Aeon: where’s the profit?

As Japanese retailers gear up to announce end of year results, few analysts are expecting good news from the biggest retailer, Aeon. The group has managed to move forward in terms of sales growth, but profits were well down in the first three quarters and it continues to struggle with its overall strategy. Senior management at key subsidiaries is likely to be replaced as a result.

Aeon may be the biggest Japanese retail conglomerate by far, but it continues to struggle with a problem that can almost be described as ‘traditional’: it can’t seem to maintain profitability while constantly striving for ever greater volume. Last year it added Daiei, a long-term target and its biggest acquisition to date, but with it comes the whole Daiei management structure and backroom operations, meaning yet more years spent absorbing and reconfiguring. Even the results of a huge cost cutting and internal consolidation programme begun in 2010 seem to have evaporated, at least for the time being.

In straight sales, core subsidiary Aeon Retail is the second largest retailer in Japan after Seven Eleven, but it is a mess of Aeon GMS stores, supermarkets, acquired stores, and other banners, along with much remaining duplication of backoffice functions. As a result, while Seven Eleven is so profitable that it comfortably masks similar issues at Seven & I Holdings’ other subsidiaries, Aeon Retail acts more or less simply as a cashflow giant.

In 1Q-3Q2014, Aeon’s operating income dropped 48% on the year to just ¥49.3 billion. New stores and the initial integration of parts of Daiei meant that sales were up 10% to ¥5.0770 trillion. Final profits were saved by the consolidation at Welcia Holdings drugstores that added extraordinary income of ¥31.6 billion, meaning that net profit jumped 47% to ¥29.3 billion overall.

Operating profits were soaked up by consolidation and acquisitions in financial services, drugstores and for overseas expansion, while losses at the core GMS operation expanded. Aeon Retail made an ¥18.2 billion loss, up from ¥5.7 billion in the red in 2013.

As with Ito-Yokado, Aeon blames the fall in demand following the Consumption Tax hike in April last year, overlooking the relative ease with which many other chains came through the downturn. Same store sales at Aeon Retail were down 2.4%, with apparel dropping 4.1% and food down 2.3%.

Aeon now says it will continue to refit its GMS chain and that, given the number of stores involved, this will take some time. Not very reassuring for investors. It is looking to small supermarkets as its main area of growth, but even here it is underperforming. Small format and discount retailing at Aeon made a ¥100 million loss in the first three quarters of last year, down from a ¥7.4 billion profit the year before. The seven regional Maxvalu chains did particularly poorly. Ministop, the group’s convenience store chain managed a ¥2.6 billion profit, but this too was down 37% on 2013.

For the food and FMCG businesses in the group, Aeon now admits its got its pricing policy wrong after the tax hike. Given its power in the supply chain, Aeon tried to hold down prices, taking a cut in profits as a result, not understanding that competitors would market their way back to growth through better ranges and more exciting shopping ideas. Aeon, like all GMS operators, seems to fail to understand that customers see it as bland, and that, even with pre-tax prices maintained, it was never all that cheap to begin with.

Aeon did not issue a change to its forecast of at least ¥200 billion in operating income for the year as a whole, but with only a quarter of this booked by November, it is close to impossible to achieve.

Investors are clamouring for a change of strategy, in particular more attention to problem areas, but spokespeople continue to fall back on the need for even greater volume at home and overseas. Aeon does intend to push forward in consolidating its excessive number of group companies, and there is even talk of reducing personnel at acquired companies by as much as half, but with profits falling, there is a pressing need for such changes to be made quickly.

In the short-term, the heads of each of the main group companies, notably Aeon Retail, Aeon Mall and Daiei, are likely to be replaced after the FY2014 results are announced.