Fast Retailing Group, established in 1963 and headquartered in Tokyo, is a global developer of fashion brands and operates primarily through three segments: UNIQLO, 86% of 1QFY25 sales; GU, 10.1%; and Global Brands, 4%. UNIQLO’s 2,541 stores include 803 in Japan and 1,036 in Greater China – its largest markets and 702 in the rest of the world. GU operates 480 stores, and Global Brands has 641 stores worldwide. The company employs over 60,000 people.

Strategy to boost China sales

UNIQLO's operations in Greater China, which account for 20% of the company's total sales, have been subdued in recent quarters, particularly in Mainland China and Hong Kong. This decline can be attributed to a mix of internal and external factors. Internally, the company has been grappling with challenges such as an inadequate product mix, inefficient marketing efforts, and the presence of approximately 150 stores in locations struggling to attract footfalls. The company plans to tackle these internal issues through local store management and aims to improve the product mix by adapting to local climates and cultures.

Despite the concerns, Mainland China holds significant growth potential. The company plans to open stores in prime locations with strong community ties and close those with low monthly sales. These strategies are designed to accurately capture customer demand and create new demand, which should aid the management in achieving its JPY1tn revenue goals in FY28. Through these initiatives the Group further plans to become the most sought-after brand in the Greater China region and expand its future network to 3,000 stores.

Top-line and bottom-line increases

The company delivered a revenue CAGR of 6.3% over the period FY19-24 to reach JPY3,104bn, whereas operating income grew at a faster pace of CAGR 13% to JPY492bn, demonstrating margin expansion of over 419 basis points (bps) to 15.9%. However, the company’s peer ZOZO, Inc. witnessed faster growth, reporting a revenue CAGR of 10.8% to reach JPY197bn in FY24. Operating income growth also outpaced Fast Retailing’s performance, reflecting a CAGR of 18.6% to reach JPY60.1bn during the same time, with margins expanding by over 878 bps to an impressive 30.5%.

Fast Retailing has reduced its debt considerably in the past five years, aided by consistent positive free cash flow (FCF). Consequently, the debt-to-equity ratio improved to 34.8% in FY24 from 52.2% in FY19. Going forward, the balance sheet is expected to remain healthy, driven by continued positive FCF, as capital expenditure is expected to track historical trends (approximately 2% of sales), notwithstanding accelerated store expansions in Europe.

In 1QFY25, Fast Retailing reported a 10.4% YoY increase in revenue to JPY895.1bn, led by strong performance from UNIQLO operations in Japan, Southeast Asia, India & Australia, North America, and Europe. UNIQLO International witnessed revenue surging by 13.7% YoY to JPY501.7bn, mainly on account of robust performance from all the international geographies barring China, which reported a drop in revenue owing to the failure of the Group to address the specific needs of individual regions.

However, the company is intensifying its investment in UNIQLO’s European assets, which account for 11.4% of total sales, by opening new stores to increase market share. UNIQLO Japan posted 9% YoY growth in revenues to JPY266.6bn, aided by a 7.3% expansion in same-store sales. Sales were also supported by suitable product mixes for warm temperatures in September, and cold weather conditions in November, demonstrating the company’s ability to respond effectively to changing weather patterns. The operating profit of the Group grew 7.4% to JPY157.5bn, whereas net profit increased at a robust pace of 22.4% to JPY131.9bn, aided by a surge in finance income, net of costs.

Full-year guidance remains unchanged

The management has kept the initial forecasts unchanged and estimates full-year FY25 revenue to increase 9.5% YoY to JPY3,400bn. The operating profit is anticipated to rise 5.8% to JPY530bn, whereas the net profit is projected to grow by 3.5% to JPY385bn. The company further forecasts an annual dividend per share of JPY 450, distributed equally between interim and year-end dividends of 225 yen each. The annual dividend reflects a YoY increase of JPY50, with a yield of 0.9%.

Valuation discount to historical levels

At a P/E of 37.8x, Fast Retailing is trading at a discount to its average 10-year historical valuation of 44.2x, but it is trading at a steep premium to its global peer average of 27.3x. The Group is also trading at a premium compared to its local peer, ZOZO, which is trading at a P/E of 31.4x. The stock delivered returns of over 22% in the last one year. Out of the 16 analysts covering the company, 3 have given a ‘Buy’ rating, and 4 have given an ‘Outperform’ recommendation for an average target price of JPY54,128, indicating an upside of over 11% from the current levels. Over the past year, sales and earnings projections for FY25 and FY26 have been consistently revised upward by analysts.

Overall, the company, with a positive outlook and strong fundamentals, presents a decent investment case. UNIQLO's operations in North America and Europe coupled with management's strategies to address internal issues in mainland China are expected to drive future sales growth. However, the company’s inability to execute highly aggressive expansion plans in North America and Europe, as well as failure to effectively address internal problems in mainland China, could hurt sales and operating margins and weaken the balance sheet over the long term.