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Morningstar | Calbee Weaving a Bear Case Into Its 2019 Guidance; Shares Offering an Attractive Upside

We walked away from narrow-moat Calbee’s result briefing with increased confidence that management is on the right track to fix overseas issues and build a foundation for long-term growth. However, guidance of flat profits for fiscal 2019 is disappointing. We believe that management has taken a cautious stance toward domestic profitability due to uncertainty caused by coming price hikes and a sales tax hike. Management intends to focus on brand building and new product development while enhancing supply chain efficiency by leveraging automation and digital technologies. We have reduced our profit estimates by 2%-4% and accordingly lowered our fair value estimate to JPY 4,000 from JPY 4,100.

While the strategies will take time to play out and the near-term growth may be capped by rising costs and marketing investment, the shares are now significantly undervalued due to a sell-off by large shareholders, a cause of a more than 20% correction over the past six months. The current share price indicates little profit growth over the next decade while we see the potential upside indicated by overseas growth opportunities and continued domestic margin expansion. Our profit estimates are about 4% above the 2019 guidance but 14% below its midterm target of JPY 40 billion for fiscal 2024.

Management has factored in an impact of a 5% volume decline caused by an average 5% price hikes on about 70% of its potato chips products and expects it will take three years to recover the lost volume. The additional profits contributed by price hikes will offset only half of JPY 3 billion cost inflation. Management appears to have woven in a worst-case scenario due to a lack of experience in price hikes and downward revision for two years in a row. As a result, improved overseas profits and benefits of price hikes are expected to be fully wiped out by volume decline and cost inflation.

While there is no track record of the impact of price hikes on demand for snacks in Japan, we anticipate the price hikes to be passed on in 12-18 months. History suggests that it usually takes 12 months to fully pass on price hikes based on recent results of other packaged-food companies including Nissin and Yamazaki Bakery. Additionally, the rival Koikeya also followed suit, hiking prices of potato chips products by 7.5%-8.7% of the retail prices from June.

On the overseas front, Calbee’s losses have lessened substantially after implementation of rigorous cost control in North America and profit growth driven by Frugra expansion in China. While the recent new brand Pop Duo snacks fail to gain traction, it is pinning hope on the new bean-based crouton products that leverage Harvest Snaps technology. Apart from the U.S., Calbee expects narrowed losses in Indonesia, helped by sales expansion, along with reduced losses in Taiwan and Philippines and cost synergies in integrating the U.K. business will lift overseas profits by about JPY 1.2 billion, reversing the loss-making trend.

Management also provided a road map and financial targets for the next midterm plan ended March 2025 with a focus on overseas growth and expansion into new food categories. Management cited a misstep in entering overseas markets with new factories before enough market testing and brand building efforts. It will increase investment to raise brand awareness in the overseas markets and bolster growth of new products/lines. It also plans to improve returns to shareholders by hiking dividends and lift payout ratio to 40% from the current 30%-plus.