth rate, and the gross margin was improved. However, due to its strategic transformation in Japan and Greater China, operating expenses increased and both operating margin and net margin declined year over year. Meanwhile, although its net profit rose 6.5 percent year-on-year, its earnings per share are expected to fall 2.27 percent to 271.32 yen due to an increase in total equity.

Based on the current market price and forecast EPS data for 2024-2026, Fast Retailing gets a PE multiple of about 39.04 in 2024, about 36.59 in 2025, and about 32.91 in 26. Its valuation is higher than that of global peers such as Inditex (25 times) and H&M (30 times), and certainly well above the average for local Japanese retailers. So its current valuation may be reasonably high. At the same time, its current dividend yield is only 0.81% and there is no related buyback plan, so investors should have higher requirements for the company's performance growth.