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Morningstar | Calbee’s Downward Revision Well Expected; Price Hike Action Required for Restoring Profit Growth

Narrow-moat Calbee’s third-quarter results came in largely in line with our forecasts. While the downward revision is well-expected, the degree of revision is somewhat greater than our expectation as domestic cost inflation accelerates. We have marginally lowered our estimates but maintained the fair value of JPY 4,100 as the increased time value of money offset the lowered earnings. Solid sales performance of the moaty domestic snack business reiterates its competitive advantage but management’s reluctance to hike prices is likely to continue overshadow the share performance until it is forced to make decisions. We have priced in a cut in promotional spend to pass on higher costs but will review our assumptions after detailed discussion with management.

The downward revision is mainly attributable to sales shortfall of the domestic granola and North America, and a surge in domestic input/packaging and logistic costs. While management indicated possibilities of price hikes and rationalization in product portfolio as measures to counter rising costs during the first-half briefing, there is no conclusion yet. It is unclear what prevents the management from making the decision as many category leaders have announced price hikes over the past few months. Given Calbee’s dominant share in potato chips with a nearly 72% share (a nearly 55% share in savory snacks) and the rival Koikeiya is also facing the same cost pressure, it appears to be easier for Calbee to raise prices than most of players in the food sector. With the domestic potato chips factories running at nearly full capacity, hiking prices seems the most effective means to maintain margins and lift sales growth.

Third-quarter sales fell 2.8% while operating profits slipped 1.7%. The key positives during the quarter are accelerated growth in China’ Frugra (granola) sales and a sales growth in the domestic frugra business after it saw a consistent decline since the beginning of 2017. Increased production capacity of Frugra boosted growth in Mainland China which saw sales more than tripled from a low base during the quarter, accelerated from a nearly 70% growth posted in the first half. While profits also improved, continued marketing investment is likely to depress margins in 2019. On the domestic front, sales of frugra turned positive after the company increased size and flavor varieties. However, the overall all granola market remains sluggish. Calbee plans to launch cereal bars or bites to expand the sales channels. While sales of potato chips fell 1.4% mainly due to a high hurdle caused by large shipment post the potato shortage, sales grew more than 10% from the level in 2017.

On the other hand, sales of North America dropped by about 2% due to slow introduction of new organic products to the largest customer Costco. Calbee has finally rolled out the new products at 80% of the Costco stores carrying Harvest Snap by December 2018. Management expects margins and profit to improve once sales volume picks up and suggested that the U.S. sales may have bottomed out. As we have cited, a recovery in North America is critical to Calbee’s profit growth as this once lucrative market saw profits plunged in 2016 and turned loss making in 2017 after failing to regain sales caused by the production troubles.