[Stock-Analysis] The Kings of Convenience: 7-Eleven
Part 1: The case for the behemoth of the Convenience Store world, 7-Eleven
The Story of 7-Eleven
7-Eleven is by far the biggest convenience store chain in the world with over 79,000 stores worldwide.
The humble beginnings of 7-eleven was in the tiny town of Oak Cliff, Dallas, in 1927. A man named Joe C. Thompson started an ice-house store named Tote'm Stores at a time where refrigerators were not yet a thing. The stores quickly took off and he had the brilliant idea to sell other things his ice customers might want, like eggs, milk and bread. The concept was so successful that he had expanded all over Texas within a decade.
The name 7-Eleven began to be used in 1946 from the fact that the stores were originally open from 7 in the morning to 11 in the evening.
In the 1950s and 60s, 7-Eleven expanded in franchise form throughout the United States, and during the 70s, the concept was exported to Europe, Asia and Australia. The demand was so high that the company scrapped the 7AM to 11PM opening hours and introduced stores that were open 24h, 7 days a week.
At the time, 7-eleven was inherently an American franchise concept, but in the 80s this was all about to change.
A young executive in Japan named Toshifumi Suzuki travelled to the U.S. on behalf of the company he worked for, Ito-Yokado.
At the time, Ito-Yokado was one of the top supermarket chains in Japan and wanted to branch into other businesses, beginning with Denny's, a chain of family restaurants founded in California (now also owned by 7-Eleven).
To secure a licensing agreement, Toshifumi was sent to the U.S. to work out the details. During this time, he happened to discover a 7-Eleven and was immediately intrigued. The concept of a 24-hour convenience store didn’t exist in Japan, even though many businessmen that worked long hours would benefit from them.
Realizing its potential, Toshifumi pitched the idea to his fellow executives at Ito-Yokado. Fortunately, they believed in the opportunity just as much as he did.
That same year, Ito-Yokado managed to negotiate a 7-Eleven licensing agreement with the owners of 7-Eleven. The agreement allowed Ito-Yokado to have complete control over 7-Eleven in Japan, resulting in creating a subsidiary company for the business. One year later, the first Japanese 7-Eleven opened in Toyosu, Tokyo.
7-Eleven in Japan was very different from its American counterpart. It was half the average American store size and delivered fresh food such as lunch boxes three times a day. They also started selling meals that were only cooked at home, like Onigiri rice-balls and Oyakodon.
Over the next decade, the Japanese arm of 7-Eleven became so successful that it managed to go public on the Tokyo Stock Exchange, grew to 3,000 stores throughout Japan, and expanded its services to allow customers to pay electricity and gas bills in-stores.
Meanwhile, the American arm was plunged into one of the largest bankruptcy scandals in history after years of in-fighting, bad store management and lackluster expansion plans.
Ito-Yokado agreed to acquire the company in 1991 and changed their name to 7-Eleven Inc (later Seven & i Holdings Co., Ltd). Only one year later, Ito-Yokado turned 7-Eleven into a high-tech machine with efficiency rarely seen in the U.S.
7-Eleven Today
Today, 7-Eleven in Japan is known for its convenience and premium products, including Seven Café, an assortment of café items such as hot and cold coffees, teas, and sweets; Seven Premium Gold, an assortment of pre-packaged dinner items such as ramen noodles, hamburger steaks, and bread; Seven Premium Fresh, an assortment of fresh items such as raw meat and fruits; and Seven Premium Lifestyle, a selection of everyday items, such as clothing, utensils, and household.
As for its services, the chain continues to allow customers to pay gas and electricity bills in stores and offers both an ATM and foreign exchange machine. Customers can also refill their metro passes, buy tickets for concerts, access free WiFi, and buy electronics such as phone chargers.
To keep up with competitors in Asia such as FamilyMart and Lawson, 7-Eleven Japan has opened stores in malls and train stations, and vending machines in offices, factories, hospitals, and schools all of which have contributed to around $42 billion in annual sales.
Meanwhile, the US is today 7-Eleven’s second largest market and more known for its large-sized drinks, such as the Big Gulp, and 24-hour accessibility.
However, 7-Eleven US is making changes to step up to its Japanese counterpart by offering healthier food options and a restaurant experience, even opening taco shops in some locations. 7-Eleven also continues to offer gas on-site, and now, drive-thru and delivery services. And while annual sales in the U.S. are around $18 billion, it’s still 57% less compared to Japan.
Business Segments
As previously mentioned, 7-Eleven is operating under the holding company Seven & I Holdings Co., Ltd., (SVNDY) since 2005. Even though the 7-Eleven stores are by far the largest part of Seven & I Holdings Co., Ltd., it has many domestic businesses that generate a lot of cash.
Business segments ranked by total sales amount (in percentage):
7-Eleven (66.3%)
Ito-Yokado (15%) - The father of 7-Eleven Japan. A general department store
Sogo & Seibu (7.7%) - A general department store. Little bit more upscale than Ito-Yokado
York Benimaru (7.6%) - A supermarket chain
Seven Bank (1.9%) - 7-Eleven’s banking arm. Hosts all 7-Eleven stores ATMs, but is also running the 7-Eleven point programs & its own bank. Segment with highest profit margin of around >20%
Loft (1.6%) - A lifestyle store that sells everything from furniture to snacks
In March 2022 Seven & I Holdings Co., Ltd., has a market cap of $44.93 Billion.
The Seven & i Holdings Stock
When you buy stocks in Seven & i Holdings (SVNDY), apart from the 7-Eleven stores, you also buy into its Japanese specific superstores, department stores and Specialty store operations (represent around 20% of operating income, but 46% of their operating revenue).
When you buy the SVNDY stock there are two main factors you have to consider:
First, 7-Eleven’s main market is Japan
Even though SVNDY’s 7-Eleven stores oversees make up a majority of the company’s revenue, the Japanese convenience stores contribute the majority of the profits.
SVNDY has managed to increase its profits abroad and successfully branched out into new ventures, but as the company’s profits are still dominated by the Japanese market.
Second, the 7-Eleven convenience stores operating profits margin is shrinking
In fact, the 7-Eleven stores’ operating profits have been shrinking ever since its peak of 32% in 2012, now reaching a low of 25%. These are still very impressive numbers for a convenience store chain, but the trend is worrisome.
Hence, SVNDY’s future growth is highly dependent on its other business ventures, especially its financial services arm which has a less than stellar record.
For example, in July 2019, 7-Eleven launched, then almost immediately suspended, a mobile payment service, 7pay. The service was hacked upon launch and attackers were able to spend money from affected customers' accounts. The service was announced to be entirely cancelled following a review of the infrastructure it ran on.
With that said, SVNDY has consistently delivered increased revenue and earnings growth over the years, and it looks likely to do so in the future.
As we can tell from their size, the company has been extremely successful in bringing its convenience stores abroad, and if it can replicate the same success with its other Japanese ventures, such as its department stores and financial services, the potential for future growth is enormous.
Main Issues
I do not want to rub more salt in the SVDNY stock’s wounds, but there are some more warning signs:
Increase in staffing costs
Both in Japan and US, the labor market has tightened substantially. We’ve all heard of the big resignation in the US, but Japan has been suffering from “low-skilled” labor shortage for decades. This has been exacerbated by the fact that Japan blocked all labor immigration since the start of Covid-19, the main source of newly hired workers for 7-Eleven.
This will have a serious effect on the stores’ profit margin. Even though convenience stores are uniquely positioned to increase automation and become less reliant on personnel, it will be hard to do this in the short-term.
Increased competition = Bigger investment in new stores
Despite 7-Eleven’s growth, the competition has grown even faster and are now toe-to-toe on almost all fronts.
On top of that, its biggest competitor, FamilyMart, is now 94.7% owned by major trading house ITOCHU Corp. and Lawson is 50% owned by Mitsubishi Corp - these parent companies have almost infinite resources to intensify competition further.
Future Outlook & Risks
In terms of the outlook for future stock growth, 7-Eleven’s parent company SVNDY is planning to unveil a new medium-term plan which consists of:
Increasing capital expenditure (CAPEX)
The company is investing heavily in new store layouts, with new layouts for over 24,000 stores.
So far, the results have been promising.
In Japan, the average daily sales difference between the first half of FY2022 and the first half of FY2020 was around ¥19,000 ($163) higher sales at stores that introduced the new layout than that at stores that did not. However, this is a huge endeavor that is already costing the company a lot.
Increasing spend for the roll-out of online order and last-mile delivery services.
The company has doubled down on delivery & partnered up with Doordash and Uber Eats to reach more customers.
To fight off the lower profit margins resulting from partnering with 3rd party delivery companies, 7-Eleven has launched an online convenience-store concept where customers can order specific items and get them delivered by 7-Eleven’s own fleet in around 30 minutes.
This endeavor is still small, but showing early signs of success.
Still, third-party delivery services are eating its lunch (pun intended), and growing much faster. This will likely further eat into 7-Eleven’s already shrinking margins even though it’s profits might increase too.
More emphasis on Environmental, Social and corporate Governance (ESG)
SVDNY has stepped up their environmental commitments.
The company is planning a joint venture with an overseas firm to set up a plastic bottle recycling factory and is looking to be “The greenest convenience store chain on the planet”.
For now, this is seen as a competitive advantage, but SVDNY’s competitors have similarly ambitious goals.
In a couple of years, these commitment will likely convert into industry standards which could further lower the company’s profit margins.
Store performance after Covid
With all planned operations requiring a lot of restructuring and capital expenditure (CAPEX), I am not expecting a major improvement in prospects for profit generation.
Assessing how consumers will behave post-pandemic is an interesting puzzle.
Foot traffic will increase significantly, offsetting the decline in average spend per visit.
Other areas of SVDNY’s business could experience a major uplift in profitability. Overseas convenience stores have low single-digit margins, but introducing more ideas from the domestic business could help raise profitability.
Despite consensus estimating a large cash burn in 2022, the company still has such strong revenue sources it will likely generate a high profit and keep its dividend yield of around 2%.
Conclusion
Seven & i Holdings is a strong company with an incredible history. Since the company became Japanese in 1991, it has had an stellar track record of sustained sales growth and which has made it the world’s most successful convenience store brand.
This has been rewarded by investors and customers alike, with ever increasing multiples (a p/e of 20-25 the past 7 years) and sales.
However, the convenience store market is becoming a lower return business due to staffing shortages, increased competition, as well as greater efforts to implement ESG policies.
With a need to increase operating costs and capital expenditure to address this, I feel that high growth will be difficult to achieve, especially in the short run.
Seven & i Holdings still has a massive potential. The company has many strong domestic businesses, such as the specialty store Loft or their financial services venture. If it could create a synergy between these and their massive network of stores oversees I think the company has a huge potential to increase its profits further.
However, looking at the stock P/E today, at 22, much of its potential upside is likely already priced in and there are many more attractive stocks on the Japanese stock market.
Therefore, I would not buy the Seven & i Holdings stock with today’s valuation.