Inflation proves blessing in disguise for Japanese retailers

TOKYO – When Japanese convenience store operator Lawson unveiled a 10 per cent price hike on its popular chicken nuggets in 2022, investors were not convinced it would go down well. After all, the product had been sold at 200 yen (S$1.90) pre-tax for 36 years, since it first hit the shelves in 1986.

Fast-forward to July 2023, Lawson’s share price reached a 4½-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 in 2022.

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

Lawson’s move illustrates the price pressures that are adding to speculation that 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 favour 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 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 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 Mr Hiroaki Tomori, chief fund manager at Mitsubishi UFJ Kokusai Asset Management.

“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 earnings per share (EPS) for the Tokyo Stock Exchange (TSE) Retail Index has risen 7.1 per cent so far in 2023, much more than the 2 per cent rise for the Topix Index. 

Investors are not 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 in 2023 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 Mr Ryohei Yoshida, senior technical analyst at Daiwa Securities.

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. BLOOMBERG