Earnings Transcript for 4452.T - Q4 Fiscal Year 2023

Yoshihiro Hasebe: I am Yoshihiro Hasebe, President of Kao. Thank you very much for joining us today for Kao’s Earnings Announcement for the Fiscal Year ending December 31, 2023. Before I begin, I would like to express my deepest sympathies to the people of Noto Peninsula and all of the Ishikawa Prefecture, who are affected by the recent Noto earthquake. Kao is also providing ongoing support by supplying mainly daily necessities and – which is for soonest recovery possible. Let me first explain about key highlights. We have implemented various initiatives to strengthen our business in 2023. This will lead to achieving global growth and improving ROIC, two key management indices that we introduced this year. We made significant progress in our business portfolio initiatives, completing structural reforms roughly on schedule. For example, we have carried out a decisive reorganization of our baby diaper business and concluded transfer agreements for tea-catechin beverage, Healthya and cat litter box system, Nyantomo Clean Toilet, both of which we had maintained as plans for more than 20 years. These actions demonstrate our commitment to strengthening our portfolio. We also made significant progress in structural reform of our human capital. The speed and quality of decision-making was improved as we moved away from matrix operations. We substantially improved profitability by working to both promote high value-added products and increased market shares as we passed on hikes in raw material prices through strategic price increases. The Household and Personal Care, or H&PC, products business in Japan posted solid results, with net sales up 2.3% year-on-year due to increase in sales volume. In August, we formulated our midterm plan, K27 strategy, announcing several strategic priorities. Those are Global Sharp Top Strategy, focusing on global growth and profitability. We saw from a metrics organization and shift to a better human capital structure, focus on improvement of capital efficiency and profitability to drive ROIC, creating R&D synergies across businesses by leveraging Kao’s technology assets. Kao has made significant early progress in structural reforms and portfolio management. And in 2024, we will continue to focus on advancing our K27 strategy to drive profitable growth, with an additional emphasis on strengthening our portfolio and realizing shareholder value. Let us now begin with an overview of the financial results from Masakazu Negoro, who is in charge of Management Finance.

Masakazu Negoro: Now let me give you an overview of the financial results. Please turn to Page 6. Net sales totaled JPY1,532.6 billion, down 1.2%. Excluding the impact of foreign exchange rates, net sales fell by 3.8% on a like-for-like basis after structural reforms. Although fiscal 2023 was a challenging year, our focus on profitability and ROIC resulted in improved operating income and profitability in core businesses as well as a significant improvement in net cash flow from operating activities. Core operating income was JPY114.7 billion, up 4.2% year-on-year. Core operating margin was 7.5%. The difference of JPY54.7 billion between core operating income and operating income was the full-year structuring reform expenses. Core net income attributable to the owners of the parent was JPY86 billion, unchanged year-on-year. Basic core earnings per share, was JPY184.95, an increase of 0.9% from the same period last year. The annual dividend is planned to be JPY150 per share, up JPY2, representing an increase in dividend for the 34th consecutive fiscal year. The cash flow from operating activities significantly improved by JPY71.6 billion through reduction in the inventory and enhanced earning power. It was allocated to growth investments such as M&As in the Skincare business. Please refer to the graph on Page 5, 6 for more details. Next is Page 7, key points of financial results. At the August earnings briefing on the results of the first half, I said that we had reached a turning point. Looking back on the past year, I believe we can say that it was a year in which we were able to build a foundation for a counteroffensive. We have started our midterm plan K27, which aims to execute the structural reforms, implement strategic price increases, promote global growth and improved ROIC. We will improve the performance in 2024, building on this basis, and continue to execute our Global Sharp Top Strategy while optimizing our business portfolio. Now let me go into more specifics. As mentioned in the key highlights, in the H&PC in Japan, we pursued higher added value and increased our market share in the Skincare business, a growth driver in this segment, and maintained our market share in the Fabric and Home Care business, a stable profit area, while implementing strategic price hikes. These do significantly contributed to profit, making up for a larger-than-expected decline in the Chinese Cosmetics business due to the reaction to the Japan’s discharge into the ocean of ALPS-treated water from Fukushima Daiichi Nuclear Power Station and in the Chemicals business, severely affected by the delayed recovery of demand in the European and Chinese markets, thus securing an increase in core operating income. On the other hand, we decisively implemented structural reforms in struggling businesses. With respect to fundamental strategic review of inefficient businesses, the baby diaper business has reorganized its domestic production in addition to terminating production in China. In addition, transfer agreements were concluded for tea-catechin beverage, Healthya and Nyantomo Clean Toilet, a pet care business. In addition to this, we carried out structural reform of human capital by introducing more agile, scrum-based teams to increase the speed and quality of decision-making as we moved away from matrix operations. As a result of these reforms, we have recorded JPY54.7 billion in expenses and expect to improve profits by approximately JPY18 billion in fiscal 2024 and by JPY30 billion thereafter. In the Skincare business, a growth driver area, we acquired Bondi Sands to create a foundation to develop the Skin Protection business on a global basis. These are all measures that will lead to business portfolio reforms. The breakdown of the JPY54.7 billion in structural reform expenses will be explained later in this presentation. Please take a look at Page 9. I will explain the performance by segment, focusing on core operating income. As a result of our focus on global growth, strategic pricing and the structural reforms, core operating income reached JPY114.7 billion, up JPY4.6 billion, with core operating margin at 7.5%. The Consumer Products business, as a whole, achieved a core operating income of JPY88.7 billion, a significant year-on-year increase of JPY9.4 billion. The major contributors were a JPY10.9 billion increase from strategic price hikes in Fabric and Home Care and an JPY8.2 billion increase in Health and Beauty Care, which offered a higher value-added products while gaining market shares. The Fabric and Home Care business and the sanitary business are disclosed separately from this time. The core operating margin of Fabric and Home Care business improved significantly to 14.6%. In the fourth quarter alone, we achieved 19.7%. On the other hand, the sanitary business posted a core operating loss of JPY9.1 billion due to the significant impact of lower sales in the baby diaper business. And the Life Care business posted a core operating loss of JPY1.3 billion due to the significant impact of lower sales in the leverage business. These two businesses were subject to structural reforms and are expected to improve in fiscal 2024, following a fundamental review performed in fiscal 2023. In the Cosmetics business, sales declined sharply in the second half as a result of curves on sales of Japanese brands due to the ALPS-treated water issue in Asia, especially in China. Core operating income totaled JPY5.3 billion for the year. In the Cosmetics business, structural reforms were also implemented to narrow down brands and reduce fixed costs. We believe these reforms will prove effective in mitigating the ongoing impact of the ALPS-treated water issue in fiscal 2024. In Chemical business, core operating income was JPY24.8 billion due to a deterioration in profit margins from the impact of falling prices of raw materials for oleo chemicals as well as the impact of sluggish demand in Europe and China. Please move to Page 10. This is an analysis of operating income of JPY9.3 billion for the fourth quarter. Of the total, JPY34.6 billion was incurred as structural reform costs. Excluding this, the core operating income increased JPY10.7 billion year-on-year. Positive items are shown in green and negative in gray. Contributing greatly among the positive factors were a JPY3 billion gain from lower raw material prices and a JPY13.5 billion gain from price hikes in H&PC and Cosmetics businesses. In particular, H&PC business managed to increase the volume while raising prices. In addition, the Chemical business showed signs of a turnaround, posting an increase of JPY3.5 billion, mainly due to the effect of improved margin in oleo chemicals. On the other hand, as I mentioned earlier, in the Cosmetics business, profit declined by JPY6.5 billion due to the impact of restrained purchases of Japanese products in China, caused by the issue of ALPS-treated water. In addition, marketing expenses, which were reduced in the third quarter, were used more in the fourth quarter, resulting in a JPY7.5 billion of negative impact from SG&A expenses. Please move to Page 12. The chart shows the total impact of raw material price rises since 2021 and the extent to which the strategic price hikes have caught up to offset them. The effect started to increase in the second half of fiscal 2023 and mostly canceled out the raw material price rises by the end of the year. We expect the benefits to continue in fiscal 2024, with the greatest year-on-year impact likely to be seen in the first half. The graph on the right compares with fiscal 2022, showing an upward trend in the second quarter, with continued year-on-year gains for the rest of the year. Please move to Page 14, which shows consolidated earnings forecast. Net sales are projected at JPY1.580 trillion or 3.6% like-for-like growth. Operating income will be JPY130 billion, up JPY15.3 billion from the previous year’s core operating income. And net income attributable to the owners of the parent will be JPY98 billion, up JPY12 billion from the previous year’s core net income attributable to owners of the parent. EPS is expected to grow by 14%. Dividend is planned to be increased by JPY2 per share. Please take a look at Page 16 for analysis of changes in consolidated operating income. In raw materials, we expect a negative impact of JPY1 billion in packaging materials. Strategic price increases are planned to be continued mainly in Japan, assuming a JPY10 billion in positive impact. In the Consumer Products business, in addition to improving earning power through structural reforms, we will accelerate overseas expansion of the Skincare business, especially UV care products in China, which will be strengthened by the addition of Bondi Sands, and make new proposals to the premium haircare market, thereby aiming for an increase of JPY15 billion. In the Chemical business, in addition to a recovery in profits from oleo chemicals, tertiary earnings and fragrances, for which additional capacity started operation in Europe, will contribute to increased profits. In addition, we plan to increase marginal profit by JPY11 billion, based on contribution of profit from high value-added performance parts. The increase in SG&A expenses is attributed to the focus on strengthening sales and marketing activities in the growth drivers, as well as an expected increase in personnel expenses. This will be mitigated by profit improvement effect of the structural reforms implemented in 2023, leading to JPY17 billion in negative impact. As a result, operating income is projected to be JPY130 billion. Please take a look at Page 18. Structural reforms are progressing as planned, and we are seeing a positive response. As for fiscal year 2023 expenses, JPY39.7 billion for drastic strategic review and reorganization of inefficient businesses and JPY15 billion for the promotion of structural reforms of human capital were posted, totaling JPY54.7 billion. The domestic career support portion of human capital structure reforms was about 80% of the planned amount. Some of the expenses related to diapers and overseas businesses will be carried over to fiscal 2024. But when combined with the gain from the recently announced business transfers, the impact on operating income is currently expected to be minor. As a result, the structural reform expenses, which were initially expected to be JPY60 billion, will be reduced by about JPY5 billion. As for the P&L effects of structural reforms, we expect that the total of 1 through 3 will continue to improve profits by about JPY18 billion in 2024 and by about JPY30 billion in 2025 and beyond as planned. These profit improvements will contribute significantly to the enhancement of ROIC in the post-reform businesses. Please move to Page 19. This page is a pictorial representation of changes in sales growth rates and ROIC by business from 2023 to 2024. The directions of arrows indicate the changes from 2023 to 2024. Although sales of baby diapers, for which structural reforms have been implemented, are expected to decline, ROIC is expected to improve due to improved profitability and asset reductions. Life Care, which is scheduled to transfer its Healthya beverage business, as announced on February 1, is also expected to improve its efficiency significantly. Although the catechin beverage business will be transferred, we will aim for growth by expanding the Hygiene business and building new co-creation businesses, going forward. In terms of business transfers, we also plan to transfer our Pet Care business during this fiscal year. In Chemicals, which faced tough business environment in 2023, we will focus on improving oleo chemicals such as tertiary amines, which started operations in Germany, and increasing sales of high value-added products to boost earnings. In Cosmetics, which also faced difficult conditions as the Chemicals business, China business risk will remain. But with structural reform to improve the earnings structure, we will accelerate investment for global growth that does not rely on the Chinese market. In Skin Care, where we acquired Bondi Sands last year, we will improve both capital efficiency and growth by accelerating the global growth potential of our Skin Protection business, led by UV care products. In the domestic Hair Care business, which has its challenge, we will take multiple measures to strengthen the foundation for growth, such as launching new premium products and introducing new communications. Through these efforts, we plan to improve company-wide ROIC from 4.1% in fiscal ‘23 to 8.6% in fiscal ‘24. We will also continue to periodically review our portfolio to further enhance capital efficiency at the company level. Please turn to Page 20. This is a ROIC improvement scenario toward K27 that we shared at last August Q2 results meeting. This does not include the increase in profit due to the positive impact of raw material prices. I believe that we will be able to get on this trend only after implementing structural reforms and realizing the 2024 plan. In this sense, we strongly recognize that fiscal 2024 will be an important period of change for Kao. Please turn to Page 21. The table shows specific figures for the improvement of sales growth rate, core operating income and ROIC between 2023 and 2024 in the three business areas in our business portfolio that we just presented. In the stable earnings area, we plan to achieve stable sales growth, mainly in Japan and Asia. For operating income and ROIC improvement, we expect steady incremental growth over 2023. The growth driver areas are Skin Care, Cosmetics and Chemicals, which drive Kao group’s growth. The difference between operating income and core operating income is the structural reform expenses. We are implementing structural reforms mainly in the Cosmetics business. And with the recovery in the Chemical business, we plan to achieve a significant improvement in operating income. ROIC improvement is expected to be 1.8 percentage points due to investments for growth. In the business transformation area, we expect sales growth to be negative 0.6%. And we also anticipate structural reforms centered on Merries, as well as business and brand transfers. As a result, we expect a particularly large improvement in ROIC of positive 7.3%. Since much of the improvement expected in fiscal ‘24 is attributable to the structural reforms implemented in fiscal ‘23, we are confident to achieve these improvements. In the long-term, we believe that the actions we are implementing as part of K27, such as the Global Sharp Top Strategy and improvement of organizational efficiency, will lead to further improvement of ROIC and creation of shareholder value. That concludes my explanation.

Operator: Thank you, Mr. Negoro. Next, Mr. Hasebe will explain our midterm plan and Global Sharp Top strategy. Mr. Hasebe, please.

Yoshihiro Hasebe: First, please look at Page 23. As we explained earlier, Kao introduce the midterm plan K27 in August. And I believe that we have made great progress toward achieving our goals. Once again, K27 vision is saving future lives. It shows our determination to become a company that solves pressing social issues through our Global Sharp Top businesses. To this end, we are introducing ROIC company-wide as an indicator of sound management. We have also decisively implemented structural reforms to strengthen our portfolio to realize growth on a global scale. We aim to become a company that sustains Global Sharp Top business, which means contributing to our customer as a leading-edge company. To this end, it is important to maximize the vitality of our entire workforce, especially our most unique and talented people. Such talent should generate businesses that grow stronger, making us an essential company in a sustainable world. Please turn to Page 24. Here, we show the four pillars of our strategy to achieve K27. Needless to say, it will be important to narrow down our current businesses to focus on Kao’s strong brands and businesses. We will shift to businesses that meet the essential demand of our customers and that are highly profitable and we will have a more global orientation. We must also increase our investment in the unique and future-oriented people, who can actually deliver on this. We will operate around such unique talent moving away from the exhaustive matrix management, allowing the aces to come together and make quick decisions. Thirdly, we will also focus on improving capital efficiency and profitability. Using ROIC as a benchmark, we are working to maximize the value of management capital. ROIC-based incentives will be given to many employees to drive home the importance of this metric to all employees. The full strategy of K27 is to build businesses through co-creation with partners. In order to utilize our technological assets more efficiently and effectively, we will take advantage of our partners’ strength in various ways to accelerate our growth and increase our own profits over the long-term. Please turn to Page 25. I will explain the steps we have taken in 2023 and how we expect them to progress into 2024 and then talk about our global shift to essential high-profit businesses. To reiterate our achievements in 2023, we laid the groundwork for expanding the Skin Protection business globally. For example, by leveraging Kao’s strong sales and marketing expertise, we have been extremely positive customer responses to Bioré products in Europe and Brazil. In the Fabric and Home Care business, we introduced new products, with high potential for global expansion, and achieved progress exceeding our plans. For the hair salon markets in Europe and the U.S., our digital marketing provided successful, and Oribe showed exceptional growth. Kao’s unique D2C channel has been expanded to all product categories, and global expansion is now underway. In 2024, in response to the strong demand, we are accelerating the rollout of our UV care products outside of Japan. We have already made a good start in China. In addition, we will introduce an improved version of high value-added sheet-type products where we excel. In the hair care business, we will launch a series of new products to try to move the business into the growth driver areas. In addition, in the chemical business, the global rollout of super high value-added, one-of-a-kind technologies will turn profitable. Next, I will explain how moving away from matrix management will strengthen Kao’s business. And I will also talk about our decisive investment in human capital. In order to incorporate challenge-based OKR into our business design, to move the organization forward, we are providing opportunities for forward-thinking people to re-skill and up-skill, including DX education. We will make these opportunities available company-wide and work to sharpen the best and the brightest talent. In order to strongly promote Kao’s strong-based approach, we are selecting people who can make quicker and clearer decisions, so-called ace personnel to carry out important tasks one after another. In addition, in order to support the K27 goals, we plan to incorporate ROIC-focused indicators into personnel evaluations, thereby introducing performance-linked assessment. Also, we will have open recruitment and selection to find suitable personnel based on individuals, career plans and company policy. By moving away from matrix management, we have been able to speed up decision making and more effectively implement business restructuring, strategic pricing and global growth. We have already seen significant benefits in fiscal 2023 and expect continued improvement in fiscal 2024. The third strategy is to improve capital efficiency and profitability. To achieve this strategy, we work to increase brand value through sales and marketing activities and improve profitability through structural reforms in 2023. We focus on our core brands and businesses and began to divest assets, for which Kao is not the best owner. In fiscal ‘24, we will continue to strengthen profitability and ROIC through disciplined portfolio management and the introduction of new high value-added products. Also, we will continue to implement further business transformation in our stable earnings businesses, which are the driver of our growth and increase their efficiency. Ultimately, we aim to improve ROIC by 4.5 points in fiscal year 2024. The fourth is building businesses through co-creation, which is a new pillar for K27. Kao’s strength lies in its abundant and diverse R&D assets that enable us to continuously bring unique products to market. In order to maximize the value of these assets and realize a stronger ROIC, Kao will work to expand and utilize its R&D expenditures more efficiently through strategic collaboration with good partners. This approach can be divided into four main parts. The first is joint businesses to develop innovative new products that can contribute to our global growth. For example, we will invest in R&D of insect repellent and eradication technology that does not use insecticides and start global deployment. We will make an announcement on this in the near future. This will also strengthen our skin protection business. The second is open innovation. We will work with the best partners to launch cutting-edge products that defy conventional wisdom. For example, this year, we will launch a product that will easily create an artificial skin that supports the skin’s healing process and also a product using next-generation cleaning technology that realizes level of cleansing that was deemed impossible. We will be announcing these in the near future. Third is global rollout through customer products, the global B2B business. This will be in the chemical business. Using Kao’s fine surface control technology, we plan to be profitable this year in a category that is in great demand globally. Fourth, we will work with our partners to improve the ROIC of existing businesses. The most promising area is the sanitary business, which is known to be a process industry. Once significant sales are established, stable earnings can be expected in this business. Currently, we are conducting joint development to create innovative sanitary products while keeping investments through a minimum. We expect to have a solid outlook on this during this year. Please turn to Page 29. Through the implementation of K27 strategy, we plan to significantly improve ROIC and operating income. Although ROIC declined in 2023, we expect to return to a growth trajectory through initiatives based on K27 and achieve ROIC of 8.6% in 2024. We are confident that our ability to implement and realize the K27 initiatives will be demonstrated. Core operating income, excluding structural reform expenses, was JPY114.7 billion, which is on an upward trajectory, coming out of a declining trend up to 2022. In 2024, we will continue to focus on profitable growth, aiming for JPY130 billion. Please turn to Page 30. I believe that we are off to a good start towards achieving the ROIC target of K27. I feel that we are finally starting to get on the right track. In 2024, we are determined to achieve ROIC, EVA, operating income and overseas sales. I would like to conclude with the key highlights that I have already shown you. In 2023, we thoroughly implemented business portfolio management, strengthened our drivers for higher profitability and felt the results of these efforts. The Global Sharp Top policy, which we set forth for K27, has started to infiltrate the minds of Kao employees around the world. We hope to maintain this momentum and demonstrate Kao’s real strength in 2024. Finally, please turn to Page 32. This year, we have prepared two events for you. The first is a briefing on Kao’s DX strategy, which will bring about marketing innovations. There are many different types of DX, but we hope you will get a sense of what Kao’s unique DX is in that briefing. The second is a briefing on the strategy of the hair care business. This will be an opportunity for us to explain how the hair care business will change this year with the continuous introduction of new products. We ask that you will kindly attend these briefings. This concludes our presentation of the financial results. Thank you very much for your attention.