EUR 850.00 For Business Accounts Only

Morningstar | Trends Unchanged in 2Q for Kao as Limited Upside Remains to the Stock

Wide-moat Kao posted a slightly weaker-than-expected second quarter, with like-for-like sales growth of just 1% and a 20 basis point improvement in the operating margin. Although the market appeared to breathe a sigh of relief that it was not worse, Kao now looks to be tracking well below its 2020 guidance of 5% like-for-like sales growth and an operating margin of 15%. We have lowered our near-term forecasts, and we now expect 2% reported sales growth this year, and we think Kao can grow at this rate in the medium term, driven by overseas expansion and a limited degree of pricing power in its moaty cosmetics franchises. The change to our forecasts has little impact on our valuation, however, and we are reiterating our JPY 8,800 far value estimate and our wide moat rating. After a fairly strong performance year-to-date, we now consider the stock to have limited upside.

Reported net sales growth of 1.6% (1.0% organic) was consistent with the first quarter, indicating that trends remain broadly unchanged. This rate of growth is below that of Kao's multinational peers, growing by at least 4% annually, which is indicative of the company's exposure to low-growth Japan (63% of first-half sales). In order to grow at all, we think Kao is pursuing the right strategies. First, it is targeting overseas expansion, and overseas revenue accounted for almost 2 percentage points more of total revenues in the first half versus a year ago. Second, we think Kao's more focused product development and marketing strategies in premium beauty care and human healthcare will bear fruit in the next three years. Third, Kao is likely to further leverage its e-commerce channel and boost the sales of its made-in-Japan human healthcare products, especially its feminine care brand Laurier, enabling 2% divisional sales growth over the next five years.