EUR 850.00 For Business Accounts Only

Morningstar | Kikkoman's in Line Profits Driven by Growth in Condiment and Soy Milk; Shares Overvalued

Narrow-moat Kikkoman's first-quarter results with a 4.6% growth (5.5% excluding foreign exchange impacts) in sales and 4.1% growth (4.7%) in operating profits are in line with our expectations. Growth in condiment/soy sauce and domestic soy milk drove margin expansion and lifted profit growth. However, growth in the lucrative North America soy sauce business slowed to low-single digits.

We have maintained our forecasts and fair value estimate of JPY 3,750, implying a 30% downside. Kikkoman's shares have gone up 55% over the past 12 months and outperformed the Topix Food Index by the same degree, despite a low-single-digit growth achieved in the same period. We suspect that either market has priced in a sizable growth, in part driven by speculation on falling soybean prices, or the ETF buying of the Nikkei Index has boosted demand for the stock. We do not think the share price reflects its true fundamental growth and see shares as overvalued.

Gross margins fell more than 40 basis points due to a deteriorated business portfolio with increased contribution of the low-margin food wholesale business in addition to a rise in input costs. Increased procurement costs also dragged profits of the wholesale business. While the market has speculated that the recent correction in soy bean prices will significantly boost Kikkoman's profits, management guides a rise in input costs in the domestic market. Given that food companies usually have long-term contracts with trading companies and hold inventory for about six months, the drop of soy bean prices may benefit Kikkoman around the fourth quarter if the prices persist at the current level.

Domestic food saw a 2% growth in sales and a 5.7% growth in operating profits, led by strength in soy milk and soy sauce related condiment. Sales of soy milk continue to climb, posting an impressive 8% top line growth thanks to marketing efforts, consumers' rising health awareness, and extended usage of soy milk in cooking. An emerging boom of soy milk ice on social media also boosted demand. Sales of dipping soy sauce for noodles and BBQ sauce contributed a 6% growth in the soy sauce-related condiment category. While sales of these categories are likely to stay resilient, increased input costs and depreciation expenses may depress domestic profit growth.

On the overseas front, food manufacturing business, mainly soy sauce, saw a 4.4% growth led by a double-digit growth in Europe. Del Monte sales in Asia posted a 22% growth mainly due to consolidation of a Chinese subsidiary. It appears that the resolved ingredient shortage issue also lifted Del Monte's sales. A 10% growth in food wholesale business was in part pumped up by increased consolidation of subsidiaries in Europe and Asia. Wholesale profits fell by more than 6% during the quarter due to increased procurement costs. Kikkoman intends to recover its margins by passing on higher costs to customers, likely in the second half. However, given that many Asia players competing in the same markets often use pricing to gain shares, price hikes may hurt Kikkoman's sales volume if rivals do not follow suit or offer cheap alternatives produced in other low-cost countries.