Kao Corp

TSE:4452

Earnings Call Analysis

Company Navigates Market with Strategic Initiatives

In the latest quarter, net sales slightly dipped by 0.2% to JPY 1,125.9 billion, a negation of forex impacts suggesting a more significant 2.9% drop. However, core operating income saw an 8% year-over-year decrease to JPY 70.8 billion, yet this illustrated a strong rebound from an earlier 36% plummet. A bright spot surfaced as the core operating profit margin leaped from 5.9% to 9.4%, credited to the Household and Personal Care sector's performance, particularly in Fabrics and Home Care. Despite a cosmetic sales slump in China, domestic sales flourished, meriting JPY 20.1 billion in structural reform expenses. Moreover, the quarter-end forecast promises an optimistic JPY 11 billion price increase, potentially buffering a JPY 3 billion raw material cost spike.

Financial Performance Overview

The company's net sales have slightly declined by 0.2% year-over-year to JPY 1,125.9 billion. When adjusted for foreign exchange (ForEx) impact, the decrease widens to 2.9%. Core operating income fell by 8% to JPY 70.8 billion, with a core operating margin of 6.3%, indicating a recovery from an even steeper decline of 36% in the second quarter. Net income attributable to the parent company dropped by 13.9% to JPY 50.2 billion, and basic core earnings per share decreased by 12.8% to JPY 108.02. The company also absorbed restructuring costs, which accounted for a difference of JPY 20.1 billion between core operating income and operating income.

Segment Analysis

The Fabric and Home Care business stood out with profit improvement, maintaining market leadership through strategic price increases and a focus on high value-added products. Inventory reductions also bolstered cash flow. This offset some negative effects such as a downswing in sales and profits within the Cosmetics business in China, primarily due to local issues affecting sales promotion activities. The Chemical business saw some recovery in sales in the United States and Japan, although performance fell in Europe. Restructuring expenses within this context, mainly for domestic disposable diaper production, aggregated to JPY 20.1 billion.

Structural Reforms and Future Outlook

Efforts to steer the company's structure toward profitability continue, including disposing of assets and curtailing non-performing segments. The company expects taking on an additional JPY 3.0 billion impact from raw material expenses and plans a price pass-through of JPY 11 billion in the fourth quarter. For the fiscal year, a core operating profit of JPY 49.2 billion is needed to hit their annual target of JPY 120 billion.

Challenges and Strategies in Key Business Segments

The Cosmetic business is on an upward trajectory in Japan while facing setbacks in Asia, especially China due to market challenges. The Hygiene and Living Care segment made significant profit gains, spearheading improvements. The Chemical business also faced pressures from reduced demand and competition in Europe but posted a marginal increase in operating income year-over-year.

Guidance and Expectations

The company aims to achieve a core operating profit of JPY 120 billion for the year, equivalent to a JPY 10 billion increase over the previous fiscal year, despite a projected decline in operating income due to structural reform costs anticipated to be around JPY 50–60 billion.

Earnings Call Transcript 2023-Q3

[Masakazu Negoro, executive]

Hello, I'm Negoro. Now if you have the presentation material on hand, please turn to Page 7 to begin with. I would like to begin with the highlights of the consolidated financial results. Net sales was JPY 1,125.9 billion, down 0.2%. Excluding ForEx impact, net sales was down 2.9%. Core operating income was JPY 70.8 billion, down 8% from the same period last year, a significant improvement from second quarter cumulative of minus 36%. As a result, the core operating margin was 6.3%. The difference between core operating income and operating income, JPY 70.8 billion and JPY 50.7 billion, the difference of JPY 20.1 billion accounts for the cumulative structural reform expenses up to the third quarter.

Net income attributable to the parent company was JPY 50.2 billion, a decrease of 13.9% from the same period last year. Basic core earnings per share was JPY 108.02, down 12.8% year-over-year. Now continuing on to Page 8. Please refer to the third quarter consolidated financial highlights. This is a highlight of the consolidated earnings for the third quarter only. We would like to draw your attention to core operating income here. The second line from the top. Core operating income was JPY 36.3 billion, up JPY 13.1 billion year-over-year. Core operating profit margin improved from 5.9% to 9.4%.

Please continue on to Page 9. So here, the key points of the financial results. At the second quarter results meeting, I mentioned that we had reached a turning point. And I believe that in the third quarter, we are moving into a growth trajectory, driven by our mainstay Household and Personal Care business. In particular, the Fabric and Home Care business, a stable profit area made a significant contribution to profit improvement while maintaining the top market share by promoting strategic price increases and high value-added products. In addition, efforts to reduce inventories also contributed to improved cash flow. In the Skin Care business, a growth driver, we work together with the sales division to revitalize the market by proposing high value-added products as the spring and summer season extended due to rising temperatures.

As a result, we were able to maintain the top market share for UV care products and other products, contributing significantly to improved profits. In the Cosmetics business, while Japanese market is on the recovery trend, G11, a focused brand achieved significant growth. On the other hand, overall core operating income fell short of the plan due to lower sales in China, where sales were affected by the treated water discharge problem and sales promotion activities were also curbed. In the Chemical business, while sales in the United States and Japan are recovering, sales and profits in Europe fell below the previous year's levels. Although they improved from the second quarter due to intensified competition amid declining demand.

As for structural transformation, which I will explain later, we recorded expenses of JPY 11.5 billion, mainly for the reorganization of domestic production of disposable baby diapers for a cumulative total of JPY 20.1 billion. Now let us continue on to Page 13. This page shows the third quarter results by segment. Please refer to Consumer Products business on the third line from the bottom. Overall sales in the Consumer Products business increased 0.6%. The breakdown of 3.8% increase in price hike and a 3.2% decrease in volume and others. Core operating income was JPY 28.8 billion, a significant increase of JPY 12.5 billion year-over-year, and the core operating margin recovered to 9.4%. This was driven by the Hygiene and Living Care and Health and Beauty Care businesses.

The Hygiene and Living Care business was the one that made the most progress in improving profits, led by strategic price increases and others with core business profit of JPY 14 billion, an increase of JPY 8.2 billion year-over-year. The Health and Beauty Care business improved profits by increasing the volume of high value-added products posted core operating income of JPY 14.5 billion, up JPY 5.5 billion year-over-year. The cosmetic business was down 1.8% in sales to JPY 59.3 billion. While positive in Japan, it was a big negative in Asia, especially in China. Core operating income was JPY 400 million overall as a result of a significant decrease in sales, partly due to the curtailment of sales promotion activities using KOLs and others due to the treated water discharge issues.

In the Chemical business, core operating income was JPY 7.4 billion, an increase of JPY 700 million year-over-year, and the core operating income margin improved by 0.4 percentage points from the second quarter despite the decrease in sales due to a decline in the market. Now please continue on to Page 14. Changes from the first half to the third quarter and analysis of changes in operating income are provided here on this page. Now first, please refer to the graph below. In the third quarter, the right-hand shows JPY 24.8 billion and the left-hand shows JPY 23.3 billion, which is the difference in operating income between the last year and this year. Excluding the JPY 11.5 billion in restructuring costs, the total income was JPY 36.3 billion, an increase of JPY 13 billion compared to JPY 23.3 billion in the previous year. Positive values are showing green and negative values in gray.

Adding the gain on raw materials of JPY 2 billion and the price increase of JPY 11.5 billion, we arrived at JPY 13.5 billion. These 2 factors have created an increase in profit. Cosmetics volume was down by JPY 1 billion year-over-year, while Chemicals marginal profit decreased by JPY 1 billion versus the prior year. Compared to the first half, chemical sales have improved significantly. SG&A expenses increased JPY 1.5 billion due in part to COGS on marketing expenses in China and Southeast Asia.

Please continue on to Page 15 for an analysis of changes in cumulative for the third quarter operating income. The chart shows the cumulative total from January to September. The JPY 23 billion in price increases absorbed JPY 8 billion in raw material price hikes and thanks to excess amount of JPY 15 billion, the majority of the JPY 6 billion volume decline in [indiscernible] Household and Personal Care business and the JPY 11 billion decline in marginal profit from chemicals was offset. Structural reform expenses totaled JPY 20.1 billion and TCR FX amounted to JPY 9 billion. I will now explain our structural reform.

Please turn to Page 23. Structural reforms are being carried out just as planned and have entered a climax from the fourth quarter. Today, I would like to discuss a little more details on the topic. The total cost of JPY 60 billion shared in the second quarter is in line with our expectation at this point in time. Therefore, we plan to record about JPY 40 billion in the fourth quarter. Now first, regarding disposable baby diapers as we have recently announced that our factory in China is proceeding with procedures for closure. We are currently in the process of selecting a transferee for the assets and land use rights, which is expected to be completed by the end of this year. As a result, we expect to incur expenses of about JPY 5 billion in the fourth quarter, including the retirement or sales of some fixed assets related to China.

In the third quarter, the company recorded an impairment loss on its domestic facilities as a result of the reorganization of domestic diaper production. Baby diapers would account for about 40% of the total restructuring cost. Next, regarding the cosmetics, we will accelerate to narrow down on the key cosmetic brands. In the other Household and Personal Care and the Chemical businesses, we plan to conduct consolidation, divestment of the low profit fixed assets and reduction of the inventories. The decrease in the gross profit caused by this product consolidation has already been incorporated in the midterm plan and is not included in the current structural reform expenses. We allocate about 20% of the total expenses in this field as a net amount, assuming the sales of some assets.

We expect that the cosmetics will account for more than 50% of the total expenses. The human capital structure reforms are intended only to maximize our employees' passion and it will to work. Our future is unpredictable because we plan to review nonprofitable businesses. The company has earmarked budget for strengthening the carrier support program. We have already provided an overview of the project internally, and we will continue to promote the project overseas. The amount of the expenses are still unknown, but we are committed to motivate our employees. We estimate that the structural reform expenses in this area will account for about 40% of the total expenses.

Page 25, operating income increase and decrease factors. Please look at the upper graph. We expect an additional JPY 3.0 billion impact from the raw materials in the fourth quarter and an JPY 11 billion price pass-through or a price increase in the fourth quarter. In order to achieve the annual target of the JPY 120 billion in core operating profit, we need JPY 49.2 billion in core operating profit in the fourth quarter. Of the JPY 16 billion difference from the actual JPY 33.2 billion, we plan to cover about 90% or JPY 14 billion with those 2 profits. While the Chemical business is on a recovery track after a sharp decline in the profits from the second half of 2022, we plan to increase the profits by JPY 4.0 billion year-on-year, mainly due to increased sales of the expanded product lineups, although there are uncertainties such as economic trend in Europe.

How much of the impact of the China's volume decline in the cosmetics products will we absorb in Japan, this is indeed the key point. The forecast is minus JPY 5 billion from the same period of the previous year. Increase in SG&A expenses are offset by the foreign exchange gains and additional TCR of the JPY 3 billion. Please see the graph below. Core operating income is expected to be JPY 120 billion for the year, with no change and the JPY 10 billion increase over 2022. In order to carry out the structural reforms, we expect the operating income to decline by JPY 50 billion to JPY 60 billion. The number shown in Orange at the bottom of the graph shows a difference from the figure introduced during the second quarter briefing.

Next, Page 26, raw material price trends and the price increase effects. The graph on the left shows the impact of the raw material price hikes starting in 2021. The chart shows that the impact of the strategic price hikes and the extent to which such increases have offset the impact of the raw material costs. We plan to cover 90% by the end of this year. The bar graph on the right shows a ratio of the major raw materials compared to what it was in the fiscal year 2022. Areas surrounded by the bar graphs represent the improvement in the profitability. Thanks to the price increase, the consumer products business started to generate more profit than the previous year since second quarter.

Page 27. I'm going to discuss that the measures from the fourth quarter in 3 business areas: First, Household and Personal Care business. Fourth quarter HPC market in Japan will remain steady. In China, we expect the economy continues to stagnate. The impact of the economic slump and the treated water issue will continue at least through the first quarter next year. In this environment, we will continue to implement the strategic price increases, and we'll also continue to promote high value-added products. Kao will continue to improve the profits through these measures. New products have performed well in the current fiscal year.

Page 32, 33 of the document introduce our main new Fabric and Home Care products, which have been steadily increasing their market share since their launches. In the Hair Care business, which has been a challenge, we are now preparing for a turnaround from the next fiscal year. Page 28, Cosmetics business. We expect the domestic market to continue to expand and inbound sales and the makeup market to recover following the third quarter. In the Chinese market, we expect a low-digit growth in the first half of the year, but we continue to have a sense of uncertainty regarding the Japanese brands. Europe is entering its peak sales season, but we do not expect significant growth due to inflation. In such a situation, the key point of our policy is to focus on expanding the sales of prestigious brands in the Japanese market.

Many of our products will keep winning the best cosmetics awards for the second half of the year following the first year. We intend to take advantage of this opportunity. In the recovery makeup market, the KATE new products and the limited edition launches are expected to boost us into, by far, the top sellers position. We will aim to become #1 in Japan. We will also focus on expanding sales in Japan by focusing on the inbound sales. In the Chinese market, although there is a sense of uncertainty, KOL, which has been suspended, has resumed its operation and the freeplus rebranded products and Curel's mainstay products, SENSAI, will also sell aggressively at the flagship stores. In Europe, SENSAI and Molton Brown are entering their best sales season.

Lastly, Page 29, Chemical business. Many of the major global chemical companies in Europe and North America have revised their full year sales and profit forecast downward. Economic recovery in European countries is sluggish and the demand remains stagnant. In the oil and the fat related field, recovery has begun in the United States, but the recovery in the high value-added information, business-related industry, which include a personal computer and the cell phones and Kao's target market has been slow.

Against such backdrop, there is no significant change in our policies from the end of the previous quarter due to the sluggish demand and El Nino-induced oil price fluctuation, the product prices would not recover significantly, but we are determined to make a steady recovery in the fourth quarter by expanding the sales of the high profit products and high value-added products, specifically, which are tertiary amines and aromatic chemicals. The materials on Pages 30 to 34 will not be covered for the interest of the time, but they are included as supplementary materials.

This concludes my presentation. Ladies and gentlemen, thank you.

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