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Morningstar | Yakult’s Growth Slowed in China but We See Improvement After New Operations Open in Summer

Narrow-moat Yakult’s fourth-quarter profits came in below its guidance as expected, but the miss is nearly 4% wider than our estimate. Management’s earnings guidance is modest with only mid-single-digit growth projected in part due to recent weakness in China. We have lowered our profit forecasts by nearly 5% for the five-year explicit forecast period, which brings our profit estimate for fiscal 2020 a touch below the guidance of JPY 57 billion in the company’s midterm plan. We have accordingly lowered our fair value estimate to JPY 8,200 from JPY 8,300.

Despite the slowing volume growth in China over the past three quarters, we reiterate our view that growth in China is likely to pick up in early summer in conjunction with operations beginning at its new factory and expansion of sales areas. Yakult will add three sales branches in June, raising the number of sales branches to 46. The two new factories will boost the capacity by as much as 30%. The escalating trade tension and slowing volume growth has battered Yakult’s share price over the past six months. We are convinced that Yakult’s brand equity and low penetration outside the three major metropolitan areas in China will sustain its growth. We view the shares as undervalued with 22% upside and consider such short-term weakness as an attractive buying opportunity.

The preliminary announcement of overseas volume during the first quarter (January- March) indicates continued slowdown in China’s volume growth, with an increase of only 1%. Apart from deteriorating consumer sentiment caused by the trade war, the announcement of a cut in VAT to 13% from 16% from April 2019 also deferred demand. It appears that Yakult’s volume growth returned to double-digit growth in April, and management is aiming to lift growth during the peak summer season between June and September.

Vietnam is emerging as a promising market, posting a 37% volume growth in 2018 and continuing that momentum into the first quarter of 2019 despite a 3.4% price hike from March 2019. While volume growth in Indonesia slowed to 6.5% from double-digit growth posted in 2018, it seems to be affected by a 6% price hike in January 2019.

Besides decelerating growth in China, a shortfall in domestic beverage sales reflecting a lack of innovative new products contributed to the earnings miss. The core supermarket channel, representing nearly half of store sales, turned negative in the second half. Yakult appears to have been struggling to develop value-added products to lift its domestic margins and profitability. To our surprise, management announced a new Yakult 100 billion L casei Shirota bacteria per bottle, the most among all its products. The product has also received government certification as functional food which will not only help improve intestinal flora but also enhance sleep quality, especially troubled sleep caused by stress. We expect the novel concept to help the product gain traction with retailers and consumers. The company has not factored in any contribution from the new product in 2019 due to the still-undecided rollout schedule, likely in autumn. Thus, the new product may help boost sales, and profits to a lesser degree, in the second half if the launch is successful.