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Morningstar | Strong Recovery in Overseas Foods Demonstrates Ajinomoto's Moat; Shares Remain Undervalued

Narrow-moat Ajinomoto's full-year profits came in 7% above its revised guidance and our expectation, thanks to a solid recovery in the moaty overseas consumer business and continued strength in healthcare sales during the final quarter. Improved growth momentum in Southeast Asia, where Ajinomoto was struggling with intensified competition and soft volume growth after price hikes, demonstrates the company's moat of intangible assets. Ajinomoto was able to leverage its research and development and distribution capabilities to regain lost ground. We have made marginal changes in our forecasts that don't affect our fair value estimate of JPY 2,100 per share. Despite an 8% price rebound after the earnings announcement, the shares remain undervalued, with 13% upside to our fair value estimate.

Business profit guidance--just 1.2% growth excluding the impact of a JPY 3.2 billion goodwill write-down--is largely in line with our estimate. One-off expenses associated with implementation of the asset-light strategy are likely to depress profits in 2019. Management shed some light on the direction and scope, likely around JPY 100 billion, of asset downsizing. While details will not be available until February 2020, management intends to complete asset downsizing by 2021, before the final year of the next three-year midterm plan. It will most likely kick off with the overseas frozen foods business, focusing on the Asian and dessert categories.

Sales fell 0.5% while business profits rose 24% during the quarter. The sales drop was caused by continued domestic weakness in addition to a 17% decline in life science sales resulting from falling prices of commoditized animal feeds. The profit growth was attributable to margin expansion in the core overseas markets, which saw profits double during the quarter thanks to price hikes and volume growth.

Contrary to management’s expectation of volume weakness in Southeast Asia, in particular Indonesia and Vietnam, the region made a strong comeback during the fourth quarter. Growth in Indonesia returned to double digits after the company renewed products and increased sales efforts. In Thailand, Ajinomoto’s largest overseas market, its beverage segment also recorded double-digit growth, recovering from the volume contraction and price competition of the core Birdy canned coffee products. Despite 20% growth in Vietnam, the strength seems to be inflated by the demand before the price hike in April. While growth in the first quarter might soften, it should not take long to recover as competitors will follow suit.

Management reiterated its commitment to shareholder returns with JPY 100 billion planned for the following three-year midterm. About two thirds will be paid in dividends while the rest will be in a form of share buyback. We anticipate the recent management reshuffle of the executive directors and presidents of underperforming subsidiaries will improve internal communication and help the organization stay agile in a rapidly changing operating environment. But given management's poor record, the market may not react to the restructuring efforts until the company delivers results.