FY2023 4Q Financial Results Conference Call Q&A Summary

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  • FY2023 4Q Financial Results Conference Call Q&A Summary

Questions from Shigeki Okazaki, Nomura Securities Co., Ltd.

  • A1The 4Q typically represents a period of lower demand for NIPSEA China, resulting in comparatively reduced sales compared to other quarters. Additionally, the operating profit margin tends to decrease as fixed costs remain constant throughout the year. Although we managed to reduce SG&A expenses in the 3Q, we strategically invested in growth initiatives during the 4Q, particularly focusing on installing CCM machines and increasing advertising expenditures in anticipation of FY2024. Taking these factors into account, we are confident that our performance has been strong across the entire year, rather than just in the 3Q and 4Q.

    As we look ahead to FY2024, NIPSEA China remains committed to its growth strategy, with a primary focus on the TUC segment, despite the challenging economic landscape in China. Our aim is to pursue market share expansion not only in Tier 3-6 cities but also in Tier 0 and Tier 1-2 cities. In the TUC market, we have observed the withdrawal of several competitors, particularly smaller players, some of whom have transitioned to become OEM partners for our brands. This strategic shift has facilitated efficient growth for us, bolstering our confidence in the effectiveness of our approach.

    In the TUB segment, we broadened our business scope to encompass non-residential sectors such as schools and public facilities, reducing our dependence on the new build sector. This diversification of our customer base has fortified our operating profit margin. Additionally, we anticipate the activation of operating leverage effects in the near future.

    That being said, we anticipate maintaining the operating profit margin in FY2024 at a level similar to that of FY2023, even without factoring in the subsidies and other one-off items totaling 8.5 billion yen recorded in FY2023. Given that March, the final month of the 1Q, experiences high demand, our performance during this period will serve as a basis for validating our FY2024 guidance.

  • A2Examining sales growth in the TUC segment, while sales volume growth is positive, the price/mix is slightly deteriorating due to higher sales growth in Tier 3-6 cities, where sales mostly consist of economy products, compared to sales in Tier 0 and Tier 1-2 cities. Despite these factors, we have positive indications of achieving our sales target for FY2024. However, it’s important to note that the Chinese market is highly dynamic, and the situation may change.

Questions from Yifan Zhang, CLSA Securities Japan Co., Ltd.

  • A1As indicated on page 5 of the presentation, our projection suggests that operating profit will rise by 9% on a Tanshin basis, or by 11% when excluding one-off income/expenses (approximately +8.5 billion yen) and provisions (approximately -6 billion yen). Assuming an operating profit growth of 11%, the contribution from new consolidations is estimated to be approximately 3.5-4% of this growth.

  • A2Out of the 11% growth in operating profit, approximately 7.5-8% can be attributed to organic growth, while new consolidation is expected to contribute around 3.5-4%. We believe we can anticipate sufficiently high growth from the existing businesses as well.

  • A3In the TUC segment, our market share in FY2022 stood at 24%, securing our position as the market leader, while the second and third competitors held estimated market shares in the high single digits. We believe we possess a substantial lead over our competitors. The combined market share of the top three players is approximately 40%, leaving the remaining some 60% of the market largely concentrated in Tier 3-6 cities, where we are actively expanding our presence. As we continue to grow our market share in Tier 3-6 cities, some smaller competitors have begun to withdraw from the market. By capturing the market share of these exiting players, we are steadily establishing a track record of high investment efficiency.

    We have confidence in our ability to achieve significant growth by capitalizing on our brand and other strengths. Despite the challenging economic climate, we are committed to simultaneously pursuing revenue growth and enhancing operating profit margins, all while maintaining a steadfast vigilance.

  • A4I will refrain from delving into the details of NPI and BNPA as their acquisitions have not yet been finalized. Nevertheless, as I outlined during the investor briefing concerning the “Buyback of India Businesses from Wuthelam Group” in August 2023, NPI has attained the second-largest market share and profitability through aggressive promotional activities in the southern states of Karnataka and Tamil Nadu. This trend has remained consistent since then.

    Despite the challenging market conditions in the Indian market during the second half of FY2023, we persisted in pursuing growth that exceeded the market, emphasizing both revenue growth and profitability improvement. Given that our growth continued to outpace market growth in FY2023, we are confident that our strategy of concentrating on the two southern states is yielding success.

Questions from Atsushi Yoshida, Mizuho Securities Co., Ltd.

  • A1Certainly, we are hopeful that the margin level in the 4Q will be sustained. Nonetheless, our performance in the 4Q exceeded expectations, and we anticipate that the favorable business environment may not persist throughout the year. Our projections are based on the assessment that we can at least replicate the same level of performance as last year.

    Regarding the impact of one-off factors, some items, such as the reclassification related to transfer pricing, contributed slightly, but not greatly, to the improvement of the operating profit margin. In the automotive coatings business, there was a significant increase in sales volume, and operating leverage worked effectively. Additionally, we raised prices in the marine coatings business, where demand has remained very strong since 2022.

    When considering Japan Group as a whole, we don’t necessarily view the operating profit margin of 12.5% as a standard level. However, we have established a groundwork to maintain a margin level just below 10%. Internally, our target for the operating profit margin is slightly below 10%, and we will consistently endeavor to surpass this benchmark.

  • A2In the decorative paints business in Japan in FY2023, we primarily offset the decline in sales volume through price increases. However, in FY2024, as the momentum of price increases diminishes, we anticipate a slight improvement in the market environment, paving the way for growth in sales volume. We believe that achieving revenue growth of 5-10% is well within our reach through various sales promotion activities.

    Based on the overall market conditions in FY2024 being better than in FY2023, we will aim to generate synergies through the expansion of market share.

Questions from Tomomi Fujita, Millennium Capital Management Asia Limited

  • A1As I mentioned previously, NIPSEA China typically collects all trade receivables in the TUC segment during the 4Q, following our annual practice. As expected, cash collected was recorded during this quarter.

    In the TUB segment, we transitioned to cash on delivery transactions around the second half of FY2022. As a result, we do not anticipate trade receivables collection to pose significant challenges at this time.

    While it’s evident that the trade receivables collection environment is improving, the main factor contributing to the positive impact of trade receivables is seasonality.

  • A2In the TUC segment, our transactions primarily operate on a cash-on-delivery basis. Conversely, in the TUB segment, trade receivables stem from real estate developers, typically involving a longer collection period. Nevertheless, we have consistently made provisions for trade receivables where necessary over the past two years. While certain developers continue to be significant clients, we are diversifying our revenue streams within the repainting and exterior paints segments, emphasizing a thorough assessment of debt collection security.

    Hence, we do not anticipate a substantial provision amount in FY2024, and the percentage of trade receivables necessitating provisions has significantly decreased.

  • A3While I will refrain from commenting on specific numbers, we have confidence in the strength of our balance sheet. As you mentioned, we intend to primarily allocate the generated cash to M&A activities to enhance EPS, which we believe will contribute to Maximization of Shareholder Value (MSV).

    While M&A activities are not our sole objective, we continuously evaluate acquisition opportunities, seeking those with low risk and reasonable valuations. Therefore, it is entirely possible that the generated cash will be utilized for M&A activities.

    While building up cash reserves is beneficial, our objective does not involve repaying debts. Our management philosophy emphasizes refraining from deploying cash towards unnecessary expenses to bolster our cash reserves.

Questions from Ryokichi Kondo, CoatingMedia Co., Ltd.

  • A1According to our estimates, we hold the second position in the automotive coatings market in Japan, with the majority of the market share being held by the top two players, including ourselves. In decorative paints, we are ranked first, although we estimate that one competitor is closely positioned. In the industrial coatings market, we command a substantial share in coil coatings, while our presence varies across segments such as construction machinery, agricultural machinery, and powder coatings. Nonetheless, we maintain our leading position in the industrial coatings segment overall. There have been no significant changes in our market position recently; instead, we are observing a slight increase in our market share.

  • A2We are actively and eagerly dedicating efforts to each segment to achieve consistent growth in market share, particularly in profitable segments. With customer value as our foundation, we aim to enhance our technical capabilities further to deliver high-quality products to our customers.

  • A3Although automobile production rebounded significantly in FY2023, our market outlook for FY2024 appears flat, as indicated by the light green color in the heatmap (reflecting growth ranging from -5% to +5%). The primary reason for anticipating a decrease in automotive revenue in FY2024 is our forecast of a slight decline in automobile production.

Questions from Takashi Enomoto, BofA Securities Co., Ltd.

  • A1While the market color for FY2024 is light green across all regions, indicating growth of -5% to +5%, the outlook varies from region to region. Based on this market outlook, we project +5-10% revenue growth for NIPSEA China and approximately +10% revenue growth for DuluxGroup. The primary driver of this revenue growth is essentially an expansion in market share.

    In regions where our brands have a strong foothold, such as Australia and China, we view these market conditions as an opportunity to further expand our market share. However, we are committed to expanding our market share in all regions as a fundamental aspect of our strategy, including pursuing market share growth in Japan where we anticipate slight market expansion.

  • A2The Raw Material Cost Contribution (RMCC) ratio declined in FY2023, but we do not anticipate a significant decrease in the RMCC ratio in FY2024. However, in regions where the RMCC ratio experiences a slight decline, we view it as an opportunity. The funds freed up could be allocated towards promotional activities or potentially used to reduce selling prices in certain regions.

    In the ever-changing Chinese market, our focus is to uphold the prices of premium products whenever feasible, while considering reductions in prices for select economy products. As we aim to broaden our market share in Tier 3-6 cities, there is a likelihood that the proportion of economy products in our product mix will rise. With the anticipation of a slight decrease in the RMCC ratio, our strategy involves maintaining our operating profit margin by reallocating the saved funds towards promotional and other activities.

    The situation varies across regions, making it difficult to provide a universal trend. However, our overarching objective is to sustain the current level of operating profit margin.

  • A3For instance, in Australia, where we have a 50% market share, we are pushing for price increases rather than price reductions. Since our products offered in this market are premium brands, we will pursue market share expansion on a value basis through selling price increases.

    On the other hand, in regions such as Malaysia and Indonesia, where the demand for economy products is strong, we will also take proper actions to increase market share through economy products, while working on establishing premium brands.

    In this way, the situation varies from region to region, and each of our partner companies is taking different actions according to their market in their effort to improve operating profit margin.

Questions from Yifan Zhang, CLSA Securities Japan Co., Ltd.

  • A1Unfortunately, I’m unable to divulge extensive details regarding our M&A activities. Nevertheless, our M&A endeavors since FY2019 have primarily centered around the decorative paints and adjacencies segments. Our acquisition criteria primarily revolved around reasonable valuations and their potential contribution to EPS growth. While there’s a chance of us acquiring a company in the industrial coatings segment, it would only be pursued if the potential target is expected to make stable contributions to our earnings and offers a reasonable valuation.

    In terms of M&A activities that contribute to MSV, we are committed to enhancing EPS by acquiring excellent companies with balanced risk and returns at a reasonable price. We conduct comprehensive evaluations of their profiles, considering factors such as the stability of their business and customer base. We approach potential targets with an open mind, without setting restrictions based on scale or business areas.

  • A2While prioritizing debt financing, we are not completely dismissing the possibility of equity financing. However, we will only consider equity financing if it is guaranteed to enhance EPS and strengthen our balance sheet.

    Equity financing will be avoided if deemed unnecessary. Given the current favorable debt financing environment, including interest rate levels, debt financing remains our primary focus.

  • A3The risk of impairment is inherent whenever goodwill is created. Situations like a rise in interest rates or the progression of stagflation, which could result in our performance falling below expectations, may elevate the risk of impairment. Hence, we consistently conduct impairment tests.

    The audit for the fiscal year ended December 31, 2023, has not yet been fully completed. However, we have not identified any situations or cases necessitating impairment recognition.

Question from Atsushi Ikeda, Goldman Sachs Securities Co., Ltd.

  • A1In FY2024, we are projecting growth rates of around 15% for the TUC segment and 0-5% for the TUB segment. The overall operating profit margin in the entire NIPSEA China will remain largely unchanged from 12.5% in FY2023.

    Revenue growth in the TUC segment in the 4Q of FY2023 stood at 8%, slightly below our expectations, as we had anticipated a slightly higher growth rate. On the other hand, revenue in the TUB segment decreased by 1%, attributed to an uptick in repaint sales for public buildings, shifting focus away from residential applications for real estate developers as part of our revenue source diversification efforts. We believe we did very well considering that we had anticipated a much larger decrease. Although our operating profit margin experienced a slight dip in the 4Q due to some price/mix deterioration, we believe it is more accurate to assess our performance by considering the combined results of the 3Q and the 4Q.

    Our performance in the 3Q was very strong even before provisions, so we reduced advertising and promotion expenses to some extent. When the 3Q and the 4Q are combined, operating profit effectively increased compared with last year. In the 4Q, we increased investments such as the installation of Computerized Color Matching machines and advertising expenses. We expect these investments will bear fruit in FY2024 by adhering to our growth strategy centered on the TUC segment.

    Indeed, our overall results for the 4Q exceeded the targets we had set. While we slightly missed our revenue target, our primary focus remains on achieving our operating profit target. We do not believe that the trend has changed significantly in just one quarter.

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