Investors are dumping Fast Retailing stock after the company slashed its profit forecast by a third. One of the potential reasons behind the cut may actually be good news.
Judging by Fast Retailing's latest statement of cash flows, it's spending less money on opening stores. While shareholders love to see a company grow, that's welcome. The owner of the Uniqlo brand has been adding outlets a bit too, well, fast.
Spending on lease deposits, which ought to track the pace of store openings, dropped by half in the six months through February. Throttling back the capital allocated to physical network expansion is a smart move given changes in consumer habits and an impending adjustment in the way companies will account for leases.
The noises coming from officials at Fast Retailing suggest that, if anything, the pace of store growth is accelerating. Uniqlo's billionaire founder, Tadashi Yanai, has laid out plans to open 100 outlets a year in China, taking the total to as many as 3,000 from the current 436. He's not stepping back from that commitment: The pace of openings in the first half was a record, and will accelerate further over the next six months, according to the company's forecasts.
One possible explanation for the discrepancy is that landlords are being more generous in their deposit demands, which in turn would indicate that rents are falling. While that would help retailers' costs, it could also be a sign that mall owners have expanded too fast and are struggling to fill empty shop-fronts -- a bad omen for any consumer company on an expansion binge.
Other retailers are becoming more circumspect. China and Hong Kong are ``quite challenging,'' Hennes & Mauritz's investor relations head Nils Vinge said on a conference call Wednesday: ``The market in general is tough, and of course we are not happy with our performance."
Aggressive growth could backfire as shoppers increasingly use physical shops only as a place to view what they want before buying online. China is the perfect example. Online retail sales rose 49.7 percent in 2014, compared with a 12 percent increase for all consumer goods, according to the National Bureau of Statistics. Apparel sales are now underperforming the broader retail market:
Within Uniqlo's Japan unit, e-commerce revenue expanded 28.4 percent from a year earlier in the six months through February, while same-store sales dropped 1.9 percent.
Instead of adding more outlets, Uniqlo should follow Apple's lead and focus more on flashier flagship stores in key cities, such as the newly refurbished outlet at 311 Oxford Street in London that opened last month. With a large network, the cost of penalty payments to break leases on underperforming outlets can mount rapidly. Store closures and asset retirements, mainly related to the U.S. business, accounted for more than half of Fast Retailing's profit decline in the most recent period.
That's especially the case now that an impending accounting change is about to make Fast Retailing look a lot more bloated. In January, the International Accounting Standards Board issued International Financial Reporting Standard 16 which, among other things, will simplify how companies account for leases. Under the new regulation, any rental agreement longer than two years will be recognized as a finance rather than an operating lease. That means the company must account for it as if the property was owned, taking the lease on to the balance sheet as an asset and liability.
As a result, corporations with a large number of physical locations will see the size of their liabilities and assets expand significantly. Lenders and bond investors will pay special attention to the resultant increase in leverage. The rules come into force in 2019 but companies are allowed to adopt them earlier.
The best news that Fast Retailing could give investors at this stage is that it's slowing down.
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