Message from the CFO, Business Management
Enhancing Capital Efficiency and Corporate Value Sustainably Through Portfolio Optimization and Strategic Group Investments
Summary of Business Results
Despite ongoing uncertainties due to inflation and international political instability, AEON made steady progress in FY2023 (fiscal year ended February 29, 2024) with the “Five Reforms” outlined in our Mid-term Management Plan.
In our retail businesses—which consist of the GMS, Supermarket, Discount Store, Health & Wellness, and International Business segments—profits were up significantly, thanks to product reforms centered on our private brand TOPVALU, improved productivity brought about by digital transformation, and reforms to the earnings structure. As a result, on a consolidated basis, operating revenue came to 9,553.5 billion yen and operating profit rose by a substantial 41 billion yen to 250.8 billion yen—both of which, along with ordinary profit, were record highs. Operating profits were down in the Health & Wellness Business, reflecting a drop in COVID-19 pandemic-driven demand, but the retail businesses overall accounted for 52.4% of total operating profit, exceeding the Mid-term Plan target of 52%. We are facing an increasingly adverse external operating environment, owing to factors such as inflation, a declining birth rate, and an aging population in Japan. Our improved profitability in the retail businesses, despite the challenging environment, can be attributed in part to our focus on the allocation of management resources while maintaining the autonomy and independence of each group company. We also leveraged economies of scale by expanding our private brand product lines and optimizing our logistics. On the other hand, the Financial Services and Shopping Center Development Businesses, which had formerly been drivers of group earnings, showed a delayed recovery in performance. I think the challenge here is to address the shift in customer behavior from products to experiences while responding to changes in the post-COVID macroeconomic environment.
We saw much weaker consumer confidence in the first quarter of FY2024 than we did in FY2023, when revenue was buoyed by pent-up demand following the government downgrade of COVID-19 to Category V status. Real wages have been declining in Japan for a long time, leading customers to become more cautious with their spending. By closely monitoring these shifts in the market, we achieved record high operating profit. Although the strategy of capturing market share through lower prices affected gross profit, resulting in operating profit and ordinary profit falling slightly below forecast, they still remained at levels second only to the previous year's all-time highs.
The Responsibilities of the CFO, Business Management
I believe my chief responsibilities are to minimize financial risk, promote sustainable fundraising, improve capital efficiency, and support the consistent execution of group strategies. When formulating strategies and numerical targets, we adopt a backcasting approach and innovation-oriented strategy - we consider the ideal future and then define concrete measures and set performance indicators to ensure that strategies and targets are not unrealistic. We then enter into a PDCA cycle. In particular, in meetings of the AEON Management Committee and Board of Directors, I strive to ascertain changes in cash flows and the balance sheet and occasionally propose agile revisions to the strategies and targets that will feed into the long-term enhancement of corporate value. As a company focused on stores and customers, our decision-making is guided by our commitment to contributing to both customers and local communities. My role, however, is to offer opinions based on the numbers, from the perspective of our businesses and the growth of the entire group. At Board of Directors meetings, where the majority are outside directors, I make it a point to raise concerns when necessary to encourage more thorough discussions.
As the group's business areas and geographical presence have expanded, the operations of the holding company have grown more sophisticated. In addition to sharing organizational goals and policies and working closely with companies within the group, I strive to eliminate organizational and operational redundancies and boost efficiency while paying attention to the diverse makeup of AEON people, such as by recruiting specialists from outside the company.
Investment Plan and Criteria
The current Mid-term Management Plan defines simple operating cash flow as operating profit + depreciation +amortization of goodwill– income taxes, etc. We expect this simple operating cash flow to exceed the average annual capital investment level of 400 to 450 billion yen throughout the Plan. Regarding investment allocations in the current Plan, digital and logistics outlays have increased from 16% in the previous Mid-term Plan to 35%, while investments in overseas stores have increased from 13% to 25%. The remaining 40% represents investments in stores in Japan. Overall investment in the first half of the current plan fell short of the target due to delays in approvals and licenses for overseas store openings and the impact of the pandemic. As a result, we raised the investment budget for FY2024 to 500¬-550 billion yen. We expect the breakdown to be 50% for stores in Japan, 25% for overseas stores, and 25% for digital and logistics applications. I intend to give top priority to allocating funds to e-commerce, principally the Green Beans business, and to digital, IT, and logistics infrastructure that will improve the profitability, efficiency, and productivity of the various group companies.
Group infrastructure cannot create value on its own. Value can only be maximized when it is aligned with the merchandising strategies, targets, and store operations of the operating companies incorporated into the various companies’ strategies, tactics, and measures. So, our functional companies are responsible for creating infrastructure that is unique to the AEON group, conducting the overall design, and making proposals while fully taking into account the scale and needs of the group, as well as the latest technology, knowledge, and trends.
Regarding IT, our investments during the pandemic centered mainly on cash registers and other storefront retail operations. Going forward, I would like to step up investment in the back office or in areas that help realize better working conditions for employees. We recognize that IT and logistics are the most important management issues that lie ahead for the group, and I expect more aggressive investment in these areas after the current Mid-term Management Plan.
In deciding on investments and managing the business, we pay attention to the ROIC (return on invested capital) for each business. Because our business segments are diverse, and each segment involves numerous companies, we have not yet disclosed detailed ROIC by segment, but generally, our Discount Store and Health & Wellness Businesses demonstrate high capital efficiency. Capital efficiency in the International Business differs between ASEAN and China, and there is no noticeable difference between the remaining five businesses—the GMS, Supermarket, Financial Services, Shopping Center Development, and Services & Specialty Store Businesses. Accordingly, our investments in Japan center on small urban stores, discount stores, and drug stores. For other stores, we will shift the investment focus from new store openings to leveraging and enhancing the value of existing store assets, including scrap and build projects, taking demographic trends into account. Overseas, we will continue to invest in mall development, focusing on ASEAN and inland China.
The most critical factor in making decisions about capital investment and M&A is an expected synergy to the group. Therefore, it is not possible to present a single quantitative decision-making indicator. Regardless of current profit conditions, we decide on new investments by looking at the relevance to the retail businesses, which are the cornerstone of all our operations.
Fundraising
Our credit rating is currently on an improving trend, buoyed by the robust consolidated cash flow we are generating. Since ratings are directly linked to financing capacity and interest rates, we intend to improve our financial conditions to get our ratings upgraded. We currently hold an A rating from Japan Credit Rating Agency, Ltd. (JCR), an A- from Rating and Investment Information, Inc. (R&I), and a BBB from Standard & Poor’s (S&P). As most of the group’s interest-bearing debt financing is yen-denominated, at present we are unaffected by sudden interest rate hikes. Furthermore, since about 70% of our debt financing is at long-term fixed interest rates, the impact of rising yen interest rates is limited. Given our high interest-bearing debt ratio, we have managed to keep our WACC (Weighted Average Cost of Capital) around 3%. Our ROIC—3.9% as of FY2023—exceeds our WACC, which indicates that our corporate value is improving under an efficient capital structure.
We have received high marks from investors for the sustainability-linked bonds (SLBs) we issued in June this year, following a similar issuance in August 2023. They appreciate the initiatives we are taking, and the sustainability performance targets (SPT) we have set to achieve a sustainable society. ESG bonds now make up a significant portion of the corporate bond market. As a pioneer and leader in businesses that contribute to society and the environment, AEON is well-positioned to excel in fundraising.
Driven by a commitment to creating a sustainable society with its customers and guided by the AEON Decarbonization Vision established in 2018, AEON aims to achieve net-zero greenhouse gas emissions from its stores by focusing on both energy conservation and generation. To achieve this, the company is promoting the use of renewable energy by introducing energy-saving equipment and installing solar panels in AEON stores and parking lots. In addition to lowering CO2 emissions, our other initiatives for include recycling plastics and reducing food waste and waste oil. One of AEON’s strengths is our ability to set performance indicators and SPTs that involve consumer participation, enabling us to contribute to sustainability from a fundraising perspective.
Profitability and Group Management Policy
Our PER and PBR are both above the Prime Market average, indicating strong investor expectations for our growth. However, I view our ROE, which remained at 4.4% in FY2023, as a significant concern. Many investors have suggested that, alongside improving profit margins, we should take immediate steps to boost profit attributable to owners of the parent company. Specifically, many have urged us to make all group companies wholly owned subsidiaries to prevent profit outflow to minority shareholders, as well as to address the significant impairment losses we have recorded.
If we think about ROE separately in terms of leverage, asset efficiency, and profitability, our leverage gives a positive impact compared to the 3.44x average for companies listed on the Tokyo Stock Exchange Prime Market as of the end of March 2024. Given the announced restructuring in the drugstore industry, we acknowledge the challenge of reducing our interest-bearing debt within the next two to three years. However, we are committed to lowering this balance in the medium to long term through disciplined financial management, aiming for a net debt-to-EBITDA ratio of 2.5x. Since we have financial businesses within the group, it is hard to generalize about the asset turnover ratio, but I understand this to be at an appropriate level. However, our biggest challenge remains in improving profitability. As a holding company, we are offering both tangible and intangible support for some underperforming subsidiaries. While there are signs of improvement, their business turnaround is only halfway complete.
Regarding the discussion of listing our subsidiaries, AEON's fundamental approach is that subsidiaries should operate based on a spirit of autonomy and independence. The key advantage of listing a subsidiary is enhancing management quality through the discipline imposed by the capital market. Listed companies are obliged to establish and maintain internal controls for financial reporting, which helps create a sophisticated governance framework. There are numerous other advantages to listing a subsidiary: It enables us to enhance synergies within the group, including between AEON and the listed subsidiary; it gives the subsidiary greater name recognition and credibility; and independence from the parent enables the subsidiary to ensure autonomous and agile decision-making. The subsidiary can also tap into a greater pool of distributors. For AEON, the financial burden decreases when a subsidiary is listed. Going public also helps a subsidiary maintain and improve employee motivation and secure talent. I believe it’s a major advantage that the group company raises its own funds, strengthens its financial position, and operates under the direct scrutiny of capital markets and financial institutions.
To ensure the independence of listed subsidiaries, AEON considers the risk of conflicts of interest between itself and the subsidiaries’ general shareholders. As a result, we reqire that subsidiaries appoint independent outside directors and establish an advisory committee of independent directors to protect minority shareholders. Our major group subsidiaries—such as AEON Financial Service Co., Ltd., AEON Mall Co., Ltd., AEON Delight Co., Ltd., and AEON Fantasy Co., Ltd.— are enhancing the group’s corporate value through collaboration with our retail businesses while fully leveraging the benefits of being listed.
However, the negative impact on ROE due to significant impairment losses recorded as extraordinary losses is an issue that requires immediate response. The impairment losses reflect the underperformance of older stores, which have not progressed as expected. In our current Mid-term Plan and beyond, considering demographic trends, our investments will focus on revitalizing old stores and those that have lost their competitive edge, alongside opening new stores, to enhance the customer shopping experience. Our goal with such investment is to reduce impairment losses by 5 to 10 billion yen every year, halving them from the FY2023 level.
Marking the 50th Anniversary of Our Public Listing
In 2024, AEON CO., LTD. marks the 50th anniversary of its stock market listing. Our company is supported by a vast number of individual shareholders. This year, we are exploring ways to enhance communication with individual investors. I also attend meetings with shareholders and highly value the perspectives of individual investors. Institutional investors are sometimes critical of our shareholder benefit program reimbursing shareholders a certain percentage of their purchase amounts. But guided by the concept of “customer shareholders,” I believe the direction of garnering support for the business side of things while promoting sales aligns with our management policy. I intend to continue this approach moving forward. We have also set a dividend policy that aims for a consolidated dividend payout ratio of 30% while maintaining the previous year’s level or more. We view a commitment to stable dividends that meet market expectations as a key measure of shareholder return. With Japanese stocks reaching a 34-year high since the Bubble Economy period, opportunities to meet with overseas investors have been increasing. In particular, since the announcement of discussions with TSURUHA HOLDINGS INC. and WELCIA HOLDINGS CO., LTD. regarding business integration, it seems that investors are increasingly looking to AEON to lead the consolidation of the drugstore industry in Japan. The majority of our Board consists of outside directors, three of whom are foreign nationals who have a global perspective on the retail industry. We will fully integrate their input and actively discuss the best ways to highlight AEON’s expansion from Japan into Asia, as well as identify areas needing improvement. We will also focus on disclosing non-financial capital, such as our initiatives to address climate change, human capital, and human rights.
Enhancing True Corporate Value
The current Mid-term Management Plan, launched in 2021, was affected by the drastic changes brought about by the pandemic, necessitating a revision of our target figures. In tandem with this, we are now preparing to formulate the next Mid-term Plan, addressing various issues, including changes in international business norms, new lease accounting rules, and other regulatory changes. However, guided by our foundational ideals and future vision, I believe it is crucial to pursue management that focuses not on short-term profit gains but on long-term goals, looking five or ten years ahead.
In a competitive global environment, our position is evolving from a group of individual companies competing independently to leveraging our combined strengths as a unified corporate group. In addition to the strengths of individual companies, I believe we should pursue a strategy of enhancing our product lines, logistics, IT capabilities, and other functions to capitalize on economies of scale. This goes beyond simple rationalization. I am convinced that when the dynamic growth driven by independence and self-reliance merges with the strengths of a conglomerate united by shared ideals and a vision for the future, it will enhance our of true corporate value. We will continue to pursue economies of scale, promote organic collaboration between the businesses, and maximize group synergies to leverage the strengths of a cohesive corporate group and meet the expectations of our stakeholders.
Hiroaki Egawa
Executive Officer
CFO, Business Management