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Morningstar | Kikkoman's Lukewarm Growth Not Commensurate With Its Rich Valuations; Shares Overvalued

Narrow-moat Kikkoman beat its full-year guidance as expected with sales and profits coming in a touch above our estimates. Management has guided a mixed outlook with a 4.4% growth in the top line and 3.3% growth in operating income for 2019. We have moderately lowered our forecasts by 1% to reflect a slower pace of margin expansion, but our profit estimate of a 6% growth remains above the guidance. A sizable increase, nearly JPY 5 billion, in overhead and marketing spend will also depress profit growth in 2019.

The results and guidance indicate that its strategy of increasing value-added offerings to lift domestic margins has not produced meaningful impacts on group’s profit growth. The midterm goal of achieving JPY 45 billion operating profits by 2020, implying a nearly 13% growth in the final year, looks challenging.

Kikkoman remains the most expensive stock under our food coverage, trading at 37 times on 2019 earnings. Despite Kikkoman’s leading shares in soy sauce and lucrative profits in the overseas markets, its shares have priced in much more than the fundamental growth and we deem it overvalued. We have maintained our fair value estimate of JPY 4,000, implying a 26% downside. Our profit forecasts are above the company’s guidance for 2019 but slightly below its 2020 midterm target.

The results and guidance raise concerns over its domestic premiumization strategy and the U.S. growth prospect. The pace of domestic margin expansion has significantly slowed down in 2018, in part due to increased logistic and depreciation expenses. The operating margin expanded merely 3 basis points in 2018 compared with more than 400 basis points achieved between 2015 and 2017. We have lowered our gross margin assumptions by about 20 basis points to reflect limited impacts of increased premium sales on margins and a slight cost increase. Correction in soy bean prices will not contribute to cost savings because of the tight supply of non-GMO soy beans.

The top-line growth, at 2.2% excluding impacts of withdrawal of the unprofitable wine products, also fell short of its target of a 3.6% CAGR over the midterm. While the company has increased R&D efforts to boost its value-added offerings, there are few hits. The strategy also faces a heightened risk if consumers turn frugal after the sales tax hike.

On the overseas front, volume growth of the lucrative soy sauce sales in North America remains modest in the fourth quarter with a 3.7% like-for-like growth. Management attributes the slowdown to increased household inventory as consumers stocked up the products prior to the price hike. We are surprised that consumers would stock up the unfrequently used and low-priced products like soy sauce. Management also cited that fierce price competition led by online retailers has made it more difficult to pass on higher costs in the U.S. market. We will pay close attention to U.S. sales trends as management expects growth to recover in 2019 when the household inventory is consumed and Kikkoman resumes its promotional campaigns at retailers.