EUR 850.00 For Business Accounts Only

Morningstar | Yakult's overseas strength offset pharma weakness; China growth accelerated. See Updated Analyst Note from 29 Jul 2018

Narrow-moat Yakult got off a good start in fiscal 2018 with a 2.3% growth in sales and flat operating profits. The results are slightly better than our expectation and seems largely in line with the company's guidance. Despite a sizable profit decline in the pharma business, moaty probiotic drinks posted healthy growth in Asia, the key growth driver in our assumptions. Yakult's shares were up more than 6% after the announcement during trading hours. We suspect the preliminary report of an accelerated volume growth in China during the second quarter, up to 16.5% from 9.9% in the previous quarter, boosted its share performance. As we have highlighted in our recent initiation report, its China volume growth often drives the shares' short-term volatility. We have maintained our estimates and fair value estimate of JPY 8,000 and consider the shares fairly valued.

Gross margins improved 77 basis points thanks to an improved mix with increased contribution of the lucrative overseas probiotic drinks and price hikes in China, Mexico, and Brazil. Yet, the loss-making pharma business wiped out most of profit growth achieved by the food businesses which saw growth in operating profits and margin expansion across all regions. Yakult has raised prices of its namesake brand probiotic drinks by 8%-9% in all the areas in China except Guangzhou from January 2018.

On the other hand, sales growth momentum of the domestic probiotic drinks appears to have slowed to 1.6% during the quarter compared with a 3.5% posted in 2017 and the guidance of a 2.6% growth. As we have cited, we are wary of the company's optimistic outlook of the domestic food business as we see limited room for volume growth. Management is pinning their hopes on growth picking up along with a core product renewal in the second half. While domestic margins improved by an impressive 93 basis points, it seems largely contributed by the increased royalties paid by the overseas markets and timing of expenses.

Operating margins in Americas advanced 167 basis points thanks to a solid 20% volume growth in the U.S. in addition to the price hikes in Mexico and Brazil. Operating profit and margin in Europe more than doubled as a result of a 4% volume growth despite it being from a low base. Yet, the preliminary report indicates volume growth in Europe slowed during the second quarter.

A solid double-digit volume growth posted by its largest Asian markets, China and Indonesia, during the second quarter indicates that the company may beat its interim guidance although it has set a conservative target for the first half. In Indonesia, growth momentum appears to have picked up on the back of improved consumer sentiment in addition to the company's efforts to grow retail distribution and the number of Yakult ladies. In China, it appears sales growth slowed in the Southern area (Guangzhou) due to the wet weather but the trade war has not affected the local consumer sentiment. Growth momentum in the other areas in China appears to remain intact. While a slowdown in China's economy may pose threat to Yakult's China growth, we expect area expansion outside three first-tier cities combined with increased penetration in the existing markets will sustain a double-digit growth in China.