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Morningstar | Unicharm Beat Interim Guidance as Expected; Rising Input Costs Likely to Dampen 2H Growth

Narrow-moat Unicharm beat its first-half guidance as expected with sales up 5.8% and core operating profits (gross profits - SG&A) up 12% during the second quarter. A strong rebound in operating margins of Asia personal care led the group's growth thanks to rigorous control of marketing spend including promotions, in addition to a solid top line growth. Despite the positive results, management has maintained its full-year guidance because a surge in petrochemical-based raw materials is likely to dampen profits in the second half. We have maintained our forecasts which are slightly above the guidance and our fair value estimate of JPY 3,500. We expect brand equity and entrenched retail relationship, the key moat sources, will continue to support its growth in Asia. Yet, we view the shares as fully valued after a 10% gain over the past three months, suggesting the profit recovery has been factored in. We expect the company to announce a share repurchase at the third-quarter result announcement as a part of its target of 50% returns to shareholders.

The 74-basis-point expansion in operating margins was attributable to a 34-basis-point increase in gross margins resulting from an improved product mix given increased contribution of feminine care, adult continence, and premium products, albeit higher input costs. Lowered marketing spend and shipping costs as a percentage to sales also helped lift margins. Yet management expects raw material cost inflation to depress second-half profits by JPY 5.5 billion compared with JPY 2.1 billion in the first half. Marketing spend is likely to pick up in the second half.

Operating margins of Asia personal care tripled during the quarter from a low base, improving across the core overseas markets including Thailand, China, and Indonesia. Specifically, China maintained a healthy growth in premium products including imported Japanese baby diaper products and the new feminine care line targeted at the young generation. However, sales of locally produced bay diapers continued to see a double-digit decline although it has lessened to low-20s from a more than 40% drop at the previous quarter.

Expansion of selling areas in India combined with the operation commencement of the third factory contributed to a more-than-40% growth in the country. It appears competition remains fierce in Indonesia where the top line growth has decelerated across all product categories in the second quarter, down to 6% from 20% posed in the first quarter. Nevertheless, sales in adult continence remain healthy in Indonesia and Thailand, growing 30% and 21%, respectively.

On the domestic front, growth has driven an 8% growth lifted by the export of premium Moony diapers to China as well as a 10% growth in sales of adult incontinence. On the other hand, sales contraction in the lucrative feminine care business caps the domestic profit growth.