Deep-dive 2022-7: Pan Pacific International

Japan's leading discount retailer on the cusp of an international expansion

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Pan Pacific International (7532 JP) is Japan’s leading discount retailer.

It runs discount stores with brand names such as “Don Quijote” and “MEGA Don Quijote”. These stores offer high-quality goods for price-conscious singles or young families.

While the store layouts may appear cluttered and chaotic, they help create an experience of a treasure hunt. Roughly 40% of store items are purchased through so-called “spot procurement” from other retailers. It represents excess inventory or returned items from other channels at massive 30-90% discounts. The low prices on many goods also lead to a certain fun factor that appeal to young individuals. You never know what you’re going to find.

Another differentiating factor about Pan Pacific is the way the company has grown. It was built from scratch by exceptionally talented entrepreneur Takao Yasuda. He started the business from a single store in Tokyo in the 1980s, finding niches that had not yet been occupied. Don Quijote was one of only retailers with late-night opening hours. He pioneered the use of “compression displays” - cramming as many items as the space allowed.

Takao Yasuda is a remarkable man. He’s a rebel in an industry where rules are rarely broken. As a Credit Suisse analyst said, many businesses have tried to emulate Don Quijote but none have succeeded so far, arguing that “the culture is completely different”. The management ethos has been captured in a 2011 book that has now become required reading for any person in Pan Pacific’s senior management team.

Over the past 15 years, the company has increasingly grown through opportunistic M&A. In 2007, for example, he led the acquisition of discount general merchandise store “Nagasakiya”, which gave the company 369,000 sqm of floor space overnight at a fraction of the price it would cost to build the stores organically. In 2017-19, Pan Pacific acquired low-performing peer “Uny”. Over time, these acquired stores have been converted into the far-more successful Don Quijote store format, which enabled 50-100% increase in store revenues and far greater profitability.

The M&A strategy has worked well. Over the past 16 years, revenues has grown at an average rate of 13% and earnings per share has similarly grown at an average rate of 13%. Pan Pacific is now among the most profitable of any Japanese retailer.

There are plenty of reasons to think that the growth will continue. First, Pan Pacific’s management team is clearly capable. Second, the discount retailing industry is still in its infancy in Japan. Secular growth has been observed for other markets such as the United States. Third, Pan Pacific’s same-store sales growth has been weak since the outbreak of COVID-19 and there’s now hope that customers will return. And finally, Pan Pacific is now on the cusp of an international expansion that will have broad ramifications on the entire business.

In 2015, founder Takao Yasuda left his native Japan to live in Singapore. While some argue that the move was part of Yasuda’s retirement plans, in my view it instead signals the start of Pan Pacific’s international expansion. The first "Don Don Donki” store was opened in Singapore in 2017. Today there are 12 stores in Singapore, and the expansion has continued to Thailand and Hong Kong. Only 15% of Pan Pacific’s stores are outside Japan, so there is plenty of growth potential.

In my personal view, the “Don Don Donki” branded stores in Singapore are amazing. What they offer customers is unmatched by any other grocery store in terms of the quality of merchandise for the price. And Yasuda is a restless individual. Growth will continue across Asia and the United States for decades to come.

It’s not obvious that Pan Pacific is undervalued in the short-term. The stock trades at a forward 2023e P/E of 17.4x at just a slight discount to the sector and the stock’s historical levels.

But given how competitive Pan Pacific is, and the long runway of growth still ahead of it, I believe that you will want to follow the story. The company targets operating profit of JPY 200 billion by FY2030, which implies yearly secular growth of around 11%.

The main risk is the risk is that Takao Yasuda fully retires or loses control of the company. He has built up a professional management team in Japan but there is still no doubt that he has been instrumental to Pan Pacific’s success.

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