Kao's Big Profit Miss Disappointing; Awaiting Signs of Improved Execution and Turnaround

Wide-moat Kao’s fourth-quarter results were again disappointing, with sales up 6.4% while core business profit was down more than 15% year over year, due to a 57% plunge in chemical profits and higher-than-expected costs. While the new measures, including withdrawal of low-return businesses and a pivot on domestic price hike strategies, sound encouraging, management’s ability to execute remains a key concern. Management has taken a cautious stance on the earnings outlook, guiding for a mere 9% growth in 2023 operating profits, as it views the commitment to achieving the guidance as the most crucial step to restore the market’s confidence in Kao after it missed profit targets for four years in a row. We have slashed our profit forecasts for 2023 and 2024 by 14%-18% to reflect sizable cost inflation in inorganic and packaging materials in 2023 and lowed our fair value estimate accordingly to JPY 7,800 from JPY 8,100. Despite a handsome upside to our intrinsic value, investors may feel less comfortable owning the name until there are signs that management starts delivering results. We consider the guidance conservative, and our operating profit estimate is 13% above the guidance.