EUR 850.00 For Business Accounts Only

Morningstar | A Positive Surprise in a Strong Rebound in the Moaty Food Growth; Meiji Shares Remain Undervalued. See Updated Analyst Note from 07 Nov 2018

Meiji’s strong profit rebound in the second quarter was a positive surprise as we had expected the unfavorable hot summer would continue depressing sales and profits. Rigorous cost control in the food business combined with a solid pharmaceutical sales growth contributed to the 15% like-for-like growth in operating profits. Management has revised up its full-year guidance marginally, with sales up 0.5% and operating profits by 1.5% to reflect consolidation of KM Biologics and sales/profit shortfall of the first quarter. We are particularly excited about accelerated growth in the overseas business, specifically China. The results echo our thesis that its brand equity and marketing/R&D capabilities, the key moat sources, will allow Meiji to capture rising demand for functional health foods in China and Southeast Asia.

We have factored in the impacts of KM Biologics consolidation and raised our fair value estimate marginally to JPY 10,000 from JPY 9,900, implying a 28% upside. Our current operating profit forecast remains a touch below its 2018 guidance and 12% below the company’s 2020 target of JPY 125 billion. The shares have been battered, falling 12% following the first-quarter results as the market has priced in a gloomy outlook and expected a downward revision. While sales in the lucrative probiotic yogurt category might remain sluggish over the short term given increased competition, we expect Meiji to leverage strengths in product development and marketing innovation to counter price competition and capture new demand.

Reported sales grew 1.7% (estimated negative 0.5% excluding the impacts of KM Biologics consolidation and revision of trade terms) In particular, like-for-like sales growth in China accelerated to 32% from the 20% of the first quarter thanks to a more-than-80% growth in the confectionery sales along with increased shelf space at retailers, a result of reorganization of its sales and marketing operations. Dairy and ice cream businesses also saw a 12% and 37% growth, respectively, boosted by rising demand for fresh milk and area expansion of distribution. Likewise, operating profits rose 16% (15% excluding KM Biologics consolidation) thanks to a sizable cost cut in the food business. A nearly 60 basis-point expansion in the group’s gross margin was largely attributable to the consolidation of KM Biologics.

Despite a deteriorated product mix of the food business resulting from a more-than-5% decline in the probiotic yogurt sales, margin contraction of the food gross margins also improved, lessened to 20 basis point from 120 basis points of the first quarter, thanks to a more-than-20% growth in its functional chocolate Cacao Kouka (meaning effect) and a decline in input costs. Operating margins also improved across all the food categories except the yogurt and milk category.

We expect the company will resume the marketing spending in the second half along with increased product launches. Recent inflation in the oil price is likely to boost packaging costs by JPY 1 billion in the second half, whipping off cost savings derived from lower raw material costs.

The pharmaceutical business saw a 1.5% like-for-like sales growth albeit the negative impact of the drug price cut which lowered sales by about 8%. The sizable profit increase was mainly boosted a delay in R&D spending and timing of booking losses on inventory disposal into the second half. Management expects consolidation of KM Biologics will boost group sales by 300 billion and operating profits by JPY 30 billion in 2018 after taking goodwill amortization into consideration. It has revised down the guidance for capital expenditure by JPY 10 billion to JPY 79 billion, due to a delay in the timing of payment.