Kao Earnings: Profit Dive Caused by Inventory Adjustment and Slow Demand but Worst Might Have Passed

Wide-moat Kao’s profit plunge in the first quarter was worse than our expectation, in part due to negative inventory movement of cosmetics and increased household stockpiling in Japan. Despite the ugly results, there are a couple of positive developments including a step-up of price hike endeavors and a strong start of new product launches. We have lowered our profit forecasts, mainly for 2023, by 12% to reflect the unexpected restructuring impacts of the cosmetics business. The adjustment is largely offset by increased time value of money, leaving an immaterial impact on our fair value estimate of JPY 7,800. The robust performance of recent product launches instills some confidence in new management that we anticipate Kao’s moat underpinned by its brand equity and product development capabilities will allow it to restore margins and return to a growth trajectory. We continue to view shares as undervalued, indicating 47% upside to our intrinsic value.