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Morningstar | U.S. Cost Inflation Depressed Nissin's Profits Despite Solid Domestic Performance

Narrow-moat Nissin’s first-quarter sales and core business profits (gross profits minus selling, general, and administrative expenses, or SG&A) fell short of our expectation, with sales up 2% and core profits down 10% year on year. While the moaty domestic instant noodle business managed to expand margins amid cost inflation, overseas weakness, specifically in the U.S. and China, has wiped out domestic profit growth. Still, gain on sale of a domestic property contributed JPY 5.2 billion profits, lifting its reported operating profits to 45% growth. The company has migrated to IFRS from this quarter. While profits may remain soft in the second quarter, given cost increases associated with the commencement of operations at the new factory in West Japan and a high comparison hurdle in addition to the unfavorable hot weather, we expect profits to rebound in the second half when the U.S. price hikes kick in. Nissin is hoping the launch of Chicken Ramen’s 60-year anniversary campaigns in August will help offset the weakness caused by hot weather. We have made minor adjustments to our forecasts, mainly for 2018, but this does not affect our fair value estimate of JPY 6,950, implying 4% downside.

A 70-basis-point contraction in gross margins is attributable to raw material cost inflation and deteriorated product mix in the U.S. Increased logistics and depreciation costs also weighed on the profits. The rising personnel costs, particularly in China and the U.S., were offset by domestic cost-cutting.

The domestic instant noodles business saw the top line grow by 2%, driven by subsidiary Myojo’s sales expansion and steady growth across most of its noodle products. Sales growth, along with improved gross margins and lowered marketing spend and administrative expenses, offset the cost increase associated with the new factory in West Japan and contributed to 6% growth in operating profits.

On the overseas front, the U.S. business suffered a loss, given rising costs of raw materials, logistics, and labor. A deteriorated product mix resulting from a drop in average selling prices, in part due to increased sales of value products at the dollar shop channel, also dampened margins. Nissin has been negotiating with retailers and obtained agreement from some counterparts to pass on higher costs, which should gradually kick in through the second half. On the other hand, Brazil posted 14% growth in sales (in local currency), thanks to a 4%-5% price hike and 10% volume growth. Apart from a successful launch of the seafood flavor cup noodles, sales appear to have taken off in June after the strike.

We remain skeptical about the company’s aggressive growth target in China. Sales grew 5% in mainland China and 3% in Hong Kong, largely contributed by expansion of the product lineup. A 37% drop in profits was attributable to the one-off nonoperating items and increased depreciation, although both negative factors will disappear from the second quarter. However, higher personnel costs will depress profit growth, leaving profit (excluding the nonrecurring items) flat year on year.