Eleven's turnaround plan needs heavy lifting to stop Couche-Tard's takeover

Japan's Seven & i Holdings is betting it can boost value by hiving off underperforming businesses and focusing on mainstay 7-Eleven stores. The outcome of its strategy will determine whether it can outmanoeuvre a $47 billion Canadian takeover bid.

Much depends on the retailer's ability to roll out a new store format in Japan, and improve profit margins overseas, analysts and industry insiders say.

Seven & i plans to split off its supermarket operation and some 30 other "non-core" units into a holding company, York Holdings. It will rename itself 7-Eleven Corp to emphasise its new focus and aims to bring in strategic investors for York and eventually list it.

 

The shake-up shows Seven & i's determination to ditch the conglomerate discount that has weighed on its shares for years.

Poor performance at the supermarket business hasn't helped either, making the Japanese company a ripe target for a takeover bid from Alimentation Couche-Tard Inc, which owns Circle-K.

The Canadian company announced a preliminary bid for Seven & in August, and sources said last week it has since hiked its offer by 22 per cent to around $47 billion. If the deal goes ahead, it would be the largest ever overseas buyout of a Japanese firm.

Given the pressure from Couche-Tard, Seven & i made an "unavoidable decision," to split the business, said veteran independent analyst Akihito Nakai.

"It's the only thing they can do," he said.

Seven & i has said it is "confident" it can unlock shareholder value through a number of strategic actions and has laid out near-term growth targets, including an EBITDA earnings target of 100 billion yen ($670 million) in the next financial year for the York unit.

Still, it's unclear how long shareholders will be willing to wait. Shareholders Artisan Partners and ValueAct Capital have previously called for Seven & i to shed what they said was unnecessary bloat. The Japanese giant employs some 157,000 people worldwide across a business that spans clothing stores, supermarkets and restaurants.

The change in portfolio strategy underscores Seven & i's "urgency to unlock shareholder value," Jefferies analyst Shunsuke Kuriyama said in a note.

In Japan, 7-Eleven stores have become a cultural touchstone, known for a ready supply of fresh food and everything from toothpaste to socks.

The Japanese stores are also highly profitable: the operating margin is 27 per cent, far above the 3.5 per cent of 7-Eleven stores outside of Japan.

Of 7-Eleven's 85,000 stores worldwide, some 21,000 are in Japan, most of them franchises. The Japanese convenience store market is also saturated: moreover, 7-Eleven faces stiff competition from rivals FamilyMart and Lawson.

Same store sales decreased slightly in the six months to September, compared to the previous year.

Reuters reported last month that some 7-Eleven owners are dissatisfied with the company's current strategy, citing concerns about competition from rivals, among other issues.

FAST ROLL-OUT

One area ripe for growth is mini-supermarkets, which are bigger than convenience stores and stock more fresh food.

Rival Aeon has rolled out more than 1,100 of its "My Basket" stores, focusing on urban areas where there is demand for the format from single and elderly shoppers. Aeon has said it wants to double the number of My Basket stores.

7-Eleven introduced a mini-supermarket of its own, "SIP", in February.

"The testing of the mini-supermarket SIP format is ongoing and will eventually lead to the creation of a second domestic growth division for the business," said analyst Michael Causton of consultancy JapanConsuming.

"Test results are promising and once all set, it will roll out fast," he said in a note on the Smartkarma investor research platform.

The focus on SIP stores shows that Seven & I will need to retain some kind of relationship with the supermarket business that will be spun off into York, said veteran analyst Nakai.

"If they completely separate themselves from the supermarkets, they will not be able to implement the new strategy," he said. "Regardless of capital ties, they need to continue a relationship of cooperation."

OVERSEAS BUSINESS

Fixing the bigger overseas 7-Eleven business may prove tougher.

Seven & i cut it full-year profit forecast by a quarter last week. That reflects "a more challenging environment with customers downgrading purchases", Morningstar analyst Lorraine Tan said in a note following the earnings.

Seven & i appears unable to cut costs fast enough to mitigate the pressure on its margins, she said, adding that cost cutting is central to plans to boost returns at the US convenience store operations.

So far, the company has announced plans to close some 444 underperforming stores overseas. It is also beefing up fresh food offerings in the United States.

It is targeting a return on invested capital (ROIC), a measure of profitability, of 10 per cent by the 2030 financial year from 6.5 per cent last year.

The question now is whether it can deliver soon enough for investors, especially due to a perception that the firm is slow to respond to calls for change.

Turning overseas convenience stores into higher margin businesses like in Japan will take a lot of work, including on merchandising, locations and marketing, as well as logistics, said JapanConsuming's Causton.

"We might see some nice improvements in three years, but five years is the minimum buy-in for the real gains to start showing through," he said.