July 10, 2018 / 8:52 AM / a year ago

Cup noodles and aspirin: Japan's drugstores stocks rally on cheap grocery push

TOKYO (Reuters) - Shares of Japanese drugstores, traditionally conservative businesses that focused predominantly on pharmaceuticals, hit record highs earlier this year as customers increasingly looked to such outlets for their grocery needs.

People walk past an electronic stock quotation board outside a brokerage in Tokyo, Japan, September 22, 2017. REUTERS/Toru Hanai

The sector’s lofty valuations have led to some profit taking over the past month, however, investors expect long-term growth in drugstore stocks, helped by lower outlays than their larger supermarket rivals and higher margins from pharmaceutical offerings.

Sector data from the Japan Association of Chain Drug Stores showed the industry posting constant growth over the past decade, with a total drugstore sales hitting a record 6.85 trillion yen the last fiscal year, up 38 percent from 10 years earlier.

For graphic on sales performances of drugstores and supermarkets click reut.rs/2NAukiE

Drugstore operators such as MatsumotoKiyoshi Holdings Co (3088.T), Tsuruha Holdings Inc (3391.T) and Welcia Holdings Co (3141.T) have succeeded in getting customers to buy discounted food items such as milk, tofu and cup noodles. Food and other items sold 1.78 trillion yen last fiscal year, accounting for about 26 percent of total sales.

Yet drugstores’ main goal is to get frugal customers to buy high-margin over-the-counter drugs and cosmetics, which are their cash cows.

“Drugstores do not expect to be profitable by selling fresh produce. They hope customers to buy drugs and cosmetics, which generate gross margins of about 30 percent,” said Jun Kawahara, an analyst at Daiwa Securities.

Analysts said that drugstores, which have been sprawling at fast pace, are better positioned to open new outlets due to their lower investment costs. While it costs about 1 billion yen to open a new supermarket store, a company would spend about 300 million yen to open a small drugstore, Kawahara said.

While individual supermarkets need land for parking, mass refrigeration and meat preparation, multiple drugstores can be supplied by one warehouse.

In the last fiscal year, industry association data showed that the total number of drugstores reached a record 19,534 nationwide, almost double the number of supermarkets.

For graphic on number of stores click reut.rs/2NBHQm5

In contrast, convenience stores’ growth is threatened by higher wage costs due to a national labor shortage.

Over the past year, shares of MatsumotoKiyoshi have jumped 50 percent, Tsuruha by 15 percent and Welcia by 45 percent, while the benchmark Nikkei has gained 10 percent. Matsumotokiyoshi trades at 22 times its projected earnings, while Tsuruha at 25.81, Welcia at 34.90 and the Nikkei trades at 16.25.

For graphic on share performances of Japan's major drugstores click reut.rs/2NEj7xJ

After reaching record highs in May and June, drugstores’ share prices have pulled back over the past month, in part triggered by a conservative annual profit outlook by Tsuruha Holdings.

“Drugstores have benefited from eating another subsector’s market share. The challenge they face now would be how they can stay competitive within the industry,” said Keita Kubota, a senior investment manager at Aberdeen Standard Investments.

Reporting by Ayai Tomisawa; Editing by Sam Holmes

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