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Morningstar | Cost Inflation and Reduced China Exports Weighing on Unicharm’s Profits; Improving into 2Q

Narrow-moat Unicharm kicked off the year with a double-digit profit decline resulting from of decreased diaper exports to China and accelerated cost inflation. The result fell short of our estimate but seems to be in line with the company’s internal target. While the degree of cost inflation, about JPY 3.2 billion mainly for the petrochemical-based materials, advanced faster than our expectation and the company’s guidance of JPY 5 billion in the first half, management expects the pace to slowdown from the second half. We therefore maintained our forecasts and fair value estimate of JPY 3,500. As the shares are trading at our fair value estimate, we view the shares as fairly valued.

Sales grew 4.8% and core operating profits (gross profits – SG&A) down nearly 19%. Sales grew more than 18% (like-for-like) in Asia thanks to a lessened decline in China’s locally-produced baby diapers as well as continued strength in feminine care in the region. While there is little explanation, a slowdown in sales of baby diapers which posted flat sales in most of its core market in Southeast Asia has raised our concern. On the other hand, Japan’s sales fell by 10% as a result of decreased export of premium baby diapers to China. However, management expects the impact of inventory adjustment caused by China’s new e-commerce laws will lessen in the second quarter as the inventory held by arbitrage sellers appears to have been decreasing.

Gross margins contracted by 290 basis points. Apart from increased input costs and a worsened product mix, currency depreciation in some of the core overseas markets including Indonesia and India, as well as increased fixed overhead of its new Kyushu factory also depressed the margin. Management has hinted at the possibility costs may decrease year on year in the second half if the crude oil price does not advance further. Additionally, increased logistic and personnel costs, partially associated with the DSG acquisition also weighed on operation profits.