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Morningstar | Calbee's Management Painted a Conservative Outlook Despite a Strong Rebound in 1Q

Narrow-moat Calbee posted a robust set of first-quarter results with sales up 8.3% (LFL 15.2% excluding the impact of divesture of the domestic bakery business) and operating profits up nearly 70%, despite from a low base due to the potato shortage of the last first quarter. While the results are better than our expectations, operating profits are trending slightly behind the company's internal target which appears to have factored in a more than 70% growth in the first quarter but flat operating profits for the rest of the year. Strong demand in the moaty domestic potato snacks combined with improved profitability of the U.S. business contributed to profit growth. We consider the company's guidance for the rest of year somewhat conservative and expect it to beat the guidance. We have maintained our forecasts and fair value estimate of JPY 4,350, implying 8.5% upside.

While the-first-quarter gross margin expanded nearly 270 basis points, it remains 28 basis points lower than the level prior to the potato shortage, causing profits to undershoot the company's target. The strong demand in potato chips was in part driven by the campaign to increase size of some standard sized potato chips products by 10-25%, a countermeasure to rival Koikeya's volume increase campaign during the quarter. Due to better-than-expected sales, the increased input costs, along with a 4% sales decline in the domestic Frugra sales and decreased production yield of other snack products, dragged the gross margin. However, the impact of the campaign and lowered factory unitization should fade in the second quarter. Sales of non-potato snacks fell more than 15% as potato chips regained the shelf space at retailers.

The results also echo our thesis calling for margin expansion through rightsizing domestic selling expenses and enhancing overseas profitability, mainly the North America market. Selling expenses as a percentage of sales continue to improve, down 50 basis points during the quarter, while operating profits and margins improve in the North America despite a slight sales shortfall.

On the overseas front, sales in North America remained soft but it has reversed the decline trend with a 4% growth on the local currency base. Gross margin improved along with enhanced plant utilization and reduced disposal losses as well as labor costs, lifting operating margins to 5.7% from 1.9%. It is aiming to gain shelf space at the snacks aisles at the retailers with the rollout of a new snack line Popper Duos in the second half and revamp Harvest Snaps with an introduction of new flavors. We think the recent trend that consumers prefer niche products is in Calbee's favor.

The Greater China region posted a more than 90% growth, driven by increased sales of Frugra granola as it further expands distribution of the brick and mortar retailers and entered the domestic e-commerce channel apart from the cross-border e-commerce. Yet, the region posted a loss due to inventory write-off of the Taiwan subsidiary, which should have little impact beyond the first quarter. Currently, online sales comprise 78% of China’s frugra sales. With the Kyoto factory commencing operation in August, it will need to rely on expansion at the brick and mortar retailers to absorb the additional supply, roughly doubling the current size of sales. Calbee has been increasing in-store tasting promotions, in an attempt to raise consumers’ awareness of the products before the increased supply. We intend to follow the development of sales expansion closely as it is one of the key drivers in our long-term growth assumption.