Kao Earnings: Profits Hit Bottom as Price Hikes Take Effect; Large-Scale Restructuring on the Way

We were dismayed with wide-moat Kao’s 4452 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.

Second-quarter results, with sales up nearly 1% (1% decline currency neutral) year on year and core operating profits down 14%, were better than its guidance. The consumer product business has showed signs of improvement. The price hike benefits (excluding cosmetics) advanced to JPY 8 billion from JPY 5 billion achieved in the previous quarter while volume held flat compared with a decline, depressing profits by JPY 4 billion in the previous quarter. We are particularly impressed by the performance in Japan, of which consumer product sales rose more than 6% year on year. Gross margins also saw a year-on-year increase for the first time since 2021. As we have pointed out, Kao has been raising prices and margins by stepping up premium offerings through innovation in product functionality since this spring. It also began to leverage popular brands to combat sales decline in struggling categories, including fabric softener and hair care in Japan. We anticipate a rise in sales contribution of value-added products will shore up average selling price increases and margin expansion.