Finance and M&A Strategies
Our Finance and M&A Strategies to Achieve MSV
Yuichiro Wakatsuki Director, Representative Executive Officer & Co-President
Conscious of our cost of capital
While maximizing EPS and PER, we also maintain our policy to have ROIC (return on invested capital) surpassing WACC (weighted average cost of capital: approximately 6%) eventually for M&A. Capital efficiency is on a slight decline as a result of recognizing goodwill linked to our M&A activities. With EPS accretion in Year 1 of acquisition, the acquired company is also expected to attain an ROIC surpassing the WACC (on a consolidated basis) within 3 to 4 years. This will be accomplished through post-acquisition profit growth and a shortened cash conversion cycle (CCC), leading to improved capital efficiency. Vigilant monitoring of any decline in capital efficiency is essential, as it can result in increased risk. However, we also recognize the importance of striking a balance between ROIC and profit growth, as being excessively focused on ROIC might lead to opportunity losses for quality M&A.
With the advantageous risk/return profile of the markets we operate in, coupled with our strong balance sheet and low funding costs, we are confident in our ability to effectively manage risk and accelerate EPS accumulation.
The table on the below shows the year-on-year improvement in individual ROIC for the major assets acquired since FY2019. This progress can be attributed to profit growth and effective balance sheet management following the acquisitions. Notably, Betek Boya achieved an ROIC above the consolidated WACC in its second year post-acquisition, while PT Nipsea is expected to reach this milestone in its fourth year of ownership, specifically in FY2024. DuluxGroup (Pacific) is projected to experience a gradual improvement in ROIC, with a positive spread anticipated in FY2024.
Finance strategy that drives our Asset Assembler model
Our capital policy revolves around enhancing TSR (Total Shareholder Return) by achieving consistent EPS growth, all the while upholding financial discipline and giving priority to growth investments.
Our financial discipline rests on three key principles: (1)Prioritize debt financing, (2) Maintain leverage capacity and promote engagement with financial institutions and credit rating agencies, (3) Consider the option of raising equity only accompanied by EPS accretion. The paint and adjacencies businesses represent significant cash flow generation capacity, and we are actively capitalizing on our low funding costs to meet our capital needs actively pursuing M&A opportunities.
We proactively implement capital expenditures that foster sustainable growth in the future noting current businesses require relatively limited capex compared to scale of revenue and cash flow. We are, however, making new investments, such as expanding production capacity and reinforcing our DX (Digital Transformation) and R&D efforts around the globe with discipline. With that, M&A is indeed the main source for additional capital needs. Based on our Asset Assembler model, we will continue to accumulate “good and low risk M&A” at a reasonable valuation.
We give paramount importance to investing in growth mainly in M&A, with a primary goal of enhancing TSR through EPS growth.
Our dividend policy is to maintain stability with a payout ratio of approximately 30%, also considering various factors such as performance trends, future investment opportunities, and dividend payout ratio in a comprehensive manner. (For information about the trends in dividends and TSR, see “Financial Highlights”.)
Effective balance sheet management achieved by adhering to financial discipline and building optimal capital structure
Regarding financial discipline, we prioritize debt financing over equity while maintaining leverage capacity to continuously secure low-cost financing. Since it is crucial to seek proper understanding of our risk nature from financial institutions and rating agencies, we engage in active dialogues with these institutions while continually enhancing our disclosure materials.
Balance sheet management
Regarding our balance sheet management, we also take CCC as a key performance indicator (KPI). Our partner companies strive to shorten CCC by reevaluating transaction terms across different regions and business units. Additionally, we have continuously undertaken measures to reduce cross shareholdings through their recent sale. Fixed assets (tangible, intangible and goodwill) have been growing driven mainly by our M&A endeavors and we actively monitor asset efficiency and profitability and occasionally take strategic actions such as the transfer of the European automotive business and the India businesses, along with implementing structural reforms in Japan Group and the marine business.
We also endeavor to mitigate goodwill impairment risk through a smooth PMI (Post-Merger Integration) backed by autonomous and decentralized management practices while maintaining discipline to accumulate high-quality M&As at reasonable valuation.
Balance sheet management policy
As of December 31, 2022
- “Cash and cash equivalents” ¥242.6bn
- “Trade and other receivables” ¥311.3bn
- “Other financial assets (non-current assets)” ¥26.1bn
- “Property, plant and equipment” ¥376.8bn
- “Goodwill” ¥825.5bn
- “Other intangible assets” ¥400.1bn
- Total ¥2,442.3bn
“Cash and equivalents”
“Trade and other receivables”
- Review the CCC to reflect the impact of the pandemic and deterioration of the conditions in the Chinese real estate market (e.g., review the trade terms and conditions)
- Take actions to respond to future credit collection risk (e.g., recording a provision for possible credit loss in China)
“Other financial assets (non-current assets)”
- Examine the rationality of continuing to hold cross-shareholdings every year (disposed of some cross-shareholdings also in FY2022)
“Property, plant and equipment”
- Take actions to improve asset efficiency and profitability through business divestiture and structural reform (e.g., transfer of the European automotive business and the India businesses, structural reform of Japan Group and the marine business)
“Goodwill” and “Other intangible assets”
- Minimize PMI risk based on autonomous and decentralized management and reduce impairment losses by accumulating “high-quality M&A”
- “Trade and other payables” ¥256.8bn
- “Bonds and loans payable” ¥722.1bn
- Total ¥1,287.0bn
“Bonds and loans payable”
- Prioritize debt financing and maintain the leverage capacity (the expected net debt/ EBITDA at the end of FY2023 is around 2.9 times assuming no further M&A activities)
- Evaluation from credit rating agencies (maintained the “A” rating from R&I)
- Stable finance procurement capability in yen (low interest rate/long-term maturity)
- “Capital” ¥671.4bn
- “Retained earnings” ¥272.5bn
- Total ¥1,155.4bn
- Reinforce financial base to prepare for growth investment such as M&A (capital increase based on new share issuance through a third-party allotment)
- Equity-based capital raising remaining an option with EPS accretion as a premise
- Take capital efficiency into the consideration of M&A decisions, including achieving ROIC that exceeds WACC
- Aim to maintain the dividend payout ratio at 30%
Status of debt
Our financial leverage is anticipated to be 3.4x net debt/EBITDA (adjusted for one-off items) by the end of FY2022 and approximately 2.9x by the end of FY2023, assuming no further M&A activities. (See “Overview and Updates on Medium-Term Plan (FY2021-2023)”.)
All debt financing is primarily denominated in yen, boasting an average maturity of 3.5 years and an average pre-tax interest rate of 0.35% as of FY2022 year end. Our focus remains on achieving an optimal capital structure, ensuring enough debt capacity to pursue new opportunities, also establishing strong trust and confidence among borrowing financial institutions and rating agencies. (For more information about the transition of credit ratings, see “Bonds and Ratings”.)
Capital allocation approach for sustainable growth
In comparison to the previous Medium-Term Plan (N-20, FY2018-2020, "MTP"), which saw an operating cash flow of approximately JPY240 bn, the current MTP (FY2021-2023) showcases an enhanced cash flow generation capability. This improvement can be partially attributed to the elimination of minority interest outflows, achieved by the full integration of the Asian JVs in FY2021. Throughout the three years of the current MTP our projections indicate an anticipated operating cash flow of approximately JPY300 bn. To achieve continuous revenue and profit growth we plan to invest about 3% of consolidated revenue in capital expenditures, leaving us with the remaining JPY170 bn in cash flow. Approximately half of this operating cash flow will be distributed to shareholders as dividends with a payout ratio of around 30%. The remaining cash flow will either pay down existing debt, or be spent directly for emerging opportunities, with the former and latter difference being a matter of timing. With the support and understanding of financial institutions and rating agencies, as well as our equity investors, we are committed to actively pursuing M&A opportunities that align with our growth strategy beyond FY2024.
Capital allocation approach