Kao Corporation (4452) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. My name is Michitaka Sawada, President and CEO of Kao Corporation. Thank you for coming to Kao Corporation's consolidated financial results analyst briefing for the 6 months ended June 30, 2020, amidst your busy schedule. We sincerely appreciate your continued support. Prior to our explanation, let us offer a deepest condolences to those who have lost their loved ones to the COVID-19 pandemic and the torrential rains in Kyushu. We would prefer to share results with all of you in person today. However, due to the resurgence of the coronavirus, this briefing will be conducted on a remote basis. Your understanding is appreciated. We will explain the overview of the Q2 results for FY 2020, followed by the Q&A session. We have representatives from the management team with us. From your left, Yoshihiro Murakami, who is responsible for our Cosmetics Business. Next to me is Toshiaki Takeuchi, who is in-charge of sales. Next to him is Kenichi Yamauchi, who oversees accounting and finance. And Tomoharu Matsuda, heads the Consumer Products Business. We will work together to answer your questions. Let us begin our explanation. This year is the final year of the Kao Group's medium-term management plan, K20. And it is the 130th anniversary of the release of Kao soap. Therefore, we started the year resolved to achieve our targets. However, as you are aware, the past 6 months required careful maneuvering in the face of the unprecedented situation caused by COVID-19. There are 3 K20 goals. The first is the commitment to fostering a distinctive corporate image; the second is commitment to profitable growth; and the third is the commitment to returns to stakeholders. Regarding the first and the third, we are making steady progress. In fact, last year, we announced our major shift to ESG management, and we plan to continue the initiatives. With regard to commitment to profitable growth, we have realized 3 JPY 100 billion brands. Other targets have been, however, difficult to achieve. As for ESG management, we are grateful to receive several positive evaluations from external organizations and will not be complacent in efforts to achieve even higher evaluations. We believe we have already reviewed the figures on this chart. So the details will be explained later as part of the overview of the financial results. Before giving an overview of business results, I would like to look back on the market situation. The upper left shows the SRI, SCI of the household and personal care market. The upper right shows the SRI and SLI of the domestic cosmetics market. And the lower half of the page shows the change in the consumer purchase price for 15 major household and personal care categories. The domestic household and personal care market, where hygiene-related products are performing well, have continued to grow strongly this year. There was a last-minute demand for domestic cosmetics before the consumption tax hike in the previous year. But sales declined after the tax hike and were affected by COVID-19 before recovering. You can see that the effect began in March, became more severe in April-May, with a recovery beginning in June. As for the 15 major household and personal care categories, products are sold with general adherence to retail prices without distributing flyers. The purchase price is 9 points higher than in 2015. This is just a brief recap on the market. Now I would like to explain the financial results for the first half. Net sales decreased year-on-year by 7.5% or JPY 54.2 billion to JPY 667.2 billion. This number excludes the impact of change in the method of sales recognition and currency translation. Like-for-like, net sales was down by 4.3% or JPY 30.4 billion year-on-year. Operating income was down by 13.8% or JPY 11.9 billion to JPY 74.5 billion. Net income attributable to owners of the parent dropped by 11.7% or JPY 6.7 billion to JPY 50.6 billion. To summarize, the results reflected the tough situation. Sales of hygiene-related products, be it hand soaps, hand sanitizers, home care products, et cetera, increased significantly year-on-year. However, in the Cosmetics Business, sales and profits have decreased dramatically over the past 6 months due to a sharp decline in inbound demand. Makeup products sales remain sluggish due to wearing masks as a common practice, the stay-at-home order and the temporary closures of retail stores. The hair salon business in Americas and Europe was also significantly affected by stay-at-home orders and the closure of sales outlets. In the Chemical Business, sales and profits declined due to the disruption in our customers' industries. As a result, we regret, overall sales and profits declined year-on-year. In addition, as decided at today's Board meeting, the interim dividend for FY 2020 is increased by JPY 5 per share to JPY 70, as originally announced. I will briefly explain the point here. Forecast at the beginning of FY 2020 presented upper and lower limits, and the minimum amount was set assuming 0 inbound demand with net sales of JPY 1.51 trillion and operating income of JPY 220 billion. In fact, COVID-19 has become a widespread global challenge and the negative impact to our business is no longer limited to the absence of inbound demand. Especially in Q2, April-June quarter, the situation worsened and the domestic Cosmetics Business, the Europe and Americas hair salon business and our Chemicals Business were greatly affected. I would like to take a closer look at cosmetics and hygiene-related products. The Japanese cosmetics market is tracked with SRI, and the January and February figures were slightly down year-on-year. But from March, the influence of COVID-19 became apparent, and Q1 results were 91% compared to the previous year. Due to the declaration of a state of emergency in April, the market declined year-on-year to 73% in April, 75% in May and 86% in June, where we see a slight recovery due to the lifting of the state of emergency situation in June. For the first half of the year, with Q1 and Q2 combined, the market trended at 84% from the previous year. The Kao Group's Cosmetics Business has grown significantly over the past few years. When the top line went up, profits followed very well. However, as mentioned, Murakami's, in his plan for the Cosmetics Business, we recognize the need to expedite structural reforms and to undertake various measures. Number one, the contribution ratio of makeup products to the overall sales is higher than other cosmetics companies. Makeup product sales are suffering from the stay-at-home behavior, and the impact is especially severe with a business model designed to drive customers from makeup to skin care products. This negative result was a direct impact of COVID-19. Number two, the number of beauty consultants is not justified by the total sales of the Cosmetics Business, making the fixed cost ratio high. Our brands were consolidated into self-selection and counseling brands, and headcounts have been allocated accordingly. However, we were impacted by the virus while in the midst of the implementation of this trial. Number three, we have been aggressively expanding our EC channels. And if possible, we would have liked to explore even the D2C model. However, we were affected by COVID-19 before the initiative was developed. The EC channels operated with the platformers are shaping into a good business. We would like to answer your questions on this topic later. But overall, it is fair to say that the overall EC channel is not functioning well. These are the 3 issues we face in the Cosmetics Business. The financial results of our peers are yet to be announced. But I think the Kao Corporation has suffered a considerable impact from COVID-19. The business for hair salons in Americas and Europe was not significantly affected from January to March, but was disrupted from April to June, resulting in 68% year-on-year. Everyone is aware that hygiene-related products, such as hand soaps, hand sanitizers and home care products for sterilization and virus removal are performing well. We feel we were able to contribute to the well-being of the society and intend to continue this effort in the future. For your information, the hand soap market in Japan was around JPY 26 billion last year, but it is now forecast to double to JPY 50 billion per annum. The hand sanitizer market was JPY 3.5 billion last year, which was quite small, but it is expanding by about 15x to JPY 50 billion, which is equivalent to the hand soap market. The Kao Group's share has risen significantly due to the substantial expansion of production capacity. This created a positive impact, but could not offset the decline in cosmetic sales, and the overall results were negative. In the future, hygiene-related products are expected to expand not only in Japan, but also overseas as hand washing and hand disinfection become a regular practice. A solid foundation for this business will be built, and we will contribute to society as Kao Group. Regarding the pluses and minuses related to COVID-19, the positive factors are centered on hygiene-related products, while the Cosmetics Business for hair salons in Americas and Europe and Chemical Business are the negative factors. Let me explain the positive factors. Skin care products include not only hygiene-related products, but also UV care products, She products and makeup removers, which are not selling well. Our hygiene-related products on a stand-alone basis has a higher number. You may think that the sales increase of just JPY 5 billion is not significant, but the figures are mainly for the Bioré brand and include the effects of other skin care products. When combined with skin care, home care and commercial use products, like-for-like sales increased by JPY 17 billion and profit increased by JPY 11 billion. On the other hand, the Cosmetics Business for Americas and Europe hair salons, and Chemicals Business had like-for-like sales decrease of JPY 42.1 billion and a profit decline of JPY 24.2 billion. The net effect of subtracting the negative from the positive factors resulted in the profit decrease of JPY 13.2 billion. This is the main reason for the JPY 11.9 billion drop in operating income. Apart from what I just talked about, there was JPY 2.8 billion of COVID-19 related extra expenses, which include items such as special requirement allowances paid to employees that had to come to work on-site due to production activity or business continuity reasons amidst COVID-19. Next, I'd like to walk you through the year-on-year sales ratio of global consumer product subsidiaries. Kao China was 108% year-on-year in the first half. Q1 was not so good, but double-digit recovery was achieved in Q2. But this is how it looks upon completing the first half. Kao Hong Kong Was at 77% year-on-year. Various factors impacted the business, not only COVID-19. It was very challenging due to political reasons. And no inbound travelers from Mainland China also had an impact. Kao Taiwan was 91% year-on-year. It was mainly the negative performance in the Cosmetics Business that had an impact. Once again, no inbound travelers from China had a strong impact. Kao Thailand was at 90% year-on-year, but now performance is finally starting to recover. As for Kao Indonesia, growth is significant, which is close to double digit. Incidentally, Kao USA was 101%. They do have a business for hair salons. But by including Skin Care, performance increased, resulting in positive performance year-on-year. Kao Germany, an entity that is representative of Europe, was also greatly impacted by the business for hair salons and was 82% year-on-year. Here, we show that year-on-year quarterly sales ratio by business. Let me break the numbers down into the first and second quarters. For the first quarter, sales increased slightly on a like-for-like basis, and profits also increased by JPY 1.1 billion. Looking across the businesses, sales reached 101% year-on-year overall. In Q2, Cosmetics was 71% and Skin Care, 97%. With the exception of Fabric and Home Care, businesses underperformed year-on-year and attained 91% on average. At the end of the first half, the sales ratio was 96%. For Skin Care, both Q1 and Q2 trended at 107% year-on-year. During the second quarter, in a typical year, hygiene products do better. But in reality, UV care products, She products and makeup remover performance was at 70% compared to the previous year. In total, the business reached 107%. As for the Hair Care mass business, Q1 was pretty good, but Q2 was impacted somewhat, leading to 94% year-on-year. First half performance ended up going below previous fiscal year levels. For the business for hair salons, Q1 managed to end at 90% year-over-year, but went down to 68% year-on-year in Q2 and 78% for the first half. Regarding Fabric and Home Care, Fabric Care was 104% in Q1 and 97% in Q2. There was a sense of stagnation, but on average it achieved 100% for the first half. For Home Care, it was 126% and 119%, respectively, reaching 122% for the first half. All included, Fabric and Home Care ended at 103%. If you analyze the details of breakdown, you will be able to gain visibility into the second half of the year. So that was an overview of the first half and some details from a different perspective. Now I'd like to move on to the second half of the presentation. This page is about initiatives and our forecast up until the end of the year. As COVID-19 continues to spread, we expect the uncertain business environment to persist in the third quarter and beyond. Regarding the third quarter, because in Japan last year there was last-minute demand in September, prior to the consumption tax hike that took effect from October, we expect a negative impact during Q3 this year. Conversely, as there was a drop-off in Q4 last year, this will serve to be a positive this year. This was what we were originally anticipating. Now as we see infection spreading again in Japan, we are expecting the recovery process to be extremely slow. So now my thoughts are that we should view performance a bit more conservatively compared to the original scenario of Q3 being challenging and achieving a bounce back in Q4. Under the current circumstances, we will carry out a variety of measures mainly around what we said were key points of the business and thoroughly review expenses. Having said that, we have reached the decision that it's difficult to achieve the original forecast announced on April 27, 2020, and have revised down the consolidated business forecast. Net sales is expected to be JPY 1.430 trillion, down 4.8% compared with the previous fiscal year and down 1.9% on a like-for-like basis. Operating income is expected to be JPY 190 billion, down 10.3% compared with previous fiscal year. And net income attributable to owners of the parent, JPY 134 billion, down 9.6%. In this revised forecast, we have not accounted for extreme situations associated with the further spread of COVID-19, such as store closures or lockdowns. Of course, we truly hope that something like this doesn't happen. And we hope that we will be able to see a gradual recovery. However, if this kind of scenario were to materialize, we think that the Cosmetics Business will be affected, in particular. So we feel that this is something we need to think about. For dividends, we will strive to increase dividends for the 31st consecutive year. And at this moment, we stick to our previously announced policy of a dividend increase of JPY 10, our share reaching JPY 140 per share. Next, I'd like to give you a better idea of quarterly performance. Originally, we wanted to exceed 2019 numbers by all means with the original forecast. But that turned out to be challenging, and we now expect performance to trend, like the red line. In Q2, performance goes below the forecast substantially. And in Q3, it is also slightly underperforming against forecast. And we expect a slow pickup in Q4. This trend led to the downward revision of our forecast. Now let me provide some numbers by business. For example, sales in the Cosmetics Business in 2019 was JPY 301.5 billion, and the 2020 forecast is JPY 205.9 billion. Compared to the previous year, sales was down by JPY 42.5 billion, but is down by JPY 41 billion on a like-for-like basis. In the first half, sales on a like-for-like basis has gone down by JPY 28.9 billion already. So doing the math, this means we are forecasting that sales for the Cosmetics Business is going to go down by JPY 12.1 billion in the second half. Applying this to the other businesses, Skin Care, Hair Care, Human Health Care, Fabric and Home Care and Chemicals. The Skin Care and Hair Care business is expected to increase by JPY 5.5 billion in the second half. Human Health Care is expected to increase by JPY 2.8 billion. Fabric and Home Care is expected to increase by JPY 10.3 billion. And Chemicals to decrease by JPY 2.8 billion in the second half. Including intersegment eliminations, sales in the second half is expected to increase by JPY 3 billion year-over-year. This was accounted for in the revised forecast I explained earlier. Sales is forecasted to increase slightly. But based off our estimates, operating income is likely to decrease by JPY 9.4 billion year-on-year. You may be wondering why operating income is going to go down so much when sales are expected to increase by JPY 3 billion. It's because we are expecting depreciation from capital investments and fixed cost increases in the second half as well. So even if sales were to increase slightly and we were to engage in cost saving, together with other measures, operating income in the second half is likely to go down by close to JPY 10 billion. That is why we forecasted that revised operating income will be JPY 190 billion. Lastly, whatever kind of circumstance we face, as management, we will not make any excuses. Even if the circumstances worsen, we will fight to the finish without losing head. Inspired by our corporate philosophy, we will strive to be of service to society. And because we are facing an unprecedented crisis, we have been acting to respond to change, but we will strive to leverage this opportunity to accelerate our efforts. This concludes my remarks. Thank you for listening. [Statements in English on this transcript were spoken by an interpreter present on the live call.]