Kirin Holdings Co Ltd

TSE:2503

Earnings Call Transcript 2021-Q2

[J. Wolchko, executive]

Good morning, everyone. My name is Yokota, Director of the Board, Senior Executive Officer and CFO of Kirin Holdings. During the first part of today's financial results presentation, I will be discussing the results for the second quarter of fiscal year 2021 and the full year forecast.

Please turn to Page 3 of the presentation materials. Revenue decreased by 1% year-on-year. While this represents a decrease of JPY 8.4 billion, the sale of the Lion Dairy & Drinks business in Australia in January of this year accounted for a decrease of 5%. Taking this into account, this actually represents a revenue increase of 4%.

While the negative impact of the COVID-19 pandemic on normalized operating profit was significant, to an extent exceeding our initial forecast, progress in reforming the profit structure allowed us to achieve year-on-year growth of 3%. This represents an increase of JPY 2.1 billion.

Regarding profit before tax, while we recorded impairment losses associated with the Myanmar business, an increase in profit from equity method affiliates allowed us to achieve year-on-year growth of 1%. This represents an increase of JPY 500 million. Since impairment losses are not treated as a tax expense, this led to an increase in corporate taxes. As such, profit attributable to owners of the company decreased by 29% year-on-year. This represents a decrease of JPY 9.6 billion.

In addition to an increase in normalized profit, share buybacks executed last fiscal year had a positive impact on normalized EPS, which grew by 16% year-on-year. This represents an increase of JPY 9 per share.

Please turn to Page 4, which discusses normalized operating profit by company. I will be discussing the results for the main group companies using the highlights on Page 5. Normalized operating profit for Kirin Brewery decreased by JPY 6.1 billion year-on-year. In terms of the total beer sales volume for the first half of the year, while the overall market contracted by 6%, Kirin Brewery contracted by only 2%, therefore, greatly outperforming the broader market.

Government requests to stop serving alcoholic beverages at restaurants in Japan's major cities starting in April, translated into a more challenging business climate for on-premise sales, even when compared to last year. Consequently, we registered a decrease of approximately 30%.

Off-premise sales continued delivering a strong performance with strong sales associated with the renewal of Kirin Ichiban and with products targeting health-conscious consumers, like Kirin Ichiban Zero Sugar. As such, sales of traditional beer defined in the narrow sense increased by 10% year-on-year, achieving its first positive result in 6 years. Furthermore, craft beer and high-value-added RTVs also delivered strong sales growth. As a result of this, sales revenue also trended at a growth level of 4%, leading to an increase in marginal profit.

I would now like to discuss selling expenses. Last year, in anticipation of the October 2020 liquor tax revision, we executed measures mainly in the second half of the year. However, during the current fiscal year, we carried out proactive investments in the first half of the year for initiatives like craft beer and Home Tap, towards realizing new value creation. As a result, normalized operating profit decreased by 19% down to JPY 25.4 billion. Normalized operating profit at Kirin Beverage increased by JPY 500 million year-on-year. Sales volume for flagship brands like Gogo-no-Kocha and Nama-cha decreased as people refrained from going outside and worked from home. However, sales of beverages containing Lactococcus lactis strain plasma increased by 46%. This represents significant growth.

Structural reform of the vending machine business progressed as planned. And by reducing costs whenever possible, including the reduction of fixed expenses, we were able to achieve a year-on-year profit increase. Normalized operating profit at Lion increased by JPY 8.4 billion year-on-year.

Last year, in the second quarter, on-premise channels were almost completely offline due to lockdowns in Australia, which began in late March of 2020. However, this year, sales volume has recovered by over 80%, and we also registered an improvement in the channel mix. These factors led to a significant improvement in normalized operating profit.

In the category of Hard Seltzer too, White Claw became the top brand in Australia in June as we continue delivering new value to consumers. Sales volume at new Belgium Brewing, our craft beer manufacturer in North America, had been growing even against the backdrop of the COVID-19 pandemic, centered around off-premise sales. Even following the lifting of mobility restrictions, New Belgium Brewing continues delivering strong sales results.

Please go back to Page 4, allow me to discuss Kyowa Kirin, which registered a year-on-year normalized operating profit decrease of JPY 4.5 billion. Gross margin increased due to an increase in overseas sales revenue, mainly from global strategic products. However, maximizing the value of global strategic products and quickly establishing a competitive global business foundation translated into an increase in SG&A expenses and research and development expenses, et cetera. This led to a decrease in normalized operating profit.

Coke Northeast was able to address a fast and pronounced recovery in the economy and in consumption demand in North America, allowing it to deliver sales revenue growth. In addition to this, sustained cost control measures delivered results and translated into a year-on-year increase in normalized operating profit of JPY 3.5 billion.

For Kyowa Hakko Bio, a strong recovery in production volume translated into a significant improvement in normalized operating profit, which grew by JPY 2.3 billion year-on-year.

Please turn to Page 6. Allow me to discuss the background of the downward revision of the full year forecast and the recognition of impairment losses at Myanmar Brewery. Myanmar has been mired in political uncertainty following the coup d'état that took place on February 1, 2021. Additionally, the number of COVID-19 cases in the country has also increased significantly starting in June.

Against the backdrop of medical institutions and facilities not being fully functional amidst a resurgence in cases, we believe we have no choice but to view market conditions as dire. The Myanmar kyat has also lost value relative to other currencies, and there is a shortage of materials used to manufacture beer cans. As such, we have taken into account an increase in raw material costs and lowered a full year normalized operating profit guidance by JPY 9.8 billion, down to JPY 6.2 billion.

On the topic of impairment losses, country risk for Myanmar was reevaluated in July from a rating of B3 down to CA using the Moody's credit ratings equivalent. This led to a sharp increase in the country risk premium used in the WACC calculation and to a significant increase in the discount rate. As a result of this, we recorded an impairment loss.

Please turn to Page 7, which discusses the revisions of the fiscal year 2021 forecast. We took a pessimistic view of the results forecast for the Myanmar business, leading us to lower the consolidated normalized operating profit forecast by JPY 10 billion compared to the initial forecast. As such, we have lowered the normalized operating profit forecast from JPY 180 billion, down to JPY 170 billion.

We have also lowered the profit attributable to owners of the company forecast by JPY 16.5 billion as a result of impairment losses associated with the Myanmar business. The forecast has, therefore, been revised from JPY 103 billion, down to JPY 86.5 billion.

While there are minor revisions to each group company's results, this forecast revision is the result of the impact amount from the Myanmar business.

Operations at our other businesses are proceeding smoothly admittedly, a surge in new cases resulting from the spread of new COVID-19 variance is having an impact, but we intended to continue enhancing the profit structure and carrying out cost reductions at each group company, allowing us to deliver profits in line with the initial forecast.

Page 9 deals with the topic of ESG updates. Regarding the environment, we derived updated analysis results based on TCFD scenario analysis. Additionally, also shown here are our social initiatives linked to fighting climate change. So we invite you to produce these later at your leisure.

This concludes my presentation.

[Yoshinori Isozaki, executive]

Good morning, everyone. My name is Isozaki, President and CEO of Kirin Holdings. Thank you for your continued purchase and use of the Kirin Group's products and for your continued support and understanding of the company's operating activities.

As you are aware, there is no end in sight to the COVID-19 pandemic as the virus continues to wreak havoc in the form of new variants. Japan is currently experiencing a fifth coronavirus wave with the state of emergency having been declared for the fourth time. I think that at the time of the declaration of the first state of emergency in April of 2020, most people couldn't have predicted things would turn out the way they did through to the present date. Ultimately, the battle against COVID-19 has been going on for over a year now with drastic changes in terms of awareness and behavioral patterns on the part of consumers.

An increase in the vaccination rate offers hope that we will be able to go back to normal life. But the risk of contracting the virus still remains as variants oppose the risk of bypassing vaccine protection. On the one hand, restricting mobility leads to economic stagnation, while on the other hand, taking too relaxed an approach carries the risk of reigniting a surge in the number of cases. In light of this, governments around the world are faced with a challenging and complex situation and are currently carrying out a variety of measures to tackle these.

One thing that this pandemic, which started last year has taught us is that human kind must learn to live alongside a variety of different viruses. As such, even after the COVID-19 pandemic is behind us, a return to life, as it was pre-COVID, is impossible. Instead, people will have to adapt and carry out their daily lives with increased awareness of the risk of infection and carry out precautions to minimize risk.

One result we expect will emerge from this is a change in greater consumer awareness as it pertains to health and prevention compared to before the pandemic. Changes in consumer awareness and behavior translate into changes in social issues. We would like to view these changes not as a risk, but rather as a business opportunity. As you are aware, CSV management stands at the core of the curing group's approach to management as we seek to offer solutions to social issues faced by consumers through our business operations and to maximize social and economic value.

As I have mentioned multiple times before, fermentation and biotechnology have been our core technologies since the Kirin Group's founding. Our corporate strengths lie not just in our alcoholic beverage and nonalcoholic beverage businesses but also in the pharmaceuticals business as we boast one of the world's most unique business portfolios. We will fully utilize our organizational capabilities, allowing us to make innovation a reality in terms of technological and marketing capabilities, which are our strengths and bridge the domains of food and beverages health science and pharmaceuticals. Through this, we will seek to address the social issues brought to the forefront by the pandemic.

As you are aware, in 2019, we announced our long-term management vision, KV2027, while simultaneously announcing a 3-year medium-term business plan, the final year of which is 2021. Starting at the onset of the pandemic last year, we carried out a full scope review of our business from the perspective of things to accelerate, transform, reduce and eliminate. This was done with the objective of minimizing the impact of the COVID-19 pandemic and towards the age of the new normal. As such, we are fully confident that the direction we were aiming for with KV2027 is correct, and that the society we had envisioned 10 years from now has arrived earlier than expected as a result of COVID-19.

In light of this, we reached the conclusion that looking ahead in terms of changes in consumer awareness and behavior and reviewing our strategy with anticipating the future is important. We are scheduled to announce the next MTBP next year. However, we have positioned the current fiscal year as a starting point for change. By carrying out reform, we will be improving our business model and profit structure.

I would now like to discuss on a per segment basis, the measures towards accelerating growth in 2022 and beyond. First, I would like to start with the domestic alcoholic beverage segment, the largest of the company's existing businesses and our founding business. The liquor tax revision was implemented in October 2020, and this brought about market environment changes in the midst of the COVID-19 pandemic. We were already anticipating a polarization in consumption into more health-conscious consumer base. However, in addition to changes to purchasing behaviors resulting from the revision of the liquor tax, the COVID-19 pandemic acted as a catalyst towards even more health-conscious consumers. We view this as an opportunity, which we leveraged by releasing Kirin Ichiban Zero sugar in the beer category under our flagship brand of Kirin Ichiban. Furthermore, we carried out a renewal of Kirin Ichiban earlier this year. Through these initiatives and others, we have been able to significantly grow our brands in the beer category, which offers high levels of profitability.

Regarding a polarization in consumption, we captured the desire of consumers to better enjoy the time they spend at home by rolling out in earnest craft beers for off-premise consumption. We additionally carried out a proactive investment in high value-added RTD. Analyzing consumer inflows for Hojun 496 reveals that approximately half switched from the categories of Happo-shu into new genre, and 1/4 switched from the regular beer category. This, therefore, indicates that the sales mix has improved to include more premium products.

On-premise channels have struggled during the COVID-19 pandemic, and it is precisely because of this that we would like to address consumer needs through off-premise channels and expand profits. The beer market in Japan has continued to contract over a long period of time. We, at the Kirin Group, are industry leaders and as such, have a responsibility to revitalize this market going forward. One such initiative in this direction is a new business model in the form of Home Tap. We seek to revolutionize the beer business with this business model and aim to revitalize the beer market.

We began carrying out test sales in 2017 and have carried out to research regarding the use of the subscription model. As such, and against the backdrop of the COVID-19 pandemic, we decided to carry out proactive investment with an eye towards the future. This business model has received praise from many of our customers as being extremely innovative. This allowed us to reach our initial annual target of 100,000 members ahead of schedule. In light of this, we have revised our target upwards to 150,000 members.

In terms of Japanese craft beers, Pilsner beers are the most famous, but Home Tap offers an enjoyable drinking experience to consumers, allowing them to rediscover the tastiness and enjoyment associated with Pilsner and a variety of different types of craft beer. On the other hand, members now consume craft beer, not just through Home Tap, but through off-premise consumption of canned craft beer. This is promising in that even after the COVID-19 pandemic has come to an end and people can once again drink beer in restaurants. We believe consumers will continue to choose to drink craft beer. We believe that Home Tab is and will continue revitalizing the beer market, unlocking synergies with the existing beer business and breathing new life into the beer market.

In January of this year, we completed the sale of Lion Dairy & Drinks, allowing us to focus on Lion Beer, Spirits and Wine. We are seeing a trend towards a steady channel mix improvements in the Oceania market, thanks to a recovery in on-premise sales.

With that being said, the COVID-19 pandemic has really highlighted the profitability levels associated with off-premise channels. High liquor taxes and container deposit legislation mean that off-premise channels in Australia structurally tend to offer low levels of profitability. In light of this, efforts to improve profitability in off-premise channels are centered around enhancing marketing ROI by strengthening brand value and improving fixed costs through SCM reform.

Within the scope of marketing reform, we hired a new Marketing Director from outside the Kirin Group. We have then incorporated consumer-centric marketing methods and techniques that allowed us to greatly improve results at Kirin Brewery and are currently carrying out efforts in restructuring our strategy.

Regarding SCM reform, 1 brewery reorganization was completed at the end of June. Our efforts will extend beyond this and by carrying out a review of the overall supply chain, we are making steady progress in terms of initiatives towards reducing costs. We want to carry out a thorough review with no areas being off limits for cost reductions, including head office expenses. As such, we will be reinspecting all levels of the profit structure and put into practice reform towards resuming profit growth after the end of the COVID-19 pandemic.

The domestic soft drink market too was significantly impacted by the COVID-19 pandemic. As working remotely becomes entrenched in the work culture, this has led to changes in consumer behavior and negatively impacted sales at convenience stores and vending machine channels near office areas. Additionally, people spend more time at home now with more people enjoying making tea on their own. This represents a change from the pre-pandemic era when consumers would prioritize convenience and went outside.

On the other hand, the health and well-being segment, which includes products with function claims, has delivered meteoric growth, thanks to more health conscious consumers. As such, we believe the beverage market is of vital importance to the Kirin Group, which considers the health science domain, a pillar going forward.

Kirin Beverage will be enhancing the sugar-free and low-sugar lineup it has nurtured so far and also functional health products, the most representative of which being LC-Plasma. Through this, Kirin Beverage will reposition itself as a beverage company in the health science domain. Sales of LC-Plasma nonalcoholic beverage products have grown by 50% year-on-year. In order to further accelerate this growth trend, we will be launching products with function claims containing LC-Plasma as part of the Gogo-no-Kocha and Nama-cha brands. By transforming our existing beverage business, we seek to steadily secure an entry mass in the domain.

Next is the Health Science domain. Sales have been very strong for our flagship LC-Plasma-related products. In light of this, we have raised annual guidance from JPY 11 billion in revenue to JPY 13.5 billion. The rationale for this is very significant health consciousness on the part of consumers following the outbreak of the pandemic. Even within health consciousness, greater interest in boosting one's immune system stands out as being particularly noteworthy.

LC-Plasma has 2 main competitive advantages. The first is scientific evidence of making it the only product sold in Japan that is allowed to make immune function claims alongside its function and efficacy. Another competitive advantage is the fact that it allows us to develop in a flexible manner, a variety of food and beverage products containing LC-Plasma. We are leveraging this ability to deliver results regardless of what form we choose for the products as a way to tackle and resolve challenges associated with caring for one's immune system.

Starting this fall, Kirin is scheduled to make available LC-Plasma to our partner companies towards the development, not just the beverages and supplements, but also of nutritional supplements and suites. Through this, we seek to create a structure, allowing us to offer multifaceted support to consumers. Also, Kyowa Hakko Bio was cause for concern in the past. However, the foundation for quality assurance at the company has become very robust. The production system, too, has also stabilized. We narrowed down the product range on the basis of new criteria and achieved a recovery in plant capacity utilization according to plan. These allowed for a return to the black during the first half of the fiscal year in terms of normalized operating profit.

Furthermore, other key points in implementing business structural reforms are our HMO production facility in Thailand and our City Choline production facility in Japan. We continue making steady progress on this front even during this period of uncertainty brought about by the COVID-19 pandemic and expect it to start operations according to schedule Thus, we are carrying out preparations, allowing us to grow B2B and B2C dramatically over the duration of the next MTBP.

Regarding Kyowa Kirin, we are making steady progress as a player in the global specialty pharma industry by expanding sales of global strategic products and by securing a pipeline capable of driving future growth. As a further ambitious endeavor, we will be carrying out efforts to realize the services beyond pharmaceuticals. Naturally, these efforts are premised on joint work with the health science domain. So this involves combining the know-how we have nurtured in each domain.

In the process of leveraging functional ingredients in the domain of disease prevention, we need to be able to address regulatory matters, including as it pertains to pharmaceutical affairs. Additionally, for services covering the pre-disease stage, in addition to medical knowledge, we also needed the know-how we nurtured in the food and beverages domain. Knowledge in both the medical and health science domains is vital in order to address the social issues in the pre-disease and disease prevention stage. As such, we are carrying out efforts towards new value generation by leveraging our strengths in each domain. In the interest of preserving our competitive edge, this is all I can currently divulge. I would like to expand upon this topic at a later occasion once we can reveal more information.

Lastly, I would like to discuss the topic of Myanmar Brewery. As CFO Yokota mentioned during his presentation, we recognized impairment losses resulting from an increase in the country risk premium, there continues to be a great deal of uncertainty, but we will continue negotiations towards the dissolution of our joint venture in the country. Admittedly, the Myanmar coup who was an exogenous event, but it is very unfortunate that we had to recognize impairment losses.

And we take this situation very seriously. Going forward we will aim to overcome all hurdles such as risk associated with the COVID-19 pandemic and geopolitical risk. By doing so, we seek to achieve our long-term management vision, KV2027, and become a global leader in CSV.

Please look forward to the Kirin Group's growth going forward. Thank you for your time.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]