Morningstar | Kao Improves in 3Q but Still Tracks Below 2020 Guidance
Growth in wide-moat Kao's core businesses improved in the third quarter, and the company continues to eke out margin gains. We have made only very minor changes to our near-term forecasts and maintain our fair value estimate of JPY 8,800 and our wide economic moat rating. Kao is still tracking below its 2020 guidance of 5% like-for-like sales growth and an operating margin of 15%, but the third quarter was an encouraging improvement. Even assuming growth and margins slightly below these targets, we think there is modest upside to the stock.Reported net sales growth of 1.6% was consistent with the first half of the year, although organic growth of 1.4% was a sequential improvement and implies third-quarter organic growth of 2.2%. The improvement was driven by the cosmetics segment, which collectively makes up over 40% of Kao's sales. In cosmetics, nine-month like-for-like growth of 4.2% implies third-quarter growth of over 6%, a very strong performance that puts Kao in line with some of its larger and more geographically diversified cosmetics competitors. While we forecast a slowdown to medium-term organic growth of around 2% in this segment, growth overseas could deliver faster growth and drive upside to our valuation if this growth is sustained.
On the other hand, competitive pressures continue to weigh on the human health care business in China, despite some new product initiatives around Merries. We believe this confirms our belief that while the international business may drive long-term growth, that growth may be volatile because Kao's economic moat lies in its domestic business.
Progress toward the 2020 target of a 15% operating margin continues to be slow, with the 13% margin only 20 basis points above the margin at the same time last year. Cosmetics is again the driver (up 6 percentage points year over year) but competition and sluggish sales growth in human health care and fabric and home care continue to offset the improvement in beauty care.
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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