Meiji Earnings: Profits Drop as Cost Inflation Peaks; Volume Decline Abates

Narrow-moat Meiji 2269 missed its guidance as we had expected and its profits are largely in line with our forecasts. We have delayed our profit rebound scenario by a year to 2024, assuming raw material cost inflation peaks in the first half of fiscal 2023. The second round of price hikes for drinking milk and yogurt to be implemented during August in Japan, stemming from increased raw milk costs, is likely to impair near-term volumes. Accelerated growth momentum in China should be a top-line driving force from 2024 after completion of four new factories in the country. Meanwhile, the recovery of probiotic yogurt and plain yogurt volumes is crucial to restoring margins and profitability. We have maintained our fair value estimate of JPY 4,350. Despite good 32% upside to our intrinsic value, investors’ appetite for Meiji may not rebound until it delivers meaningful top-line growth, which requires new hit products to bolster domestic probiotic sales or rapid distribution expansion in China.

Fourth-quarter sales grew 8.6% with operating profits down 23% as cost inflation combined with volume decline induced by price hikes weighed on profits. Yet, volume decline continued to narrow quarter on quarter with the pace of recovery divided between commoditized and value-added products. Sales of value-added products including probiotic yogurt, one of the key profit contributors, rose to more than 4% with volume decline narrowing to less than 2%. On the other hand, sales of commodities products including plain yogurt and chocolate bars remain sluggish as consumers trade down to cheaper alternatives. We think the outperformance of value-added products indicate Meiji’s moat of intangible assets underpinned by its product development capabilities. Moreover, price hike benefits continue to kick in. Price hikes offset nearly 90% of cost increases during the fourth quarter, compared with about 75% in the third quarter and less than 50% for the first half.