Morningstar | Kao Decelerates in 4Q but Growth Could Deliver Margin Expansion
Kao posted an in-line fourth quarter but missed our full-year sales growth estimate by a whisker. The full-year EBIT margin was also close to our forecast. We are maintaining our cash flow forecasts that assume steady margin expansion, and our JPY 8,800 fair value estimate and our wide economic moat rating. We believe Kao is fairly valued.Fourth-quarter sales decelerated to just 0.3%, but Kao still ended the year in positive growth territory, with 1.3% like-for-like sales growth. By business division, trends were little changed in the fourth quarter, with beauty care, and cosmetics in particular, driving growth. In the cosmetics segment, which makes up almost 19% of Kao's sales, like-for-like sales growth of 5% was solid and comparable to some of Kao's multinational cosmetics competitors. We forecast a medium-term slowdown in organic growth of about 2% in this segment. Growth overseas could deliver faster growth and drive upside to our valuation if sustained.
On the other hand, the human healthcare business remains weak, and inventory adjustments in the e-commerce channel contributed to a weak fourth quarter. Full-year like-for-like sales fell 4.4%. We believe that while the international business may drive long-term growth, and our valuation assumes a rebound to growth in the human healthcare segment this year, growth may be volatile because Kao's economic moat lies in its domestic business.
Progress toward the 2020 target of a 15%Â operating margin continues to be slow, with the 13.8% margin only 10 basis points above the margin of the prior year. The cosmetics segment materially drove all of the consolidated margin improvement (up 5 percentage points to almost 10%) but competition in human healthcare and fabric and home care continue to offset the improvement in beauty care. We believe growth in the human healthcare segment should drive medium-term margin expansion.
Kao is engaged in the manufacture and sale of consumer products, cosmetics and industrial chemical products. Co.'s principal products include cosmetics, soaps, facial cleansers, body cleansers, shampoos, conditioners, hair styling products, hair coloring agents, beverages, sanitary napkins, baby diapers, bath additives, oral care products, laundry detergents, fabric treatments, cleaning products, and commercial-use products. Co. also provides fatty alcohols, fatty amines, fatty acids, glycerin, commercial-use edible fats and oils, surfactant, plastics additives, toner and toner binder for copiers and printers, ink and colorants for ink-jet printers, fragrances and aroma chemicals.
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