Morinaga & Co Ltd

TSE:2201

Earnings Call Transcript 2020-Q2

[Eijiro Oota, executive]

I'm Eijiro Oota, President and Representative Director of Morinaga & Co., Ltd., and I'll be presenting today's results briefing. I will begin by relating to you my management philosophy. I believe that the most important thing for a company is to ensure that it remains a going concern or, in other words, to grow and develop continuously and perpetually.

I think that 3 attributes are important for us to achieve this: customers' perspective, diversity and Morinaga's founding spirit. Taichiro Morinaga founded Morinaga 120 years ago with the dream of providing delicious and highly nutritious confectioneries to the people of Japan, taking on the major challenge of popularizing Western confectioneries, which were unavailable at the time in Japan.

While it is important for us to pass on this founding spirit, I think that the way we adapt and shape it or change according to the times. It is precisely for this reason that we must ensure that customers continue to choose our products by viewing things from our customers' perspective that is by keeping our finger on the pulse of the market and meeting customer expectations as the times change.

Furthermore, I believe that diversity is essential for living up to customer expectations. I want all of our employees to aspire to make Morinaga an enduring company that continues to grow by embracing the concept of management by everyone on the basis of these 3 important attributes.

First, I will discuss the financial results for the first half of the fiscal year ending March 31, 2020. Sales and income increased in the first half. Net sales rose JPY 2,265 million year-on-year to JPY 106,989 million. And operating income, likewise, increased JPY 1,535 million to JPY 12,975 million, a record high for second quarter cumulative operating income. Ordinary income increased JPY 1,690 million to JPY 13,535 million, while profit attributable to owners of parent rose JPY 1,471 million to JPY 9,153 million.

This slide shows net sales and income by business segment. Net sales from the Food Manufacturing segment were JPY 103,049 million, an increase of 2.4% year-on-year, and segment income was JPY 12,900 million, up JPY 1,608 million. I will explain this result in more detail in a separate presentation of the results by segment.

This slide provides a more detailed look at net sales and operating income in the Food Manufacturing business. This business has 3 product groups: Confectionery & Foodstuffs, Frozen Desserts and Health Products.

Net sales of the Confectionery & Foodstuffs product group rose JPY 327 million or 0.6% year-on-year, and operating income rose JPY 1,115 million. Net sales of the Frozen Desserts product group increased JPY 1,653 million or 7%, and operating income rose JPY 751 million. Net sales of Health Products rose JPY 471 million or 2.2%, while operating income fell JPY 258 million. Although overseas sales fell JPY 1,134 million year-on-year, this is mainly attributable to the impact of dissolution of a partnership with a joint venture in Indonesia.

This slide shows factors affecting consolidated operating income, which increased in comparison with the first half of the previous fiscal year. Income was negatively affected by increases in raw materials prices, labor costs, distribution costs and other expenses to above the levels assumed in the initial plan. However, income rose, thanks to efforts to reduce raw material-related costs, the revenue increasing effect of highly profitable products, the impact of revision to product standards in the Frozen Desserts product group and profitability improvement in the overseas business.

I will now discuss factors affecting net sales and operating income by product group. Sales and income from the Confectionery & Foodstuffs segment increased. In Japan, sales of HI-CHEW and Carré de chocolat was strong, each rising 11% year-on-year. Overseas, sales in the U.S. rose sharply by 27.1% year-on-year, but sales decreased overall due to dissolution of a partnership with a joint venture in Indonesia.

Turning now to factors affecting operating income. Income rose, thanks to growth in sales of highly profitable products, profitability improvement in the overseas business and greater efficiency in advertising spending despite the impact of higher distribution costs.

Sales of some products in the Frozen Desserts product group were affected by unfavorable weather in July. However, sales of the mainstay Jumbo group products increased 4% year-on-year. And sales of Biscuit Sand and ICEBOX group rose 18% and 11%, respectively. Income increased year-on-year as the impact of higher prices of milk ingredients and increases in distribution costs, warehousing and storage fees and other costs was absorbed by the revenue increase and the impact of revision to product standards.

This slide shows details of the results for the Health Products group. First half sales of the mainstay in Jelly products decreased year-on-year due to unfavorable weather in July. However, overall segment sales increased year-on-year as a result of continued growth in sales of in Bar and other products sold under the in brand and mail-order sales of Healthy Life with Angel products, which rose 22% and 2%, respectively. Income decreased year-on-year. The main factors affecting operating income included the impact of lower sales of in Jelly and an increase in distribution costs, which offset efforts to increase efficiency in advertising spending.

Now I will discuss the full year financial results forecast. The full year results forecast is unchanged from the forecast announced in May. We plan to record full year net sales of JPY 207,000 million and operating income of JPY 21,000 million, achieving increases in sales and income.

We also plan to achieve our full year operating income margin target of 10%. We will steadily execute our plans as we aim for sales growth for the eighth consecutive year and income growth for the seventh consecutive year.

This slide shows factors affecting operating income in the full year financial results forecast. With regard to raw materials prices, as in the first half, we will focus on frontline cost-cutting efforts such as the replacement of raw materials whose market prices are trending up in competitive buying. Although increases in distribution and other expenses will negatively affect profits, we will steadily work to strengthen the earnings foundation with a view to achieving a full year profit increase through product mix improvement and other measures.

The graphic on this slide visually represents the 2018 medium-term business plan, which we announced last year. The themes of the plan are: build a starting point for growth, and solidify the business foundation and accelerate the growth strategy. The graphic shows that existing domains will support Morinaga with solid earning power. The wellness domain will drive continuous growth and the global domain will underpin future corporate growth.

Although until now, we have set 3-year medium-term targets, from now on, our policy will be to formulate plans using the backcasting approach while articulating a future vision of Morinaga in preparation for achieving medium- and long-term targets. We have used the expression 7 to 10 years because the periods will vary by theme. We will set somewhat specific medium- and long-term targets for each theme. The first 18 months of the 3-year medium-term plan instituted last year have ended, and we have reached the halfway point of the plan.

I will now discuss the future direction of Morinaga, including a progress report. Let's first look at existing domains. We have implemented structural reform of our domestic business as a response to anticipated cost increases in the form of rising raw materials prices, increases in labor and distribution expenses and the decline in size of the working population.

One of the structural reforms in Japan involves focusing on 8 major brands. Jumbo group, HI-CHEW and in Jelly, shown at the right of the graph, have a large-scale impact on both sales and profit. The first task is to further strengthen and differentiate these brands.

Next, shown in the middle of the graph, are Morinaga Biscuits, CHOCOBALL and Morinaga Amazake. We will aim to increase sales of these brands, allowing them to, as it were, chase after the 3 brands to the right.

Next come the chocolate products DARS and Carré de chocolat. We will invest in production of these brands and have positioned them as brands targeted for foundational strengthening. We will steadily engage in initiatives, not only to increase sales of these brands but also to improve profitability and ensure that they make a profit contribution.

As a measure to further strengthen the mainstay brands, we have implemented a HI-CHEW brand extension initiative involving diversification of packaging. This has made it possible to engage in strategic display area development, and we have expanded points of contact with customers who visit product display areas. This is a strategy for increasing sales and income of an individual brand and further broadening the base of a mainstay brand by continuously taking measures to place a strong brand in a variety of display areas. As a result of this initiative, net sales of the HI-CHEW brand grew 11% year-on-year in the first half.

This slide shows the DARS brand and Morinaga Biscuits series as examples of this strategy. We will expand these mainstay brand-strengthening measures to other brands as well. For some retail formats, our strategic display area development efforts remain insufficient. We will, for instance, rigorously engage in sales and product initiatives directed at drug stores and discount stores, which are expanding channels. We will also rapidly implement initiatives to reach inbound tourists. Although we are certainly taking a cold-eyed view of our existing domains in Japan, we believe that room remains for expansion with the right sales strategies and intend to bolster our channel strategies.

Next, I will discuss the situation of the Frozen Desserts segment in somewhat greater detail. The graph to the left shows the net sales growth rate in the Frozen Desserts segment. Taking the fiscal year ended March 31, 2009 as 100%, the ice cream market overall has grown more than 30% to JPY 506.5 billion in the fiscal year ended March 31, 2019. In comparison, sales of our Frozen Desserts product group have shown growth of nearly 60%, far exceeding market growth, and our market share has increased by 1.6 points as well.

The graph to the right shows net sales per SKU. In the fiscal year ended March 31, 2009, the earning power per SKU of our products was some 1.1x that of the average of 6 other leading manufacturers. In the fiscal year ended March 31, 2019, the difference was approximately 1.3x, which indicates that our Frozen Desserts product group has stronger earning power with fewer SKUs compared to the products of other manufacturers, and that earning power is further increasing. This brand strength was particularly clearly demonstrated in the first half when the weather was unfavorable.

The graph to the left compares to the year-on-year monthly sales results of Morinaga with sales in the ice cream market as a whole. During some months this year, the daily high temperatures in Tokyo were 3 to 5 degrees Celsius lower than last year, and the industry as a whole struggled. Morinaga was able to show growth exceeding the market throughout the first half.

Jumbo group products are the mainstay products in the Frozen Desserts product group. Development of next-generation brands, such as Biscuit Sand, Ita Choco Ice, chocolate-coated ice cream shaped like a bar of chocolate and the crepe -- ice cream-filled crepe is proceeding favorably as well. An increase in the ratio of stores stocking these products is substantially contributing to sales growth.

For Jumbo group, we are focusing on freshness marketing, an initiative to turnover product inventory in 5 days, from manufacture to shipment from the warehouse. We believe this initiative gives us a strong competitive advantage.

Choco Monaka Jumbo already has a high stocking ratio. We believe we can still increase sales further by continuing initiatives to increase in-store turnover, including target-specific promotions. I think we will also be able to achieve a 19th consecutive year of sales growth.

Sales of Vanilla Monaka Jumbo also increased substantially in the first half. Since there is ample room for increasing the ratio of stores stocking Vanilla Monaka Jumbo, we are working to increase the stocking ratio by airing TV commercials specifically for this product.

in Jelly is 1 of the 8 core brands and a signature Morinaga wellness product line. We believe that the function-specific product lineup and strong brand value are strengths of in Jelly. However, competition in the jelly drinks market is intensifying, and we are stepping up our response. Once again this season, in our advertising, we are emphasizing certain settings and occasions where people drink in Jelly in a way that corresponds to customer needs for function-specific products, namely exam preparation, beauty and heat stroke avoidance. In particular, we will step up emphasis on sports themes as momentum for sports builds in the coming months. For instance, we have been featuring professional tennis player, Naomi Osaka, in advertising since September. She was actually drinking in Jelly while playing in the French Open this year, and we believe that conveying this fact to customers will lead to a further increase in the brand value of in Jelly.

Also, under the current medium-term plan, we are developing new products that correspond to the needs of customers in order to cultivate the next generation of users. We are also developing new products in cooperation with major retailers for distribution through limited channels and engaging in initiatives to provide differentiated new functions and suggest new ways to drink the products. Through this initiative, we will seek to assuredly secure new display areas and further solidify the position of in Jelly.

The graph to the right shows the results of purchase rate analysis by age group. As a result of promoting various occasions on which to drink in Jelly to young people who have never tried it, the purchase rate of persons aged 10 to 19 has doubled compared to 2015. I think this clearly indicates that we have acquired younger users. We believe that we can increase the value of the in Jelly brand through display area development and other measures. This will involve carrying on with differentiated product development, proposing new situations in which to drink the products and initiatives with major retailers. We plan to continue with this strategy.

The wellness domain will drive Morinaga's ongoing growth. We are tapping new needs by combining proprietary technologies, which are a key asset of ours, and a variety of different natural ingredients. The sales contribution from wellness products increased by 1 point year-on-year to 44.4%. We are actively investing in advertising for wheat germ crackers, which contain wheat germ; in Bar protein, which provides an easy way of ingesting protein, and other wellness products.

In particular, sales of Ramune revenue rose substantially last year and have continued to grow this year as well. Until now, Ramune was only targeted at children and sold in a container resembling an old-fashioned carbonated drink bottle. Thanks to the launch of old-school Ramune in a small pouch format for adults and efforts to change people's perception of the brand, sales growth is so high that old-school Ramune was ranked 15th in Nikkei Trendy magazine's hit product rankings this year.

Morinaga is continuing research into cocoa as well as research into Passienol, a polyphenol extracted from the seeds of passion fruit based on proprietary technology. We will continue product development to enable customers to experience the health value discovered through this basic research.

Next, I will discuss capital investment and factory reorganization implemented to solidify our business foundation and accelerate growth strategy-related initiatives. This graph shows change in capital investment and operating income margin since the fiscal year ended March 31, 2010.

In the 2018 medium-term business plan, we announced total capital investment of JPY 40 billion, for investment in growth and strengthening of the future foundation. Although we don't disclose detailed investment categories from before the fiscal year ended March 31, 2019, maintenance and updates accounted for a large proportion of the total investment amount.

Morinaga has maintained strong earning power the past few years, and our operating income margin has remained at a level of about 10%. By moving at this time to make investments for strengthening our foundation and growth that we have been unable to make until now, we will seek to strengthen the business foundation in order to secure stable earnings into the future. At the same time, we will strive to further boost earnings in order to cover a temporary increase in depreciation.

The markets for the product categories in which we plan to invest are growing. Looking at chocolate, for instance, sales of Carré de chocolat are growing against a backdrop of increased consumption by seniors. However, we also consider improvement of the profit structure through added value enhancement to be necessary and are focusing on this.

In the ice cream category, we aim to secure the top line and further profit contribution by bolstering efforts to cultivate next-generation products in addition to Jumbo group. Although competition for sales of jelly drinks is intensifying, the in Jelly brand has high brand value. By further focusing on branding, we will aim to secure the top line and further profit contributions as with Jumbo group.

Finally, I will discuss the global domain. This slide shows the first half results and full year forecast for the global domain. We forecast full year sales of JPY 11.8 billion in the fiscal year ending March 31, 2020, which represents 16% growth year-on-year when excluding Indonesia, where we dissolved a partnership with a joint venture in January this year. The impact of this dissolution is substantial, and we expect an overseas sales ratio of 4.8%, down 1.1 points year-on-year. However, our business in the U.S. is performing favorably and sales are up 27% year-on-year. There are many positive signs, and there is no change in our plan to increase sales by continuing to focus on the U.S.

I will now discuss our strategy for HI-CHEW in the U.S. in detail. The HI-CHEW brand is the cornerstone of our strategy for the global domain. I will again explain why we entered the U.S. market with the HI-CHEW brand. The population of the U.S. is about 2.5x that of Japan. The candy market is about 4x the size of Japan's, and the market is growing.

HI-CHEW's candy category is unusual in that it isn't dominated at all by a single brand. The market share of Skittles, the category leader, is 5.4%. We are implementing our U.S. strategy in the belief that we can be successful in this market by leveraging the unique value of HI-CHEW.

This graph shows the growth in sales of HI-CHEW in the U.S. and our sales target. Sales are trending favorably. At the time of the launch, we introduced HI-CHEW at influential retail chains. In-store turnover of these chain stores rose, and we introduced HI-CHEW to other chains. Then once product introduction had expanded to a certain level, we add TV commercials. This has increased product recognition among target demographics and led to an increase in in-store turnover. Introducing HI-CHEW in sales channels targeting general U.S. consumers and the increasing in-store turnover, in particular, have driven overall growth. We will increase sales going forward by continuing to promote product introduction and boost in-store turnover.

This table shows which of the top 10 U.S. retailers we have so far introduced HI-CHEW to. HI-CHEW has been introduced at all of the chains listed, except DIY or home appliance chains that do not handle food products. However, there are still areas of the U.S. where product availability and recognition are low. We believe that we can further open up the market by steadily growing the business in these areas. For this reason, we will continue to air nationwide TV commercials and move to increase sales through promotions. We will also expand and enhance the product lineup, which is fewer SKUs than competing products, in accordance with the display area requirements and consumer needs.

Production quality performance was an issue standing in the way of increasing sales in the U.S. business. However, we have made substantial improvements by strengthening the production management system, developing local personnel and implementing integrated manufacturing and sales initiatives. We also plan to expand production capacity at the U.S. plant in January 2020 to support future sales growth. We will install an additional manufacturing line and expect to increase production by 30%. Since we have put in place an integrated manufacturing and sales system, we will now aim to further increase HI-CHEW sales in the U.S.

I will now discuss new businesses in the global domain. Thanks to expansion of HI-CHEW in the U.S., we are gradually establishing a commercial distribution network in the market. We are now considering introduction of the next brand in the U.S. We will also execute a strategy to roll out and firmly establish the HI-CHEW brand in other geographical areas, using HI-CHEW in the U.S. as a foundation. I think that we will boldly decide to make major investments in our global business when the timing is right. We are pursuing a growth strategy in the global domain that includes these elements.

This slide shows Morinaga's stance on cash flow utilization. As before, our approach is premised on building a solid financial foundation in preparation for risks. We will provide appropriate shareholder returns after prioritizing investments for productivity improvement, strengthening of product development capabilities and acceleration of growth.

On Slide 2, I explained that diversity is essential for us to continue to meet the expectations of our customers. Diversity at Morinaga lies in the leveraging of each person's individuality. When I consider the purpose of diversity in the first place, I see diversity as a means of generating innovation. I want to ensure diversity for the purpose of growing the organization in step with the times. Promoting diversity is about creating a work environment and mechanisms that enable people from diverse backgrounds to actively contribute. Also seeking further knowledge by obtaining insights from outside sources leads not only to diversification of the workforce, but also to diversification of knowledge. That is the basis for generating innovation and creating new value.

I believe that this process results in continuously meeting customer expectations and also results in passing on Morinaga's founding spirit and philosophy over time. Promotion of diversity, including work style reform, has progressed to some extent. Much remains to be done, however, and we will work to further develop our diversity agenda. The expression, "a wide range of initiatives," expresses what should be done to promote diversity.

Morinaga & Co. marked its 120th anniversary this year. This slide shows a newspaper ad we ran in August 2019. The ad depicts Morinaga's history and products introduced down the years, using a visual resembling a board game. Morinaga has many brands that have been passed on from parent to child, to grandchild and continue to be cherished by multiple generations. We will press ahead with efforts to remain a company with products popular among people of all ages.

We plan to open the Morinaga Angel Museum, which will also be referred to as Morium, in the spring of 2020 as a 120th anniversary project. Morium will be a facility that enables people to enjoy plant tours.