Company Reports

Wide-moat Kao’s robust profit rebound, with first-quarter core operating profits having nearly tripled, gives us confidence that Kao is on track to rebuild its margins and poised to beat its profit guidance. Despite the restructuring impacts and China headwinds, solid domestic recovery fueled margin expansion and profit growth. The results echo our thesis that Kao’s margins would leap after price hike benefits fully kick in while cost inflation eases. The volume growth achieved amid price increases in Japan also substantiates its moat underpinned by brand equity and research and development capabilities. We have fine-tuned our foreign exchange assumptions and marginally lift our fair value estimate to JPY 7,600 from JPY 7,500 to reflect increased time value of money. Our projection that core operating profits will exceed the pre-covid peak level in 2026, a year before management’s new target, remains intact. We continue to view shares, trading at 12% discount to the intrinsic value, as undervalued. Our operating profit for 2024 is 7% above guidance.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent of product/service offerings to predict success. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

Wide-moat Kao’s JPY 5 billion shortfall in fourth-quarter business profits is worse than our forecast, although we had expected a profit miss as a demand slump dragged China’s cosmetics sales. While the result looks somewhat disappointing at first sight, profits were depressed by a boost of marketing investment and brand rationalization of the cosmetics business. On the other hand, we are encouraged by the fact that price hike benefits continued to progress while volume turned positive during the quarter.

Wide-moat Kao’s robust profit rebound boosts our confidence in its ability to restore margins and profitability. Third-quarter sales fell 1.6% (currency-neutral 3.9% decline) while core business profits soared 53%, thanks to expanded price-hike benefits and eased cost pressure. We are particularly encouraged by sizable margin improvement of the fabric and homecare business, Kao’s cash cow, as well as progress in price hikes. It appears that business profits are JPY 5 billion or 8% above its nine-month internal target. We have maintained our forecasts and fair value estimate of JPY 7,500. Kao remains our top pick of the Japan consumer sector, and we continue to view Kao’s shares as undervalued, indicating 41% upside from the close of Nov. 8.

We think wide-moat Kao’s renewed midterm targets for cosmetics and skincare are viable. Kao’s pivot of its cosmetics growth strategies and commitment to doubling down on the suncare growth echo our thesis that recovery of cosmetics sales and margins will boost Kao’s profits, while suncare is an area where Kao stands a good chance to succeed overseas. We have made no changes in our forecasts and continue to view Kao’s shares, trading at 25% discount to our fair value estimate of JPY 7,500, as undervalued, While we are positive about its recent developments, including rising pricing benefits in Japan and restructuring endeavors, China remains a key swing factor to the near-term profit outlook.

We were dismayed with wide-moat Kao’s downward revisions after we initially took in its earnings, but were encouraged by second-quarter performance after taking a detailed look. The good progress made on the domestic price hikes during the quarter indicate that profits (excluding charges) might have hit bottom, instilling confidence in its ability to return to a growth trajectory. The successful price hikes in Japan demonstrate its moat, underpinned by brand equity and R&D capabilities. We have reduced our fair value estimate to JPY 7,500 from JPY 7,800 after factoring the JPY 60 billion restructuring impacts, but maintained our view that core operating profits will exceed pre-COVID-19 peak levels in 2026, a year before management’s new target. We continue to view shares attractive and would take correction on profit downward revision as opportunities to accumulate shares.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent of product/service offerings to predict success. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

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.

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.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent of product/service offerings to predict success. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

Wide-moat Kao posted mixed third-quarter results. Profits fell short of our expectations as unfavourable product mix in beauty and healthcare sales appears to have led to widened margin contraction. Conversely, the domestic toiletry sales, and in particular the moaty laundry detergent category, continued to improve quarter on quarter. While management has maintained its full-year profit guidance, hoping that accelerated domestic growth momentum and greater price hike benefits will help it catch up during the fourth quarter, we think the gap is too large to close.

Wide-moat Kao’s reduction in 2022 profit guidance (but with dividends maintained) was widely expected by the market and Morningstar, although we had expected the sharp correction in palm kernel oil prices would alleviate the impact of cost inflation. The dreadful second-quarter results, with sales up 9.2% (up 3.7% on a currency-neutral basis) and core operating profits down 26%, were no surprise, given skyrocketing commodity prices and China’s lockdowns. We focus on the progress made by the underlying businesses on the back of strategic pivots and price hikes rather than the near-term cost pressure and profit outlook. We are encouraged by improved market share in several key product categories despite marginal contribution to profits. While our intrinsic value implies 41% upside, execution will remain the main concern of investors who may not feel comfortable owning the name until management starts delivering results.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent of product/service offerings to predict success. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

It is no surprise that wide-moat Kao’s first-quarter result was ugly, with sales up 8.2% (like for like up 4.8%) and operating profits plunging 25% year on year, despite a low comparison hurdle. Contrary to our expectation that management would revise down full-year guidance, the result appears ahead of its internal target. Timing of the JPY 50 billion share buyback announcement also came earlier than we had expected. Benefits of price hikes are likely to kick in from the second quarter although the measures seem insufficient to cushion further cost pressures. We have maintained our forecasts and fair value estimate of JPY 8,100, implying a handsome 35% upside. Whether Kao will be able to meet its profit guidance hinges on the success of price hikes and recovery of cosmetics demand in addition to commodity price trends. We find the cost increase is too large to be absorbed through price hikes and cost-reduction measures over the short term. Our operating profit for 2022 is 6% below guidance.

We have reduced wide-moat Kao’s fair value estimate to JPY 8,100 from JPY 8,500 to reflect the commodity cost surge through 2022 as commodity prices, further elevated by Russia’s war in Ukraine, show no signs of trend reversal. We anticipate that Kao will reduce its profit guidance at the first-quarter result announcement scheduled for mid-May. It is no doubt that current inflation headwinds will hit Kao’s bottom line hard, likely through the rest of year, unless the ongoing geopolitical tensions are greatly eased. Yet, price hikes triggered by the current hardship could turn into margin expansion opportunities when the commodity price trends reverse. Despite near-term cost pressure, we continue to view Kao’s valuations attractive, trading at a handsome 55% upside to our new intrinsic value.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent and little detail in product/service offerings. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the China baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

Wide-moat Kao’s fourth-quarter result is disappointing, but a concrete plan presented by the CEO on measures to reinvigorate growth is encouraging. While we had expected profits to fall short of its full-year guidance, the 15% shortfall (excluding a JPY 7 billion impairment) in operating profits is much wider than our expectation of a mid-single-digit miss. Kao will take price actions on selected products from March although cost inflation will remain a drag on profits into 2022. Management guides 5% growth in the top line and more than an 11% increase in operating profits for 2022, anticipating a gradual recovery in cosmetics sales and double-digit growth in Asia to lift growth.

We are reducing wide-moat Kao’s profit estimates by 2%-8% from 2022 and onward to reflect cost headwinds stemming from a steep escalation of palm kernel oil prices as well as delay in demand recovery caused by the omicron variant surge. Despite a profit cut and expectation of slow profit recovery in 2022, we expect Kao’s moat, underpinned by its research and development capability, coupled with restructuring efforts, will enable it to regain growth momentum from 2023. Our new fair value estimate of JPY 8,500, lowered from JPY 8,700, presents a handsome 45% upside from the current share price. We suggest investors take near-term profit weakness as opportunities to build a long-term position. The precision healthcare to which we have factored in modest profit contribution is a free embedded option if the business takes off.

Kao has laid out a long-term plan to guide its growth through 2030, aimed at heightening its global presence and achieving JPY 2.5 trillion in sales with a 16% profit margin. The top-line target, implying 6.1% CAGR through 2030, looks challenging. Prospects of the newly established precision healthcare business look uncertain, given no precedent and little detail in product/service offerings. In contrast, the margin goal seems viable, given room to boost profitability of cosmetics and restore growth trajectory as well as margins of the China baby diaper business. Its innovation endeavors and growth outlook of China and precision healthcare will play crucial roles in accelerating group growth, in our view.

Wide-moat Kao posted mixed third-quarter results. The profit weakness spotted in the household and toiletry categories, in part caused by greater-than-expected cost inflation, was a key negative while its outperformance in the cosmetics segment was a positive surprise. As expected, the coronavirus surge in Japan and Southeast Asia, apart from cost inflation, was a key drag on third-quarter performance with sales up 2.3% year on year but operating profits down 16.5%. We have reduced our profit forecasts for mainly 2021 and 2022 by around 5% to reflect higher costs, JPY 4 billion or 50% above 2021 guidance. Despite the profit shortfall, we remain positive about Kao’s progress in brand reorganization and operation restructuring of consumer products including cosmetics and thus its long-term outlook. A strong rebound in its market share of the bathtub cleaner category, followed by the launch of value-added products (Airjet), again demonstrates Kao’s research and development capability, a key moat source behind our wide moat rating. While cost inflation and the coronavirus might continue to weigh on Kao’s profits into 2022, we expect double-digit growth once these external negatives dissipate. Our profit adjustments are largely offset by increased time value of money, leaving an immaterial impact on our fair value estimate of JPY 8,700, implying a handsome 33% upside to the current share price.