[Stock-Analysis] The Kings of Convenience: Lawson
Why you should stay away from the world’s 3rd largest convenience store
This is the third and final part of my series about the three largest convenience store chains in the world. To read part 1 (7-Eleven) and 2 (FamilyMart), click here & here.
Overview
Lawson is the world’s 3rd largest convenience store chain with over 17,000 stores, behind the other Kings of Convenience, 7-Eleven & FamilyMart
To date, Lawson operates over 11,384 stores. They are found in all 47 prefectures of Japan, as well as China, Indonesia, Thailand, the Philippines and USA.
History
Lawson has had a very rocky history.
The name Lawson and its trademark white milk-can against a blue background date back to 1939 in Ohio, the United States, where Mr. J. J. Lawson ran a dairy milk store. "Mr. Lawson's milk store" was locally renowned for its fresh and delicious milk and many customers traveled far and wide to buy milk there every morning. J.J Lawson expanded his store concept and started selling more items every time he opened up a new store.
It wasn’t until 1959 that Lawson started its real growth journey. That year, the company became an affiliate of the American food giant Consolidated Foods Inc. and continued to widely expand its network of stores out of Ohio while establishing a convenience store logistics system which enabled them to be stocked every morning.
In 1985, Lawson was sold to a convenience store chain called Dairy Mart, which consequently converted all Lawson stores to Dairy Mart stores.
In 2002, a Canadian-based convenience store company, Alimentation Couche-Tard of Laval, Quebec, bought Dairy Mart and converted most of the stores to their sister brand Circle K. After that, the Lawson brand practically died in the US, even though some products, like Lawson’s Chip Dip, can still be found on shelves within Circle K.
However, with the establishment of "Lawson USA Hawaii, Inc.", Lawson returned to the U.S. market, with two locations in Honolulu opening on July 7, 2012.
Further expansion in both Hawaii and the mainland U.S. is planned.
Presence in Japan
If you didn’t already know, the rights to the Lawson brand and its stock is both owned by Japanese companies.
Lawson's operations in Japan began with the opening of the first Lawson store in Sakurazuka in Osaka on June 14, 1975. At that time, Daiei, which was the parent company of Lawson, had entered into a consulting agreement with Consolidated Foods Inc.
While Daiei was already a major player in Japan’s supermarket business, the concept of a “convenience store”— something more than corner shop, but smaller than a full-blown grocery, was still new to the country (another U.S. import, 7-Eleven, made its Japanese debut a year earlier).
Japan, with its densely packed cities and increasing taste for modernization, was an ideal environment for the convenience store model. Lawson’s took off.
Lawson flourished and with a tactic of rapid expansion with the help of Daiei’s investments and buying up smaller Japanese convenience store chains and rebranding them to Lawson stores quickly made them the third largest convenience store brand in Japan.
In 2014, Lawson bought the luxury supermarket Seijo-Ishi and expanded its own luxury food-items selection with their boutique concept Lawson Natural.
Over the years, Lawson has managed to stand out from its peers with many brand collaborations with brands including with the game Dynasty Warriors 7, Demon Slayer and Dragon Quest.
In February 2017, Mitsubishi Corp bought a 50.1% stake in Lawson. As a result, Lawson is now a subsidiary to Mitsubishi Corp.
Should You buy the Lawson Stock?
Even though a majority of Lawson is owned by Mitsubishi Corp, the stock is still purchasable on the Tokyo Stock Exchange, under the ticker 2651.
Compared to both 7-Eleven and FamilyMart, the Lawson stock is the purest play on the convenience store business as an absolute majority (80%) of its revenue comes directly from its convenience store business.
On the surface, Lawson (2651) looks like an interesting buy now. Its stock price has fallen by more than 20% since the end of last year and it has a high expected dividend yield of nearly 3%. On top of this, its profits have been stable for many year so there is a small risk of profit fluctuations.
The TL;DR
I am just going to say it straight, stay away from the Lawson stock!
Lawson’s Price to Earnings (P/E) ratio was at 40 times 15 years ago, but now it is in the 20 times range. The Price to Sales (P/S) ratio decreased from 1.8 times 15 years ago to 0.9 times. Since the end of last year, stock prices have been on a downward trend and have fallen by nearly 20%. Even though the stock has fallen this much, it is still relatively expensive, and there are no bright signs on the horizon.
There are four core that needs to be addressed for Lawson’s decline to stop:
1) The 24-hour/365 days a year requirement for franchise owners from Lawson’s headquarters are unsustainable.
2) Lawson’s royalty on its franchise owners is too large, but a decrease could result in billions of yen in decrease in profits.
3) Increased logistics and labor costs. The impact of the decrease in profits is likely to be several billion yen.
4) Lawson’s Management is incompetent compared to 7-Eleven and FamilyMart. They all face the issues of labor shortage and anger from franchise owners but 7-Eleven has started to address it with taking on more stores and reviewing the 24h requirement, and FamilyMart by rolling out unmanned stores.
The In-depth Review:
Owners are exhausted by the 24-hour business requirement
Businesses of major convenience stores such as Seven-Eleven and Lawson are made up of two people, a franchise owner and a headquarters.
The [franchise] owner is responsible for the 24-hour operation of the store. On the other hand, the headquarters provides logistics and goods to the stores.
Basically, the owner solely bears the burden of running the store on a 24h/365 days a year schedule.
The share of gross profit between the owner and the head office is about 4: 6. However, the owner must pay labor costs such as part-time jobs from the gross profit of the store.
The owner and the headquarters had a win-win relationship until now, but recently, various problems have arisen:
Problem 1) As a result of the labor crunch we’ve seen in Japan, owners cannot find part-time workers at midnight, so many owners have to work themselves, leaving them overworked and exhausted.
Problem 2) Soaring part-time salaries. Another consequence of the labor shortage is increasing wages which the owners also solely have to eat up. The take-home income of many owners is declining to unsustainable levels.
Of course, the owner is a sole proprietor and carries business risks. Some owners run a number of prosperous stores. Lawson also has about 14,000 stores, so there are many places that are profitable, but in many cases sales have declined due to intensifying competition with rival stores (Seven-Eleven, FamilyMart, supermarkets, drug stores).
It has become quite difficult to stay open 24 hours a day, both healthily and financially.
Yes, both 7-Elevel and FamilyMart suffer from the same issues, but financially Lawson is handling its day-to-day operations much worse:
Employees have tripled in the last 15 years, but accounts receivable turnover has deteriorated
The financial changes that have occurred in Lawson over the last 15 years are:
1) Tangible fixed assets increased 5 times from 70 billion yen to 350 billion yen
2) Full-time employees tripled from 3,500 to 10,000
3) Equity has increased 1.8 times
4) Sales have increased 2.6 times
5) Operating profits have increased 1.9 times
6) Accounts receivable turnover days (the time it takes for Lawson to get the money they are owed) have deteriorated from 10 days to 30 days
7) The number of stores increased from less than 8,000 to 14,000 in 15 years
At a glance, it looks that investment efficiency of Lawson has deteriorated considerably compared to 15 years ago.
The fact that the number of regular employees has tripled even though the number of stores has not doubled is probably the result of the increase in the number of employees engaged in logistics, systems, and guidance at production sites due to vertical integration.
Lawson’s efforts to increase sales is focused more on expanding in-store options, as opposed to increase the company’s service offering (as 7-Eleven has done with Seven Financial Services, Seven & i Net Media etc.). These options are everything from an in-house bakery, more advanced copying machines and unique food & beverages. As a result, more services with low profit margins are included in each owners store offering.
As a result, the profit margin will drop, and to make it even worse, the load on the employees and the stores will increase.
Imagine if you’re just a part-time worker, having to learn all these miscellaneous tasks. It's not a target for comparison, but the convenience store clerk has many more tasks than the average government workers or bank clerk!
How bad treatment of franchise owners affects the Lawson stock
Investors have already warned management about their incompetence. Lawson’s Price to Earnings (P/E) ratio was at 40 times 15 years ago, but now it is in the 20 times range. The Price to Sales (P/S) ratio decreased from 1.8 times 15 years ago to 0.9 times. Since the end of last year, stock prices have been on a downward trend and have fallen by nearly 20%. Even though the stock has fallen this much, it is still relatively expensive, and there are no bright signs for it.
The plight of convenience store owners is that there are cases where rivals open near their own stores or the same Lawson store opens.
A dominant strategy for Lawson has been to allow multiple stores in the same area to improve logistics efficiency. Recently, many franchise owners will not tolerate it anymore. The owners are disappointed that the headquarters thought they were on their side, but have realized that they have to stand up for themselves.
And, as mentioned above, soaring hourly wages and night shifts are sacrificing both the franchise owners' profits and health.
Again, these problems affect 7-Eleven and FamilyMart, but Lawson’s management is just far behind on addressing them. In fact, 7-Eleven, has changed its stance and is reviewing its 24-hour business & FamilyMart is expanding its unmanned stores at an unprecedented rate.
For Lawson to improve its operations, its s tock price will likely fall further…
I think that for Lawson to keep its franchise owners, a complete review of the its 24h store opening requirement needs to happen. This will increase the profits of the owners, but not headquarters. The reason is simple: customers rarely come in the middle of the night and the late-night part-time workers are expensive. However, sales will decrease which is what headquarters split with the owner.
Furthermore, regarding the share between the owner and the headquarters, at present, the headquarters takes 40% to 70% of the gross profit, but it should be reviewed by a few percent. If you don't, you won't be the owner. For example, if royalties decrease by 1% (if the owner takes an extra 1%), it is still a factor of billions of yen. As an owner, I would like you to do at least this much.
In addition, the salaries of 10,000 temporary employees held by the headquarters are expected to rise and distribution costs are expected to rise. This will also increase the cost by several billion yen.
Even if it can be absorbed by raising the price to some extent and rationalization, it will be a factor of decrease in profit by about 150-250 in total.
However, Lawson shares have a high dividend payout ratio, so there is an immediate concern that dividends will decline if profits decline.
In such an adversity, the headquarters should focus on revamping launch various operations. For example, by introducing an unmanned store system, it may be possible to overcome the predicament. Compared to both 7-Eleven & FamilyMart, Lawson does not have any significant plan to roll-out these stores - a big red flag that management is not taking its issues seriously enough!