In a surprising turn of events, Japan’s retailers are enjoying an earnings windfall amidst rising prices, signaling a shift in consumer behavior. Lawson, a prominent convenience store operator, made headlines with a 10% price increase on its beloved chicken nuggets last year, a move met with skepticism by investors. However, as of July 2023, Lawson’s share price has soared to a 4½-year high of ¥7,320, fueled by robust earnings in the three months leading up to May. The company’s quarterly net profit doubled compared to the same period last year, defying expectations and highlighting the resilience of Japan’s consumers in the face of higher prices.
Supporting the Stock: Passing on Rising Costs
Lawson’s bold decision to pass on increasing costs to consumers has resonated positively, catching investors by surprise. The stock’s strong performance indicates that retailers may be more successful in transferring the burden of rising expenses than initially anticipated. Kengo Yamamoto, a fund manager at Norinchukin Zenkyoren Asset Management, notes that this alignment of consumer acceptance and retailer action has bolstered Lawson’s stock price. The ripple effects are significant, shedding light on the mounting pressure for the Bank of Japan to potentially revise its inflation forecast upward in the coming week.
Shifting Investment Strategies: Emphasizing Domestic Demand
The impressive earnings from retailers have prompted strategists and fund managers to reevaluate their investment portfolios, leaning towards domestically driven companies. Funds like Alma Eikoh Japan Large Cap Equity have reallocated their investments, reducing exposure to chip stocks in favor of defensive names. Similarly, U.S.-based hedge fund Indus Capital Partners has redirected funds towards domestic consumption-oriented stocks. This shift underscores the growing confidence in the resilience of Japan’s domestic demand and its potential for driving economic growth.
Mixed Performance and Market Outlook
While retailers like Ryohin Keikaku, the operator of Muji, witnessed a surge in share prices following strong earnings, other factors tempered overall market sentiment. Seven & I Holdings experienced robust domestic sales, albeit with earnings falling short of estimates due to overseas business challenges. Hiroaki Tomori, chief fund manager at Mitsubishi UFJ Kokusai Asset Management, reveals that he had anticipated this surge in profits as retailers slashed fixed costs during the pandemic, but the extent of the boost remained uncertain. As a result, the market struggled to accurately estimate the scale of the profit surge.
Improved Earnings Forecasts and Price Targets
Analysts have been progressively raising their price targets for Lawson, aligning them with the convenience store operator’s stock performance. Earnings forecasts for the sector have shown consistent improvement, with the 12-month forward earnings per share for the Tokyo Stock Exchange (TSE) Retail Index witnessing a 7.1% increase so far this year, surpassing the 2% growth observed for the broader Topix index. This trend indicates growing optimism and recognition of the retail sector’s potential for profitability.
Consumer Sentiment and Uncertainty
Despite the positive developments, investors remain cautious about the sustainability of higher prices. Recent government surveys reveal a softening sentiment among service-sector workers regarding the economic outlook after five consecutive months of improvement. This raises concerns about consumers potentially reaching their tolerance limit for inflation. The TSE retail gauge has also underperformed compared to other investment opportunities, such as semiconductor-related firms, trading houses, and stocks with low price-to-book ratios.
Promising Indicator: Wholesale Price Inflation
Ryohei Yoshida, senior technical analyst at Daiwa Securities, highlights a positive outlook for Japanese retail stocks based on wholesale price inflation trends. He suggests that wholesale price inflation, which serves as a proxy for cost increases faced by retailers, is likely to fall below consumer price inflation in the coming months. Historically, this pattern has correlated with outperformance of retailer stocks, presenting an encouraging signal for the retail sector’s future prospects.