R H2O Retailing / 8242 COVERAGE INITIATED ON: 2020.04.30 LAST UPDATE: 2021.06.15 Shared Research Inc. has produced this report by request from the company discussed in the report. The aim is to provide an “owner’s manual” to investors. We at Shared Research Inc. make every effort to provide an accurate, objective, and neutral analysis. In order to highlight any biases, we clearly attribute our data and findings. We will always present opinions from company management as such. Our views are ours where stated. We do not try to convince or influence, only inform. We appreciate your suggestions and feedback. Write to us at [email protected] or find us on Bloomberg. Research Coverage Report by Shared Research Inc. H2O Retailing / 8242 RCoverage LAST UPDATE: 2021.06.15 Research Coverage Report by Shared Research Inc. | https://sharedresearch.jp Coverage INDEX How to read a Shared Research report: This report begins with the trends and outlook section, which discusses the company’s most recent earnings. First-time readers should start at the business section later in the report. Executive summary ----------------------------------------------------------------------------------------------------------------------------------- 3 Key financial data ------------------------------------------------------------------------------------------------------------------------------------- 5 Recent updates ---------------------------------------------------------------------------------------------------------------------------------------- 6 Highlights ------------------------------------------------------------------------------------------------------------------------------------------------------------6 Trends and outlook ----------------------------------------------------------------------------------------------------------------------------------- 9 Monthly sales -------------------------------------------------------------------------------------------------------------------------------------------------------9 Quarterly trends and results --------------------------------------------------------------------------------------------------------------------------------- 11 Medium-term management plan -------------------------------------------------------------------------------------------------------------------------- 23 Business ------------------------------------------------------------------------------------------------------------------------------------------------ 32 Business model --------------------------------------------------------------------------------------------------------------------------------------------------- 32 Market trends ---------------------------------------------------------------------------------------------------------------------------------------- 48 Strengths and weaknesses ------------------------------------------------------------------------------------------------------------------------------------ 56 Historical performance and financial statements ------------------------------------------------------------------------------------------ 57 Income statement ----------------------------------------------------------------------------------------------------------------------------------------------- 57 Balance sheet ----------------------------------------------------------------------------------------------------------------------------------------------------- 58 Cash flow statement -------------------------------------------------------------------------------------------------------------------------------------------- 59 Profitability analysis --------------------------------------------------------------------------------------------------------------------------------------------- 59 Historical performance ---------------------------------------------------------------------------------------------------------------------------------------- 60 Other information ---------------------------------------------------------------------------------------------------------------------------------- 68 History -------------------------------------------------------------------------------------------------------------------------------------------------------------- 68 News and topics ------------------------------------------------------------------------------------------------------------------------------------------------- 69 Major subsidiaries ----------------------------------------------------------------------------------------------------------------------------------------------- 70 Corporate governance and top management --------------------------------------------------------------------------------------------------------- 71 Policy on shareholder returns ------------------------------------------------------------------------------------------------------------------------------- 71 Major shareholders --------------------------------------------------------------------------------------------------------------------------------------------- 72 Profile ---------------------------------------------------------------------------------------------------------------------------------------------------------------- 72 02/73 H2O Retailing / 8242 RCoverage LAST UPDATE: 2021.06.15 Research Coverage Report by Shared Research Inc. | https://sharedresearch.jp Coverage Executive summary Business overview H2O Retailing Corporation is a retailer that mainly operates department stores (Hankyu Department Stores and Hanshin ◤ Department Stores) and supermarkets (such as Izumiya and Hankyu Oasis). The company operates 16 department stores in Japan, mainly along the Hankyu Railway and Hanshin Electric Railway lines. It also has 171 supermarkets and superstores (called general merchandise stores or GMSs in Japan) in the Kansai region (as of May 2021). The company follows an area dominance strategy targeting the Kansai region. Kansai has around 20mn consumers and includes the prefectures of Osaka (population of 8.8mn), Hyogo (5.5mn), and Kyoto (2.6mn). H2O’s strategy is to have consumers make as many of their everyday purchases as possible at its supermarkets and enjoyable, non-routine shopping at its department stores. While being affected by a structural decline in department store sales amid competition from specialist stores and shopping centers, the company aims to make the retail spaces at its department stores unique. In this way, H2O aims to attract more customers in the Kansai region (primarily through its Hankyu Main Store and Hanshin Umeda Main Store), as well as to increase the number of visitors from other parts of Japan and overseas. To secure a new earnings base during a difficult period for expansion in the domestic department store market, the company opened Ningbo Hankyu (located in Zhejiang, China; company stake of 47.6%), its first overseas department store, in April 2021. H2O was created through the 2007 merger of Hankyu Department Stores and Hanshin Department Stores. Their respective ◤ predecessor companies were the Hankyu Market (now Hankyu Main Store), which opened in Osaka’s Umeda district in 1925, and Hanshin Mart (now Hanshin Umeda Main Store), which opened in 1933. Hanshin Electric Railway is H2O’s largest shareholder, with an 11.9% stake, followed by Hankyu Hanshin Holdings (TSE1: 9042), which holds an 8.4% stake. Effectively, Hankyu Hanshin Holdings, the parent company of Hanshin Electric Railway, therefore holds a 20.3% stake in H2O (making it an equity-method affiliate). H2O, Hankyu Hanshin Holdings, and Toho (TSE1: 9602) together form the Hankyu Hanshin Toho Group. The group’s business interests span urban transport, real estate, hotels, department stores, supermarkets, and entertainment. H2O has four business segments: the Department Store, Supermarket, Shopping Center Management, and Other businesses. ◤ In FY03/21, sales were JPY739.2bn, with these segments accounting for 47.0% (52.7% in FY03/20), 38.0% (39.5%), 8.6% (1.0%), and 6.4% (6.8%), respectively. Operating loss was JPY4.4bn (operating profit of JPY11.2bn in FY03/20). By segment, the company reported operating loss of JPY1.9bn in the Department Store segment (operating profit of JPY11.5bn in FY03/20), operating profit of JPY4.2bn in the Supermarket segment (operating loss of JPY2.5bn in FY03/20), operating loss of JPY113mn in the Shopping Center Management segment (operating profit of JPY4.1bn in FY03/20), and operating loss of JPY2.7bn in the Other segment (operating profit of JPY2.9bn in FY03/20). Previously, the company had maintained solid performance in the Department Store segment with sales growth driven by its Hankyu Main Store. However, this trend was broken as the company reported operating loss in the same segment due primarily to impact from the COVID-19 pandemic. On the other hand, the company reported operating profit in the Supermarket segment, in part because it transferred the Izumiya non-food segment, which had been continuously generating operating loss, into the Shopping Center Management segment. The company is currently implementing structural reforms, including cost restructuring for its department stores, closure of unprofitable supermarkets, and conversion of Izumiya general merchandise stores into shopping centers. H2O’s long-term business plan, GP10, espouses a “Kansai dominance strategy.” This strategy centers on the Department ◤ Store business (non-routine purchases) and the Supermarket business (routine purchases) and extends to the operation of commercial