EUR 850.00 For Business Accounts Only

Morningstar | Continued Challenges Facing Ajinomoto's Moat Food Business; Management Execution a Key Issue. See Updated Analyst Note from 31 Jan 2019

To our surprise, narrow-moat Ajinomoto has again revised down its full-year guidance given impairment losses of the U.S. frozen food operations and the African affiliate Promasidor as well as the prolonged weaknesses in some moaty food businesses. The third-quarter profits excluding impairment losses were largely in line with our expectation, but management is guiding a gloomier fourth quarter. We have lowered our profit forecasts by 6%-9% and reduced our fair value estimate to JPY 2,100 from JPY 2,400 to reflect the newly emerged weakness of the overseas food business and continued challenges facing the domestic frozen foods and coffee businesses.

We are bewildered by the second downward revision taken place in just three months following the first one given that there seem few changes in its operating environment, but management seems to expect the negative trends will persist while previously regarding them temporary. Ajinomoto lowered business profit guidance by JPY 9.5 billion including JPY 3.2 billion of write-down in Promasidor’s trademark. Sales weaknesses seen in the domestic frozen foods and decelerating growth in Indonesia and Vietnam are the key negatives behind the downward revision.

Sales fell 1.3% while business profits plunged 13% (2.6% decline excluding trademark impartment loss of Promasidor). Domestic food business saw a nearly 16% decline in business profits as unseasonal weather affected sales of its lucrative instant soup sales. However, we expect sales to rebound during the fourth quarter when temperatures drop. Sales of moaty overseas foods held flat while profits excluding earnings contributed by equity affiliates rose by 17% thanks to rigorous cost control and price hikes in Thailand. Yet, management has taken a more cautious stance on the growth outlook of Indonesia and Vietnam, citing that fierce competition initiated by Unilever has depressed volume growth. Increased marketing budget in the fourth quarter along with major product renewals of the core seasonings products is attributable to earnings downward revision.

The equity affiliate Promasidor operates mainly in five countries in Africa. Recent profits have deteriorated due to political issues causing disruption in raw material imports, specifically dairy products, and sluggish consumption depressed by a sizable correction in crude oil prices. The impairment loss was mainly attributable to a delay in margin recovery in dairy products. Ajinomoto remains upbeat on the outlook of the seasonings markets in Africa and intends to work with Promasidor management to improve sales. Despite a 33.3% stake, Ajinomoto is involved in Promasidor’s operations. Likewise, the impairment loss of the U.S. frozen food business was also caused by a delay in margin recovery as a result of production troubles at the new factory and soaring logistic costs. Management expects the business to attain a nearly double-digit margin around 2021 or 2022. We expect the production issues will be resolved in the first half of 2019 and margin expansion is highly achievable if it concentrates on the Asian and appetizer categories and divest the low-margin Italian operation.

It appears that management does not have a firm grasp of business operating environment and competition of the businesses operated by food business subsidiaries. A lack of sense of urgency and delayed communication between the headquarter and subsidiaries are responsible for a series of downward revisions. Given its poor track record, market may not react to the restructuring efforts until the management deliver results. Ajinomoto has announced an “asset-light” operation plan, aiming to reduce its asset burdens and lift returns on invested capital. The restructuring process and downsizing/ divesture are most likely to take place in fiscal 2019. While we expect profits to leap in 2020, we project JPY 103 billion in business profits by fiscal 2021, the end of its next midterm plan, a number significantly lower that its target of JPY 130 billion.