Inflation Proves Blessing In Disguise For Japan Retailers

(Bloomberg) -- When Japanese convenience store operator Lawson Inc. unveiled a 10% price hike on its popular chicken nuggets last year, investors weren’t convinced it would go down well. After all, the product had been sold at 200 yen ($1.45) pre-tax for 36 years since it first hit the shelves in 1986.

Fast forward to July 2023, when Lawson’s share price reached a 4 1/2-year high of 7,320 yen after the company reported brisk earnings in the three months to May. Its quarterly net profit doubled from the same period last year.

“Looking at the reaction to Lawson, retailers appear to be passing on rising costs more than investors have been expecting,” and that’s supporting the stock, said Kengo Yamamoto, a fund manager at Norinchukin Zenkyoren Asset Management Co. 

Lawson’s move illustrates the price pressures which are adding to speculation the Bank of Japan may upgrade its inflation forecast next week. Robust earnings from retailers have helped reinforce the view that consumers in the world’s third-largest economy can withstand higher prices. 

Some strategists and fund managers are rotating their stock-selection to favor domestic demand-driven ones. A top-performing fund, Alma Eikoh Japan Large Cap Equity, has trimmed chip stocks for defensive names, while US-based hedge fund Indus Capital Partners has shifted money into domestic consumption stocks. 

Shares of Muji operator Ryohin Keikaku Co. rose by their daily limit last week after it reported strong earnings thanks to improved margins in Japan as well as a recovery in China. Seven & i Holdings Co. also posted brisk domestic sales even though its earnings missed estimates due to weakness in its overseas business.

“I knew from my dialogue with retailers during the pandemic that they have cut fixed costs quite aggressively, so I’d been thinking their profits will jump as soon as their sales return,” said Hiroaki Tomori, chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co. “But it was harder for markets to estimate just how much that boost will be.”

Since August, analysts have been raising their price targets on Lawson, maker of the much-loved “Karaage-Kun” snack, largely to catch up with the convenience store operator’s stock.

Analysts’ earnings forecasts have been steadily improving for the sector. The 12-month forward EPS for the TSE Retail Index has risen 7.1% so far this year, much more than 2% increase for the Topix Index. 

Investors aren’t sure quite how sustainable higher prices will be though. A government survey of service-sector workers showed sentiment on the economic outlook has softened over the past two months after five straight months of improvement, raising concern that consumers may be reaching their pain threshold for inflation. 

The TSE retail gauge has also underperformed the broader Topix so far this year amid other opportunities such as semiconductor-related firms, trading houses and shares with low price-to-book ratios. 

One indicator bolsters the outlook for Japanese retail stocks, though, said Ryohei Yoshida, senior technical analyst at Daiwa Securities Co. Wholesale price inflation, a proxy of cost increases for retailers, “looks set to fall below consumer price inflation within a couple of months,” and when that happens, retailer stocks tend to outperform, he said.

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