EUR 850.00 For Business Accounts Only

Morningstar | Human Healthcare Holds Kao Back From 2020 Goals in 1Q

Despite a slow start to the year, Kao maintained its guidance for the full year and we are maintaining our wide moat rating and JPY 8,800 fair value estimate. We believe Kao is currently reasonably priced.

First-quarter sales decelerated again, contracting 0.2% on a like-for-like basis. By business division, trends were little changed from the fourth quarter, with beauty care, and cosmetics in particular, driving growth. In the cosmetics segment, which makes up 19% of Kao's sales, like-for-like sales growth of 12% was a standout and ahead of even some of Kao's multinational cosmetics competitors. This helped to offset further weakness in the human healthcare business, which was down 10.8% on a like-for-like basis. This was driven by weakness in China, which management blamed on recently introduced regulations that tighten e-commerce sales practices in order to protect intellectual property and consumers and to reduce tax evasion. More concerning, however, was pressure on pricing on Merries in China, which will take several quarters to cycle through.

Progress toward the 2020 target of a 15% operating margin took a step back in the first quarter, with the 11.0% margin 20 basis points below the margin of the prior year. The operating leverage inherent in the business was apparent, with the growth in the cosmetics segment driving nearly 8 percentage points in divisional operating margin improvement, while the margin in the human healthcare business fell 11 percentage points to 4.7%. Our valuation is not dependent upon a 15% margin by 2020, and we model a medium-term operating margin of 14.7%, although we may lower our margin assumptions if Kao's human healthcare segment does not stabilize in the next few quarters.