EUR 850.00 For Business Accounts Only

Morningstar | Rising Costs Weighing on Profits Despite favourable Currency Movement; Kikkoman Overvalued. See Updated Analyst Note from 01 Nov 2018

Narrow-moat Kikkoman’s second-quarter profits are in line with our expectation but trended slightly above its guidance. It has revised up its full-year sales guidance by 2% to reflect a more favorable U.S. dollar-Japanese yen rate but maintained the profit targets given rising input costs.

We have marginally lowered our estimates for 2018 but raised our fair value estimate to JPY 4,000, up from JPY 3,750, to reflect a higher stage-two RONIC assumption and increased time value of money. Nevertheless, our new fair value estimate implies a 32% downside. Kikkoman’s shares are trading at 40 times P/E and 21 times EV/EBITDA on 2019, more than twice the multiples of the Topix food sector. We suspect that either market has priced in an unrealistic growth, or its relatively high weight in contrast to its market cap has boosted demand for the stock. We do not think the share price reflects its true fundamental growth and see shares overvalued. Our profit forecasts are slightly above the consensus and the company’s guidance for 2018 and 2020 midterm plan.

It appears that the better-than-expected first-half profits was largely boosted by a delay in domestic spending into the second half. Management has revised down the profits guidance for the second half owing to price inflation of agricultural and fishing goods in the U.S. (wholesale business), as well as rising energy, packaging, and transportation costs. Management intends to pass on higher costs to wholesale customers but negotiation with customers is likely to take some time. While the price correction in soybeans caused by the trade war looks favorable to Kikkoman, it will not benefit Kikkoman in 2018 given its long-term contracts with trading companies, often fixed for six months for Japanese food companies. However, if the soy bean prices stay at the current level through the next few months and there is no significant change in foreign exchange rates, costs should fall in 2019.

The 6.2% growth (6.5% excluding foreign exchange impacts) in sales is boosted by a 6.4% growth in overseas foods and 11% growth in overseas wholesale while a 6.4% growth in operating profits were lifted by the top-line growth of the overseas wholesale business and a 115-basis-point decrease in the SG&A ratio as a percentage of sales. On the other hand, a nearly 2% decline in the moaty domestic soy sauce sales and margin contraction of the lucrative overseas condiment business are the key negatives for the second quarter.

It appears that volume decline in the domestic soy sauce was in part caused by irregular hot weather and sales of the premium soy sauce remains healthy. Moreover, Kikkoman has hiked prices of home-use soy sauce products from August and prices of professional-use items from October to pass on higher costs in the U.S. Margins should rebound if the U.S. economy stays on a strong growth path. Given that soy sauce for professional use represents more than 60% of its U.S. volume, we think its sales in the U.S. are more likely to be influenced by the economic condition and thus a slowing U.S. economy will have a greater impact on Kikkoman’s profits given than the North American market contributes more than 45% of the group profits.