´´ The Expensive - Kao corp. (JP:4452)

Monday, July 2, 2012

The Expensive - Kao corp. (JP:4452)

Company Overview

Kao corporation, also called the Procter and Gamble of Japan, was founded in 1887 and is headquartered in Tokyo, Japan. It  engages in the production of beauty care, health care, home care and chemical products worldwide. The beauty care business segment, Kaos biggest segment by sales, provides cosmetic-, skin care- and hair care products. Human healt care segment, its second biggest segement by sales, offers food and beverage products, sanitary products (baby diaperes/sanitary napkins) and personal health products (oral care products, bath additives, etc.).

The third biggest segement is the fabric and home care segement, providing laundry detergents, kitchen-and house cleaning products, etc. The forth biggest business segement is chemicals, which produces oleo chemicals (including fatty alcohols), fatty amines, fatty acids, glycerin and commercial-use edible fats and oils, performance chemicals, comprising surfactants, plastics additives, and super plasticizers for concrete admixtures. This segment also provides specialty chemicals, such as toner and toner binder for copiers and printers; ink and colorants for inkjet printers; and fragrances and aroma chemicals.

For further readings on Kao's business and history I recommend the following link.


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Analysis of Operation


Although Kao is engaged internationally, its biggest chunk of sales still comes from within Japan. The region outside Japan, that contributes mostly to international growth is Asia&Oceania, which is about to overtake USA&Europe as Kao's biggest export market.

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The big jump in sales in 2007 is mainly attributable to the take- over of Kanebo cosmetics and (to a lessor extent) Molton brown in 2006. With that strategic move, Kao is now Japan's second biggest cosmetic producer after Shiseido. Those take-overs are also the main reason for Kao's margin compression from 2007 onwards, as depreciation charges on intangibles, goodwill and trademarks increased significantly. To a lessor extent, an increase in R&D expenses contributed to Kao's margin compression.

Although Kao has already depreciated its intangibles significantly in the last six years, it is very likely that further depreciation is going to cap net-income in the coming years, albeit in a lessor extent.

Actual gross-, operatin- and net- margins at Kao are 57%, 9% and 4,3% respectively.

Average margins are: Gross-margin (15yrs.) ==> 56%; operating-margin (18yrs.) ==> 10% and
net-margin (18yrs) ==> 5,1%

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Decrease in ROE, ROA and EPS are mainly due to the aforementioned factors.

Actual reading in EPS is ¥ 100 ==> P/E (actual) of 22.
Averages (18yrs.) is EPS of ¥ 90 ==> P/E (average) 23

ROE and ROA (actual) ==> 9,5% and 5,3%
ROE and ROA (average 18) ==> 10,6% and 5,75%

Analsis of Cash-flow


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 Kao has been (free) cash-flow positive for the last 18 years. Only in 2006 it posted a negative free cash-flow in the strict version (OCF- CFI), due to the takeovers.

Actual operating cash-flow per share is ¥ 238 ==> P/OCF (actual) of 9
Average OCF (18 yrs) is ¥ 230 ==> P/OCF (aver.) of 9

Actual FCF (normal) is ¥ 158 ==> FCF-yield (act.) of 7%
Average FCF (18yrs.) is ¥ 145 ==> FCF-yield (aver.) of 6,6%

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As mentioned before, the chart above shows the main reason for the depressed earning readings compard to its cash-flow readings.

For example, prior to the 2006 takeovers, Kao's net-income averaged (12 yrs.) ¥ 47`400 Mios.
Depreciation in that time span averaged ¥ 54'700 Mios.
==> depreciation over net-income had (on average) a factor of 1,16. That is already a pretty high reading!

After the takeovers income averaged ¥ 57'301 (7 yrs.), while deprecition averaged ¥ 86'506 Mios.
==> depreciation over net-income had a factor of 1,51. This is rather excessive!

Analysis of Balance Sheet


Also liquidity ratios came under pressure after the takeovers of  2006. Since than they've been recovering swiftly and are more than satisfactory now.

Actual readings for working capital ratio = 1,57 and acid test (current assets - inventory) = 1,14.

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Cash-holdings have been increaing, too. With roughly 10% of market cap, cash-holdings are not excessive.

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Debt-reduction is a priority for Kao's management and is progressing swiftly. Especially noteworthy is the reduction of interest bearing debt, which increased significantly due to the takeovers of 2006, but are almost at pre-takeover levels, in just 6 years. Good job CFO of Kao.

Analysis of Dividend and Treasury stocks

Although debt reduction has been one of the management's priorities, so has been the return to the shareholders. That makes the CFO's good job on debt reduction to an impressive one.

At least for 18 years Kao has been consistantly raising its dividend year after year. Unfortunately, didvidend increases have stalled lately.

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Furthermore, Kao has been repurchasing its stocks in a significant manner. Basic policy regarding treasury shares is the cancellation

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Kao is a very expensive stock. 2,2 times book and 22 P/E ratio can't be described as a bargain investment.
Operating cash-flow metrics are relativising the valuation issue and also does the fact, that book value is pressured by significant depreciation of intangibles.

But still. Kao is expensive. It is the most expensive stock in my japan portfolio. But I was willing to buy the issue and are holding on to it. It is a great and stable business,  with a management, that seems to be aligned with shareholders interest (e.g. dividend increase and share repurchases when warranted), but not jeopardizing the company's long-term financial and competitive position  (e.g. debt increase; decrease in R&D, etc)

Disclosure: Long Kao corp. (JP:4452)

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