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Pigeon investors wary of baby bottle maker's Chinese e-tail boom

Analysts take dim view as marketing costs grow and brick-and-mortar sales suffer

Pigeon products on display at a baby products store in Shanghai.

TOKYO -- Japanese baby goods maker Pigeon has found a mixed blessing in its fast-growing Chinese online sales, with higher marketing costs and slumping brick-and-mortar sales worrying investors.

Pigeon joined well over 100 brands -- including heavyweights like iPhone maker Apple, sportswear giant Nike and Japanese cosmetics maker Shiseido -- in ringing up at least 100 million yuan ($14.5 million) from a June sale at Chinese e-commerce leader Alibaba Group Holding. E-commerce has driven Pigeon's growth in China and now generates half its sales there.

Yet the growth has drawn a cool reception from the foreign investors owning almost half of the company's shares. Western and Asian shareholders have questioned Pigeon about Chinese operations in recent earnings conferences. Its February-April online sales in China grew by double digits, but its sales at physical stores there slumped. Weighed down by the yen's strength against the yuan, Pigeon's overall China sales sank 1% on the year, and its China segment profit fell 3%.

The market is awash in pessimism that Pigeon's shift from physical stores to online will push up marketing costs. While e-commerce may seem to be a more efficient way to generate sales, it can also be costly, especially when companies must heavily subsidize sales to offer heavy discounts during events like Alibaba's.

Who bears the burden from such sale events depends on negotiations between the e-commerce platform and the company whose goods are on offer -- and the bigger the platform, the better terms they can extract from the seller. Pigeon was forced to bow late last year when second-ranked Chinese e-commerce company JD.com pressed it to bear more promotional costs.

Pigeon will be "in trouble" if physical-store income continues to shrink, an executive said, in part because that would erode the company's ability to negotiate with online shopping platforms.

Expecting Pigeon's sales promotion costs to grow sharply as it works to invigorate both online and brick-and-mortar business, Goldman Sachs Japan analyst Keiko Yamaguchi in June lowered the company's target share price to 3,800 yen from 4,175 yen. The new target is far below Monday's closing price of 4,245 yen.

Safety is key for Pigeon's bread-and-butter product of baby bottles, and companies with proven track records and strong branding tend to hold on to competitive advantages.

The Japanese company does have rivals, such as Philips Avent of the U.K. and Germany's Nuk. But "with new entrants facing restraints, Pigeon has been able to avoid too much competition," Mitsubishi UFJ Morgan Stanley Securities analyst Wakako Sato said.

Advertising and sales promotion costs, collectively referred to as marketing costs, have grown to equal 6% of Pigeon's sales in recent years. The company cut costs and seized on growth in Asian markets to lift its operating margin to 19% in the year ended January 2018, for a doubling over seven years. But the margin growth appears to have reached its peak as China's shift toward e-commerce brings higher costs.

"What was once a straightforward narrative of growth has grown murkier, and more and more investors are coming to view [Pigeon's] price-earnings ratio of more than 30 as overvalued," an analyst at a Japanese brokerage said. Raising its roughly 30% estimated share of the Chinese baby bottle market could be key to pushing its stock higher, as could seeking new growth routes in markets like Southeast Asia and the U.S.

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