Shiseido Co Ltd

TSE:4911

Earnings Call Transcript 2021-Q2

[Takayuki Yokota, executive]

I would like to talk about the business results for the first half of 2021. Please refer to Slide 3. I will begin by going over the key headlines for the first half of the year. There are 5 key messages that I would like to deliver today.

Due to the intermittent states of emergency, the Japan region has been experiencing weak momentum. However, due to the strong recovery in our global footprint, the company was able to achieve solid growth at Shiseido Group. Operating profit was JPY 23 billion, an increase of JPY 26.4 billion compared to the previous year's negative JPY 3.4 billion. We turned the COVID crisis into an opportunity to build back better for a stronger Shiseido to establish a resilient financial base, along with the agile cost management and reduction of fixed costs.

Based on the midterm strategy, WIN 2023, the global transformation is on track. The progress made in the first half is as shown on the slide. The digital transformation, one of the key strategies for WIN 2023 is also on track. The strategy includes expansion of e-commerce, the launch of the joint venture in July with Accenture called Shiseido Interactive Beauty and introduction of FOCUS. Furthermore, stronger cash management created JPY 21.1 billion of cash in the first half through a reduction of inventory and sale of idle assets and higher ROIC was achieved by improving the balance sheet.

Next, please refer to Page 4 for the executive summary of the P&L. Net sales was JPY 507.7 billion, up 18% versus last year on an FX-neutral basis. Overseas businesses grew substantially driven by China, EMEA and the Americas, offsetting the COVID affected regions such as Japan and Asia. E-commerce continued to grow mainly in Prestige, marking a global growth of high 20s in percentage with a sales ratio of 30%. Also, skin beauty brands such as Shiseido and Clé de Peau Beauté, the company's strategic investment area grew by double digit, driving the overall growth. Skin care sales ratio was 63% globally, an increase of 15%.

Operating profit was JPY 23 billion, an increase of JPY 26.4 billion year-on-year. On top of the increase in net sales, effective cost management was executed in areas such as marketing investments and expenses adapting to the market's environmental changes. Out of the minus JPY 44.6 billion in extraordinary loss, JPY 42.3 billion is the cost affiliated with the business transformation.

The further breakdown is as follows: the impairment loss and onetime costs from the partial termination of Dolce&Gabbana license was minus JPY 33.9 billion. Other structural reforms was minus JPY 8.4 billion and EMEA's organization plan costs as well as the impairment loss from the withdrawal of the hyaluronic acid business are included. The details are mentioned in the slide, supplemental data 10.

As a result, the net profit attributable to owners of parent was minus JPY 17.3 billion. Yet as for the existing business base results, excluding the business transformation impact was positive JPY 24.6 billion.

Next, please look at Page 5. This is the year-on-year net sales. As you can see, compared to last year, we are capturing solid growth. Of course, the recovery from COVID-19 impact last year affect an increase, but Q2 marked a big growth in net sales, that for China and EMEA, the sales were positive even compared to 2019. The net sales of overseas business for the first half, excluding Japan, was positive 29% on FX-neutral basis. And even versus 2019, it was positive 6%, showing acceleration in growth.

Next is the performance by brand. Globally, skin beauty brands such as Shiseido and Clé de Peau Beauté captured strong momentum. On top of that, due to the COVID vaccination in EMEA and Americas, we were able to capture the demand recoveries in makeup and fragrance markets contributing to positive growth for brands in these markets.

Next is Page 7 about the Japan business. For the Japan market, the intermittent states of emergency from January to June resulted in continuation of difficult situation with low traffic. As a result, the local market was a little short of last year. For April to June period, we had a low single-digit growth with market recovery compared to last year when the retail stores such as department stores were closed during the same period.

By category, skin care is performing strong and sun care that had a big decline last year showed recovery as people started to be more active. On the other hand, both the base makeup and point makeup markets continues to be on a declining trend.

Within such environment, we are recovering in terms of total market share for the first half, especially for skin care and sun care as these markets are recovering, brands such as HAKU, with the strong selling renewed beauty serum and ANESSA with limited edition Pokémon collaboration products are contributing to the market share recovery. Furthermore, base makeup that responded quickly to consumer needs, such as base makeup that won't get on masks or tone-based amidst the mask-wearing lifestyle are expanding share as well.

E-commerce continues to grow. Along with the live commerce we started last year, we expanded the beauty consultant online counseling in all the department store counters from end of March, gaining great feedback from consumers. We launched a new omnichannel campaign from end of June called, Fun! Fun! BEAUTY. With online, off-line area and working together with our business partners, the contents reached an audience of over 80,000 people in just about 2 weeks since the start.

Next is Page 8, the China business. The China market had already started to recover from the COVID impact last April to June period, and the intense competition continues. On this such environment, we have been continuing to capture strong growth online and off-line and accelerating the growth even compared to 2019.

As the scale of online events continue to grow throughout the market, we have made strong strategic investments into limited products and scaling out the live commerce events. Due to these efforts, we were able to achieve an increase of over 60% growth versus last year in the 618 promotion event. The rankings of the main prestige brands improved, proving fruit of the proactive marketing activities, allowing the company to expand its market share.

Next is Page 9, the other regions. The restrictions differ by country and region in the Asia Pacific, but Taiwan, South Korea, Thailand and Vietnam, which are regions that cover a big portion of our sales have experienced rapid increase in COVID cases, resulting in slower traffic due to restriction measures.

Under such circumstance, we launched 16 e-stores in the major EC platforms of these countries and regions in the first half of the year, accelerating the EC rollouts for growth. Travel Retail continues to grow in Asia, driven by Hainan. Travel Retail and EMEA and Americas are starting to recover versus last year as some of the travels are resuming due to vaccination, but there continues to be delays in recovery in areas such as Japan. In the Americas, although there may be influences from the rebound impact due to suspension of logistics centers last year from or retailers stocking up inventory as the forecast market recovery, overall the momentum is improving in all categories.

The sales of Drunk Elephant in the Americas declined due to the rebound from rapid EC sales expansion last year. The brand was able to offset that by strengthening the rollout globally. As a result, Drunk Elephant's overall sales on shipment basis was equivalent to last year's level. And going forward, we will continue to enforce activities in Americas and further expand global rollouts. The skin care share continued to expand in EMEA as well as the EC accelerating its growth.

Next, Page 10 shows a trend of the cost of goods sold ratio. On a year-on-year basis, the COGS ratio went up by 0.5 points in the first half. But excluding the impact of reclassification of COVID-19 related cost to extraordinary losses last year and negative FX impact on elimination of unrealized profit due to yen depreciation, it actually improved.

As well investment to new factories, the in-house manufacturing ratio is expanding due to increase of utilization as planned and productivity is improving gradually. Also due to lower inventory write-offs as a result of inventory control, the COGS ratio shows an improving trend after hitting the peak in Q3 of 2020, as shown in the graph.

Next, Page 11, on the cost structure. SG&A ratio decreased 9.2 points like-for-like, excluding the impact of reclassification of the COVID-19 related cost to extraordinary losses in the previous year, due mainly to sales recovery, higher marketing investment efficiency owing to an increase of digital medium -- digital media mix as well as thorough cost management. While marketing investment is enhanced in China, cross-border marketing is pursued with both regions, China and Travel Retail working closely so that Travel Retail also bears a ripple effect. We will continue strict cost management in line with market changes.

Next, Page 12, on the operating profit. Operating profit in China decreased by JPY 7.6 billion year-on-year. But excluding the impact from intercompany transaction prices, like-for-like operating profit margin improved year-on-year. On the other hand, there are positive impacts in other segments that have brand holder functions. There is an analysis of operating profit for the Americas and EMEA on the next page.

EMEA in the first half, nearly achieved breakeven, which is a highlight in view of profitability improvement going forward. Now on the Americas and EMEA, losses contracted substantially in both regions due mainly to commercial-based profitability improvement and fixed cost reductions through organizational and structural reforms. 70% Of JPY 26.4 billion year-on-year improvement in OP in the first half is attributable to those 2 regions, making a big contribution to improving the group-wide earnings foundation.

In the Americas, commercial base margin improved dramatically, thanks to higher sales and lower fixed costs due to counter reductions for Bare Escentuals started from last year as well as organizational and structural reforms. Profitability improved substantially in EMEA thanks to higher sales, improved commercial base margin due to higher cost efficiency as a result of organizational reforms and lower amortization of Dolce&Gabbana trademark. Given that the first half momentum continues, breakeven on a full year basis might well be achieved in EMEA.

Please turn to Page 14 on digital transformation. E-commerce sales ratio and its growth rates are expanding due to enhanced rollout of the e-commerce sites, digital promotions as well as live commerce conducted proactively across various brands and regions. Consumer engagement is also stepped up by strengthening digital CRM and improving data platforms. Furthermore, in addition to internal digital economy, Shiseido Interactive Beauty is accelerating DX by incorporating external know-how and insight from Accenture to enhance digital capability to drive digital transformation.

Next on Page 15. While investment for future growth is increased, such as capital expenditure for equipment at new factories in Japan and system investment, cash is generated through sale of idle assets and strategic shareholdings as well as inventory reduction. As a result, free cash flow was positive JPY 16.4 billion, recording the first half positive figure for the first time in 3 years.

As shown in the table on the right, inventory, which was built up to hit the peak in the second quarter last year has been reduced as planned. Inventory at the end of June this year is actually lower than what's reported in the table, as it includes approximately JPY 5 billion FX impact.

In the third quarter, there is a cash in associated with the transfer of the Personal Care business and the free cash flow for this fiscal year is forecast to be around JPY 100 billion. Cash and debt are at healthy levels, realizing stable financial base.

Now on Page 16, let me elaborate on strategic actions for the second half. We will enhance the business foundation for growth ahead of recovery from COVID-19. First of all, we are committed to completing global transformation within 2021. We will continue investment in key areas, including skin beauty, new brands, innovations and China. Actions for new Shiseido Ultimune, Second Skin and Drunk Elephant will be explained in the next slide.

Regarding business development in new areas in China, as announced in the press release issued today, we agreed to establish a fund with the Chinese investment firm, Boyu Capital for strategic investment into startups into China. The fund will explore to invest money injected by Shiseido into local emerging brands in beauty and wellness as well as in related technology companies such as e-commerce services and consumer experience technology. We are aiming at launching the fund by the end of this year. We will also continue to drive digital transformation as one of the major strategies of WIN 2023.

Moving on to Page 17. In July, the brand, Shiseido's symbolic serum, Ultimune, was renewed and relaunched in Japan, China and other countries and regions in Asia, which will be followed by successive rollout globally. It's the third renewal, and with innovative technology, in addition to enhancing skin immunity, it also approaches the bloodstream to boost up the power of skin from within.

Next on Second Skin. After 3 years of research since the acquisition of patented technology in 2018, it's slated for launch in October. Incorporating the brand's proprietary technology, the Second Skin will offer new experiences. Drunk Elephant, which is being rolled out globally will also be launched in Japan in October. Further rollouts and schedule in Asia Pacific, such as South Korea, Travel Retail and so forth by the end of 2021.

Finally, let me touch on the first half summary and the full year outlook. Both net sales and operating profit were above the plan in the first half. Overall, strong momentum continued globally, and we have made progress with building a solid foundation for generating profit. Global transformation has also been carried out on track. Having said that, it's extremely difficult to predict market outlook due to a variety of factors.

While full-scale recovery of economic activities anticipated aided by vaccination rollout, there are increasing uncertainties, both home and abroad, owing to the spread of COVID-19 variants in different countries, including Japan, where positive cases breaking daily record in Tokyo these days. Therefore, we haven't introduced any changes to the full year outlook announced in May.

At the appropriate timing, we will announce it upon careful assessment of external environment and market trends. Even in such environments, we will continue agile cost management in line with market changes and continue enhanced investment in key areas, aiming at realizing sustainable growth.

I will now hand over to Mr. Uotani to continue the presentation.

[Masahiko Uotani, executive]

Hello, everybody. This is Uotani speaking. Now I would like to talk a little bit about the annual -- the full year outlook.

We're talking about OP of JPY 27 billion for the full year outlook as of May timing, but we had the good results in May. So when you think about the full year impact, of course, we should be reviewing the full year outlook because of the numbers that we weren't able to achieve in the first half.

However, looking at the current situation, just looking at the past week in Japan, the whole situation has been changing significantly. So we figured that for us to come up with an accountable number, we would like to see how things are. So when we say when we are -- talk about the full year outlook, we're not -- we're saying that we're not going to change or that it's going to remain unchanged. We just have not introduced any changes at this time, and we will be announcing it at the appropriate timing.

As for myself, last August, due to this COVID crisis -- based on this COVID crisis, in the next 3 years, I came up with a scenario to recover in the next 3 years, and that has not changed. And so I will be reviewing what I've mentioned before, but I would like to just go for some of the points.

Because this COVID could actually turn into an opportunity, and because when we recover from this situation, we will have a stronger financial basis and have a better -- stronger foundation as a company, build back better. And we have been taking this as an opportunity to drastically review our business.

So within the environment with COVID, we are trying to do the best we can. And it is difficult, but as the vaccination penetrates more and more even in Japan, as we can see in EMEA and Americas for vaccination, maybe -- if with the vaccination towards the end of the year, if it's more under control, we are assuming that we can look at a predictive economy better.

But in any case, I would like to continue to make sure we have the full business structure reform put in place, the business transformation put in place. And with that built and completed this year, we want to fully roll it out next year and try to accelerate. And enhancing the supply chain, the new plants, the new factory, Kyushu, Kurume plant, the third new one that we have recently built, we will be launching soon. And so we will have 3 new plants that will be operating, which would mean that we would have higher efficient manufacturing and supply situation with robotics and AI.

So with that in mind and looking at the COVID environment that we are building our business, but we would like to do a full rollout of the business recovery next year. And then from next year, we will focus on the skincare. The skincare ratio, we wanted to be 80% and e-commerce to be over 35%, and the productivity to double.

And as we look for 2030, the Personal Care business, we would like to fully start to work on the 2030 vision. At the same time, the long-term investment for our supply network, the innovation, especially related to sustainability, the innovation related to sustainability, that is something that we would like to really work closely on going forward.

And FOCUS, we're on track. FOCUS is a really big project. It's integrating the global platform system. So there's a lot of investments and a lot of work that's been put in place that we are planning to complete in 2023. And people -- to have our good people plan, we would like to do that, too.

The next slide is just about the global transformation. This is a chart that we've shown you before, and you've seen this chart many, many times. The message is very simple. We are on track. What we have planned, we are executing, and we are on track to execute and complete.

That is it with myself. Thank you.

[Operator]

[Operator Instructions] The first question comes from Hirozumi-san of Daiwa Securities.

[Katsuro Hirozumi, analyst]

This is Hirozumi from Daiwa Securities. I have 1 question. In the first half, you beat the plan. By how much you exceeded your sales and OP forecast?

[Takayuki Yokota, executive]

So I'll be providing an answer to your question. Thank you very much. Including the FX impact, approximately JPY 10 billion or so or slightly less, we had exceeded the plan. Japan business, we struggled, but the Americas with the progress of vaccination and also in the EMEA and Travel Retail centered on Hainan and Asia Pacific offset the downside recorded in Japan and exceeded the sales forecast, including the FX impact. Americas, EMEA and Travel Retail top line grew, and as a result, OP also beat our internal forecast.

[Katsuro Hirozumi, analyst]

The sales exceeded JPY 10 billion. By how much OP exceeded your internal forecast?

[Takayuki Yokota, executive]

OP exceeded more than JPY 5 billion against the plan.

[Katsuro Hirozumi, analyst]

So JPY 10 billion and JPY 5 billion above the forecast correct, respectively? Or slightly more?

[Masahiko Uotani, executive]

Our forecast is JPY 27 billion for OP.

[Katsuro Hirozumi, analyst]

So JPY 10 billion and JPY 8 billion exceeded the plan for sales and OP, correct?

[Masahiko Uotani, executive]

Yes.

[Operator]

Next question, CLSA, Oliver-san.

[Oliver Matthew, analyst]

Question related to China. Like-for-like was plus 29% year-on-year. The Prestige, what was the growth of Prestige? And the -- can you -- can I get a comment about the growth of China in the future?

[Masahiko Uotani, executive]

Oliver, with great knowledge about China, we got a great question on China. So please wait, we are checking some of the numbers.

[Takayuki Yokota, executive]

For China Prestige, plus 40%, a little -- exceeded 40%.

[Masahiko Uotani, executive]

And as you saw in the graph that we showed you earlier, you should have seen that the Prestige ratio is growing. And Personal Care will be leading this. So therefore, the ratio of Prestige will grow even more.

And Premium. Premium, we call it Cosmetic Premium, it's like a semi-prestige area in China market. So we don't do a low-price mass, as you know, in China. So looking at China in the future, of course, there's many different market research, but the premium and mid-tier to above-premium in China consumers that should grow more. So we would like to concentrate our portfolio more. There's more potential for that. So I believe that, of course, looking at the market situation, I think there's an opportunity that can synergize with that and have a lot more room for growth.

[Operator]

Moving on to the next question from UBS, Kawamoto-san, please.

[Hisae Kawamoto, analyst]

I have a question regarding the Q2, a big improvement in Japan. Looking at your materials, sales were down, but profit went up by JPY 4.4 billion. And there was an impact from the reclassification of COVID-19 related cost to extraordinary losses. So that means that the profit improved substantially. And the inbound also improved. It seems that some travelers are back to Japan, and I'd like to know the background for the increase in profit in Japan in the second quarter, especially.

[Takayuki Yokota, executive]

Japan business for the first half, JPY 9.2 billion and 5.4% OP margin. And external sales were down minus 1% in the first half. On the other hand, cross-border EC export to China and intercompany transaction increased by 41%. And we are working on to reduce inventory level. And there was lower inventory write-offs and fixed cost decreased. And the Japanese team is working on those measures very hard.

And as for marketing investment, even under a difficult condition by digital shift, we have seen improved ROI and we have reduced the actual marketing investment in terms of the yen terms. And we are working on to establish a foundation for digital transformation with Accenture. And as a result, we have achieved improvement in profit in Japan as a whole.

So intercompany transaction to other regions have pushed up the profit in Japan, but also there was a lower inventory write-offs and fixed cost reductions. And in reality, on a like-for-like basis, OP in Japan was almost on par with last year.

[Masahiko Uotani, executive]

Let me add 2 points from my side. As Yokota-san mentioned also, in the second half last year, Japan business started the inventory reduction actions and also including inventory reductions in distribution channel. That, I think, yielded good results.

And also in the second quarter of this year, under the concept of promoting skin beauty, there have been important initiatives: firstly, the renewal of HAKU, which is very successful; and secondly, ANESSA last year, there was a bad weather impact and so on. But this year, we are seeing more people going out and ANESSA has been growing substantially this year.

So skin care products grew. Also in the front line, we are developing consumer continue to use our products. Even though Japan faces population decline, of course, we need to cultivate new users and new consumers. But also, it's important to improve loyalty among consumers. And we are working on those measures very hard, and digital plays an important role here.

And all these reforms, which we started last year have yielded results. And Tadakawa-san now is the President for the Japan business, and he served as CFO for 5 years. And he's closely monitoring sales and profitability very strictly. And that's also helping to improve profitability in Japan business.

[Hisae Kawamoto, analyst]

Can you also comment on the inbound business, the growth of 30% of inbound?

[Takayuki Yokota, executive]

Due to the timing of the point reward, we had seen some concentration. Actually, in the first half, it was minus 65 against versus 2019. So the basic trend has not really changed.

[Masahiko Uotani, executive]

Considering the FX, the inbound compared to last year might get slightly better. And because of COVID, we haven't seen troubles fully resumed between Japan and China, so we shouldn't be that optimistic.

[Operator]

Next question from Mizuho, Saji-san.

[Hiroshi Saji, analyst]

I have a question about Q2 China. I want to confirm with you about something in Q2. Page 25, Q2, including the brand holder cost, it's not so bad with the explanation. So on the surface, when you look at China alone, it could be difficult. But when you think of all the other things, it doesn't mean the margin is not going down, so that was the explanation.

But the profitability itself, I would like a comment on that. And including live commerce, it is becoming more competitive. The intense competition is continuing. So there might be margin pressure in certain area of China. So how do you view this China market?

[Takayuki Yokota, executive]

Due to our system -- accounting system, our global brand holder is in Japan, the headquarters. From there, we export and China as a business will sell. That's the business model that we have within our company. So therefore, the transfer price, we do have the pricing based on the -- based on the transfer price. And based on that, we split the profit. That's kind of the business model we have.

And to that, when we look at the Chinese business -- China business, it looks like the profitability is going down. But based on the accounting that we manage, the profitability is actually going up. So therefore, the sales -- net sales and profit is actually going up in China.

But to your point, the marketing cost that we would need to put in to win in this intense competition in China, we are increasing our marketing investment. But especially the cosmetic brands, we've been closing some of the negative performing stores in the cosmetic and shifting more to online. And as a result, we are lowering the fixed cost as well. In result, we are absorbing the marketing cost increase, and that has contributed to the OP margin to go up. And that's really what happened in the first half of China. The number you see here doesn't tell the whole story, so if you can kind of dismiss that.

[Masahiko Uotani, executive]

Two more things I would like to add to that. One, so true within this COVID environment from last year, the competition has become more fierce, especially e-commerce. The e-commerce ratio is so high, especially in China. When you look at the top 5, we are in the top 5, but it is more the Europe and American brands. And as you know, Europe and American market have struggled a lot due to COVID. So I think China market was the only market that we had -- we brands have had and companies had hopes for.

And so the companies that had money went right into China to -- and invested in it. That's how the competition got even more intense. And we do think that, but we do have to go into it. We need to fight to get the share and to realistically expanded our share, our market share. Especially in terms of e-commerce, we've done many promotions sampling. Yes, we've invested a lot into that. But as a result, it's the competition, and that's led to the growth in share. So we're trying to build a strong platform for the future.

The second point I wanted to mention is for Shiseido. There's the China Mainland in Travel Retail and Hainan. It's a different P&L. It's a different organization. Well, some are overlapping company and then there's Japan. So especially for our Shiseido, the inbound tourism, the people that come to travel to Japan or go to Hainan, what kind of behaviors do they do? These people will learn about the brand when they're home in China Mainland and purchase when they travel overseas, whether to Japan or to Hainan islands.

So the organization P&L in China, the marketing cost is expanding, but the impact is captured, of course, within China Mainland, but also within Travel Retail with Hainan Islands. And as you know, Travel Retail has very high sales. And we don't have it right now, but this will lead to purchasing in Japan as well.

So these 3 are actually combined or put together. Well, if we could, we would combine it to really see the sales of China. However, due to how it is, it's split. But so with that in mind, maybe for next year as well, we will invest more in China. And -- but the fruit or the sales will -- could be captured through a Travel Retail in Japan. So we're thinking to switch our mentality from that kind of thinking.

[Hiroshi Saji, analyst]

These 3 affiliated businesses in China compared to 6 months ago, do you feel more confident about the business in the China-related business? Or are you more concerned?

[Masahiko Uotani, executive]

Wait, which concern?

[Hiroshi Saji, analyst]

So China business overall, including -- so China business overall Mainland and Travel Retail in Japan, are you more concerned or confident?

[Masahiko Uotani, executive]

I think this kind of leads to what we mentioned in Oliver's question earlier, but especially the Prestige category, we're very strong. We're very confident. We're growing our confidence. At the same time, because the past growth was so rapid and high and the major EC players -- with collaboration and partnership with the EC players, we were able to grow significantly.

We don't think that growth rate or speed will continue infinitely. And there will be -- so then there will also be maybe diversification of channels and changes in EC. So we need to make sure we're always adapting into the change. So we do have that kind of humble concern with us always to make sure we're catching up to the market.

[Operator]

Next question, Morgan Stanley, Miyake-san.

[Haruka Miyake, analyst]

This is Miyake from Morgan Stanley. I have a question regarding China and Travel Retail. First, regarding China. Prestige continues good momentum. And in Q1, Q2, looking at CAGR, Prestige grew 35%. It's steady, but I think that you could have grown bigger. What's your comment on that?

And as for Travel Retail, last year, in Q2, revenue was down by 30%. But in the first half of this year, it was up 20% or so. So I think it was not really strong. So could I have a comment regarding China and Travel Retail? For both regions, margin improved, but by what points -- percentage points has margin improved for both regions?

[Takayuki Yokota, executive]

I think there were 3 questions or so. The first question was regarding Prestige. Prestige could have grown faster, correct? Linking back to Oliver's question, it grew over 40%. We have won market share. So we competed on par with global peers in my view. So Prestige grew over 40%, which we think is a good figure or encouraging figure. Of course, it's better if we grow faster, but I think it was satisfactory.

[Masahiko Uotani, executive]

Hong Kong was down. Maybe your question factored in the underperformance in Hong Kong.

[Haruka Miyake, analyst]

Well, I'm looking at the number for Mainland China.

[Masahiko Uotani, executive]

Well, I think that our Prestige grew over 35%, but let us check into it. Hong Kong is recovering quite substantially, and Prestige grows, as I mentioned earlier. We have seen market share gains for all the brands. And I think that we have been performing quite well in our prestige brands and our presence has improved. But I will give your comment or give the feedback to Fujiwara-san.

[Haruka Miyake, analyst]

What about your comments on Travel Retail?

[Masahiko Uotani, executive]

Travel Retail consumers who used to visit Japan should be buying in China or through Travel Retail. And in Hainan, we have many numbers of counters, and we are being very proactive and aggressive in Hainan. And compared to other companies, we're competing on par. The [ sole ] is down more recently. However, TR Asia as a whole, our growth rate is not low in my view. If we include travel -- if we consider Travel Retail in Western countries, it looks lower. But in Travel Retail Asia, I think that we are growing quite steadily.

[Haruka Miyake, analyst]

I thought that there was a rebound in Western countries for Travel Retail?

[Masahiko Uotani, executive]

Well, we are not actually seeing a rebound in Western countries through Travel Retail. Travel Retail U.S. is overseas. Even though domestic travel is recovering, but we're not seeing recovery of foreign travels. Duty-free store is targeting foreign travelers.

[Haruka Miyake, analyst]

In Q1, Travel Retail outside of Asia existed, but we're not -- we don't see that this year. In Q2, last year already, Japan, the U.S., we didn't have sales. So Asia's growth should be more outstanding in Q2 compared to Q1, I think.

[Masahiko Uotani, executive]

Well, Travel Retail's driver is the Chinese consumers. And within China, consumption in China and consumption in Hainan which is regarded as Travel Retail, and those are expanding. But other areas, Chinese consumers are not traveling. They can't come back to Japan, and they haven't traveled to or other Asian countries.

So TR Japan, for instance, unfortunately, is down 90% year-on-year. So all in all, we have to consider all the aspects, all parts of the world through Travel Retail. There are more bases in Asia like Japan, Singapore, Hong Kong, et cetera, for Travel Retail. And we are expanding those bases in Travel Retail. But we are -- unfortunately, we have not seen the recovery as yet.

[Haruka Miyake, analyst]

So within China, the demand momentum is quite strong for Prestige. But without troubled demand, you can't really capture the full demand, is that the real picture? But if the Travel Demand comes back, the demand in China should accelerate further, correct?

[Masahiko Uotani, executive]

Yes, 120 million people, Chinese consumers traveled in the past. So the impact is quite huge.

[Haruka Miyake, analyst]

Finally, the margin for Travel Retail and China, by how many points did margin improve?

[Takayuki Yokota, executive]

In China, it improved by 1 percentage point.

[Haruka Miyake, analyst]

What about Travel Retail?

[Takayuki Yokota, executive]

About 5 points improvement. Those are for first half numbers -- improvements for the first half.

[Operator]

Next, Citigroup, Miura-san.

[Nobuyoshi Miura, analyst]

This is Miura from Citigroup. First question, as a request or a proposal, sales went up by 900 extraordinary loss and profit impact was last year. So if you think about that, the profit return -- the profit has returned about 50%. So the ROI to the sales is heightening. So if you can appeal that in numbers. That's the 1 thing -- first thing I would like to mention. If you have any comments to that, please do.

But second point, I understand that a lot of things are going on track. And looking at your scheduled time line, I understand that you're on track with the schedule. But what we need to think about here is there are new things that arise that are unseen. So it's becoming -- and then it could be a risk that -- looking at the China platform, to just depend on that, it's a little bit risky. And looking at the domestic market, COVID-19, I mean, to be honest, I don't think anybody can predict what's going to happen with COVID-19 in Japan.

So there's a lot of things that's unknown. And I'm sure as a result, there are new concerns and new challenges. So to Uotani-san, rather than hearing about the progress of what's already in schedule, I'm sure you already have new ideas of -- even with this risk, we're going to have to do this. Would you be able to share with us what's on your mind about how to combat the potential risks in the future?

[Masahiko Uotani, executive]

Thank you. First of all, for the first point, you've given us advice.

[Takayuki Yokota, executive]

It's hard to explain. But in principle, we've said -- we disclosed JPY 26 billion increase of profit. And last year, with the COVID extraordinary losses of about JPY 16 billion, and there's about impact of JPY 3 billion for this year as well. So when we net that, it's about JPY 13 billion. So it's about JPY 13 billion plus JPY 26 billion, meaning about JPY 40 billion is the actual improvement amount.

[Masahiko Uotani, executive]

And well, Miura-san, is saying you should appeal that more. You should talk about it more and advertise it more.

[Takayuki Yokota, executive]

Okay. Thank you. Maybe for next earnings call.

[Masahiko Uotani, executive]

We tend to be very humble. So with that -- so this links to your second comment, just like what you have said, Miura-san, when you look at just the first half, we are improving much better than planned. But like you said, there's a lot of uncertainties in the future, and there's new challenges that we may see.

And in terms of China -- and then China is having COVID spread once again, too. But even excluding COVID, China market has rapid change all the time. The platformers, us included, were able to grow. So we've been able to grow with the China market, but it's been diversifying again. So it used to be the one giant platform, but we can't grow just with that, it's diversifying. So we need to adapt to that.

And when we look at the consumers, too, May, June, I had investor meeting with some of the Western countries. And a lot of the questions we got was China local cosmetic manufacturers are growing was kind of the questions and comments that we got in the investor visit in May, June. And that's to the Generation Z, the changes of the Generation Z. I mean this generation, since they were born, the China economy was always good.

It's kind of the same in Japan. Post-World War, a lot of the importation happened, and all the industry grew, and we flourished. And I think similar to that -- and that's why we have decided to do this fund with the China Boyu Fund, to do the Shiseido Beauty Innovations Fund. But it was from the brand, the channel, as a company perspective with various meanings that we want to keep up to date with the China market.

And all these changes are happening and continue to happen, but we need to continue to adapt and change. And that's the obstacles or challenges that we continue to have to do. Of course, so as a result, it's uncertain. But we can't just say all that it's uncertain, and it's risky. We need to look into it, and we need to keep on adapting and changing. And that's why we see China and enhancing our China office as kind of the second headquarter. And even for the Shiseido Beauty Innovations Fund, we've brought in a Chinese member to lead this fund.

So in this way, China will probably continue to change and will always continue to be volatile, but it's including regulations -- authoritative regulations. But that's something we need to adapt to. So if you think of -- if we define that as risk, yes, there's a lot of challenges. But we are building our strength so that we can overcome these changes and adapt to these challenges.

Second point, in terms of Japan domestically, due to what the government is saying, they're saying that by September, about 70% of the Japanese people will be vaccinated, meaning we will hit the herd immunity. But that's a bit -- I'm a bit skeptical of -- well, nobody knows. We don't -- none of us know that. So looking at the Japan business. So how do we forecast the forecast the Japan business? How do we create an outlook for the Japanese outlook?

So that kind of goes back to the point I was mentioning. That's why we would like to -- we haven't introduced any changes at this time. And lunch time, they had the Congress, the Diet meeting. And Nishimura-san, one of the ministries said in Osaka, there was 100 people cluster. And it is true, our sales channels, our department stores, our retailers, we're seeing a lot more of the COVID cases, maybe due to the Delta. I mean the COVID cases are increasing.

So when you look at Japan, it's very uncertain. Nobody knows. It's still growing. And so there's many checklists to go through to look at the forecast. And that is why we haven't introduced any changes at this time for our outlook. And maybe around Q4, we can talk about it. But hopefully, being optimistic -- with hopes to be optimistic, by next spring, we can be -- we can go out, maybe we can travel. Yes, there could be positive cases, but the world is more normalized, and we're hoping that, that would happen in about spring timing of next year.

[Nobuyoshi Miura, analyst]

China diversifying, but rather than deciding that and defining it's this and the risk is that, you -- your thinking is that it's more important to be ready to adapt to any changes and risks and uncertainties.

[Masahiko Uotani, executive]

Whether we're perfect to be able to adapt to anything and everything, that's something that we'll always work on and continue to work on. But we will continue to get the market information, get the people structure and have the digital acceleration and any of the product development power in China and investments or investment fund to start-up companies like the fund we've launched in China. So in these ways, we have come up with many, many measures to be able to adapt to the changes and uncertainties in China.

[Nobuyoshi Miura, analyst]

Lastly, when you -- from Uotani-san's perspective, Estée Lauder and L'Oreal, how would you assess them? How would you evaluate them?

[Masahiko Uotani, executive]

I'm not in any position to mention about these 2 players. The 1 thing I may say is they are global excellent companies, both of them. In terms of profitability and size, as you know, and the speed, they're very speedy, agile. And they're obviously very global with the global talent. And compared to Shiseido, they were adapting more to the global aspect far faster than we did. And from 2016, the things I've been doing in a matrix, I think they started doing that kind of global thinking and global organization mind, it's probably 10 years before I started. So we would like to catch up to them as much as -- as soon as possible. But I see them as great rivals and as maybe 2 companies to kind of benchmark for ourselves as well.

[Operator]

Next question is from Goldman Sachs, Yamaguchi-san.

[Keiko Yamaguchi, analyst]

This is Yamaguchi from Goldman Sachs. I have a question regarding the EMEA and the Americas. The Americas had a distribution problem last year and sales grew this year, and sales also grew in EMEA. I'd like to know the sustainability of the sales growth in those 2 regions.

And also, you said that you are committed to complete global transformation and you transferred the Personal Care business and terminated the -- had the termination of the license with Dolce&Gabbana, but other kind of ideas do you have.

[Masahiko Uotani, executive]

I have -- I would like to confirm your question. I wasn't aware that we had any issue with a distribution center in the U.S.

[Keiko Yamaguchi, analyst]

In Q2, I remember that you had issues with the distribution in the U.S.

[Takayuki Yokota, executive]

No, there was not -- it was the impact from lockdown -- was fully locked down in the U.S. So in the second quarter last year, we couldn't really operate the business. So it was not the issue with the distribution center.

[Masahiko Uotani, executive]

That occurred back in 2014, and that's fully resolved. The Americas and EMEA, looking at April to June quarter, the recovery was bigger than what I expected. Looking at the media report, the vaccination progress and people started going out, not wearing masks and the consumptions are recovering. And the beauty industry have very good affinity with people who go out.

So to be honest, more than what our management expected, performance was better. But in the Americas and EMEA, we are concerned about the Delta variant. But I think that the people are staying calm. And it doesn't seem that there will be further lockdowns or restrictions. So the basic momentum and the basic trend, we think will continue.

Depending on the recovery, NARS are growing and recovering. And the skin care, which we had put effort is also increasing and -- which is helping to improve the earnings foundation in the Americas and EMEA. So that's my view for those 2 regions.

Of course, there are many things that we have to do in terms of structural reform. And there are still many things that we can't disclose as yet. But we made announcement about the Dolce&Gabbana termination of license. It's still continuing. It's still underway. The organizational reform to reduce fixed cost, we already started last year. So this stays from November.

With driving shift from brick-and-mortar to online, we are optimizing our organization in line with those market changes. Dolce&Gabbana, we will actually terminate the license in December, and we will see the benefit afterwards. So the structural reform, organizational reform in the Americas and EMEA, we are starting to see impact. There may be further movements or further efforts in both regions. But in 2023, Yokota-san mentioned that we are expecting to see 5 points or 10 points improvement in those 2 regions. Otherwise, we can't achieve 15% OPM company-wide.

So we have to see improvement in those 2 regions and also in Japan, so the local management is really committed in achieving recovery. And if we have -- when we have clearer views or ideas, we will share with you at the right timing.

[Keiko Yamaguchi, analyst]

Dolce&Gabbana is growing and other brands, I think, are growing. What's the background for the growth in the first half? Is it driven by the Americas and EMEA?

[Masahiko Uotani, executive]

The fragrance market is recovering as more and more people started going out. So the fragrance market is growing. And Dolce&Gabbana and narciso rodriguez, those fragrance brands have achieved growth. And other brands in the others, for instance, NARS are growing very rapidly. The rankings improved in the Americas. And in China, NARs grew over 80% year-on-year. NARS also grew in Japan by 20% year-on-year. The makeup has been very slow from last year, and NARS is making a big contribution under a difficult environment. The brand is very strong. And as people started going out, makeup, I think, is really -- there is a reactivated demand for makeup products. Laura Mercier is also seeing growth. bareMinerals is also growing on a year-on-year basis.

[Keiko Yamaguchi, analyst]

So you're seeing craze coming from various fragrance brands, correct?

[Masahiko Uotani, executive]

Yes.

[Keiko Yamaguchi, analyst]

Amid COVID-19 makeup category really struggled. And although there is a recovery of makeup now, the direction of your transformation will remain unchanged, correct?

[Masahiko Uotani, executive]

Well, skin beauty concept was launched last year and which really penetrated globally including China, the Americas and EMEA, and various marketing initiatives are underway. And there will be impact from the transfer Personal Care business and we are aiming at the skin care ratio of 80% in 2023, which should contribute to improvement of profitability.

And in Ibaraki, Osaka, the full-scale operation will start at factory, and we will incur depreciation cost burden. However, we will see better efficiency in terms of the manufacturing and should have a better impact on COGS. And we can expect to see the positive impact from the new factory operations.

Goldman Sachs has an overweighting on the Japanese stocks. I saw some article. And I hope that investors will draw more attention to the Japanese stocks, including our stock.

[Operator]

It is almost time, so we would like to take 1 last question. From Mitsubishi UFJ Morgan Stanley, Sato-san.

[Wakako Sato, analyst]

First half exceeded the plan. But some of the -- and we've been talking about the extraordinary losses. But by division, what was the plus and minus? I would like some details on that. And with the net sales up by JPY 90 billion, OP up by JPY 40 billion, it seems like OP could have been higher. With the gross margin of 70% and fixed cost declining, the marginal profit margin should be 50%.

So when you think about this, is -- your increase in profit should be more than that. Of course, this year, you're working on a lot of different projects. So that's why you used up a lot of cost. But if you're going to have sales of JPY 100 billion, then it has to go up by JPY 70 billion to achieve maybe JPY 100 billion, but -- to achieve 15% in OPM. So by segment, can you briefly go through what's good, what's working, what's not working? And the 5% -- so next year, 75% to 80% in the margin ratio. Where are you aiming for the numbers?

[Takayuki Yokota, executive]

So by segment, what was good, what was not bad? Is that what you mean? So Japan, the Japan top line did not -- we weren't able to achieve the top line for Japan. So I think that was lower than what we had expected. And what offset the Japan performance was Americas, America with the vaccination penetration and EMEA. And furthermore, Travel Retail, Hainan Island had offset the slowdown in Japan, and we were able to exceed the forecast.

[Wakako Sato, analyst]

China was in line, right?

[Takayuki Yokota, executive]

Yes, China was -- China and Asia was pretty much in line. Yes. Asia was a slight decline, maybe.

[Masahiko Uotani, executive]

So second question, to Sato-san's question, including my interpretation. The cosmetic business. I, myself, have been in many other companies within mass marketing, but this gross margin, 21%, the marginal margin -- 79%, so it's close to 80%. I think that's, first of all, the starting point. So that means that the mix management of business and brands, that's very important.

So for example, Personal Care. The gross margin was somewhere in the 60s. And that's probably the average for mass companies. And then there's the Prestige Premium. And then, of course, there's the personnel cost for the beauty consultants. But how much can we capture there? And the 3 categories, if -- can we heighten the average of the 3 categories, the fragrance, makeup? And we've been working on those, too.

But due to COVID, skincare, beauty, we've been talking about it and we were going to push it for the 3 years. And so for that, we're going to be patient and we want to make sure that skin care, we become a very strong presence. And I think that's very important for our mix.

And by increasing our sales, the average margin will go up. And for those that won't go up, we can divest and then we can lower some of the points to improve. So this overall business transformation that we are planning, the average margin, it's all the lower average margin areas. If we complete that for next year, we could probably see more of a higher-margin brands that will contribute to the company.

And the other element is, as you saw in Yokota-san's presentation earlier, the COGS ratio was about 23% with higher efficiency. And it went up to 27%, and it's starting to go down. And by 2023, we want to aim to achieve about 21%. And we have the new skin care plant, so that should contribute to that.

So I think that is probably the most -- one of the most important things. And of course, the marketing costs. But as the sales is dropping, 29%, I feel, is a bit high; 26% is about the marketing costs that I feel is adequate and appropriate. So from that perspective, the marginal profitability if we can achieve that. So to focus on the Prestige and Premium means to achieve those kind of numbers.

[Wakako Sato, analyst]

Reduction of fixed costs. So the inbound may not come back like it used to because of all these Hainan Island shoppers. So during all these extraordinary profit and loss, I think it's the timing to kind of smuggle that in there, if I may say so. But you may need to work on that. Otherwise, the profitability for Japan, it's probably not going to go back to the level of when the inbound was peaking in Japan. So I was a bit concerned about that.

[Masahiko Uotani, executive]

Well, to that, there's 2 things to say from the ESG perspective, from kind of the ethical perspective. During this COVID pandemic, a lot of people are losing their jobs and social instability, how should we behave and act as a company? I think that's very important as a big company. And second point is to realize what you are saying, Sato-san, we need to make sure we can secure the employment and realize that and achieve what we want with the P&L. And that's what resulted in the divestment of the Personal Care business, for example.

From a Shiseido financial perspective is where we have targets to achieve. Of course, for EMEA and Americas, we're digging further into it. But just like that, like I've mentioned, when it's 2023, the fixed cost ratio, to bring that down, I'm saying I'm going -- we're going to double the productivity. So of course, yes, it's important. But at the same time, how do we resolve these very difficult challenges in the future? And we've been working on these challenges from various ways. And China come up with measures to do the best and to protect the people as well, and that kind of led to the divestment.

So withdrawing or divesting and when we have done all these discussions, I will always think about protecting the employment, protecting our employers and make sure that, that goes on the discussion of the negotiation.

[Operator]

With this, we would like to close the Q&A session. Lastly, I would like to have a word from Uotani-san.

[Masahiko Uotani, executive]

Kitagawa-san has given me some time to make a few comments. Reflecting back the first half of this year, we had combat against the COVID-19. And we have 9,000 beauty consultants in Japan, and they had much anxiety and concerns. And there are positive cases of COVID-19, but we are trying to overcome the current crisis and situation and waiting for customers to come back, and we are doing live streaming and calling consumers to receive orders.

So we are taking various measures amid such difficulties. This is happening not only in Japan, but globally, and we have shared the good spirit to achieve the JPY 23 billion OP in the first half and cash flow has improved as a result of the structural reforms.

For the second half of the year, as discussed, there are uncertainties, and the full year outlook. You might have thought that we could have made up our revisions, and I share the same view, but we need to assess the external environment before we make our new revisions. And also, we have to see the impact from structural reforms before we make revisions to the forecast, and I appreciate your understanding.

What's important here is that we are doing structural reform and also making investment for future growth. And we will continue those efforts amid difficulties, so that we can achieve the full-scale recovery next year onwards.

And I would appreciate your understanding and continuous support. Thank you very much for your time today.

[Operator]

Thank you very much, everyone, for joining. We will now close the earnings call.

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