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Japan Equity Research

23 August 2013

Japan Macro plus One Vol. 1 Consumer


Price Power Revolution Coming - Food/HPC and Retail Sectors
! Japan Macro plus One is a new equity research series. It is a thematic approach linking macro forces to specific sector and company dynamics. In this volume 1 we analyze the rapidly changing price power dynamics between food producers and retailers. In doing so, we aim to add substance to Japans newfound macro policy focus on inflation, as well as offer concrete insights into how the consumption tax hike is likely to force an accelerating gap between winners and losers on both sides, producers and retailers. ! In our view, the consensus maybe too complacent on the consequences of the Abenomics all-out attack on deflation. Inflation forces from both perspectives, cost-push and demand-pull, are well under way: the labor market is tightening, the money and credit economy is accelerating, and the cost-push dynamics are now forcing retailers to become more innovative and experimental in their pricing strategies. Moreover, positive wealth effects from real estate are bound to boost demand by much more than currently anticipated: Homeownership is high at 73.1%, and households paid back over 50 trillion of debt over the past decade. The net result: of all Japanese over 20 years old, 43.8% now own their home completely debt free, up from 39.5% ten years ago. If, as we suspect, Abenomics succeeds in raising real estate prices, the wealth effect is bound to be more substantial than historical references may suggest. ! Gap between companies to widen as prices diversify: Consumption in Japan stands at the turning point between deflation and inflation under Abenomics, and our assessment is that prices are headed for a period of increasing diversity. We highlight companies with a flexible grip on pricing that goes beyond merely passing along higher input costs and allows them to maximize margins by controlling sales volumes, as well as category market shares that support this. We recommend three companies as investment ideas in the food, beverage and tobacco sector: JT (2914, Overweight), which is seeking to establish Mevius as a premium brand through its grip on pricing (the strongest in the sector); Suntory Beverage & Food (2587, Overweight) for its advanced format management; and Kao (4452, Overweight) for the theme of the breakout from deflation. ! Implications for the retail sector: After 15-plus years of deflation, we believe prices are finally poised to trend upward moderately. In terms of demand, we expect relatively strong consumption among the wealthy and low- to middleincome households. On the supply side, we expect small and midsize firms to continue losing market share while larger firms with robust structure and scale become even more dominant. In terms of stock selection, we think the key is capability to deliver added value to consumers beyond just lower prices for the same level of quality. From this perspective, we like major CVS operator Seven & i Holdings (3382, Overweight); differentiated SPAs like Ryohin Keikaku (7453, Overweight) and ABC-Mart (2670, Overweight); and discount retailer Don Quijote (7532, Overweight), which employs unique store management and merchandising strategies.
Director of Japan Equity Research Jesper J Koll
AC

(81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Ritsuko Tsunoda

AC

(81-3) 6736-8627 ritsuko.tsunoda@jpmorgan.com Bloomberg JPMA TSUNODA <GO>

Dairo Murata

AC

(81-3) 6736 8620 dairo.murata@jpmorgan.com Bloomberg JPMA MURATA <GO> JPMorgan Securities Japan Co., Ltd.

See page 64 for analyst certification and important disclosures, including non-US analyst disclosures.
J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Table of Contents
Macro (Jesper Koll) Japan The Inflation Opportunity ..........................................3 Inflation Forces at Work........................................................4 The Great Squeeze................................................................4 Buying Power of the People ....................................................5 From More Jobs but Less Pay to More Jobs and More Pay .7 Money Matters ..........................................................................8 Rich Japan ................................................................................9 Bottom Line Yes, Demand-Pull ..........................................12 Consumption Tax Hike...........................................................12 Food, Beverage and Tobacco Sector (Ritsuko Tsunoda) Food, Beverage and Tobacco Sector ..................................13 Manufacturers' control over pricing tested by transition from deflation to inflation ......................................................13 Analysis of factors in manufacturers' costs ........................14 Trends in raw material prices................................................15 Rise in raw material costs due to weak yen.........................17 Consumption tax hike ............................................................19 Endgame for deflation; trends in store prices and PBs......21 Manufacturers control over pricing redefined.................25 Price diversity, importance of category share .....................25 Investment ideas ....................................................................28 Retail Sector (Dairo Murata) Retail Sector ..........................................................................30 With inflation ticking up, retailers must deliver added value aside from pricing ..................................................................30 Retail price trends: Per-customer sales bottom out at listed retailers ...................................................................................31 Current mood and pricing policies of major retailers .........34 Reassessing the impact of consumption tax hikes.............35 Competition: Demand growth to offset impact of higher prices, supply-side growth ....................................................40 Retail price outlook and implications ...................................41 Investment ideas ....................................................................44 Appendix Food & HPC Sector ............................................46 Appendix Retail Sector .......................................................54

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

AC

Japan The Inflation Opportunity


Japan stands at a key inflection point: after decades of de-facto stagnation and deflation, growth and inflation are now on the horizon. In our view, the Japan consensus may well be too conservative on both points. In this paper we try to highlight how exactly inflation may come to Japan, combining both a macro overview with sector specific analysts from the producer-to-consumer chain in the food & beverage sector. We are doing so because we aim to get away from a mere macro analysis focus. This is because, in our view, a key lesson from Japans unprecedentedly drawn out experience of deflation is that simple macro economic theoretical frameworks do not go far to explain the extraordinary shifts in both absolute and relative prices across Japan that occurred over the past 20 years. To wit: at end-2012, nominal GDP was stuck at levels last seen in 1991; residential property prices were at levels last seen in 1985; but real GDP did grow by about 1% on average over the past 20 years. In our view, the leaders of Abenomics deserve full credit for recognizing the complexity at work in Japans economy: their overriding goal is to end deflation, to get toward 2% real and 3% nominal GDP growth; and to get out of deflation, they seek to activate all policy tools available money, fiscal, and regulatory. In other words, to hit these targets, they do not simply rely on some sort of preconceived dogma like, for example, inflation is always a monetary phenomena; no, they are pragmatists and realists, knowing that the combination of macro and micro is needed to achieve a fundamental break from the deeply entrenched deflationary equilibrium. Make no mistake: in our view, Japan offers potentially high rewards for investors precisely because the consensus investor and analyst community remains convinced that Prime Minister Abe will fail to achieve his 2% real, 3% nominal growth goals.
Figure 1: Nominal GDP, Real GDP and Land Prices
trillion
1,600 1,400 1,200 1,000 350 800 Land (LHS) 600 400 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 300 250 200 Nominal GDP (RHS)

trillion
Real GDP (RHS) 550 500 450 400

Source: Cabinet Office (National Accounts of Japan), J.P. Morgan.

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Inflation Forces at Work


In our view, all major signposts in Japan point toward inflation. This is true from both sides cost-push inflation and demand-pull: ! Cost-push: 1) Weak yen 2) Rising commodity prices 3) Labor market bottlenecks 4) Rules, regulations & taxes ! Demand-pull: 1) A new credit & leverage cycle 2) Rising employment & wages 3) Wealth effects 4) Rules, regulation and taxes Importantly, these economic drivers of inflation are compounded by a policy regime that has made a complete about turn from previous practices: Prime Minister Abe and his team do want inflation: they did force a fundamental change onto the Bank of Japans policy goal, i.e. they now do have an inflation target they are accountable for.

The Great Squeeze


The cost-push from the weaker yen and rising global commodity prices is easily documented. The BoJ corporate price index data shows raw materials prices currently rising at almost 18% from a year ago, while intermediate goods prices are rising at 5% and final goods prices at about 3%.
Figure 2: Cost-Push Inflation
% YoY

35.0 30.0 25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 Jan-10
Source: Bank of Japan, J.P. Morgan.

Raw materials Intermediate goods

Final goods

Nov-10

Sep-11

Jul-12

May-13

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

In our view, the really interesting inflection point did occur much earlier, in 2003/04. That was when the relationship between intermediate goods prices and final goods prices began to fundamentally change: until 2004, both intermediate and final goods prices more or less moved at the same trend. Since 2004, intermediate goods prices started to rise, while final goods prices continued their moderate decline.
Figure 3: The Great Squeeze - Intermediate Goods Price and Final Goods Prices
2010=100

140 130 120 110 100 90 80 Jan-85 Jan-90 Jan-95 Jan-00

Intermediate goods

Final goods

Jan-05

Jan-10

Source: Bank of Japan, J.P. Morgan.

The Great Squeeze forced fundamental changes in Japan retail industry and the producer-supplier relationship. White Label and Private Brand or Own Brand production got adopted by those retailers with a vision and the financial power to implement it. In our view, no matter how much final goods price power returns, the fundamental break in the producer-retailer relationship that started about a decade ago is unlikely to change. If at all, cost-push pressures are poised to widen the gap further between those retailers who can implement more aggressive own-brand strategies and those who cannot.

Buying Power of the People


Where does the buying power of the people come from? Here, the increasing tightness of the labor market is a key positive dynamics, in our view. First of all, Japan has turned into a genuine job-creating machine: the number of people employed has surged at an annualized rate of just below 3% since the start of this year. Make no mistake the basic thrust in the labor market has turned supportive for consumer demand growth, in our view.

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 4: Japan Non-farm Employment Up and Away


Million people

56.0 55.5 55.0 54.5 54.0 53.5 53.0 2000 2001 2002 2004 2005 2006 2008 2009 2010 LFS-employed, SA - Japan 2012

Source: Ministry of Internal Affairs and Communications, J.P. Morgan.

The detailed dynamics of Japans employment upturn is further testimony to how much Japans economy has actually been changing: the manufacturing sector has been cutting jobs manufacturing employment is down by 1.6 million people since 2000; almost all the job creation has come from the merchandising sector, wholesale and retail, up 903,000 since 2000, and the service sector (which is really services for individuals, like barbers, nurses, etc.), up 1.24 million. In addition, Japans non-profit sector has been a big growth sector, with employment there up 355,000.
Figure 5: Japan Employment & Compensation by Major Sector
Share in Employment (%) Agriculture Manufacturing Construction Utilities Wholesale and retail trade Finance and insurance Real estate Transport and communications Information & Communications Service activities Government services Public administration Non-profit services 2001 1.5 20.5 9.2 0.8 17.6 3.3 1.3 6.5 2,9 29.1 7.8 4.8 2.5 2011 1.7 17.1 7.4 0.9 18.7 3.2 1.4 5.9 3.2 30.4 7.1 4.3 3.1 Share in Compensation (%) 2001 0.8 21.7 9.4 1.4 14.9 4.5 1.3 7.1 3.0 23.6 12.4 7.8 2.9 2011 0.9 20.0 8.3 1.3 14.6 4.5 1.5 6.8 3.2 22.7 12.1 7.9 3.9 Employment Growth ('000 people) 2001 to 2011 145 -1,550 -887 34 903 10 87 -206 134 1,238 355 -213 355 Per Capita Wage ( million) 2001 2011 2.64 2.28 5.24 5.23 5.04 8.09 4.19 6.77 5.17 5.42 3.57 4.03 7.89 8.11 5.77 4.99 6.60 3.45 6.29 4.89 5.06 4.42 3.29 7.54 8.18 5.57

Source: Cabinet Office (National Accounts of Japan), J.P. Morgan.

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

From More Jobs but Less Pay to More Jobs and More Pay
Unfortunately, the switch from a manufacturing to a service economy did actually force a net loss of purchasing power for employees. This is because the high job growth sectors started out relatively low paying: the average manufacturing sector job paid 5.24 million per year per worker in 2000, and that was virtually unchanged by 2011. Meanwhile, the average merchandising job wholesale or retail paid 4.19 million in 2000 but only 3.45 million by 2001, a drop of almost 18%. The dynamics are similar for the services industry (and indeed the non-profit sector). So while manufacturing now accounts for barely 17% of total employment (down from 20.5% in 2000), it still accounts for 20% of total compensation (from 21.7% in 2000). Against this, wholesale and retail now employs 18.7% of all workers but accounts for only 14.6% of total compensation. Interestingly, the biggest gap between employment share and compensation share is actually Government services in general, public administration in particular, with the latter accounting for 4.3% of all employment but 7.9% of all compensation.
Figure 6: Average Annual Compensation by Employee by Sector
million / employee

9.0 8.0 7.0 6.0 5.0 4.0 3.0 2001 2002 2003 2004 2005 2006 2007 2008 2009 Wholesale & Retail Finance

Public administration Utilities

Manufacturing Construction Services 2010 2011 2012

Source: Cabinet Office (National Accounts of Japan), J.P. Morgan

From here, the key dynamics, in our view, is poised to be an upturn in wages and total compensation in the relatively lower- and middle-pay sectors of Japan, i.e. merchandising, construction and individual services. All these sectors are highly labor intensive, with limited room for greater automation. The demand-pull implications of this thesis are obviously positive. At the same time, the cost-push implications are also significant: if we are right, and wholesale and retail wages start to rise, cost-push pressures for retailers are poised to force more consolidation and sector streamlining, in our view. Moreover, the growing tightness in the supply of labor is poised to raise the premium for better on-the-job training. Companies with true career development programs are poised to be able to widen their skills and corporate culture gaps to those companies that cannot afford to offer them. Clear speak: Japans labor market tightness and skills shortage is poised to be a positive driver for corporate consolidation, particularly in the merchandising sectors, in our view.
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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Money Matters
While labor market developments are always going to be a lagging indicator of aggregate demand and inflation, Japans money and credit economy offers insights in more immediate developments, if not forward-looking. Here, the news is unambiguously positive for our pro-growth, pro-inflation thesis. Monetary aggregates speak for themselves. Note here the synchronized pickup in all the data, from narrow BoJ base money via M2 money supply, all the way to M3 broad liquidity. The last time this synchronized expansion occurred was in 2005 to 2007, when it was forced to an end by the BoJ engineering a sharp slowdown in base money creation. Given the new BoJ focus and mandate, it appears unlikely this will be repeated in the foreseeable future, in our view.
Figure 7: Money Economy - Now Growing Across All Aggregates
% YoY % YoY

4.0 3.0 2.0 1.0 0.0


M2 (LHS) M3 (LHS)

40.0 30.0 20.0 10.0 BoJ total asset (RHS) 0.0 -10.0 -20.0

-1.0 -30.0 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12
Source: Bank of Japan, J.P. Morgan.

Importantly, a key driver for the expansion in Japans broader monetary aggregates is the beginning of a new leverage cycle from Japans household sector. Specifically, demand for mortgages has been rising steadily over the past two years, after the Fukushima disaster set off a disaster-induced rebuilding cycle. However, the mortgage demand cycle has steadily grown and has now expanded out to across all the major urban areas of Japan. In our view, this start of a new leverage cycle, led by households, is a key reason to be optimistic that, yes, this time is different the Bank of Japan is no longer just pushing on a string.

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 8: Mortgage Growth - A New Credit Cycle Gets Going


% YoY

4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 Mar-09

Mar-10

Mar-11

Mar-12 mortgage

Mar-13

Mar-14

Source: Bank of Japan, J.P. Morgan.

Rich Japan
For the mortgage credit and leverage cycle to be sustained, the expected upturn in Japans labor and income markets are very much key. At the same time, there is a great supporting factor coming into play, in our view: positive wealth effects in general, and in particular the positive asset carry effects from a combination of high homeownership and record-low debt burden. Japans household sector balance sheet is in tremendous health, in our view. In the beginning we outlined that residential real estate prices are back to a level last seen in 1985. This deflationary adjustment did force a strong negative undercurrent for domestic demand over the past 20 years. At the same time, however, Japanese households did work hard to restore their overall financial wealth and balance sheet: they repaid 50 trillion of debt over the past 15 years, while growing their non-real estate assets at the same time. When combining net financial assets together with real estate holdings, Japanese household balance sheets actually never really declined.
Figure 9: Balance Sheet of Households
trillion
2,500 Liabilities(RHS) 2,000 1,500 1,000 500 0 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012
Source: Cabinet Office (National Accounts of Japan), J.P. Morgan.

trillion
430 410 390 Financial assets (LHS) 370 350 330 310 Currency and deposits (LHS) 290 270 250

Land + Net Financial Assests (LHS)

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Importantly, home ownership has actually continued to increase: in 2012, 73.1% of all Japanese households owned the home they live in. Remarkably, only 36.7% of all Japanese carry a mortgage.
Figure 10: Home Ownership Ratio by Age Group
% of Group

100.0 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0

73.1 58.5 44.2 20.8 4.5

73.5

78.6

82.5

86.8

88.3

82.2

87.7

total 20 25 30 35 40 45 50 55 60 65 70 24 29 34 39 44 49 54 59 64 69 own house( ) as of 2000 own house( ) as of 2012


Source: Statistics Bureau, Ministry of Internal Affairs and Communications, J.P. Morgan.

Figure 11: Percentage of Age Group that Carries a Mortgage


% of Group

60.0 50.0 40.0 30.0 20.0 10.0 0.0 1.9 36.7 33.3 43.1

51.8

48.1 40.8 31.7 17.2

10.6

14.1 7.6

total 20 25 30 35 40 45 50 55 60 65 70 24 29 34 39 44 49 54 59 64 69 who pays mortgage loan (%) as of 2000 who pays mortgage loan (%) as of 2012
Source: Statistics Bureau, Ministry of Internal Affairs and Communications, J.P. Morgan.

It is no surprise that mortgage debt falls with age. However, given Japans population pyramid, the implications are very significant. Specifically, of the Japanese people who are twenty years old or older, we calculate that, as of 2012, 43.8% actually own their home and carry zero debt. That is up from 39.5% ten years ago.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 12: Japanese with Zero Debt and Full Home Ownership
% of Population over 20 Years Old

18.0 16.0 14.0 12.0 10.0 8.0 6.0 4.0 2.0 0.0

16.7

7.2 2.3 3.0 4.4 5.1

0.8 30 34

1.4 35 39

1.9

40 45 50 55 60 65 44 49 54 59 64 69 People without debt & Home as of 2000

70

Source: Statistics Bureau, Ministry of Internal Affairs and Communications, J.P. Morgan.

Figure 13: Debt and Home Ownership in 2000


000 people, % Total Population over 20 People without debt % of total People without debt + Home % of total 100,737 76,764 76.2 39,781 39.5 20 24 8,421 8,210 8.2 354 0.4 25 29 9,790 8,694 8.6 999 1.0 30 34 8,777 6,548 6.5 1,018 1.0 35 39 8,115 5,137 5.1 1,347 1.3 40 44 7,800 4,329 4.3 2,028 2.0 45 49 8,916 4,859 4.8 3,076 3.1 50 54 10,442 6,537 6.5 4,647 4.6 55 59 8,734 6,105 6.1 4,961 4.9 60 64 7,736 6,258 6.2 5,168 5.1 65 69 7,106 6,125 6.1 4,875 4.8 70 14,900 13,961 13.9 11,309 11.2

Source: Statistics Bureau, Ministry of Internal Affairs and Communications, J.P. Morgan.

Figure 14: Debt and Home Ownership in 2012


000 people, % Total Population over 20 People without debt % of total People without debt + Home % of total 105,019 78,240 74.5 45,949 43.8 20 24 6,370 6,249 6.0 166 0.2 25 29 7,219 6,454 6.1 736 0.7 30 34 8,093 5,398 5.1 882 0.8 35 39 9,712 5,526 5.3 1,496 1.4 40 44 9,315 4,490 4.3 2,021 1.9 45 49 7,966 4,134 3.9 2,430 2.3 50 54 7,639 4,522 4.3 3,185 3.0 55 59 8,320 5,683 5.4 4,584 4.4 60 64 10,632 8,803 8.4 7,559 7.2 65 69 7,861 6,753 6.4 5,353 5.1 70 21,892 20,228 19.3 17,535 16.7

Source: Statistics Bureau, Ministry of Internal Affairs and Communications, J.P. Morgan.

The key takeaway here is simple: Japans household sector has a tremendously strong balance sheet; and while Japan is ageing rapidly, the age-cohort analysis suggests that the now retiring baby boom generation has remarkably high home ownership, without any debt to speak off. For consumer demand, this suggests that positive wealth effects from rising real estate prices are first and foremost likely to pull up spending demand from seniors, rather than juniors. This should keep high a rising preference for services and highbrand conscious, as well as domestically produced goods.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Bottom Line Yes, Demand-Pull


In our view, the combination of a tightening labor market, growing credit demand, as well as solid prospects for positive wealth effects from high real estate exposure by the household sector, should indeed allow for an asymmetric inflation and growth outlook bias for Japan going forward. At the same time, cost-push factors are also real. The combination is poised to force not a rising tide that lifts all boats, but more industry and sector consolidation.

Consumption Tax Hike


In our view, the upcoming consumption tax hike is poised to add momentum to the underlying forces outlined above. Frontloading momentum is poised to be strong, with consumers eager to lock in pre-tax hike prices for large ticket items. At the same time, we judge that consequent payback is poised to be much more limited than during previous tax hike periods. This is because the combination of a tightening labor market and rising bank credit and leverage is creating a backdrop that simply cannot be compared to the past two episodes of tax hikes. When the consumption tax was introduced in April 1989, it was part of an overall policy tightening designed to cool the economy and bring down inflation. Window guidance on tighter bank lending standards, as well as restrictions on lending for real estate development, had been put in place one year before the consumption tax went from zero to 3%; and barely eight weeks after the tax hike came into effect, the Bank of Japan hiked interest rates the first in a series of hikes that launched a hard monetary attack on the bubble economy. When the tax was hiked from 3% to 5% in April 1997, the Asia financial crisis hit just three months later, forcing an unprecedented collapse in Japans export economy. Asian contagion spread throughout global asset markets and, on October 27, 1997, Wall Street crashed 7.2%. In our view, it takes a serious stretch of the imagination to even try and correlate the 1997 tax hike to possible future implications of consequent hikes: yes, 1997/98 was special, but not because of Japans tax hike.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Ritsuko Tsunoda (81-3) 6736-8627 ritsuko.tsunoda@jpmorgan.com Bloomberg JPMA TSUNODA <GO>

AC

Food, Beverage and Tobacco Sector Manufacturers' control over pricing tested by transition from deflation to inflation
We believe this is a good opportunity to review manufacturers' control over pricing at a time of keen interest in how prices will shape up alongside the consumption tax hike. Looking back, our assessment of manufacturers' control over pricing has been confined merely to their ability to transfer input costs into prices. This has certainly been influenced by an environment characterized by protracted deflation and a tendency toward low ambitions, but we think there are fledgling signs of a change in how consumers react to prices.

Figure 15: Cash Earnings Trend (excl. bonus payments)


340,000 335,000 330,000 325,000

Consumers appear to be less inclined to react positively and increase their unit purchases in response to campaigns that seek to make products appear good value by increasing quantities. It looks to us as though food products are becoming less priceelastic. Looking back at the unprecedented increase in tobacco tax in October 2010 and the corresponding sharp price hikes implemented by the cigarette industry, priceelasticity was not as high as manufacturers feared. In addition to examining these trends, we also highlight the fact that cash wages have started to turn up. Retailers and manufacturers have pursued deflationary strategies because of this long decline in incomes. However, we believe "affordability" strategies that set prices at levels that make it easy for consumers to buy products have effectively ended up as strategies to attract customers to stores, meaning rock-bottom pricing has become the norm, while the system of tax-inclusive price labels has also encouraged uniform pricing at the store level. So how will tax-exclusive labeling and the consumption tax hike affect rock-bottom pricing? Will ex-tax rock-bottom pricing emerge? Or will manufacturers still have to absorb costs in order to achieve the rock-bottom pricing that has become so firmly established under tax-inclusive price stickers? Finally, did this kind of ossified pricing really tally with consumer needs, given the content of what was offered? Assuming that greater freedom to set prices will lead to a change in corporate strategies themselves, we examine conditions and strategies for firms to break ranks from standard strategies brought by uniform pricing, and to avoid commoditization. In this report we set out points for discussion between industrial corporates and investors, and we draw up our own investment ideas within the sector, via (1) a summary of the current situation by analyzing cost factors for manufacturers, (2) a review of store-level pricing, share, and PB trends in major products by category, (3) our own redefinition of "control over pricing," and (4) examination of new pricing strategies to maximize margins by leveraging diversification in prices.

2008/01

2008/07

2009/01

2009/07

2010/01

2010/07

2011/01

2011/07

2012/01

2012/07

Source: Ministry of Health, Labor and Welfare Monthly Labor Survey

2013/01

320,000

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Analysis of factors in manufacturers' costs


Manufacturers' operating costs can be divided broadly into COGS and SG&A expenses, though factors driving up costs fall roughly into two categories, namely raw material prices and rebates to retailers.

Variable factors for COGS


When raw material prices increase because of market prices or a weaker yen, manufacturers need to transfer all or part of this into their own prices. However, when raw material prices fall, it is the commodity food companies supplying processed food production manufacturers with bulk food materials that can reduce their purchasing prices, whereas branded food product firms try and keep prices at elevated levels, either by launching campaigns that offer larger quantities or by using higher-quality raw materials to revamp products whose appeal rests on their valueadded. However, manufacturers have to be able to create products that convince their customers (retailers and consumers) of the value-added appeal, and only a handful of firms are capable of passing this stringent test. Thus, ordinary products that do not qualify for this come under pressure for price cuts, and manufacturers' shipment prices also see a certain increase in the burden of rebates. Monies paid to retailers for cooperating in campaigns that play on the perception of value-for-money in store prices are booked on the manufacturers' statements of income as higher promotional expenses. On the other hand, the retail counterparties' approach to booking such revenue is inconsistent, and it is thus hard to pin down many elements from outside in this rather opaque trading practice.

Changes in branded product companies' ASPs reflected not in sales but in promotional expenses
Under Japanese GAAP, actual changes in manufacturers' prices are poorly reflected in higher or lower sales. Rebates agreed between retails and wholesalers are included in sales, clouding the picture for prices that ought to be visible in manufacturers' sales. European and US companies with home markets in mature, inflationary nations can explain inflation in terms of changes in prices and in mix, giving clear margin analysis and making it easy to pin down final profits attributable to shareholders. The high degree of transparency in earnings is assured by simple business models and well-polished presentations. This can also be easily reflected in share prices. On the other hand, information meetings with many Japanese companies pass over sales and immediately look at changes in operating profitindeed, many firms are keen to talk in terms of variance in absolute monetary values. Corporate sales targets under deflation have frequently been hard-to-achieve goals, rather than commitment to realistic figures. This has meant that attention has tended to focus on the details of cost-savings designed to absorb the fall in profits associated with a top-line shortfall. We feel it has thus been more efficient to talk about these factors in terms of increases/decreases in absolute values. However, sticking to Japan's unique, traditional style confuses global investors and might make global comparisons hard to draw.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Trends in raw material prices


Protracted rise in market prices; now some prices rising, some falling
The JPMJ Basic Materials Index rose to 305.7 as of July 2013 (January 2000 = 100), while the JPMJ Materials Index climbed to 388.3 over the same period. The raw materials index is currently down 1.1% compared with last year, whereas the materials index is up 9.7% because of the rise in petrochemical markets. Since the start of this year they are up 3.6% and down 4.2%, respectively. On top of the changes in market prices since the start of this year, we have applied a simple average of +6.4% for gasoline and natural gas prices to reflect fluctuations since the start of this year, and a provisional figure of +1% for indirect manufacturing costs. From these weighted averages we estimate that manufacturers' COGS will rise 1%. In order to absorb this cost increase the companies would have to pass along 0.6% of this into prices to maintain margins, and 0.6% to keep gross profits unchanged as well.
Figure 16: YTD Change in JPMJ Basic Materials Index, JPMJ Materials Index, and Fuel Costs
JPMJ Basic Materials Index JPMJ Materials Index Fuel Costs
Source: J.P. Morgan

Change YTD 3.6% -4.2% 6.4%

Figure 17: Manufacturers Cost Analysis


Input Cost for Food & Beverage + HPC Food & Beverage +HPC Packaging Overheads Energy/Distribution COGS Increase Gross Margin Before Price Hike Input GP GPM Sales % increase to retailer 1) Maintaining the same gross margin 2) Maintaining the same gross profit
Source: J.P. Morgan

% of Total COGS 50% 30% 10% 10%

YoY chg. 3.6% -4.2% 1.0% 6.4% 1.0% 30%-70%

100 67 40.0% 167.0

After Price Hike Case 1 101 67 40.0% 168.0 0.6%

Case 2 101 67 39.9% 168.0

0.6%

Assuming retailers' purchasing costs and manufacturers' sales are equivalent, and estimating total COGS by grossing up purchasing costs COGS ratios of 84%, retailers would need to pass along 0.4% to keep margins unchanged, and 0.4% to keep gross profits at the same level. If they leave prices unchanged, gross profit margins would erode by 0.3% under this calculation. The degree to which companies will need to transfer costs into prices given the current rise in markets is relatively modest, but our impression is that the increase in the cost of imported raw materials caused by the weaker yen is more serious.
15

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 18: Retail Cost Analysis


Input Costs Merchandise PB COGS Energy/Distribution COGS Increase Gross Margin Before Price Hike Input Of which, merchandise GP GPM Sales Retailers price hike scenario 1) Maintaining the same gross margin 2) Maintaining the same gross profit 3) No pass-through price hike
Source: J.P. Morgan

% of Total COGS 84% 13% 3%

YoY chg. 0.6% 0.6% 6.4% 0.8% 26% Case 3 200 168 69 25.7% 269

199 167 70 26.0% 269

Case 1 200 168 70 26.0% 270 0.4%

After Price Hike Case 2 200 168 70 25.9% 270

0.4% 0.0%

Figure 19: JPMJ Basic Materials Index (Jan. 2000 = 100)


400 350 300 250 200 150 100 50 0

2000/01

2000/07

2001/01

2001/07

2002/01

2002/07

2003/01

2003/07

2004/01

2004/07

2005/01

2005/07

2006/01

2006/07

2007/01

2007/07

2008/01

2008/07

2009/01

2009/07

2010/01

2010/07

2011/01

2011/07

2012/01

2012/07

2013/01 2013/01

Source: J.P. Morgan

Figure 20: JPMJ Materials Index (Jan. 2000 = 100)


500 450 400 350 300 250 200 150 100 50 0

2000/01

2000/07

2001/01

2001/07

2002/01

2002/07

2003/01

2003/07

2004/01

2004/07

2005/01

2005/07

2006/01

2006/07

2007/01

2007/07

2008/01

2008/07

2009/01

2009/07

2010/01

2010/07

2011/01

2011/07

2012/01

2012/07

Source: J.P. Morgan

16

2013/07

2013/07

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Rise in raw material costs due to weak yen


Next we summarize the results of our talks with the companies at the end of the fiscal year about the earnings impact of the weaker yen on commodity food product earnings. It is no exaggeration to say that scarcely any branded food product or HPC companies either provided a full explanation of the impact of the weaker yen or factored this into their earnings forecasts.
Figure 21: Full-Year Company Guidance and 1Q/2Q FY13A: Impact on Operating Profit from Higher Material Costs and Weaker Yen
million Commodity Food Company 2264 2269 2270 2607 2602 2613 2001 2002 2284 2282 1332 1331 Morinaga Milk Meiji HD Megmilk Snow Brand Fuji Oil Nissin Oilio Group J-Oil Mills Nippon Flour Mills Nissin Seifun Group Ito Ham Nippon Meat packers Nippon Suisan Maruha Nichiro HD Branded Company 4452 4911 8113 2914 2501 2502 2503 2897 2875 2802 2801 2267 2220 2229 2810 2871 2593 2587 Kao Shiseido Unicharm JT Sapporo HD Asahi GHD Kirin HD Nissin Foods Toyo Suisan Ajinomoto Kikkoman Yakult Kameda Seika Calbee House Foods HD Nichirei Ito En SBF OP 11,500 29,000 17,000 16,000 6,700 6,600 11,000 23,700 7,000 34,000 12,500 18,000 OP 116,000 39,000 70,000 616,000 15,300 118,000 150,000 25,500 31,000 75,000 22,500 29,000 4,000 18,000 12,500 17,000 23,000 75,000 FY2013 Co. E 1Q/2Q FY13 A Impact of higher Net impact of material costs higher material Higher material Impact of yen (lower) Impact of yen depreciation costs (lower) costs (lower) depreciation 3,200 2,000 700 700 0 5,500 No estimates 700 700 0 2,000 Not considered 150 150 0 1,800 2,000 Not disclosed Not disclosed Not disclosed 10,700 13,600 200 -2,950 3,150 20,800 19,300 4,600 1,600 3,000 0 No impact due to passalong to 0 0 0 shipment price 1,100 600 0 -200 200 4,000 No estimates 510 410 100 4,500 No estimates 1,800 900 900 600 500 0 0 0 1,500 1,500 0 -600 600 FY2013 Co. E 1Q/2Q FY13 A Impact of higher Net impact of material costs higher material Higher material Impact of Yen (lower) Impact of Yen depreciation costs (lower) costs (lower) depreciation 2,000 Not disclosed 3,500 0 3500 1,000 Not disclosed 0 0 0 3,500 800 200 -100 300 Not disclosed Not disclosed 0 0 0 400 Not considered 100 -100 200 3,500 1,000 -700 -1700 1000 -1,600 Not considered -600 -2600 2000 1,200 1,200 -400 -400 0 870 400 -400 -400 0 4,700 Not disclosed 2,300 1300 1000 1,400 1,100 500 0 500 1,400 Not disclosed -200 -200 0 400 400 310 310 0 1,500 185 185 0 800 800 20 20 0 8,500 7,000 2,000 500 1500 2,100 2,100 NA NA NA Not disclosed 0 0 -1,000 1,000

Source: Data from companies and hearings Note: Higher material costs from impact of yen depreciation for Nisshin Oilio and J-Oil Mills will be net impact of 500 million to take into account the higher meal prices. Morinaga Milk: Euro=120 and OP sensitivity to 1 move is 30 million. Note: Overall, Kao stands to benefit from 5 billion in lower raw material costs, even though such costs have actually risen for pretty much everything other than palm oil. The chemical segment is not affected by price reductions, but the consumer segment must contend with a lingering 2 billion impact from higher raw material costs. Ajinomoto expects its domestic food business to encounter an approximately 1.7 billion increase in raw material costs (1.2 billion for processed foods, 500 million for frozen foods). Note, however, some raw materialsmost notably rice and dried bonitoare not exposed to forex shifts. Calbee's forex rate is actually an average for raw-material purchasing; it is not the same as the target rate it uses for financial planning purposes. Ito En will disclose 1Q results on September 2.

17

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

In AprilJune corporate earnings, commodity foods were conspicuously affected by higher costs brought by the weaker yen, but the impact on branded food product firms also appears to have been surprisingly heavy. However, market prices are currently falling, while companies are also working to cut purchasing unit prices, such as by changing specifications of raw materials used in products, offsetting the increase in costs associated with the weaker yen, and this is making it superficially hard to see the true picture. That said, the impact will surface each quarter, and companies will presumably have to respond. The risk of a downward revision at 1H results announcements will grow for companies unable to pass along higher costs into prices from summer through autumn this year.
Figure 22: Price Revisions Due to Increase in Raw Material Costs and Weak Yen
Company Yamazaki Baking Kewpie Nippon Meat Packer Ito Ham Maruha Nichiro HD Nisshin Seifun Group Nippon Flour Mills Meiji HD Morinaga Milk Megmilk Snow Brand Takara Shuzo Announcement Date 2013/05/23 2013/08/07 2013/05/13 2013/06/13 2013/08/01 2013/05/22 2013/06/03 2013/07/23 2013/07/25 2013/08/02 2013/08/20 Effective Date Price Revision

2013/07/01 Hikes shipment prices for bread 3-6%, sweet buns 2-6% 2013/10/18 Mayonnaise contents changed from 500g to 450g 2013/07/01 2013/07/22 Prices hikes on 89 types of ham/sausage and 62 processed food products (both home-use and commercial). Prices revisions stem from changes in product planning and boost prices 5-11%; average price hike is 8%.

Retail/wholesale prices hiked 5-15% (average: 8%) on 210 ham/sausage products and 70 processed precooked food products 2013/09/02 Price hikes by subsidiary Aixia (pet food processor/seller) 2013/07/01 Price hikes home-use wheat flour +2-7%, some home-use pasta sauces +9-11% 2013/07/01 Price hikes home-use wheat flour +2-6%, home-use mix flour +2-5% 2013/10/01 16 products of milk hiked 1-4% on a 5/kg increase in the dairy farm price 2013/10/01 Milk price hiked by 5/kg, increasing shipment price by 5 2013/10/01 Shipping price of 29 products (including milk) increased 1-4% The shipment value of refined sake and cooking sake (about 170 products) rose 2-7% (average of 4%). This 2013/10/01 number excludes sales of autumn and winter seasonal products, year-end gift sets, and Shochikubai Shirakabegura "Mio"

Source: Data from companies and hearings

18

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Consumption tax hike


Figure 23: Consumption Tax Rate by Country
30% 25% 20% 15% 10% 5% Sweden Russia 0%

Special legislation has been introduced to ensure higher consumption tax is transferred into prices, and the Fair Trade Commission will forbid retailers from refusing to pass this along into prices, and ban both retailers and manufacturers from sharing the pain. Nevertheless, rebates may be levied under a different name, leading to cuts in ex-tax prices in real terms. This is because retailersin particular, volumesales supermarkets, GMS, and discount storesare firmly wedded to rock-bottom pricing in order to make products look good value-for-money in store-level prices. Assuming manufacturers have to absorb the cost of cutting ex-tax prices far enough to offset the 3% consumption tax hike, a simple calculation suggests this will give rise to reductions of 3% in revenue and 3ppt in gross profit/operating profit margins. In particular the food sector has many subsectors and companies with operating profit margins under 3%, so simply speaking we can envisage a scenario under which profits are wiped out. If the second consumption tax hike in October 2015 goes ahead, the cost burden will increase by 2ppt from 8% to 10%. We feel companies languishing on low margins now face a period in which they will have to justify their existence. Manufacturers have developed and launched a constant stream of new products supported by highly profitable items amid the long struggle with retailers for margin, but this has left many weak products with no prospects for a long future on the market, supported by strong products. True innovation is hard to achieve, and during this period consumers have become more selective, leading to commoditization. Manufacturers' marketing prowess is being put to the test in a commodity era, and companies are clearly polarizing into winners and losers. The days when a strategy of uniformity seeking safety in numbers used to work are now over, in our view. In light of other countries' consumption tax levels, we would not be particularly surprised to see further tax rate increases in Japan in the future. Costs are on a longterm uptrend, so we assume no lasting reductions from now, even if there are market corrections or near-term price fluctuations. Manufacturers' profitability will worsen unless they can transfer costs into prices. This is an uncomfortable fact, but needs to be taken on board for businesses to survive. We think perceived scale in category market shares will be seen as increasingly important.
Japan

France

Source: Country data

Singapore

England

Germany

Australia

China

US (LA)

19

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 24: GPM (Y-axis) and OPM (X-axis) Scatter Chart in FY2012 for Branded and Commodity Food Companies
60.0%

JT SBF
50.0%

CCW Ito-En Sapporo HD*


House Foods

Yakult KirinHD* Nissin Foods HD


Kirin HD

Asahi GHD*

Calbee Toyo Suisan GPM 35%

40.0%

Kikkoman Yamazaki Baking SapporoHD

Ajinomoto Asahi GHD Nisshin Flour Kiwpie

30.0%

Meiji HD Morinaga Milk Megmilk Snow Brand Nippn

20.0%

Nissui Ito Ham

Nippon Meat Packer Fuji Oil

Nisshin Oilio J-Oil Mills Maruha Nichiro


10.0%

0.0% 0.0%

OPM 3%
2.0% 4.0%

OPM 5%
6.0% 8.0% 10.0% 12.0%
20.0% 14.0%

16.0%

Source: Bloomberg and J.P. Morgan. Note: Three beer companies with * show sales excluding alcohol tax and OP goodwill adjusted.

Figure 25: GPM (Y-axis) and OPM (X-axis) Scatter Chart in FY2012 for HPC Companies
85.0%

80.0%

Pola Orbis HD Shiseido Kose

Dr. Ci Labo

75.0%

70.0%

Fancl
65.0%

60.0%

GPM 60%
Lion Kao Mandom Kobayashi Pharma

55.0%

50.0%

45.0%

Unicharm

40.0% 0.0%
Source: Bloomberg 20

OPM 3%

OPM 5%
10.0% 15.0% 20.0% 25.0%

5.0%

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Endgame for deflation; trends in store prices and PBs


Although we take a more detailed look in the retail sector chapter, existing-store ASPs in the traditional retail channel appear to be turning up. We have looked for evidence that deflation is winding down in light of PB products' category weightings, product prices in main categories, and share levels, based on Nikkei POS data.
Figure 26: Ranking of Categories with High Private Brand (PB) Weightings
%
25.0 20.0 15.0 10.0 5.0 13.9 12.7 11.6 9.3 7.6 7.2 7.0 6.8 6.3 5.7 5.6 5.0 23.7

4.1

3.4

2.6

2.4

2.1

1.2

1.1

1.1

0.5

Low Malt + New Genre

Instant Noodles (cup)

Female Basic Skin Care

Instant Noodles (pillow bag)

Female Colored Cosmetics

Frozen Food

Ham & Bacon

Alc Free Beer

Soft Drinks

Prepared bread

Sweet bun

0.0

Umami Condiment

Soy Sauce

Bread

Lactobacillus Beverage

Powder Clothing Detergent

Liquid Clothing Detergent

Feminine care
43

Baby diaper

Shampoo

Sausage

Source: Nikkei POS as of July 2013

Figure 27: Ranking of Categories by Degree of Dominance of Top Three Companies


%
99.4 100 80 60 40 20 98.2 92.6 90.6 88.2 87.9 86.0

82.6

79.5

78.7

77.7

73.1

71.4

71.1

70.5

69.8

69.6

64.6

59.7

58.5

52.2

46.4

33.9

Low Malt + New Genre

Instant Noodles (cup)

Female Colored Cosmetics

Female Basic Skin Care

Instant Noodles (pillow bag)

Umami Condiment

Liquid Clothing Detergent

Powder Clothing Detergent

Lactobacillus Beverage

Source: Nikkei POS as of July 2013

Prepared bread

Feminine care

Ham & Bacon

Alc Free Beer

Frozen Food
21

Soft Drinks

Sweet bun

Soy Sauce

Tobacco

Bread

Sausage

Baby diaper

Shampoo

Curry

Beer

Tobacco

Curry

Beer

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Categories with high PB weightings


We examined Fuji Keizai and other data, in addition to Nikkei POS, to analyze the weight of PB products by category. Although there is no great difference in broad trends, there are variations in approaches to data and big differentials in datasets for some products. In this report we have integrated product category data for the Japanese market with the Nikkei POS data we update and distribute monthly. (POS data hereafter are as of July 2013.) The Nikkei POS data samples 24 categories, of which PB weightings are over 10% in four, namely ham & bacon (23.7%), frozen foods (13.9%), bread (12.7%), and sausages (11.6%). Within these, ham & bacon and sausage ASPs are broadly flat. The top three companies' combined share of the ham & bacon category is 43.0%, while the top four companies have a combined market share of 54.0% (Nippon Meat Packers 15.9%, Itoham 14.2%, Prima Ham 12.9%, Marudai Foods 11.0%). In the sausage category, the top three companies have a combined share of 59.7% (Nippon Meat Packers 24.8%, Itoham 20.7%, Marudai Foods 14.2%). ASPs are falling in the frozen foods and loaf bread segments, and again taking the degree of market dominance in terms of the top three companies' share and the number of firms with aggregate share over 50%, these are 33.9% and five companies in the frozen foods category (Ajinomoto 12.6%, Nichirei 12.4%, Nippon Suisan 8.9%, TableMark 8.8%, Maruha Nichiro 7.8%; aggregate share of 50.5%), and 70.5% and two companies in the loaf bread category (Yamazaki Baking 37.0%, Shikishima Baking 24.7%; aggregate share of 61.7%). Looking more closely at trends in frozen foods, ASPs at Ajinomoto (industry leader with 12.6% share) are rising, running counter to the industry average, and its PB prices are also above the industry average. Despite this, other NB manufacturers' ASPs are below the industry average, while five companies are needed to give a majority market share, so the degree of industry dominance is relatively low. On the other hand, in the loaf bread market, industry leader Yamazaki Baking has a 37.0% market share, and adding in second-ranked Shikishima Baking gives aggregate share of 61.7%, but even then the PB weighting is still high, and average industry product ASPs are falling.

Categories with high degree of dominance


There are 15 categories in which the top three companies' share exceeds 70% (in descending order): tobacco, umami condiments, liquid clothing detergent, baby diapers, feminine care, powder clothing detergent, beer, alcohol-free beer, low malt/new genre, instant noodles (pillow bag), instant cup noodles, sweet buns, lactobacillus beverages, female colored cosmetics, and bread. Price trends for each of these are as follows. Rising product ASPs: Five categories, namely liquid clothing detergent, baby diapers, alcohol-free beer, instant noodles (pillow bag) and lactobacillus drinks. Flat product ASPs: Four categories, namely tobacco, beer, low malt/new genre, and female colored cosmetics.

22

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Falling product ASPs: Six categories, namely umami condiments, feminine care, powder clothing detergent, instant cup noodles, sweet buns, and bread.

Product categories with fairly low degree of dominance but stable ASPs
The only category with a fairly low degree of dominance but rising ASPs is shampoo, with the top three companies occupying an aggregate 52.2% of the market (Kao 22.0%, P&G 18.4%, Shiseido 11.8%) and even the top four companies accounting for 63.1% (the above three plus Unilever's 10.9%). Soft drink ASPs are flat, but the top three have only 58.5% of the market (based on Inryou Souken data for FY2012). In the ham & bacon and sausage markets, PB weightings are comparatively high, as stated, but product ASPs are stable. Female colored cosmetics and soy sauce tend to be stable as well. One category in which the top three firms' aggregate share of 69.6% gives a relatively high degree of dominance but moderately falling ASPs is curry.

Categories in which ASPs continue to fall


Figure 28: Industry ASP for Powder Clothing Detergent Monthly Trend
300

250

Although there is some overlap with the above categories, ASPs are declining in nine categories: curry, loaf bread, sweet buns, prepared bread, instant cup noodles, powder clothing detergent, umami condiments, feminine care, and frozen foods. P&G's low-priced strategy has affected powder clothing detergent, having a marked impact in JanuaryMarch 2013, but Kao's new product, Attack Funmatsu Tsumekae, launched thereafter appears to have checked the decline in ASPs. This consumerfriendly new product is sold in an innovative package that took six years to develop. As the change in Kao's ASP precipitated by the launch of a new value-added product shows, we believe the market leader's pricing strategy has a major impact on product categories that are dominated by a few players. House Foods has top share for curry (46.5%), but it pursues a low-priced strategy. In response to the average 9.7% increase in the government's selling price of imported wheat in the April 2013 revision, Yamazaki Baking increased its own price for July 1 shipments of loaf bread by 36% and sweet buns by 26%, but this was simply in response to the increase in its wheat costs, and the company plans to respond to the higher cost of other raw materials such as oils and sugar by changing product specifications and cost-cutting. Despite strategically cutting its ASP, it was unable to secure corresponding volumes, and 1H operating profit fell 24%. The price downtrend in the instant cup noodle segment is being affected by rising demand for value-added non-fried bagged noodles, and we think company marketing strategies are probably focusing on the latter. Cup noodles and bagged noodles are eaten in differing circumstances, but innovations in bagged noodles engender considerable surprise, while it looks as though cup noodles are fairly steady. If the price band at which consumers regard NBs as value-for-money is coming down, there is the a that price hikes associated with the increase in the consumption tax will inflict a painful decline in volume.

200

Source: Nikkei POS

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

150

23

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 29: Degree of Dominance for Top Three Companies in Each Category and ASP Trends
Liquid Clothing Detergent Baby diaper Alcohol-Free Beer Instant Noodles (pillow bag) Lactobacillus Beverage Tobacco Beer Low Malt + New Genre Female Colored Cosmetics Umami Condiment Feminine care Powder Clothing Detergent Instant Noodles (cup) Sweet bun Bread Shampoo Female Basic Skin Care Soy Sauce Sausage Soft Drinks Curry Ham & Bacon Prepared bread Frozen Food
Source: Nikkei POS as of July 2013 and J.P. Morgan Note: A, B and C refer to Figure 30.

% of PB Share by Top 3 ASP Trends by Trend line (%) (%) 3.4 92.6 Uptrend 5.0 90.6 Uptrend 5.7 82.6 Uptrend 5.6 78.7 Uptrend 6.3 71.4 Uptrend 0.0 99.4 Flat A 1.2 86.0 Flat A 6.8 79.5 Flat A 0.5 71.1 Flat A 1.1 98.2 Downtrend B 0.0 88.2 Downtrend B 9.3 87.9 Downtrend B 7.0 77.7 Downtrend B 2.4 73.1 Downtrend B 12.7 70.5 Downtrend B 2.1 52.2 Uptrend 1.1 69.8 Flat C 7.6 64.6 Flat C 11.6 59.7 Flat C 2.6 58.5 Flat C 4.1 69.6 Downtrend 23.7 43.0 Flat 7.2 46.4 Downtrend 13.9 33.9 Downtrend

Figure 30: Degree of Dominance for Top Three Companies in Each Category and ASP Trends (Image Chart)
Alc Free Beer

Price

Liquid Clothing Detergent Shampoo Instant Noodle (pillow bag) Lactobacillus Beverage Baby Diaper

C
Ham & Bacon

Prepared Bread, Frozen Foods Price Share Curry

B
Share

Source: Nikkei POS and J.P. Morgan Note: Category A: Beer, Low Malt + New Genre and Female Colored Cosmetics. Category B: Umami Condiment, Feminine care, Powder Clothing Detergent, Instant Noodles (cup), Sweet bun and Bread. Category C: Female Basic Skin Care, Soy Sauce, Sausage and Soft Drinks.

24

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Manufacturers control over pricing redefined


Hitherto our assessment of manufacturers' control over pricing has been limited to their ability to maintain margins in response to changing market conditionsin other words, their ability to transfer higher input costs into product prices. However, we think an era has begun in it which it will be increasingly important to align product presentation more closely with consumer needs, such as by changing container sizes and offering more user-friendly packaging, in light of falling price elasticity evident in fledgling changes in consumer purchasing behavior and the growing preference for products packaged in sizes that leave no waste out of environmental concerns. On the assumption that greater freedom to set prices will naturally lead to a change in corporate strategies, we examine conditions for firms to break ranks from standard strategies that have brought uniform pricingin the form of rock-bottom prices and to avoid commoditization. We highlight new pricing strategies designed to maximize margins by leveraging diversification in prices, and we change our understanding of "control over pricing" from "the ability to transfer higher input costs through to pricing" with "the ability to control volume through flexible pricing."

Price diversity, importance of category share


Figure 31: Market Cap Trends for Microsoft and Apple $ billion
800 600 400 200 0

Microsoft

Apple

Source: Bloomberg

Consumers and the retail sector are impressed by innovation. The best business case for manufacturers is when they create new value that has not existed before. However, we believe this kind of innovation occurs at the time of generational changes in products and technology, taking place on a very long cycle. For example, it was 1999 when Microsofts market cap posted its sharpest growth, and it then took 14 years before Apple's market cap peaked out in 2013. If Windows is appraised in terms of growth in market share resulting from the broad applicability of its technology rather than any change through genuine innovation, then perhaps we have to go back to the invention of the printing press to find the last technological innovation before Apple. Although it takes time to implement genuine innovation, competition between companies furthers efforts toward creating technological reform, shortening product lifecycles. Products for which technological innovation leads directly to lower prices react as if they are commodity items, a far cry from how branded products react to prices. Fortunately, in the consumer staples sector the pace of technological reform is slow, and both technological advances and new product development are leading to a better ASP mix. Innovation in this sector for food and drink consists of offering new flavors and fresh value (time-saving, diet). For toiletries it involves repositioning by revamping daily products to suit the times, and developing human healthcare products for an aging society. In mature, inflationary nations in which consumer selectivity is already welltempered, prices have to convincingly reflect value. We think the aim of manufacturers' product development will evolve into a drive to evoke both passion and empathy.

90/1 92/1 94/1 96/1 98/1 00/1 02/1 04/1 06/1 08/1 10/1 12/1

25

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Long-lasting first-comer benefits for firms with high share


On the other hand, in the food and HPC sector, technological innovation progresses slowly, so first-comer benefits last a long time. Product categories in which technological innovation has not taken shape are a goldmine for companies with high market shares. Kao CEO Michitaka Sawada said (when talking about Kao's ironing starch brand Keeping) that revamping even brands in low-growth markets to align them with the times changed their relative positioning. We estimate that Kao has a share of more than 80% in this category. There is no growth in the market, so product development has low priority. However, ironing starch is a daily essential, and demand for a product that satisfies the concept of smartening up the appearance of clothing is likely to persist, even in a hundred years' time. In this case, Kao is likely to stimulate the market through innovation, and then reap the benefits as the company with top market share. We also envisage increases in ASPs corresponding to value-added as product upgrades are added. We estimate that a scenario of rising ASPs would substantially lift Kao's margins, with its high market share for daily essentials.

Opportunities to win market share through technological innovation in mature markets


On the other hand, one example of a turnaround in a similarly low-growth product that does not lend itself to innovation is instant bagged noodles. In 2012 Toyo Suisan launched Maruchan Seimen non-fried instant bagged noodles. This created valueadded inherent in the taste sensation of fresh noodles combined with reduced calories, thereby breathing fresh life into the bagged noodle market. Toyo Suisan's share of the bagged noodle market was very low, and it thus played second fiddle to market leader Nissin Foods. However, the fact that its share was low to start with meant it did not cannibalize the market for its own products, and the company thus achieved net growth.
Figure 32: Industry ASP Weekly Trend for Instant Noodles (Pillow Bag)
215 210 205 200 195 190 185 5/12 5/19 5/26 6/16 6/23 6/30 7/14 7/21 7/28 8/11 8/18 180 6/2 6/9 7/7 8/4

Industry Average

Supply was unable to keep up with demand, leaving some shortages, so category ASPs had been rising, but a fierce onslaught by Nissin Foods and increased production capacity have given both companies capacity for about 300 million servings. Although ASPs turned down to some extent from August, they have recently shown a recovery trend. Current store prices stand at about 350 for a fiveserving pack, but bargain sale prices could become established at 298, in our view. On the other hand, the impact on cup noodle demand of the perceived value-formoney in bagged noodles is a point of concern. Average industry cup noodle prices are below 105 but remain above 100, though consumers are used to perceived value-for-money, and we will need to keep a close eye on how they react to higher cup noodle ASPs as bagged noodle promotions gear up.

Source: Nikkei POS

Signs of a spread in format management


Manufacturers scrap campaigns driven by larger quantities, showing efficacy is receding One regular, established way of making products look good value for money without lowering prices has been through sales of products in larger sizes, but a growing number of food manufacturers are scrapping these. The appeal of buying products in larger quantities has receded, compounding the issues of higher raw material costs resulting from rising market prices and the weaker yen. Although the number of people per household is in decline, the number of households is growing. We believe

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Japan Equity Research 23 August 2013

that the focus will need to be more on portraying value-for-money through quality rather than quantity when seeking to capture senior demand. Kewpie hikes mayonnaise ASPs per gram by changing container size One leading example of an overwhelming market share in Japan's food industry is mayonnaise, in which market leader Kewpie (66.0% market share) announced a change in the size of its mayonnaise containers for the first time in 50 years. It announced a switch from the 500g mayonnaise containers that had been on sale for around 50 years (since March 1964) to 450g. The manufacturer recommends using the product within 30 days of opening to maintain the flavor, but it took an average of around 34 days to use up each bottle in 2012, so the company decided to change to an appropriate container size. The smaller container meant packaging materials account for a higher proportion of costs, thus leading to an increase in ASP per gram. The recommended retail price for the 500g bottle is 382 excluding consumption tax, or 0.76 per gram. The retail price for the 450g bottle is 350, which seems less expensive than the 500g unit, but ASP per gram of 0.78 on the former is 2.6% higher than on the latter. The retail price of a 350g container is 294, or 0.84 per gram, putting the ASP per gram 10.5% higher than for the 500g bottle and 7.7% higher than for the 450g container. Drinks companies trial price hikes at some vending machines The vending machine channel faces both upside potential and downside risk from higher consumption tax rates, and major beverage companies that use this as their main channel are experimenting with various pricing strategies in some machines and in some regions, such as selling 130 canned coffee. Suntory Beverage & Food's Senior Managing Director Shinichiro Hizuka said at the results briefing that it was trialing price changes. We think this is mainly to pin down price elasticity. Although Japan's food and beverage manufacturers are not used to raising prices, we think that they will be able to run more flexible pricing strategies and efficiently deploy promotional expenses once they have accumulated trial data on price elasticity by category. The broad picture overlaps with that of JT three years ago, before it experienced large-scale price revisions.

Figure 33: Kewpie Mayonnaise Correlation b/w Size and Price per gram

Source: Company data Note: Permission for use granted.

Categories in which domestic and overseas price gaps suggest scope for big price hikes
Comparing consumer staple prices between the mature developed nations of Europe/the US and Japan reveals big gaps between domestic and overseas prices in the following categories (Figures 34-36). There are differentials of 2-3x in areas such cigarettes and laundry detergent.
Figure 34: Price of Cigarettes (20 sticks)

1,200 1,000 800 600 400 200 0 US UK Japan


Source: Euromonitor as of Jan. 2013

Figure 35: Price of Concentrated Liquid Detergents

150 100 50 0 UK US Japan


Source: Euromonitor as of Sep. 2012

Figure 36: Price of Bread

80 60 40 20 0 US Japan UK
Source: Euromonitor as of June 2012

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Investment ideas
Looking at near-term implications of the consumption tax hike for the food, beverage and tobacco sector, one possible scenario is the negative one of an increased burden on consumers diminishing purchasing power, but over the medium term we think a reduction in corporate tax can feed through to higher wages, improved employment, and rising capital expenditure, and this would be positive if the propensity to consume were also to improve. We believe the change in how labels display in-store prices implemented alongside the consumption tax hike will allow manufacturers to strategically diversify prices away from ranges that have become ossified under tax-inclusive sticker prices during the long period of deflation. Companies capable of leveraging such advantages have to have high category market shares as a basic prerequisite, and we think differences in perceived share will open up the gap between individual firms.

JT (2914, Overweight): Strongest control over pricing in domestic sectors, upgrading Mevius to premium status
Our top pick in Japan's food, drink, and tobacco sector from a global perspective is the tobacco industryin other words, JTwhich has the greatest control over pricing of all the sub-sectors. JT changed its long-selling Mild Seven line into the Mevius brand in a successful global rebranding operation rarely seen even worldwide. Its share of the Japanese market continues to rise thanks to the change in the brand, and we believe we can look for JT to exercise its ability to set prices commensurate with value, regardless of the consumption tax hike. There are no particularly conspicuous incentives surrounding earnings in this period after 1Q results, while the yen has firmed, and JT has underperformed TOPIX, but we regard this as an attractive entry level. JT is the only company in Japan's consumer sector to use IFRS, while its FY2014 P/E of 11.4x, EV/EBITDA of 7.0x, FCF yield of 7.2%, and dividend yield of 4.0% are at discounts of 21%, 35%, and 13%, respectively, to the global averages, whereas its dividend yield of 3.9% is 13% below the global average based on the August 20 share price. JT has a highly competitive portfolio that allows it to capture both trading down in developed nations and trading up in emerging economies. Thus, although it maintains the highest double-digit EBITDA growth rate worldwide, we believe that a staged increase in its payout ratio will generate a dividend growth rate in excess of 30% over the coming three years through FY2015. We believe that JT's dividend growth and improving dividend yield will help push up valuations, but this is not yet factored into the share price.

Suntory Beverage & Food (2587, Overweight): Record of creating brand value and broadening format management
Suntory Beverage & Food started up its soft drinks business from scratch and has established itself in the No. 2 spot in the industry by creating strong second-placed brands. The nature of the soft drinks business means that utilitarian thirst-quenching drinks and indulgence drinks are sold differently, but the company has a record of expanding the scale of sales through the virtuous circle of using high brand shares won through small-volume containers to effectively promote sales of drinks in larger

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Japan Equity Research 23 August 2013

packages. The company flexibly changes ASPs by selling the same drinks in different sizes, and has managed to develop mega-brands in this way. It has a record of not merely transferring costs into prices but also of seeking to maximize margins by setting different prices according to the container size. This is how we interpret President Nobuhiro Torii's comment that "you sometimes have to sell cheaply to build up a brand." It was talks with SBF that gave us the opportunity to review our definition of control over pricing as the ability to control sales volumes. The company acquired Orangina in 2009 and is currently running a strategy of lifting ASPs per milliliter by playing on a perceived sense of value through small-size packaging in the European market, where there are concerns over momentum in consumption. It has created a group-wide environment conducive to using its expertise and experience to set ASPs commensurate with brand value and to operate an active pricing strategy, even in challenging business conditions in mature markets.

Kao (4452, Overweight): Benefits from high category market shares


Consumer staple companies' operating profit margins can be broadly explained by category market shares, in our view. Kao's market shares in its major product categories range from around 30% to over 60%. Its domestic consumer segment's operating profit margin is nearly 12%, while we put Kanebo Cosmetics' EBIT ratio after adjusting for goodwill amortization expenses at about 15%, but we think margin improvement of about 5ppt will not be too hard to achieve when prices are rising.
Figure 37: Category Share and EBITA/OP Margin
EBITA/OP Margin, %

25.0

L iquid detergent
20.0

P owdery

S hampoo

detergent

15.0

10.0

Feminine care
5.0

B aby diaper S kin care / Colored


cosmetics

0.0 0.0 10.0 20.0 30.0 40.0 50.0 60.0 70.0


Category share, %
Source: Company data and Nikkei POS Note: Category share by Nikkei POS as of July 2013.

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Japan Equity Research 23 August 2013

Dairo Murata (81-3) 6736-8620 dairo.murata@jpmorgan.com Bloomberg JPMA MURATA <GO>

AC

Retail Sector With inflation ticking up, retailers must deliver added value aside from pricing
! Regarding retail prices, we believe deflation has ended and we are now entering a period of moderate price inflation. Based on our bottom-up research, we believe it is premature to expect a paradigm shift to a sustained period of 2% inflation. However, we believe the 15-year cycle of deflation is over and prices are finally poised to trend upward moderately. The longer-term outlook for retail prices and retailer sales, including after the proposed consumption tax hike in 2014, varies considerably depending on target customers, types of products sold, and business strategy. On the demand side, we currently forecast (1) relatively strong consumption by lower income households thanks to government policy measures (aggressive public investment, temporary benefits, and income subsidies), and (2) continued brisk demand among wealthier households thanks to the impact of unprecedented monetary easing on asset values (wealth effect). However, we do not expect consumption by middle-income households, the largest market segment, to recover in earnest until after the income environment improves and the consumption tax hike as taken effectfrom around mid-2014 at the earliest. Regarding the supply side, we expect the market to become an increasingly crowded red ocean, as rising input costs, consumption tax hikes, and industry reorganization (greater emphasis on profitability) drive stiffer competition to offer the same quality at a lower price. Accordingly, we believe (1) smaller retailers will continue to lose market share, and (2) larger, more competitive retailers with robust systems and scale will become even more dominant. Assuming an environment of moderate price inflation, we think the keys to stock selection are structure and capability to deliver satisfaction and added value to consumers beyond just lower prices for the same level of quality. The sub-sectors (and stocks) we favor, assuming a sustained uptrend in retail prices, include the major convenience store chains (Seven & i Holdings, FamilyMart), which dominate in terms of store convenience and merchandising; major SPA retailers (Ryohin Keikaku, ABC-Mart, Point), which have established clear competitive superiority through differentiation; and discount chains such as Don Quijote, which boasts unique store management and merchandising strategies. Conversely, we think the business environment will become increasingly challenging for smaller GMS and supermarket chains, as well as smaller home centers, drugstores, and CVS chains that have failed to adequately differentiate themselves.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Retail price trends: Per-customer sales bottom out at listed retailers


Price trends: Pace of decline in core-core CPI is slowing
Figures 38 and 39 show the breakdown of Japans consumer price index (CPI). CPI excluding fresh food had been declining modestly YoY, but in May it was flat YoY and in June rose 0.4%. However, this owed mainly to the weaker yen, which pushed gasoline prices and electric power and gas rates higher. In other categories (food, furniture and home goods, education and entertainment, etc.) the pace of deflation slowed, but CPI growth was still negative YoY. Figure 39 shows the trend in core-core CPI, which excludes fresh food and energy prices and is therefore considered a better gauge of demand strength. Prices are still down slightly YoY, but the pace of decline has been slowing since the economy bottomed out in 2010 following the US financial crisis, and the deflationary cycle is clearly winding down.
Figure 38: CPI (Composite Index Excluding Fresh Food; by Category)
YoY%
5
Food Furniture & household utensils Clothes & footwear Culture & recreation All items

-1

-3

-5

-7

00.1

00.7

01.1

01.7

02.1

02.7

03.1

03.7

04.1

04.7

05.1

05.7

06.1

06.7

07.1

07.7

08.1

08.7

09.1

09.7

10.1

10.7

11.1

11.7

12.1

12.7

13.1

Source: MIC, J.P. Morgan

13.7
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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 39: Core-core CPI Pace of Decline in Core-core CPI Is Slowing


YoY %
0.5

0.0

-0.5

-1.0

-1.5

-2.0 00.01 00.07 01.01 01.07 02.01 02.07 03.01 03.07 04.01 04.07 05.01 05.07 06.01 06.07 07.01 07.07 08.01 08.07 09.01 09.07 10.01 10.07 11.01 11.07 12.01 12.07 13.01 13.07 All items, less food (less alcoholic bevera ges) and energy
Source: MIC, J.P. Morgan

Listed retailers: Traditional retail formats log positive growth in per-customer same-store sales
On the other hand, Appendix Figures 96-116 show the trends in per-customer sales (per-item sales as available) and customer traffic derived from monthly sales data for the major listed retailers. Per-customer sales equals per-item sales times the number of items sold, and although it is not an exact measure of inflation, it does provide a basic picture of the trend. Generally speaking, most retailers were already seeing an uptick in per-customer sales even before the arrival of Abenomics. In particular, even in the GMS, supermarket, drugstore, home center and other traditional retail formats where key merchandise is typically name-brand items, per-customer sales have stabilized and are, in fact, up YoY at most firms. However, among grocery stores and other retailers that mainly sell non-discretionary products, we understand customer traffic and number of items sold per customer are not increasing much despite efforts to carry more private-label merchandise and products geared to the local market. We attribute this to a sluggish recovery in demand coupled with increasingly stiff competition in localized markets from both similar and different retail formats (particularly discounters and drugstores). Per-customer sales at Seven-Eleven Japan are down modestly YoY, an exceptional case among the major CVS chains. We attribute this to an expanded lineup of lowerpriced store-brand items and the marketing/promotion of these as everyday items to housewives and older consumers. On the other hand, this strategy has increased customer traffic, and overall sales are up solidly.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Unit prices already rising even in consumer electrics segment, a key driver of deflation
Nitori, a quintessential low-price manufacturer/retailer, is successfully increasing its per-customer sales by strengthening its lineup of slightly higher-end merchandise (Appendix Figure 114). Per-customer sales are even rebounding in the home electronics segment, which is widely viewed as one of the main drivers of price deflation in Japan. At Ks Holdings, per-customer sales had been declining steadily since 2009, but they started rising again from February 2013 and the company says they are still trending upward. In this particular segment, the drop in per-customer sales owed in large part to TV prices, but TV prices have stabilized over the last six months or so and are currently up at least 10% YoY (Figure 40).
Figure 40: Sustained Growth in Ks Holdings Same-store Sales per Customer from 2013
YoY%

40.0% 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% -40.0% -50.0% -60.0%

20.0% 15.0% 10.0% 5.0% 0.0% -5.0% -10.0% -15.0% -20.0% -25.0% -30.0%

10/06

10/08

10/10

10/12

11/02

11/04

11/06

11/08

11/10

11/12

12/02

12/04

12/06

12/08

12/10

12/12

13/02

13/04

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

Trends in apparel segment vary based on company strategy


A notable exception to the environment described above is the apparel segment. In some cases per-customer sales at clothing retailers are still declining due to factors specific to the individual company. A good example is domestic Uniqlo stores, where per-customer sales continue to decline because (1) relatively inexpensive bottoms (leggings, etc.) are accounting for a growing share of overall sales, and (2) Uniqlo increased the number of weekend sale days (since Oct 2012). On the other hand, customer traffic has improved considerably. At Ryohin Keikaku, food sales are currently solid, and at Point, per-customer sales are declining because cut & sew items are accounting for a larger share of total sales. However, because these retailers are not intentionally pursuing low-price strategies, we look for their per-customer sales to start improving moderately from this autumn.

13/06

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Japan Equity Research 23 August 2013

Reasons for disparity between macro and micro conditions


To summarize, the macro CPI trend basically conforms with the trend in listed retailers sales data, but in certain product segments there is some disparity. We attribute this to (1) factors specific to the individual companies; (2) the impact of players other than the major listed retailers (unlisted firms, smaller listed firms, etc.); and (3) differences in pricing definitions (e.g., with respect to home electronics, the Ministry of Internal Affairs and Communications uses a quality standard and therefore determines that prices have declined in the event that technology improvements result in a lower price.

Current mood and pricing policies of major retailers


Some retailers are turning bullish on the prospects for sustained inflation
In our discussions with listed retailers, we heard comments indicative of a bullish outlook on prices along with comments suggesting the opposite. At this point it is still a minority of major retailing firms that, based on a top-down approach, believe Japan has entered a long-term period of sustained inflation and are implementing appropriate countermeasures. It is our impression that opinions vary depending on location, type of merchandise, and managements attitude. The following are some of the comments we have heard from major retailers that sound bullish on the prospects for sustained inflation. ! Thanks to rising stock prices and the resulting improvements in asset values and consumer confidence, sales of luxury brands, jewelry, watches, and other highpriced items are strong. We hiked prices for several luxury brands by over 10% due to the weaker yen, but sales volumes are still increasing. (Major department store) Instead of the lowest priced option, consumers are increasingly opting for a slightly more expensive but better product within the same category (including shampoo, toothpaste, food items, etc.) (Major discount retailer) Price is an element of added value. When competitors are selling the same products, we must be conscious of market pricing. However, we are not trying to be the low-price leader. We want to minimize the price factor by increasing added value in other ways. (Major convenience store chain)

Among retailers that have benefited from deflation, managements mindset will have to change
On the other hand, some retailers remain skeptical about the prospects for sustained inflation. Most of Japans major listed retailers have benefited from deflation and have grown their market shares over the past 15 years. For many firms, higher prices tend to reduce customer traffic, so they resist price hikes. In fact, the term price hike is virtually taboo, and thus the prevailing view seems to one of skepticism about the possibility of sustained inflation. We believe this management mindset will have to change in order for a healthy rate of inflation to take hold in Japan. The following are some of the more skeptical comments we heard.
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Japan Equity Research 23 August 2013

With respect to womens apparel, sales to middle-income and upper-middleincome consumers are not recovering noticeably. This is probably because salaries are not rising. (Major department store) We try to project a price image to consumers, and as a company we never announce price hikes. Consumers are extremely selective and price-sensitive, which makes it difficult to raise the price of an identical item. We can, however, lift price points by introducing new products with better features or improved quality. (Major clothing retailer) Some other firms are raising prices due to the weak yen, but it is our policy to not raise prices. We will not pass the consumption tax increase along to our customers. In our view, low price is one of the valuable services we offer our customers. The weak yen and pending consumption tax hike make for a challenging environment, but we actually consider this an opportunity to work together to improve our company in areas like raw materials and product development. (Major furniture and interior goods retailer) We researched retail industry trends in various countries to see what happens after a consumption tax hike, and we found that discount retailers tend to gain market share. This has been the case in Japan as well, and we expect the trend to hold after April 2014. Consumers are extremely price-sensitive with respect to the 100200 items they buy frequently. Do consumers choose to shop at the supermarket that raised prices? (Major GMS and supermarket operator) The economy and Abenomics have virtually no impact on our sales. Our sales are affected more by the weather, particularly the number of rainy days. (Major drugstore chain)

Reassessing the impact of consumption tax hikes


A consumption tax hike could potentially have a major impact on future retail prices. Accordingly, in this section we reassess the implications for retail prices and the retailing industry.

(1) Comparison/contrast versus April 1997 in terms of impact on consumption


Following the consumption tax hike of April 1997, the Japanese economy rapidly decelerated and the adverse effects of the tax hike were magnified. However, some seems to view that the negative economic impact in 2014 will be as bad as it was in 1997. This view comes from four key factors: (1) the relative health of Japans financial system (two major financial institutions failed in November 1997); (2) the impact of the Asian currency crisis (July 1997); (3) positive effects of Abenomics; and (4) plans for an additional consumption tax hike (because another 2% hike is planned for October 2015, a post-tax-hike drop in demand should be limited).

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Japan Equity Research 23 August 2013

As an additional technical factor, a special measures law will allow retailers to display both tax-inclusive and tax-exclusive pricing in 2014, and this may reduce the perceived tax burden when consumers look at product price tags (in 1997, only taxexclusive prices were displayed). Among these factors, we believe (1)(3) are particularly relevant, with factors (1) and (3) likely to have the greatest influence in terms of muting the negative impact of a consumption tax hike. Conversely, a factor that could magnify the tax hikes negative impact compared with 1997 is the current size of the national burden. Estimating the change in national financial burden, including the consumption tax hike along with changes in income tax rates and social security contribution rates, we find that the one-year change is roughly 9 trillion in both 1997 and 2014. However, because there are currently no plans for the kinds of offsetting tax breaks adopted in 1997, the effective increase in the national burden will total an estimated 11.4 trillion in 2014, versus an effective increase of only 3.2 trillion in 1997. Meanwhile, owing to 15-plus years of deflation, the average annual household income in Japan has declined from 6.58 million in 1997 to 5.48 million in FY2011. Although the number of households has increased over this period, the 9 trillion net increase in the national burdenas a percentage of total household income in Japan (total employee compensation)will jump to an estimated 3.7% in 2014 from 3.2% in 1997.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 41: Change in National Burden Before and After Consumption Tax Hike (1997 vs. 2014)
<At last increase in Apr 1997> Category Consumption tax Temporary tax cuts Systemic cuts National insurance Period Apr 97 Apr 96 Apr 95 Aug 96 Details Up from 3% to 5% 15% fixed rate reduction Tax bands eased, minimum threshold up One-time 0.425% hike in personal national pension contributions Employee insurance co-payments up from 10% to 20% For 8.9 mn resident tax-exempt seniors, disabled and single-parent households Total YoY change 3.5 trn FY95 3.5 trn FY96 2.0 trn 3.5 trn Consumption tax hike FY97 5.2 trn 3.5 trn 0.6 trn FY98 5.2 trn 3.5 trn 0.6 trn

Healthcare payments Temporary benefits

Apr 97 Apr 97

5.5 trn 2.0 trn

0.8 trn 0.1 trn 3.2 trn + 8.7 trn

0.8 trn 5.2 trn 1.3 trn

<At proposed increase in April 14> Category Consumption tax National insurance Period Apr 14 17 17 Higher electricity charges Special reconstruction income tax Temporary benefits Note* Jan 13 undecided Fixed 2.1% over 25 years We assume temporary benefits will be introduced, but no details yet Total YoY change
Source: Compiled by J.P. Morgan from EPA's Japan Economic Update 2010 and MoF and MHLW websites.

Consumption tax hike Details Proposed increase from 5% to 8% 0.177% hike in personal national pension contributions (annual) 280 increase in national pension contribution (annual) 0.8 trn 0.3 trn 0.3 trn 2.2 trn + 1.4 trn 0.6 trn 0.3 trn undecided 11.4 trn + 9.2trn 0.6 trn 0.3 trn undecided 12.2 trn + 0.8 trn FY12 0.8 trn FY13 1.6 trn FY14 8.1 trn 2.4 trn FY15 8.1 trn 3.2 trn

Note: Regarding the national burden, + indicates an increase in the national burden (decline in net take-home pay), while indicates a decline in the burden (increase in net take-home pay). Note*: Electricity charges: Assumes nationwide increases of 5% in electricity charges from Apr 13, Apr 14. Note: FY = Apr-Mar. Assumes that the amount of consumption tax remain the same and flat tax value.

Consequently even without unforeseen disruptive factors at home or abroad like in 1997, we find it difficult to imagine that a 2014 hike in consumption tax will have negligible economic impact. A package of measures/outcomes is likely to be instrumental to containing a consumption slowdown in 2014 once consumption tax goes up. Specifically we will be looking for key (i) economic measures such as a supplementary budget, (ii) a range of income support measures (such as benefits for low-income earners, favorable home and car purchasing loans/subsidies) and (iii) policies to brighten the national outlook (a range of growth measures and reforms aimed at building sustainable pension and healthcare systems).

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

(2) Basic company policies: Unreasonable to expect uniform retail price rises
The proposed hike in consumption tax has yet to get the formal go-ahead, so it is difficult factoring in the likely impact on earnings when it remains to be seen exactly how the big retailers will respond/deal with the increase. Below we outline what companies who have come up with measures say they will do. Our impression is that mass-market private brands could be where most of the cuts in underlying pricing occur. ! Nitori: Says it plans to pay the tax increase itself rather than pass it on in higher retail pricing; in other words, it will make efforts to absorb the impact of cuts in underlying pricing in areas such as sourcing of raw materials and product development. ! ABC-Mart: Says it may make real markdowns to maintain overall pricing of mass-market private brands, but wants to absorb as much of the impact as it can through upstream efforts. Many national brands and slightly higher-priced private brands are not already rounded down, so the plan here is to pass on the tax increase in higher retail pricing. ABC-Mart says it will display prices inclusive of tax (Xebio says the same, apart from the bit about including tax). ! Shimamura: Considering the cost and time required to change price tags, Shimamura says it will continue to display tax-inclusive prices. Retail inventory as of end-March 2014 will remain priced at the same levels (effective price cut at the firms expense). Regarding merchandise procured thereafter, strategies will include collaboration with suppliers, pass-through of some costs, and raising both prices and quality level simultaneously. The firm intends to subsequently adjust pricing depending on sales volumes. ! FamilyMart, Lawson: Neither is inclined to pursue a strategy of marking down more aggressively. Both are inclined to put up prices of national brands to pass on the tax increase.

(3) Price tag, systems issues


Retailers will incur one-time costs on changing price tags and adjusting merchandise control systems when consumption tax goes up. Many companies are still looking at how to deal with these issues and assess their likely impact, which at the moment makes it hard to quantify the effects. However, a number of companies we have talked to recently mention that (i) for retailers with annual sales of 200300 billion, the additional cost of replacing price tags and updating systems could range from tens of million yen to over one hundred million yen, (ii) they are likely to deal with the tax change over a matter of months, otherwise costs would jump at the end of March, just before the increase and (iii) it would be expensive to make a wholesale switch to digital pricers used in some food supermarkets. Based on these comments, we think the one-time costs to retailers would largely depend on (i) the number of tax increases and (ii) methods of price labeling. In other words we think the impact would be minimal under the current most likely scenario of longer-term, unlimited tax-exclusive pricing recognized under the Act on Special Measures Concerning Taxation and a two-stage increase in April 2014 and October 2015 (or a one-time increase in April 2014). Conversely, five increases of 1% each and limited-time tax-exclusive pricing would have a much bigger impact.

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Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Below we list the main points of the Act on Special Measures, which at present limits tax-exclusive pricing to two years. Industry groups such as the Japan Chain Stores Association and the Japan SM Association, made up of many retailer members, are pushing for long-term use of the tax-exclusive formula.
Figure 42: Main Points of Act on Special Measures (Temporary Legislation Until End-March 2017)
Restrictions on retailers Consideration for retailers Consideration for SMEs Monitoring system
Source: Nihon Keizai Shimbun, J.P. Morgan

Prohibits sale of goods at reduced levels of consumption tax Allows tax-exclusive labeling to cut down work for the retailer Allows pricing cartels whereby retailers can put up prices simultaneously to reflect higher consumption tax. Gives powers of investigation and guidance to individual ministries/ Cabinet Secretariat advisory office

(4) Issue of rounding down pricing


Another issue to watch is that of rounding down prices, which numerous retailers have been using to attract consumers by making prices look reasonable. Take items of food, for instance currently priced at total amounts of 198, 298 and 598 and everyday items of clothes priced at 990, 1,280, 1,900 and 2,990 to offer a sense of value for money. The price of a 1,990 item at the moment is likely to change as follows after consumption tax goes up. Right now only Nitori and a very small number of manufacturing retailers say they will make real cuts to prices as in Case 3 in Figure 43. Meanwhile Aeon says it will aim, for example, to keep selling a 118 loaf of bread at that price until next year. Uniqlo is not making any comment, but we expect it to keep tax-inclusive pricing on basic items where it is now (in effect a price cut).
Figure 43: What Will Happen to the Price Tag on an Item That Now Sells for 1,990 After Consumption Tax Hike in 2014?
Now Total price displayed 1,990 After hike in consumption tax from 5%->8% Case 1: Case 2: Total price displayed 2,047 Tax-exclusive formula (1) Item 1,895 Tax 152 Tax exclusive formula (2) Item 1,895 Case 3: Tax-inclusive price kept (cut in real terms) Item 1,843 Tax 147

Item 1,895 Tax 95

*Tax-exclusive formula (1) shows both price of item and tax, (2) shows item only
Source: J.P. Morgan

Put differently, apart from some proprietary SPA merchandise and some abovementioned own labels and private brands, tax-inclusive pricing could prove liberating from conventional rounding-down. In the food sector in particular many say they find it difficult to keep prices at present levels when raw materials are more expensive and the yen is strong (they respond by changing package size for some merchandise). Moreover, introducing tax-exclusive pricing so that items are labeled before tax can soften the impression that an item has become more expensive. We think one point

39

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

of interest will be whether tax-exclusive pricing prevails in future over manufacturing and retailer pricing policies and outlook.

Competition: Demand growth to offset impact of higher prices, supply-side growth


Total retail floor space in Japan projected to increase 1.3%
That said, it is hard to see any real improvement in the state of retailing sector competition, which is worth heeding from a pricing perspective. As shown in Figure 44, the total registered floor space of large-scale retail stores over 10,000m2 in size increased by 59% YoY in FY2012 and by 72% YoY in 1Q FY2013 (AprJun). However, the pace of growth in all large-scale stores (over 1,000m2) is slowing, to +10% YoY in FY2012 and +3% YoY in AprilJune 2013. Looking at recent applications for new large-scale stores, most are for very-large (over 20,000m2) suburban shopping centers, power centers, and large commercial facilities situated near major train terminals. These retail facilities are expected to open for business around six months to two years after construction notices are filed.
Figure 44: Applications for New Store Openings Under the Large-scale Store Law
CY No. of applications YoY Total fl. space reported for new openings (000 m2) 3,961.6 4,371.5 2,743.4 2,080.8 2,317.7 1,978.3 2,177.7 125.4 184.1 241.4 228.0 144.1 188.9 YoY Avg. fl. space No. of reported for applications for new openings over 10,000sqm (000 m2) 5.4 5.8 4.2 3.0 4.0 3.3 3.1 2.8 3.1 3.1 3.2 2.7 3.5 96 91 29 26 28 22 37 5 2 5 7 2 3 YoY Total fl. space reported for new openings over 10,000sqm (000 m2) 1,996.7 2,172.7 752.3 551.5 647.4 486.9 773.1 160.7 26.9 108.2 128.2 70.4 108.2 YoY Avg. fl. space reported for new openings (000 m2) 20.8 23.9 25.9 21.2 23.1 22.1 20.9 32.1 13.5 21.6 18.3 35.2 36.1

2006 2007 2008 2009 2010 2011 2012 2013 Jan. Feb. Mar. Apr. May. Jun.
Source: METI, J.P. Morgan

730 751 651 692 578 600 694 45 60 78 72 54 54

0.3% 2.9% -13.3% 6.3% -16.5% 3.8% 15.7% 21.6% -16.7% 5.4% 1.4% 12.5% -8.5%

-9.4% 10.3% -37.2% -24.2% 11.4% -14.6% 10.1% 10.5% -14.7% 5.4% -0.5% 9.4% 2.4%

5.5% -5.2% -68.1% -10.3% 7.7% -21.4% 68.2% 150.0% 100.0% 25.0% 600.0% -33.3% -25.0%

-8.1% 8.8% -65.4% -26.7% 17.4% -24.8% 58.8% 232.1% 133.9% 65.4% 811.1% 73.3% -12.1%

On the other hand, competition to open smaller retail formats (under 1,000m2) shows no signs of easing. In the CVS segment, for instance, the five major publicly-listed chains project at least 3,000 net new store openings annually (combined), equivalent to roughly 6% of all stores nationwide. Likewise, the 10 major listed drugstore chains plan to open more than 500 new stores (net basis), equivalent to a 5% increase in total stores nationwide. We estimate the impact of this growth in retail floor space as follows. First, as shown in Figure 44, gross retail floor space of all large stores (over 1,000m2) has increased by 22.7 million m2 annually over the past five years (including FY2013 to date). Although it is difficult to estimate shuttered floor space with accuracy, we estimate net annual growth in floor space at 1.5 to 2 million m2.

40

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

As for smaller stores (under 1,000m2), net new CVS floor space is around 390,000m2, and net new drugstore floor space (major chains) is around 350,000m2. Including these figures, we estimate that new retail floor space is increasing by well over 2 million m2 per year in net terms. According to commercial statistics, Japan had roughly 150 million m2 of total retail floor space in 2007. As of end-2012 this figure had increased to around 160 million m2, which means net retail floor space growth has averaged around 1.3% annually over the last five years.
Figure 45: Total Retail Floor Space in Japan
000 square meters

160,000 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 1970 1972 1974 1976 1979 1982 1985 1988 1991 1994 1997 1999 2002 2004 2007
Total sales floor space
Source: METI "Current Survey of Commerce"

Note: CY basis

The question facing Japans retail industry generally is whether demand growth is sufficient to absorb this 1.3% annual growth in total retail floor space along with 1 2% annual price escalation (from consumption tax hike and rising CoGS). Looking at Japan as a whole, we believe the supply-demand gap will gradually narrow thanks to demand growth supported by the longer-term benefits of Abenomics (wealth effect plus improvements in income levels and consumer sentiment). That said, competition and demand characteristics, which significantly influence pricing, tend to vary by location and merchandise category. Supply-demand is unlikely to recover uniformly throughout Japan. Whether a retailer sees healthy price inflation will mostly depend on four key variables: (1) product characteristics (necessity or added value); (2) customer characteristics (price sensitivity and loyalty); (3) competitive climate (intensity of equal-quality price competition); and (4) management characteristics (innovation and ability to compete on factors other than price).

Retail price outlook and implications


We have the two following points to make about the outlook for retail pricing as we now see things based on our observations so far and discussions with major retailers.

41

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Outlook for impact on demand: Relatively reassuring outlook for low-income earners and the wealthy
We think merchandise aimed at the wealthier upper-middle classes could be relatively little affected by an increase in consumption tax, considering the Abenomics wealth effects potential to keep going. There could also be firm demand from the lower- income earners since they look likely to benefit from the governments economic policies. On the other hand, we do not expect consumption by middle-income households, the largest market segment, to recover in earnest until at least mid-2014sometime after the income environment improves and the consumption tax hike has taken effect. Figure 46 shows the trends in macroeconomic and industry conditions along with changes in the demand structure.
Figure 46: Macroeconomic and Industry Conditions Plus Impact on Personal Consumption
<Domestic Factors> Abenomics
Aging society

<External Factors>
Global competition More costly raw materials Rising stock market; asset Weak yen Better big company earnings

Monetary/fiscal/growth strategy
Domestic manufacturing employment subdued by shift overseas

Source: J.P. Morgan

Time
42

Higher employment in healthcare & construction

Energy , import price inflation

Middle class consumption flat

Policy support gained with benefits

Higher consumpt-ion by wealthy, highincome earners Higher retail prices

Consumption tax up

Support for consumption by lowincome earners

Moderate improvement in middle-class consumption?

Higher employment, income

Broadimprovement in earnings

Virtuous spiral of higher demand -> price inflation -> better earnings -> higher wages

Prices rising for products other than proprietary SPA merchandise and store-brand items
Our basic sense of prospects by merchandising category is as follows: (i) After the consumption tax goes up, many retailers are planning to keep retail prices where they are on proprietary SPA merchandise, particularly big volume sellers (with the intention of absorbing effective markdowns by making greater efforts in upstream areas, such as procurement and production control).

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

(ii)

Many companies feel it will be difficult to pass on all cost increases and the whole of the tax increase in the case of frequently purchased everyday necessities (market share may go up if prices are effectively marked down, but the concern is that CoGS will rise). Big retailers hope they will be able to keep prices of everyday necessities reasonable by maintaining prices of proprietary private brands (or improving their contents). One example is the price of Aeons branded bread.

(iii)

Put differently, we generally expect to see higher input costs and the increase in consumption tax passed on to retail pricing in the case of most national brands, apart from regular purchases. The problem is what will happen to volumes after retail prices go up. We think much will depend on merchandise characteristics, sustainability of demand (consumer sensitivity to pricing) and the state of competition.

Supply side and outlook: Determinants of sales and earnings once prices go up
Factors on the supply side likely to contain price competition include (i) growth in the retail pie itself (shop formats), (ii) strength or otherwise of price competition between rivals, (iii) dominance by top retailers and their pricing policies, (iv) degree of competition from alternative channels and services such as online shopping and (v) supply side developments (over-competition turning into price pressure). Other elements that come into play include consumer sensitivity to pricing from one type of retailer to another. To illustrate the point, we give an overview of the top players and their degree of dominance in Appendix Figures 117-123 and sales value by format in Appendix Figures 124-125. These tables confirm significant structural differences in competition from format to format. Looking at the convenience store segment, for instance, the scale of the segment itself is growing, plus the segment is gaining a larger share of Japans overall food/beverage market. Meanwhile, there is healthy and orderly competition because all of the major players are listed companies. The GMS and supermarket segments are a different story. Achieving healthy price escalation in these segments will likely prove challenging, mainly because (1) listed companies do not dominate the segment, and (2) unlisted companies have a relatively large presence in the segment (dominant regional discount stores and supermarket chains). The home center segment basically fits the latter pattern. The home electronics retailing industry is becoming increasingly dominated by a few firms, but competition among the major players and from online retailers is intense. The drugstore segment, on the other hand, is a highly fragmented industry, but because the scale of the segment itself is currently growing and the major chains differ in terms of strategic direction, the industry structure is not that bad. All in all we think areas likely to show relatively fierce future competition are (i) retailers of commodities in the food line (SM, GMS, DS), (ii) retailers of household commodities (GMS, HC and uncompetitive DGS), and (iii) electrical retailers. Conversely, those areas with relatively good prospects of sustaining higher prices are
43

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

(i) the big convenience stores, (ii) drugstores with clearly defined characteristics and competitive drive, (iii) specialty retailers (e.g. Don Quijote) clearly able to appeal to consumers on points other than price, and (iv) retailers with private brands of quality that cannot be rivaled on price.

Factors when picking stocks to invest in


We consider ability to offer consumers clear value other than price instrumental to stock picking under a scenario of sustained price inflation. Specific components include store convenience, specialization, customer service and ability to merchandise (value for money versus aspects such as functionality, dominance of brand image and rarity). As long as all these elements are evident, retailers are likely to find it relatively easy to put up retail prices and contain the impact of falls in volume.

Investment ideas
We highlight the following subsectors and stocks to watch on the basis of retailers ability to keep putting up retail prices: the big convenience store operators s which are much more convenient and better run than the rest (Seven & i Holdings 3382, Overweight and FamilyMart 8028, Overweight). In terms of eschewing price competition (for equal quality) in favor of strategic emphasis on delivering added value, improving customer convenience, and developing more store-brand items, we believe Seven-Eleven Japans business model is particularly easy to understand. The chains private-label products (Seven Premium and SEJ Original) are summarized in Figure 47, and by FY2015 the company eyes roughly 2.4 trillion in total sales of these two store-brand lines alone. Specific initiatives by SEJ include an expanded lineup of SP Gold items that feature flavor and quality equal to or better than that of specialty stores, at reasonable price points. The company is already collaborating with top makers such as Nissin Foods, Toyo Suisan, and Suntory in product categories such as high-end bread, instant ramen noodles, and premium beer. In an inflationary environment, we think this approachfocusing on added value rather than low pricewill likely appeal to consumers.

44

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 47: Expanding Lineup of Seven Premium and Original Store-brand Lines
billion

2,500

2,000

1,500

1,000

500

2007 2008 2009 2010 2011 2012 SEJ original products Seven premium products
Source: Company data, partly J.P. Morgan assumptions Note: Figure for the first year (2007) of Seven premium is the accumulation from May 2007 to May 2008. Note: J.P. Morgan assumption for FY2008-FY2012 SEJ original products.

2015 (Company plan)

Other subsectors and stocks to watch assuming the coming inflation phase: the big SPA retailers that clearly stand out from the competition [Ryohin Keikaku (7453, Overweight) and ABC-Mart (2670, Overweight), Point (2685, Overweight)]; clearly differentiated DS [Don Quijote (7532, Overweight)] in terms of store operations and merchandise, and drugstore chains [Sundrug (9989, Neutral)], with scope for growth revolving around relatively high-growth, high-margin HBDC merchandise.

45

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Appendix Food & HPC Sector


Figure 48: Industry ASP Trend for Shampoo

Figure 49: Market Value Share by Company: Shampoo


%

510 500 490 480 470 460 450


Other 34.8%

PB 2.1%

Kao 22.0%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

440

P&G 18.4% Unilever 10.9%


Source: Nikkei POS as of July 2013

Shiseido 11.8%

Source: Nikkei POS

Figure 50: Industry ASP Trend for Powder Clothing Detergent

Figure 51: Market Value Share by Company: Powder Clothing Detergent (%)
PB 9.3% P&G 8.7% Other 2.8%

300

250

200 Lion 16.9% 150

Kao 62.3%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 52: Industry ASP Trend for Liquid Clothing Detergent

Figure 53: Market Value Share by Company: Liquid Clothing Detergent (%)
PB 3.4% Other 4.0%

360 340 320 300 280 260 Lion 24.1%

Kao 46.8%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

240

P&G 21.7%
Source: Nikkei POS as of July 2013

Source: Nikkei POS 46

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 54: Industry ASP Trend for Baby Diapers

Figure 55: Market Value Share by Company: Baby Diapers


%

1,300 1,250 1,200 1,150 1,100 1,050 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 1,000

Other PB 4.4% 5.0%

P&G 26.8%

Unicharm 36.3%

Kao 27.5%
Source: Nikkei POS as of July 2013

Source: Nikkei POS

Figure 56: Industry ASP Trend for Feminine Care

Figure 57: Market Value Share by Company: Feminine Care


%

330 320 310 300 290 280 Kao 32.3% Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 P&G 7.0% Other 12% Unicharm 48.9%

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 58: Industry ASP Trend for Female Basic Skin Care

Figure 59: Market Value Share by Company: Female Basic Skin Care
%

2,500
PB 1.1% Kose 11.6% Other 18.3%

Kanebo 13.6% Kanebo+ Kao

2,000

27.7 %
Shiseido total 26.6%

Kao 13.8%

1,500
P&G Max Factor 15.3%

Shiseido 18.1%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

1,000

Shiseido Int'l 8.2%


Source: Nikkei POS as of July 2013

Source: Nikkei POS

47

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 60: Industry ASP Trend for Female Colored Cosmetics

Figure 61: Market Value Share by Company: Female Colored Cosmetics (%)
kanebo 15.6% Other 26.9% PB 0.5% P&G Maxfactor 6.7% Kose 9.7% Kanebo + Kao 30.5 % Shiseido total 25.7 % Shiseido 18.3%

1,800 1,700 1,600 1,500 1,400 1,300 1,200 1,100 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 1,000

Kao 14.9%

Shiseido International 7.4%


Source: Nikkei POS as of July 2013

Source: Nikkei POS

Figure 62: Industry ASP Trend for Tobacco

Figure 63: Market Value Share by Company: Tobacco


%

1,600 1,400 1,200 1,000 800 600 400 200 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 0

N. American products 14.6% PM 6.5%

Swiss products 0.2%

Other 0.4%

JT 78.3%

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 64: Industry ASP Trend for Instant Noodles (pillow bag)

Figure 65: Market Value Share by Company: Instant Noodles (pillow bag) (%)
Nissin 28.0%

220 210 200 190 180 170 160 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 150
Sanyo 15.3% PB 5.6% Other 15.7% Nissin+ Myojo 35.7 %

Myojo 7.7% Toyo Suisan 27.7%

Source: Nikkei POS 48

Source: Nikkei POS as of July 2013

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 66: Industry ASP Trend for Instant Noodles (cup)

Figure 67: Market Value Share by Company: Instant Noodles (cup)


%

112 110 108 106 104 102 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 100
Toyo Suisan 17.1%
Source: Nikkei POS as of July 2013

Other 15.3% PB 7.0% Acecook 9.6% Nissin +Myojo 51.0 %

Nissin 42.9%

Myojo 8.1%

Source: Nikkei POS

Figure 68: Industry ASP Trend for Beer

Figure 69: Market Value Share by Company: Beer


%

750 700 650 600 550 500 450 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 400

Suntory HD PB 11.4% 1.2%

Other 1.4%

Sapporo 14.4%

Asahi 49.1%

Kirin 22.5%

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 70: Industry ASP Trend for Low Malt / New Genre

Figure 71: Market Value Share by Company: Low Malt / New Genre
%

440 420 400 380 360 340 320 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 300
Suntory HD 16.0%

Other 2.7% PB 6.8% Sapporo 11.0% Kirin 41.0%

Asahi 22.5%
Source: Nikkei POS as of July 2013 49

Source: Nikkei POS

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 72: Industry ASP Trend for Alcohol-Free Beer

Figure 73: Market Value Share by Company: Alcohol-Free Beer


%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

300 280 260 240 220 200 180 160 140 120 100

Other PB 3.8% Sapporo 5.7% 7.9% Suntory HD 47.2%

Kirin 10.4%

Asahi 25.0%

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 74: Industry ASP Trend for Soft Drinks

Figure 75: Market Value Share by Company: Soft Drinks


%

115 110 105 100 95 90


Asahi Beverage 10.0% Ito-En 10.9% Suntory 19.6% Other 21.3% Coca Cola 27.9%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

Kirin Beverage 10.2%


Source: Inryou Souken in FY2012 (Jan- Dec)

Source: Nikkei POS

Figure 76: Industry ASP Trend for Lactobacillus Beverages

Figure 77: Market Value Share by Company: Lactobacillus Beverages


%

170
Other 22.3% PB 6.3% Yakult Honsha 49.7%

165

160

155
Danone Japan 8.0%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

150

Kagome 13.7%

Source: Nikkei POS 50

Source: Nikkei POS as of July 2013

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 78: Industry ASP Trend for Umami Condiments

Figure 79: Market Value Share by Company: Umami Condiments


%

280

260

Kirin Kyowa Foods 7.9%

PB 1.1%

Other 0.7%

240

220
Ajinomoto 90.3%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

200

Source: Nikkei POS

Source: Nikkei POS as of July 2013

Figure 80: Industry ASP Trend for Soy Sauce

Figure 81: Market Value Share by Company: Soy Sauce


%

245 240 235 230 225 220


Higashimaru 3.2% Ichibiki 3.5% PB 7.6% Yamasa 9.0%
Source: Nikkei POS as of July 2013

Other 24.6% Kikkoman 52.1%

May-12

May-13

Mar-12

Mar-13

Jul-11

Jul-12

Sep-11

Nov-11

Sep-12

Nov-12

Jan-12

Source: Nikkei POS

Figure 82: Industry ASP Trend for Frozen Food

Jan-13

Jul-13

Figure 83: Market Value Share by Company: Frozen Food


%

195 193 191 189 187 185 183 181 179 177 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 175
Maruha Nichiro 7.8% Table Mark 8.8% PB 13.9% Other 35.6%

Ajinomoto 12.6% Nichirei 12.4% Nissui 8.9%

Source: Nikkei POS

Source: Nikkei POS as of July 2013 51

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 84: Industry ASP Trend for Ham & Bacon

Figure 85: Market Value Share by Company: Ham & Bacon


%

340 320 300 280 260 240 220 Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13 200
Marudai 11.0%
Source: Nikkei POS as of July 2013

Other 22.3%

PB 23.7%

Prima Ham 12.9%

Ito Ham 14.2% Nippon Meat Packer 15.9%

Source: Nikkei POS

Figure 86: Industry ASP Trend for Sausage

Figure 87: Market Value Share by Company: Sausage


%

290
Other 21.9% Prima Ham 6.8% PB 11.6%

280

Nippon Meat Packer 24.8%

270

260

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

250

Ito Ham 20.7% Marudai 14.2%


Source: Nikkei POS as of July 2013

Source: Nikkei POS

Figure 88: Industry ASP Trend for Curry

Figure 89: Market Value Share by Company: Curry


%

165 160 155 150 145 140


Other 22.9% Meiji 3.4% PB 4.1% Ezaki Glico 5.0% House Foods 46.5%

Jul-10 Sep-10 Nov-10 Jan-11 Mar-11 May-11 Jul-11 Sep-11 Nov-11 Jan-12 Mar-12 May-12 Jul-12 Sep-12 Nov-12 Jan-13 Mar-13 May-13 Jul-13

S&B 18.1%
Source: Nikkei POS as of July 2013

Source: Nikkei POS 52

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 90: Industry ASP Trend for Bread

Figure 91: Market Value Share by Company: Bread


%

130
Kobeya 5.7% Fuji Baking 8.8% PB 12.7% Other 11.1% Yamazaki Baking 37.0%

125

120

115

May-12

May-13

Mar-12

Mar-13

Jul-11

Jul-12

Sep-11

Nov-11

Sep-12

Nov-12

Jan-12

Jan-13

Jul-13

110

Shikishima Baking 24.7%


Source: Nikkei POS as of July 2013

Source: Nikkei POS

Figure 92: Industry ASP Trend for Sweet Buns

Figure 93: Market Value Share by Company: Sweet Buns


%

108 106 104 102 100 98 96 94 92 May-12 May-13 Mar-12 Mar-13 Jul-11 Jul-12 Sep-11 Nov-11 Sep-12 Nov-12 Jan-12 Jan-13 Jul-13 90
Shikishima Baking 13.7%
Source: Nikkei POS as of July 2013

PB 2.4% Kobeya 6.7%

Other 17.8% Yamazaki Baking 46.0%

Fuji Baking 13.4%

Source: Nikkei POS

Figure 94: Industry ASP Trend for Prepared Bread

Figure 95: Market Value Share by Company: Prepared Bread


%

185 180 175 170 165 160 155 150 145 May-12 May-13 Mar-12 Mar-13 Jul-11 Jul-12 Sep-11 Nov-11 Sep-12 Nov-12 Jan-12 Jan-13 Jul-13 140
Kobeya 3.8%
Source: Nikkei POS as of July 2013 53

Yamazaki Baking 32.8% Other 42.6%

PB 7.2% Shinobu Foods 6.4%

Takaki Bakery 7.2%

Source: Nikkei POS

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Appendix Retail Sector


Figure 96: Ito-Yokado SSS Sales per Customer and Customer Traffic
YoY%

Figure 97: Aeon SSS Sales per Customer and Customer Traffic
YoY%

8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 -12.0 -14.0 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0 -5.0 -6.0 -7.0 Customer traffic (RHS)

4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 05/02 06/02 07/02 08/02 09/02 10/02 11/02 12/02 13/02 Sales per customer (LHS) Customer traffic (RHS)

2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 -2.0 -2.5 -3.0 -3.5 -4.0

Source: Company data, J.P. Morgan Note: Figures for FY-end until Feb 2012 and thereafter figures for each quarter-end. Note: Aeon + Aeon Retail until Feb 2009.

Figure 98: Yaoko SSS Sales per Customer and Customer Traffic
YoY%
8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 4.0 3.0 2.0 1.0 0.0 -1.0 -2.0 -3.0 -4.0

Figure 99: Inageya SSS Sales per Customer and Customer Traffic
YoY%
9.0 7.5 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5 -6.0 -7.5 -9.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 9.0 7.5 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5 -6.0 -7.5 -9.0

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Per-item sales (LHS)

Customer traffic (RHS)

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

54

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 100: Maruetsu SSS Sales per Customer and Customer Traffic
YoY%

Figure 101: Seven-Eleven Japan SSS Sales per Customer and Customer Traffic
YoY%

4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5 -6.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01

6.0

12.0
4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0

9.0 7.5 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

Figure 102: Lawson (Consolidated) SSS Sales per Customer and Customer Traffic
YoY%

Figure 103: FamilyMart (Parent) SSS Sales per Customer and Customer Traffic
YoY%

12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01

9.0 7.5 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5

12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01

9.0 7.5 6.0 4.5 3.0 1.5 0.0 -1.5 -3.0 -4.5

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

Sales per customer (LHS)


Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Customer traffic (RHS)

55

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 104: Sundrug SSS Sales per Customer and Customer Traffic
YoY%

Figure 105: Sugi Holdings SSS Sales per Customer and Customer Traffic
YoY%

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: Figures for drugstore business from April 2010. 3-month MA for customer traffic.

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 Customer traffic (RHS)

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: Figures for New Sugi Pharmacy from March 2013. 3-month MA for customer traffic.

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 Customer traffic (RHS)

Figure 106: Cosmos Pharmaceutical SSS Sales per Customer and Customer Traffic
YoY%

Figure 107: Don Quijote SSS Sales per Customer and Customer Traffic
YoY%

12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS) Customer traffic (RHS)

12.0 10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

10.0 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 -8.0 -10.0 Customer traffic (RHS)

Source: Company data, J.P. Morgan Note: Figures for sales per customer are J.P. Morgan assumption. 3-month MA for customer traffic.

56

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 108: Domestic Uniqlo SSS Sales per Customer and Customer Traffic
YoY%

Figure 109: Shimamura SSS Sales per Customer and Customer Traffic
YoY%

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 Customer traffic (RHS)

15.0 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 05/01

15.0 12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS) Customer traffic (RHS)

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Figure 110: United Arrows SSS Sales per Customer and Customer Traffic
YoY%

Figure 111: Ryohin Keikaku SSS Sales per Customer and Customer Traffic
YoY%

15.0 10.0 5.0 0.0 -5.0 -10.0 05/01

15.0 10.0 5.0 0.0 -5.0 -10.0 06/01 07/01 08/01 09/01 Sales per customer (LHS) 10/01 11/01 12/01 Customer traffic (RHS) 13/01

12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS)
Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

12.0 9.0 6.0 3.0 0.0 -3.0 -6.0 -9.0 Customer traffic (RHS)

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

57

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 112: Point SSS Sales per Customer and Customer Traffic
YoY%

Figure 113: ABC-Mart SSS Sales per Customer and Customer Traffic
YoY%

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 05/01

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01 Sales per customer (LHS) Customer traffic (RHS)

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 05/01 06/01 07/01 08/01 09/01 10/01 11/01 12/01 13/01

20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 Sales per customer (LHS) Customer traffic (RHS)

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Figure 114: Nitori SSS Sales per Customer and Customer Traffic
YoY%

Figure 115: Komeri SSS Sales per Customer and Customer Traffic
YoY%

25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 05/01 06/01 07/01 08/01 09/01 Sales per customer (LHS) 10/01 11/01 12/01 Customer traffic (RHS) 13/01

25.0 20.0 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0

15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 05/01

15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 06/01 07/01 08/01 09/01 Sales per customer (LHS) 10/01 11/01 12/01 Customer traffic (RHS) 13/01

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

58

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 116: Shimachu SSS Sales per Customer and Customer Traffic
YoY%
10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0 07/01 08/01 09/01 10/01 Sales per customer (LHS) 11/01 12/01 Customer traffic (RHS) 13/01 10.0 7.5 5.0 2.5 0.0 -2.5 -5.0 -7.5 -10.0

Source: Company data, J.P. Morgan Note: 3-month MA for customer traffic

Figure 117: FY2012 Convenience Stores Market Share (Estimated Market Size 9 Trillion)
%

Ministop 3.9% Circle K Sunkus 10.5%

Others 8.4% SEJ 38.8%

FamilyMart 17.5% Lawson 20.9%

Source: METI Current Survey of Commerce, JFA Convenience store statistics, Company data, J.P. Morgan

59

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 118: FY2012 SM/GMS Operators Market Share (Estimated Market Size 21.8 Trillion)
%

Aeon Retail 9.1%

Ito-Yokado 6.0%

MaxValu (6 companies) 3.9% Uny 3.3% Daiei 2.9%

Others 59.4%

Izumi Life 2.3% 2.3% Benimaru + YorkMart 2.2% Arcs Valor 2.0% 1.9% MaruetsuIzumiya 1.4% 1.5% Heiwado 1.7%

Source: METI Current Survey of Commerce, JFA Convenience store statistics, Company data, J.P. Morgan

Figure 119: FY2012 Department Stores Market Share (Estimated Market Size 7 Trillion)
%

Isetan Mitsukoshi 15.6% Others 44.3% J. Front Retailing 11.3%

Sogo Seibu 12.0%

H2O Retailing 5.8%

Takashimaya 11.1%

Source: METI Current Survey of Commerce, JFA Convenience store statistics, Company data, J.P. Morgan

60

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 120: FY2012 Furniture Retailers Market Share (Estimated Market Size 2 Trillion)
%

*Ikea 3.0% Nitori 14.8% Otsuka Kagu 2.4% *Yamashin 2.3% *Tokyo Interior 1.8% *Actus 0.5%

Others 75.1%

Source: Nikkei MJ (July 17, 2013), J.P. Morgan Note: *Unlisted company

Figure 121: FY2012 Electronics Retailers Market Share (Estimated Market Size 7 Trillion)
%

Yamada Denki 20.5% Others 48.0% K's Holdings 8.5%

Edion 9.2%

Bic Camera 5.3%


Source: Nikkei MJ (July 17, 2013), J.P. Morgan Note: *Unlisted company

*Yodobashi Camera 8.5%

61

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 122: FY2012 Drugstores Market Share (Estimated Market Size 6 Trillion)
%

Sundrug 5.1% Matsumoto Kiyoshi 7.7% Cocokarafine Healthcare 4.9% COSMOS Pharmaceutical 4.7% Sugi HD 4.5% Others 65.3% Tsuruha HD 4.0% Kawachi HD 3.8%

Source: Nikkei MJ (July 17, 2013), J.P. Morgan

Figure 123: FY2012 Home Center Market Share (Estimated Market Size 4 Trillion)
%

Komeri 7.9% *Cainz 8.7%

Konan Shoji 7.4% Nafco 5.8% Others 65.3% Homac 4.9%

Source: Nikkei MJ (July 17, 2013), J.P. Morgan Note: *Unlisted company

62

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Figure 124: Commercial Sales in Japan and Market Scale of Major Subsegments (1)
billion, 000 sqm, 000 Total retail Sales (bn) 1980 1985 1990 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 87,920 104,550 137,946 144,810 139,435 135,055 135,257 135,081 135,477 132,328 135,666 134,041 137,585 Supermarket Sales (bn) 5,684 7,299 9,486 11,515 12,622 12,565 12,501 12,734 12,872 12,599 12,537 12,933 12,953 Sales floor ('000 sqm) Department store Sales (bn) 6,501 7,982 11,456 10,825 10,011 8,763 8,644 8,465 8,079 7,177 6,842 6,661 6,639 Sales floor ('000 sqm) 5,409 6,201 6,942 7,578 8,218 7,698 7,352 7,441 7,352 7,112 6,868 6,840 6,719 Convenience store Sales (bn) # of stores Sales floor ('000 sqm)

20,468 22,071 22,348 22,912 23,612 23,884 24,160 24,909 25,227

3,380 7,360 7,399 7,490 7,943 7,981 8,114 8,775 9,477

35,461 39,600 40,183 40,405 40,745 41,724 42,347 45,466 47,801

3,546 3,960 4,018 4,041 4,075 4,172 4,235 4,547 4,780

Source: METI Current Survey of Commerce, J.P. Morgan Note: CY basis

Figure 125: Commercial Sales in Japan and Market Scale of Major Subsegments (2)
billion, 000 sqm, 000 Consumer electronics Sales (bn) Sales (bn) (GfK) (FY) (Current Survey of Commerce) (CY) 1985 1988 1991 1994 1995 2000 2005 2006 2007 2008 2009 2010 2011 2012 4,141 4,885 6,442 7,272 7,000 7,300 7,500 7,600 8,500 9,500 8,500 7,480 2,663 4,457 4,677 4,967 5,234 5,443 5,631 5,803 5,941 Drugstore Sales (bn) (JACDS) Sales floor ('000 sqr m) (HCI) Apparel Sales (bn) (Yano Keizai Kenkyujo) (CY) Shoes Sales (bn) (Yano Keizai Kenkyujo) (FY) HC, Furniture Sales (bn) (J.P. Morgan estimates, based on Current Survey of Commerce)(CY)

7,842

496 2,033 4,432 4,900 5,293 5,724 6,134 6,423 6,831 7,316

10,157 10,276 10,285 9,828 9,061 8,923 9,050 9,014

1,692 1,631 1,453 1,394 1,424 1,447 1,406 1,345 1,331 1,323 1,315

2,306 2,146 2,216 2,147 2,174 2,100 2,228 2,299

Sources: METI Current Survey of Commerce, GfK Japan, JACDS, HCI, MIC Household Survey, Yano Keizai Kenkyujo, J.P. Morgan

63

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Companies Recommended in This Report (all prices in this report as of market close on 21 August 2013) ABC-Mart (2670) (2670.T/4250/Overweight), Don Quijote (7532) (7532.T/5160/Overweight), FamilyMart (8028) (8028.T/4370/Overweight), JT (2914) (2914.T/3365/Overweight), Kao (4452) (4452.T/3035/Overweight), POINT (2685) (2685.T/4680/Overweight), RYOHIN KEIKAKU (7453) (7453.T/8120/Overweight), SUNDRUG (9989) (9989.T/4290/Neutral), Seven & i Holdings (3382) (3382.T/3460/Overweight), Suntory Beverage & Food (2587) (2587.T/3560/Overweight)
Analyst Certification: The research analyst(s) denoted by an AC on the cover of this report certifies (or, where multiple research analysts are primarily responsible for this report, the research analyst denoted by an AC on the cover or within the document individually certifies, with respect to each security or issuer that the research analyst covers in this research) that: (1) all of the views expressed in this report accurately reflect his or her personal views about any and all of the subject securities or issuers; and (2) no part of any of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this report.

Important Disclosures

! Lead or Co-manager: J.P. Morgan acted as lead or co-manager in a public offering of equity and/or debt securities for Suntory Beverage & Food (2587), JT (2914) within the past 12 months. ! Client: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients: Suntory Beverage & Food (2587), Kao (4452), JT (2914), Seven & i Holdings (3382), SUNDRUG (9989). !
Client/Investment Banking: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as investment banking clients: Suntory Beverage & Food (2587), JT (2914).

! Client/Non-Investment Banking, Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-investment-banking, securities-related: Suntory Beverage & Food (2587), Kao (4452), JT (2914), Seven & i Holdings (3382). ! Client/Non-Securities-Related: J.P. Morgan currently has, or had within the past 12 months, the following company(ies) as clients, and the services provided were non-securities-related: JT (2914), Seven & i Holdings (3382). ! Investment Banking (past 12 months): J.P. Morgan received in the past 12 months compensation from investment banking Suntory Beverage & Food (2587), JT (2914). !
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Company-Specific Disclosures: Important disclosures, including price charts, are available for compendium reports and all J.P. Morgan covered companies by visiting https://mm.jpmorgan.com/disclosures/company, calling 1-800-477-0406, or e-mailing research.disclosure.inquiries@jpmorgan.com with your request. J.P. Morgans Strategy, Technical, and Quantitative Research teams may screen companies not covered by J.P. Morgan. For important disclosures for these companies, please call 1-800-477-0406 or e-mail research.disclosure.inquiries@jpmorgan.com. Explanation of Equity Research Ratings, Designations and Analyst(s) Coverage Universe: J.P. Morgan uses the following rating system: Overweight [Over the next six to twelve months, we expect this stock will outperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Neutral [Over the next six to twelve months, we expect this stock will perform in line with the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Underweight [Over the next six to twelve months, we expect this stock will underperform the average total return of the stocks in the analysts (or the analysts teams) coverage universe.] Not Rated (NR): J.P. Morgan has removed the rating and, if applicable, the price target, for this stock because of either a lack of a sufficient fundamental basis or for legal, regulatory or policy reasons. The previous rating and, if applicable, the price target, no longer should be relied upon. An NR designation is not a recommendation or a rating. In our Asia (ex-Australia) and U.K. small- and mid-cap equity research, each stocks expected total return is compared to the expected total return of a benchmark country market index, not to those analysts coverage universe. If it does not appear in the Important Disclosures section of this report, the certifying analysts coverage universe can be found on J.P. Morgans research website, www.jpmorganmarkets.com. Coverage Universe: Tsunoda, Ritsuko: AJINOMOTO (2802) (2802.T), Asahi Group Holdings (2502) (2502.T), JT (2914) (2914.T), Kao (4452) (4452.T), Kikkoman (2801) (2801.T), Kirin Holdings (2503) (2503.T), Nissin Foods Holdings (2897) (2897.T), Sapporo Holdings (2501) (2501.T), Shiseido (4911) (4911.T), Suntory Beverage & Food (2587) (2587.T), Toyo Suisan Kaisha (2875) (2875.T), Unicharm (8113) (8113.T), YAKULT HONSHA (2267) (2267.T)
64

Jesper J Koll (81-3) 6736-8600 jesper.j.koll@jpmorgan.com

Japan Equity Research 23 August 2013

Murata, Dairo: ABC-Mart (2670) (2670.T), AEON (8267) (8267.T), Don Quijote (7532) (7532.T), FAST RETAILING (9983) (9983.T), FamilyMart (8028) (8028.T), Isetan Mitsukoshi Holdings (3099) (3099.T), K's Holdings (8282) (8282.T), KOMERI (8218) (8218.T), Lawson (2651) (2651.T), Nitori (9843) (9843.T), POINT (2685) (2685.T), RYOHIN KEIKAKU (7453) (7453.T), SHIMAMURA (8227) (8227.T), SUNDRUG (9989) (9989.T), Seven & i Holdings (3382) (3382.T), Xebio (8281) (8281.T), YAMADA DENKI (9831) (9831.T) J.P. Morgan Equity Research Ratings Distribution, as of June 28, 2013
Overweight (buy) 44% 56% 42% 76% Neutral (hold) 44% 50% 50% 66% Underweight (sell) 12% 40% 8% 55%

J.P. Morgan Global Equity Research Coverage IB clients* JPMS Equity Research Coverage IB clients*

*Percentage of investment banking clients in each rating category. For purposes only of FINRA/NYSE ratings distribution rules, our Overweight rating falls into a buy rating category; our Neutral rating falls into a hold rating category; and our Underweight rating falls into a sell rating category. Please note that stocks with an NR designation are not included in the table above.

Equity Valuation and Risks: For valuation methodology and risks associated with covered companies or price targets for covered companies, please see the most recent company-specific research report at http://www.jpmorganmarkets.com, contact the primary analyst or your J.P. Morgan representative, or email research.disclosure.inquiries@jpmorgan.com. Equity Analysts' Compensation: The equity research analysts responsible for the preparation of this report receive compensation based upon various factors, including the quality and accuracy of research, client feedback, competitive factors, and overall firm revenues. Registration of non-US Analysts: Unless otherwise noted, the non-US analysts listed on the front of this report are employees of non-US affiliates of JPMS, are not registered/qualified as research analysts under NASD/NYSE rules, may not be associated persons of JPMS, and may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with covered companies, public appearances, and trading securities held by a research analyst account.

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Japan Equity Research 23 August 2013

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Copyright 2013 JPMorgan Chase & Co. All rights reserved. This report or any portion hereof may not be reprinted, sold or redistributed without the written consent of J.P. Morgan. #$J&098$#*P

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