EUR 850.00 For Business Accounts Only

Morningstar | Yakult's China Slowdown Temporary; Weakness Creating Good Buying Opportunities

Narrow-moat Yakult’s third-quarter profits came in below our expectation as a result of increased sales expenses. We have lowered our volume assumption for China to reflect the weakness in the fourth quarter, likely to stay through the first half of 2019, but leave our fair value estimate of JPY 8,300 unchanged as the adjustment is offset by increased time value of money. The company is likely to miss its guidance unless it achieves a sizable cut in sales expenses during the quarter. Nevertheless, we expect Yakult will resume the growth momentum when the two new plants in China commence operations in the second quarter. We view the shares as undervalued with a decent 15% upside.

The preliminary announcement of the overseas volume during the fourth quarter (October-December) indicates a further slowdown in volume growth in China, estimated at 1.4% compared with 3.1% posted in the third quarter and 13.7% during the first half. The volume decline posted in December was attributable to a high comparison hurdle prior to the price hike implemented in January 2018 in addition to the cold wave disrupting logistics. Despite a low unit price at RMB 2.4 per bottle of its iconic product, Yakult’s sales do not seem to be immune to the economic turmoil in China. During the economic slowdown in late 2015, its volume growth tumbled to low single digits from low double digits during the fourth quarter of 2015 and the low growth continued through the first quarter of 2016. Yet, sales volume bounced back to double-digits and further accelerated to high-teens in nine months after the slowdown. We are convinced that Yakult’s brand equity and low penetration outside the three major metropolitan areas in China will sustain its growth and consider that such short-term weaknesses create attractive buying opportunities.

The decline in domestic beverage and pharmaceutical sales, along with adverse foreign exchange impacts in South America, offsetting growth in Asia, was attributable to the flat sales during the quarter. Gross margins widened nearly 120 basis points thanks to price hikes in China, Mexico, and Brazil (July) and enhanced operational efficiency as the factories in China were run at full capacity during the quarter. Despite suspension of marketing investment during August and September due to limited product supply, increased personnel costs resulting from the recruitment of 500 people offset the cost savings. The triennial global sales event also boosted expenses during the quarter.

Management has hiked the dividend by 10% to JPY 44 after it has better visibility to the full-year earnings. Yet, Yakult’s dividend payout ratio remains at high teens, the lowest among our food coverage. Given the pile of cash sitting on its balance sheet with a net cash position, we expect a constant raise in dividends and occasional share buybacks.