Thinking Points

  • Asia’s largest retailer Aeon (TSE: 8267) was left behind in the convenience race while Asia’s second largest retailer Seven & i Holdings (TSE: 3382) dominated the scene.
  • Armed with Welcia Holdings (TSE: 3141), now Japan’s largest drugstore chain, Aeon is out-conveniencing the convenience industry.
  • Investors can expect to see more M&A deals, further drugstore/pharmacy industry consolidation, and other related opportunities in this movement.

The undisputed leader in Japanese convenience, Seven & i Holdings (TSE: 3382), is under attack. And the attacker isn’t UNY Family Mart (TSE: 8028) or Lawson (TSE: 2651), the #2 and #3 players in convenience. It’s Welcia Holdings (TSE: 3141), Japan’s biggest drug store chain backed by majority shareholder and Asia’s largest retailer by annual revenues, Aeon (TSE: 8267).

But before we get into the war, let’s take a look at history.

Malls, shopping centers, and the birth of Japanese convenience

In 1956, Dayton’s (the same company that built Target [NYSE: TGT]) opened up the first shopping mall in the world: Southdale Center in Minnesota, USA. Less than 10 years later, Hyogo-based supermarket chain Daiei experimentally opened Japan’s first shopping mall in Osaka: Daiei Shonaiten (1964). Four years later in 1968, the company proceeded to open Japan’s first outdoor shopping center: Daiei Koriten).

Related image
Daiei Kouriten, the first outdoor shopping center in Japan

With “price destruction” as its slogan, Daiei displaced department stores and quickly became Japan’s largest retailer (1972). Other retailers followed, shaping the 1970s and 80s into the age of mall and shopping center operators. There were 6 key players: Daiei, Ito Yokado, Saison, Jusco, Nichii, and UNY. Daiei, Ito Yokado, and Saison, having hit one trillion yen in sales in the 1980s, were referred to as the “Big 3”.

Unable to compete with the scale of emerging malls and shopping centers in the 1970s, smaller retailers were feeling the pain. The struggle extended to Morita Company, a Nagoya-based brewery (alcohol, soy sauce, bean paste) and distributor. Its customers, mainly small liquor stores, watched sales decline as supermarkets and shopping centers popped up nearby.

Lead by Kazuaki Morita, the younger and lesser known brother of Sony (TSE: 6758) co-founder Akio Morita, the Morita group opened Japan’s first convenience store on July 11th, 1971. This marked the birth of 7-Elev… scratch that, CoCo store.

The first convenience store in Japan

Yes, CoCo store, short for “Comfort and Convenience”. The idea, of course, came from when Kazuaki visited the US and discovered 7-Eleven (Japanese). Store number 1 was owned and operated by the Morita Group. And the group worked to convert its struggling liquor store customers into convenience stores.

Then, the Big 3 retailers started moving.

Around the same time, Tokyo-based Ito Yokado was trying to communicate to small retailers that local shopping districts and large scale retail facilities can coexist (Japanese). According to then Ito Yokado director Toshifumi Suzuki, small retail’s struggle wasn’t due to big retail coming in, but rather because small retailers had a productivity problem. Lacking a real-word example of a small-but-successful retailer, his message didn’t go through very well.

This eventually led to 7-Eleven Japan adopting a franchise system. Ito Yokado approached Southland Corporation, parent of 7-Eleven, to introduce the American convenience formula in Japan. In 1974, 7-Eleven Japan opened its first store in Tokyo.

Meanwhile, Daiei was talking to US-based Consolidated Foods, which owned Ohio-based Lawson’s Milk Company. The following year, Daiei opened its first Lawson store in Osaka.

And Seiyu (Saison group) had set up its first experimental convenience store in 1973, but didn’t get its first franchise Family Mart store opened until 1978.

Jusco and UNY were late to the party, opening Ministop (TSE: 9946) and Circle K/Sankus in 1980, respectively. Nichii never showed up.

Aside from CoCo store and the big retailers, smaller convenience chains also emerged. Seico Mart, founded in 1971, is a private regional powerhouse primarily operating out of Hokkaido. Yamazaki Baking (TSE: 2212), one of the world’s 5 biggest bakers, started its own convenience chain Daily Yamazaki in 1977. A local Kanagawa/Tokyo grocer Fuji Super started Three F in 1979. And finally, Poplar (TSE: 7601), originally a liquor store, converted into a convenience store in 1983 and expanded its store network thereafter.

Japan’s “Economic Miracle” comes to an end

In the early 1990s, however, the bubble comes to an end and people tighten up their wallets. It didn’t end there either. Category killers like Uniqlo (Fast Retailing [TSE: 9983]) in apparel, Nitori (TSE: 9843) in furniture, and Yamada Denki (TSE: 9831) in consumer electronics started aggressively expanding their footprint. Discount retailers like Don Quijote (TSE: 7532) started gaining traction too, and by the late 1990s, Daiei, Saison, and MyCal (formerly Nichii), all heavily in debt, started falling apart.

Meanwhile, Ito Yokado remained relatively healthy, thanks to its historical focus on productivity and item level inventory management. Jusco, which had a strong supermarket business, was among the first to introduce private branded products that offered national-brand comparable quality for a lower price, keeping the company competitive and healthy.

MyCal filed for bankruptcy in 2001, with 1.9 trillion yen in liabilities. Aeon (formerly Jusco) sponsored MyCal through restructuring and in 2003, the company became Aeon’s subsidiary.

Struggling to survive, Daiei sold off most of its Lawson stake to Mitsubishi Corporation (TSE: 8058), one of Japan’s largest trading companies, in 2001. In 2004, Daiei went under the supervision of the Industrial Revitalization Corporation of Japan, which is like Sweden’s Securum (in other words, bankruptcy and restructuring for big companies). In 2005, one of Japan’s largest trading companies Marubeni Corporation (TSE: 8002) and Japanese private equity firm Advantage Partners became Daiei’s sponsor. In 2007, Marubeni, Daiei, and Aeon announced a partnership, bringing Aeon on board for further restructuring. Later that year, Aeon’s private label brand products were put on Daiei shelves. In 2013, Aeon purchased most of Marubeni’s stake in Daiei, making Aeon the largest shareholder (44%). In 2015, Daiei becomes a wholly owned subsidiary of Aeon.  

After the bubble burst, Seiyu subsidiary Tokyo City Finance found itself with a mountain of non-performing loans, forcing Seiyu to sell its assets and eventually resulting in the dismantling of the Saison Group. Itochu Corporation (TSE: 8001), another one of Japan’s largest trading companies, purchased Seiyu’s stake in Family Mart, making Itochu the largest shareholder. With the intermediation of Sumitomo Corporation (TSE: 8053), another big trading company, Seiyu eventually became Walmart’s wholly owned subsidiary (2002 ~ 2008).

More recently in 2016, Family Mart and UNY (along with Circle K/Sankus) merged. Then most of the Circle K/Sankus stores were converted into Family Mart (ongoing). And on October 11, 2018, UNY Family Mart Holdings (TSE: 8028) announced that it will sell its stake in UNY to Don Quijote and take a 20% stake in Don Quijote.

We’ve mentioned 4 of the 7 large Japanese trading companies so far. The other three are Mitsui Corporation (TSE: 8031), Toyota Tsusho Corporation (TSE: 8015), and Sojitz Corporation (TSE: 2768). Though Mitsui is involved with 7-Eleven, it’s influence on the company is considerably less compared to Mitsubishi’s influence on Lawson or Itochu’s influence on Family Mart. Toyota Tsusho and Sojitz both lean more towards the automotive industry.

Convenience growth continues

Despite big retail being in shambles, convenience slowed down for only a brief moment, then continued on its growth track.

Source: HighCharts FreQuent (Japanese), data from Japan Franchise Association, translation by author

7-Eleven Japan’s growth was fueled by centralized management, rigorous inventory management (i.e., Tanpin Kanri), area-dominant store strategy, and of course, the franchise model. More recently, the company doubled down on its food-focused strategy and started pouring resources into its foreign operations.

Family Mart grew by developing its own information system, pushing for an area-franchise system with regionally strong businesses, and M&A (am/pm in 2010, Coco store in 2015, Circle K/Sankus in 2016).

Lawson’s growth too, was supported by an area-franchise system. It also partnered with smaller convenience chains Poplar (2014) and Three F (2015). In 1997, the company became the first to operate stores in all 47 of Japan’s prefectures. Family Mart joined the club in 2006, and 7-Eleven is expected to join with its planned 2019 entrance into the Okinawa market.

Today, 7-Eleven (20,260 stores), Family Mart (17,132 stores), and Lawson (13,992 stores) are the top 3 players, accounting for about 93% of the convenience chain market in terms of store count.

Source: HighCharts FreQuent (Japanese), translation by author

And there’s a key player missing in this picture: Aeon.

Aeon-lead Ministop, with 2,261 stores in Japan at the end of 2017, was left far behind. Ministop reported losses for the first time in fiscal 2018.

Meanwhile in drug stores and pharmacies

While the Japanese convenience industry was growing explosively and quickly consolidating, drug stores and pharmacies remained fragmented. Although the consolidation trend started in recent years, both industries remain fragmented today. MAC Advisory, an M&A advisory specializing in pharmacy M&A, produced a neat chart:

Source: MAC Advisory (Japanese), translation by author

According to MAC Advisory, the top 20 companies account for 25.3% of prescription sales in the Prescription Pharmacy market. For the Drug Store market, the top 20 companies account for 86.4% of sales.

The top 5 players in the Prescription Pharmacy market are:

Source: MAC Advisory (Japanese), translation by author

And here are the top 5 players in the Drug Store market:

Source: MAC Advisory (Japanese), translation by author

For over two decades, Matsumoto Kiyoshi held the #1 spot (by revenues) in drug stores. In late 2014, Aeon made its move: A tender offer on Welcia Holdings, raising Aeon’s stake in the company from 37.4% to 50.1% (Japanese). Then, Aeon proceeded to merge 3 of its mid-tier drug store subsidiaries with Welcia. By 2017, Welcia Holdings had become the largest drug store chain in Japan by revenues.

Now, the Aeon “Keiretsu”’s influence is difficult to gauge. This is because Aeon has historically acquired small stakes in many different companies, but mostly remained a silent partner with its 300+ group companies. This stance changed when Aeon group drug chain operator CFS Corporation, lead by its founding family, tried to merge with pharmacy leader Ain Pharmacies in 2007. Aeon voted against the merger, won a proxy battle, and prevented the merger. A few years later, CFS was merged into Welcia.

Aeon still has a considerable amount of reach left. From a capital partnership going back to 1995, Aeon remains the largest shareholder (12.86% stake) in Tsuruha Holdings, the #2 drug store chain in Japan. Neither Tsuruha or Welcia has made any mention of a merger… yet.

Aeon’s War: Super-Convenience

Last year, Welcia co-founder and board chairman Takamitsu Ikeno declared war against the convenience industry:

“We will start offering products commonly available at convenience stores.”

Source: Nikkei BP (Japanese), translation by author

To be sure, Welcia’s 1,693 store network pales in comparison to 7-Eleven’s 20,260 stores. But a Welcia-Tsuruha-Ministop 5,000 strong store alliance within the Aeon group starts looking more formidable.

What Aeon missed out on in the age of convenience, it’s fighting to regain in super-convenience.

Structurally, it’s easier for drug stores and pharmacies to develop a network of stores to sell convenience products than it is for convenience stores to start selling drugs and prescriptions. The key bottleneck is a regulatory requirement: You need a registered sales clerk for OTC drug sales. More details on that here.

Today, many of the convenience industry’s core offerings – meals, drinks, daily necessities, bill payment services, 24 hour operations – are increasingly being offered at Welcia, often times at a discount. A recent Nikkei BP article highlighted this, comparing price points for two popular products:

According to the Nikkei BP article, you can buy a 525ml bottle of Oi Ocha (left), a popular green tea, for 78 yen at Welcia ($0.68 USD). At 7-Eleven a 600ml bottle of Oi Ocha costs 120 yen ($1.05 USD). On a per milliliter price comparison, 7-Eleven’s price is 34% higher than Welcia. Additionally, the same cup of ice cream (right) that you can buy at Welcia for 108 yen ($0.95 USD) is sold at 7-Eleven for 130 yen ($1.14 USD). This is something Welcia can do because it captures its margin in cosmetics, OTC drugs, and prescriptions.

The competitive environment becomes even more interesting when considering Aeon’s relationship with Lawson and parent Mitsubishi. Mitsubishi, with its 4.64% stake, is actually Aeon’s second largest shareholder behind the Bank of Japan. Taking a look inside Ministop, you’ll find the same Loppi machines (used for purchasing tickets, paying bills, etc). A Mitsubishi-Aeon alliance would create a drug/convenience store network on a similar scale to that of 7-Eleven.

And it’s not like Seven & i Holdings is twiddling its thumbs and waiting around either. With an already sizeable drug store operation through Ito Yokado, the company had a late and somewhat surprising start in pharmacies. Earlier, we mentioned Aeon’s proxy battle to prevent group company CFS corporation’s merger with pharmacy leader Ain Holdings in 2007/8. Well, shortly after the merger plans were scrapped, Ain Holdings entered into a capital partnership with Seven & i Holdings in 2009. Today, Seven & i Holdings is the #2 shareholder in Ain with a 7.76% stake, only behind leading shareholder Ain founder Kiichi Otani.

So far, 7-Eleven’s presence in drug stores and pharmacies have more or less been limited to Ito Yokado operations, and mostly out of news coverage. With that said, if its area-dominant convenience strategy is any indication, 7-Eleven will likely rollout whatever drug store/pharmacy it has up its sleeve at lightning speed once it gets rolling.

What this means for investors

Of course, if you’re reading this, you’re probably contemplating what sort of investment opportunities the shift in convenience/drug store/pharmacy industries create. First, it appears Aeon has a headstart in “super convenience”. But 7-Eleven, known for centralized management and supply chain efficiency, likely won’t stay quiet for long.

Figuring out who “wins” this war is a bit of a toss up, and there’s always the possibility that neither one comes out ahead. With that in mind, there are several things that are almost certain to take place – like increased M&A of small and mid-tier drug/pharmacy chains, system implementation for a more consolidated pharmacy industry, rolling out of private label drugs etc.

The first level (and most obvious) investment opportunities are M&A of small and mid-tier chains. Some candidates are:

  • Medical Ikkou (TSE: 3353) – mid-tier Aeon group pharmacy chain
  • Satudora Holdings (TSE: 3544) – mid-tier drug store chain
  • Yakuodo (TSE: 3385) – mid-tier drug store chain

But the second level investment opportunities, or “backdoor” plays are often interesting too:

  • Nakano Refrigerators (TSE: 6411) – refrigerator manufacturer with ~40% revenue exposure to 7-Eleven, with good prospects for strong business performance after 7-Eleven doubled down on food strategy.
  • Medical System Network (TSE: 4350) – Operates pharmacies and nursing homes. Develops ordering system connecting medical distribution to pharmacies and hospitals.
  • EM Systems (TSE: 4820) – develops and sells pharmacy software, electronic medical record software, etc.

The bottom line

Aeon’s war against 7-Eleven has begun with Welcia on the frontlines. Its “super convenience” strategy  takes traffic away from convenience stores by offering the same products for less while remaining profitable through OTC drugs, prescriptions, and cosmetics.

So far, 7-Eleven hasn’t meaningfully responded. That said, the company is known for centralized management and supply chain efficiency, and now armed with Ain Holdings, the largest pharmacy operator.

While it’s impossible to tell which company will come out out ahead, investors can seek out investment opportunities by looking into smaller drug/pharmacy chains (M&A) or other companies likely to perform in line with industry trends (food strategy, system implementation, etc).

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Kenkyo Investing
Kenkyo Investing

Kenkyo Investing applies a value investing approach to Japanese equities, providing insights that are often unavailable to non-Japanese speakers.