Food Industry Research Analysts INITIATION

30 August 2016 Asia Pacific/Japan Equity Research Food Products (Personal Products (Japan)) / MARKET WEIGHT

Masashi Mori 81 3 4550 9695 [email protected] Recommend Morinaga Milk Industry and Morinaga & Co. ■ Initiating coverage: We rate three companies OUTPERFORM: Morinaga Milk Industry (2264), Morinaga & Co. (2201), and Meiji Holdings (2269). We have NEUTRAL ratings on four companies: Kikkoman (2801), Ajinomoto (2802), Toyo Suisan (2875), and Nissin Foods Holdings (2897). We rate one firm UNDERPERFORM: Yakult (2267). We are already covering Calbee (2229) with a NEUTRAL rating. We believe the foods sector remains under selling pressure due to relatively high valuations. However, we are fundamentally bullish on companies that have strong medium-term earnings growth profiles and are not currently overvalued. ■ Five key points: Our basic evaluation standards are: (1) companies positioned in the few growth categories in the Japanese foods market: yogurt and chocolate due to rising health consciousness; fruit granola and other cereal due to changing breakfast habits; and cheese, coffee and alcoholic beverages due to changes in food culture; (2) companies set to benefit from shifts in consumption behavior in Japan: those strong in B-to-B distribution, those able to meet growing demand for ready-made meals, those able to respond to growth in the convenience store channel; (3) companies having a strong presence in emerging markets with attractive future demographics; (4) companies positioned to ride the Japanese food boom and other tailwinds and which are positioned for sales growth in developed nations outside of Japan; and (5) companies capable of making internal shifts, including restructuring and management mindset. ■ Strong products outside of Japan: As the popularity of a given food is highly dependent on the region and local taste preferences, differentiation is the key to overseas growth. As it is relatively easy to showcase the uniqueness of Japan in confectionary, seasonings, and alcohol, we see significant room for overseas growth in these categories. In Asia, we believe confectionary offers the greatest growth potential because it is easily differentiated in terms of product and flavor, has relatively low average sales prices, and is well suited for younger people, who have few food biases. ■ Expect 8% annual profit growth over the next three years: We look for aggregate profit growth of 8% for the 14 major food companies. We expect an ongoing rise in attention placed on margins and capital efficiency. Amid signs of a growing low-price orientation in the Japanese market, there are concerns of slowing growth in emerging nations. However, there is still significant room for increased sales/production efficiency, so we expect the margin improvement trend of the past few years to continue. ■ Top picks are Morinaga Milk Industry and Morinaga & Co.: Both companies seem undervalued and appear positioned for double-digit profit growth over the medium term. A series of restructuring programs aimed at boosting margins are only halfway towards their goals, leaving significant room for improvement in various financial indicators. Our large-cap top pick is Meiji Holdings. We believe the majority of positives are already priced into the shares, but given the good balance of strong fundamentals and the share price, we would view a share price correction as a good buying opportunity. We expect all three companies to benefit from greater selection and focus in their domestic brand portfolios, but the issue is overseas earnings contribution. As expectations are low now, we believe signs of success overseas would pose upside risk.

DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access

30 August 2016

Key charts

Figure 1: Ratings, target prices and market caps for food sector coverage Price Chg Mkt Mkt Company Code Rating TP 29-Aug to TP cap cap (JPY) (JPY) (%) (JPY b) (USD m) Morinaga & Co 2201 OUTPERFORM 1,000 823 21.5 223 2,219 Calbee 2229 NEUTRAL 4,400 4,020 9.5 538 5,351 Morinaga Milk 2264 OUTPERFORM 850 677 25.6 169 1,677 Yakult Honsha 2267 UNDERPERFORM 4,200 4,740 -11.4 834 8,296 Meiji Holdings 2269 OUTPERFORM 10,500 9,400 11.7 1,435 14,280 Kikkoman 2801 NEUTRAL 3,400 3,350 1.5 705 7,012 Ajinomoto 2802 NEUTRAL 2,400 2,265 6.0 1,295 12,888 Toyo Suisan 2875 NEUTRAL 4,300 4,240 1.4 470 4,678 Nissin Foods Holdings 2897 NEUTRAL 5,800 5,830 -0.5 685 6,814 Source: Companies data, Credit Suisse assumptions

Figure 2: Sales and profit breakdown by region in our food sector coverage Meiji HD Ajinomoto Yakult Kikkoman Nissin Foods Calbee Toyo Suisan Morinaga&Co Morinaga Milk Japan 93% 47% 61% 43% 79% 90% 80% 94% 95% Asia ex JP 5% 23% 24% 7% 10% 5% 0% 2% 2% FY0 sales mix Americas 2% 21% 13% 6% 10% 4% 20% 5% 0% EMEA 1% 9% 2% 44% 1% 1% 0% 0% 3% Japan 99% 42% 28% 26% 91% 88% 58% 100% 100% Asia ex JP 1% 41% 48% 8% 6% 3% 0% 0% 0% FY0 OP mix Americas 0% 13% 23% 55% 3% 9% 42% 0% 0% EMEA 0% 4% 1% 11% 0% 0% 0% 0% 0% confectionary seasonings, dairy products, dairy products, soy sauce, instant noodle, potato-based (chocolate, dairy products, Main products frozen foods, cancer therapy instant noodle confectionary food distributor confectionary snack, cereal snack, chewing beverage animal nutrition product gum) Thailand, US, China, China/HK, Brazil, US, Korea, HK, Germany, Important overseas countries US, China Indonesia, Indonesia, US, West Europe US, Mexico Indonesia, US US, Mexico Taiwan, China Indonesia Vietnam, Brazil Mexico, Brazil Source: Companies data, Credit Suisse assumptions

Figure 3: Valuations and medium-term growth rate for food sector coverage Mkt Div. Div. OP EBITDA OP EBITDA Company Rat- cap Stock Performance (%) PER (x) PBR (x) EV/EBITDA(x) ROE payout yield ROIC CAGR CAGR margin margin ing (USD b) 1m 3m 6m 1y FY1E FY2E FY1E FY2E FY1E FY2E FY2E FY2E FY2E FY2E FY0-3 FY0-3 FY0-3 FY0-3 Japan Food Morinaga & Co O 2.1 21.4 46.7 30.2 27.0 20.2 17.8 2.6 2.3 10.2 9.3 12.9% 17.3% 1.0% 14.5% 18.4% 12.1% 8.9% 11.9% Calbee N 5.2 -10.9 -1.6 -12.0 -13.2 30.3 27.7 4.0 3.7 12.6 12.0 13.2% 31.0% 1.1% 22.8% 8.0% 5.9% 12.0% 14.9% Morinaga Milk O 1.6 -11.2 0.6 27.5 17.9 18.0 16.4 1.2 1.2 7.6 7.2 7.1% 17.0% 1.0% 5.2% 12.7% 7.4% 3.2% 6.3% Yakult Honsha U 7.7 -4.0 -10.2 -12.1 -30.9 30.8 30.5 2.2 2.1 13.3 13.2 6.9% 21.2% 0.7% 6.9% -2.6% -1.8% 9.3% 15.5% Meiji Holdings O 13.5 -12.6 -5.3 3.8 -4.4 22.7 21.3 3.0 2.7 11.4 10.4 12.8% 22.6% 1.1% 12.5% 11.2% 8.0% 7.7% 11.1% Kikkoman N 6.3 -8.3 -12.4 -9.8 -15.2 26.9 32.0 2.7 2.5 15.5 15.0 7.9% 32.5% 1.0% 8.8% 1.9% 1.5% 8.1% 11.1% Ajinomoto N 12.6 -14.2 -11.6 -18.1 -14.3 25.7 23.8 2.1 2.1 9.6 9.2 8.9% 33.6% 1.4% 9.0% 3.9% 1.9% 8.2% 12.3% Toyo Suisan N 4.2 -7.4 -0.7 4.8 -4.8 20.6 20.6 1.6 1.5 7.6 7.2 7.4% 34.0% 1.7% 11.9% 4.2% 5.6% 7.7% 11.1% Nissin Foods N 6.2 -0.2 5.4 12.5 1.6 28.5 23.7 1.7 1.6 13.0 11.0 6.8% 34.5% 1.5% 6.9% 10.9% 7.1% 6.4% 9.7% Note: Ratings: O=OUTPERFORM, N=NEUTRAL, U=UNDERPERFORM Source: Company data, Credit Suisse estimates

Figure 4: Near-/medium-term share-price catalysts Near-term catalysts Medium-term catalysts, long-term investment themes Company （within 6 months）（6–24 months） Confirmation of sustainability of growth in yogurt, slowdown in growth Scope for growth in probiotics yogurt, timing of earnings contribution from Meiji Holdings of powdered milk overseas business Ajinomoto Shareholder returns Expanded growth in processed food, seasonings in Japan, Asia, the Yakult Honsha Timing of recovery in China SustainedAmericas growth in Asia, the Americas, recovery in pharmaceuticals Kikkoman None in particular Solidbusiness growth in Asia, Latin America Nissin Foods Sustainability of firm sales of instant noodles in Japan, rising sales in Growth in sales in China, Brazil, Southeast Asia Holdings China Toyo Suisan Timing of recovery in US, Mexico Growth in new markets (Latin America, India) Morinaga & Co. Further upward revisions to guidance Growth in the US, Indonesia; restructuring of Japan business Morinaga Milk Upward revision to guidance, sustainability of growth in yogurt Improved margins due to restructuring, solid growth in B-to-B business Industry Calbee Full-fledged recovery in US Growth in Asia, Europe; rebuilding China business Source: Credit Suisse

Food Industry 2 30 August 2016

Domestic food market: Searching for the few growth categories Demographics indicate that quantitative growth for the Japanese food market as a whole is basically unlikely. According to a survey by Nikkan Keizai Tsushin, Japan’s processed food production value (perishables not included) is expected to remain stable at around ¥23tn. Meanwhile, even amid calls for slower macroeconomic growth, emerging nations, especially those in Asia, are still attractive markets based on demographics and the potential for consumers to move up the food price ladder. The Japanese food market is currently experiencing growth in the yogurt and chocolate categories owing to such factors as growing health consciousness. In the beverage market, energy drinks and bottled water (in PET plastic bottles) are growing. Another growth area is the cereal category such as fruit granola, which reflects changing breakfast habits. The cereal category ranks first in volume growth, at double digits, over the past five years. Nutritional supplement foods are also growing due to an increase in the skipped-meal rate. The cheese, coffee and alcohol categories continue to expand due to underlying support from shifts in food culture. Our basic evaluation standards are: (1) companies positioned in the few growth categories in the Japanese foods market; (2) companies set to benefit from shifts in consumption behavior in Japan: those strong in B-to-B distribution, those able to meet growing demand for ready-made meals, those able to respond to growth in the convenience store channel; (3) companies with a strong presence in emerging nations with attractive future demographics; (4) companies positioned to ride the Japanese food boom and other tailwinds and which are positioned for sales growth in developed nations outside of Japan; and (5) companies capable of making internal shifts, including restructuring and management mindset.

Figure 5: Major processed foods in Japan and global five-year sales volume CAGR (2011–15) (%) 18 16 Japan World 14 12 10 8 6 4 2 0 -2 -4

Source: Company data, Euromonitor, and various industry data

Food Industry 3 30 August 2016

Domestic food market: Growth in ready-made meal market is attractive According to the Foodservice Industry Research Institute, the Japanese restaurant industry grew 2.2% YoY, to ¥25.2tn, in 2015. Although the industry was hurt by a contamination scare at the start of the year, it subsequently recorded relatively upbeat growth supported by higher per-capita spending on dining out, a rise in the number of foreign visitors to Japan, and an increase in corporate entertainment expenditures. We believe it will be difficult for the restaurant market to sustain growth, partly because of increasingly cautious consumer spending on dining out amid growing economic uncertainty. Meanwhile, the category of "prepared meals sold at retail stores," which includes bento (lunch box) shops, delicatessens, and takeaway fast food outlets, grew 5.4% YoY to ¥7.1tn. We attribute this to two structural shifts: (1) greater budget-mindedness is prompting consumers to seek more opportunities to eat at home rather than dining out and (2) growth in the number of consumers of prepared meals, including everyday dishes, due to a shift in household composition to a higher number of single people and senior married couples. More older consumers in particular are becoming aware of the convenience and good taste of prepared meals, which are generally becoming common at the household dining table.

Figure 6: Market growth in Japan's dine-out industry Figure 7: Market growth in the prepared-food retail industry

(¥ trn) (¥ trn) 30 7

25 6 5 20 4 15 3 10 2

5 1

0 0

Source: Foodservice Industry Research Institute Source: Foodservice Industry Research Institute

Ajinomoto is a good example. The company expects the commercial-use food products market to grow 5% in FY3/17. Growth in ready-made meals sold by convenience stores is striking. The expanding menu of prepared meals and growing demand for more flavorful dishes is expected to boost demand for Ajinomoto’s functional ingredients. Ajinomoto defines its business as B-to-B-to-C and targets increased sales to central kitchens and the backyards of mass merchandisers. Also, the restaurant industry is become more focused on cost reductions due to sharply higher personnel costs and escalating competition, so we believe there is still room for growth in Ajinomoto’s B-to-B business.

Food Industry 4 30 August 2016

Figure 8: Market growth trends for Japan's dining-out and Figure 9: Shares of domestic food expenditures prepared takeout food industries

(%) Dining out (1997=100) Dining out Home-meal replacement 166 50 Dining out and Home-meal replacement 170 158 160 150 151 45.045.244.9 44.6 44.9 144 145 144 146 44.1 44.344.1 44.144.0 150 142 141 142 45 42.842.843.042.8 135 137 138 132 134 41.2 140 130 40.640.7 130 118 40 37.7 36.536.6 36.636.836.6 120 35.8 36.0 35.9 35.8 35.4 35.535.435.2 35.535.635.135.3 110 100 35 33.4 98 100 94 93 89 88 87 33.5 100 85 84 84 84 85 84 83 85 90 81 81 79 80 31.8 30 28.4 80 70 27.8

2013 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2014 2015

Source: Foodservice Industry Research Institute Source: Foodservice Industry Research Institute Currently, supermarkets are the most important sales channel for the food industry. However, sales through convenience stores, drugstores, and other chain stores have been growing recently. In Japan, the merchandise catalog channel, including online sales, accounts for only around 5% of food sales, but with more companies bolstering their omni- channel capabilities, we see future growth potential in this area. As the distribution industry, both wholesale and retail, gradually increases in size and penetration, we expect the weighting of major chain stores to increase. Also, private brand (PB) sales growth appears to be subsiding for now. There is always a certain number of consumers who focus on low prices, and the current economic situation appears to be tilting even more consumers in this direction. The proportion of PB merchandise is low in Japan compared with Europe and the US, but major domestic chains are stepping up PB marketing. Therefore, from a long-term perspective, we believe it is becoming increasingly important for national brand (NB) makers to co-develop and/or manufacture PBs on a contract basis. We believe that NBs will remain under pricing pressure amid the increasing scale of the distribution industry and the expansion of the PB market. From this situation, we expect two outcomes: (1) weeding out of companies with weak products and cost competitiveness and (2) increased management recognition of the importance of margins. Over the past few years, more Japanese food companies have transitioned to management systems that focus on boosting margins and capital efficiency. We expect this trend to strengthen due to the industry shifts discussed above.

Figure 10: Japan processed food market share by sales Figure 11: Convenience store sales as a percentage of channel (2015) total retail sales in Japan Non-Store Retailing CVS sales total (JPY trn, LHS) (Internet,Homesh 12 8.0% opping,etc) Other CVS share of total retail sales (%, RHS) 5% Non-Grocery 1% 10 7.5% Specialists 5% 8 7.0%

Convenience 6 6.5% Stores 19% 4 6.0%

Supermarkets 2 5.5% 58% 0 5.0% Traditional Grocery Retailers 12%

Source: Euromonitor, Credit Suisse Source: METI’s Current Survey of Commerce, Credit Suisse

Food Industry 5 30 August 2016

Figure 12: PB share (volume basis) in major European countries (2015) Switzerland 52% Finland 30% Spain 50% Hungary 34% UK 46% Denmark 32% Portugal 41% Sweden 31% Germany 43% Czech 32% Belgium 42% Holland 29% Austria 41% Norway 29% France 35% Italy 21% Slovakia 33% USA 20% Poland 29% Japan 10% Source: European data by Private Label Manufacturers Association (PLMA), US data by IRI Consumer Network, Japanese data is Credit Suisse estimates.

Food Industry 6 30 August 2016

Overseas markets: Easy differentiation in confectionary and seasonings categories Because a food's popularity is highly dependent on the region and local taste preferences, companies with a strong presence in a given area have an advantage. Consequently, differentiation is more important for overseas expansion in the food industry compared with other general consumer goods. Japanese companies have achieved relative success in three main categories: (1) products that leverage technologies developed in Japan, such as instant noodles and umami seasonings (i.e., flavor enhancers); (2) products, such as high-quality soy sauce and Japanese whiskies, that have made inroads into other developed regions such as Europe and the US amid the global Japanese food boom and heightened value placed on product authenticity by consumers; (3) confectionary products, which are relatively easy to differentiate, especially for younger consumers in emerging nations in Asia as well as for inbound tourists. As it is relatively easy to showcase the uniqueness of Japan in confectionary, seasonings, and alcohol, we believe these categories have the greatest growth potential.

Figure 13: Companies with products suited for overseas markets Features of products, regions where strong Around 60% of Chinese market for noodles in standing cups (strong in seafood Nissin Foods Holdings flavor), lion's share of Brazil's instant noodles market Toyo Suisan Top share of instant noodles markets in US, Mexico Ajinomoto First in the world to develop and sell umami seasoning (worldwide seasoning) Kikkoman World's largest soy sauce manufacturer, strong in North America and Europe Kewpie Expanding sales of mayonnaise and salad dressings in China and Southeast Asia House Foods Strengthening curry business (restaurants, roux sales) in China Yakult Honsha Worldwide sales of Yakult probiotic drinks featuring lactobacillus Healthy snacks popular in North America, fruit granola popular among visitors to Calbee Japan Ezaki Glico Sells Pocky in China, also beefing up ice cream sales in Southeast Asia Fujiya Developing pop candy in China Developing Soyjoy confectioneries and Pocari Sweat beverage in Asian markets Otsuka Holdings (China, Indonesia) Suntory, Asahi Demand for Japanese whisky growing worldwide Kotobuki Spirits Visitors to Japan purchase western style confectioneries as souvenir gifts Meiji Holdings, Visitors to Japan purchase powdered baby milk Morinaga Milk Industry Source: Credit Suisse For reference, we discuss the results of a survey of the Chinese market by JETRO (Japan External Trade Organization). According to the survey, some 90% of people in China have experience purchasing Japanese food products. The category with the highest buying experience rate was confectionaries, at 66% of respondents. Also, when asked what they liked most about Japanese foods, many respondents answered "quality," "taste," and "safety." The consumers were, however, not happy with the high prices of the products. Also, our own survey reveals the popularity of Pocky from Ezaki Glico (2206), candies from Fujiya (2211) and UHA Mikakuto, and Soyjoy from Otsuka Pharmaceutical (a bar- type snack based on soybean paste). These products are sold in general supermarkets, and their respective price ranges are not significantly different from local products. Confectionary accounts for a substantial portion of the few Japanese food products that have become popular in foreign markets. As confectionary is easily differentiated by packaging, taste, and product form, its target market is younger people, who are more open to new food options. Also, purchasing patterns by visitors to Japan show heavy buying in the confectionary category. We believe this reflects the ease of carrying confectionary items back home as souvenirs. In any case, we believe that confectionary offers the greatest growth potential because it is easily differentiated in terms of product and flavor, has relatively low average sales prices, and is well suited for younger people, who have few food biases.

Food Industry 7 30 August 2016

Figure 14: Fujiya and UHA Mikakuto candy offerings at a Figure 15: Ezaki Glico’s Pocky and Pretz on shelves at a regular Chinese supermarket regular Chinese supermarket

Source: Credit Suisse (photo taken in Chengdu) Source: Credit Suisse (photo taken in Chengdu) Figure 16: Chinese consumers who have bought Figure 17: Chinese consumers' liking for Japanese-made Japanese food products food products (%) 100 (%) 100 90 80 80 66.3 53.9 70 61.8 59.7 60 60 48.8 47.4 46.7 50 40.9 40 26.2 33.4 40 31.8 20 10.5 8.7 30 0.8 15.5 20 0 10 1.5 Like very Like Indifferent Do not like Do not like 0 much very much at all

Note: Based on survey of 1,200 males and females in their 20s, 30s, Source: JETRO and 40s, living in Shenyang, Dalian, and Shanghai Source: JETRO Figure 18: Favorable aspects of Japanese-made food Figure 19: Problems with Japanese-made food products, products, according to Chinese consumers (%) according to Chinese consumers (%) 100 60 52.7 90 50 80 38 70 63.5 40 32.4 60 54.1 30 21.7 21.1 20.5 19.3 50 20 40 5.4 7.1 27.2 10 30 24.1 22 20.8 20.3 0 20 10.5 5.3 10 4.7 1.9 0

Source: JETRO Source: JETRO

Food Industry 8 30 August 2016

FY16 and medium-term profit growth outlook Following the 2009 financial crisis and the March 2011 earthquake, food manufacturers have struggled with low margins, and a growing number are now restructuring their operations. Calbee is one of the companies that has achieved the most success in improving margins and capital efficiency. OPM, only 6.9% in FY10, rose to 11.4% in FY15, while ROE improved from 6.5% to 14.6%. Various companies such as Meiji Holdings subsequently strove to achieve production and sales efficiency gains, riding a wave of improving margins. Japanese food manufacturers' management structures had remained unchanged until recently. Management showed little concern for boosting margins and tended to focus more on hitting sales targets than on margins: they sought to boost sales, to increase the number of stock keeping units (SKU) and new products as they sought to secure retail shelf space, and to develop and manufacture high-quality products. Cost-cutting awareness was rare. The corporate environment was especially challenging before Abenomics. Due in part to this external climate, the attitude of the management teams at various companies started to change, which helped lift the average operating margin at major Japanese food companies from 4.1% in FY11 to 5.5% in FY15. During this period, business was boosted by a weaker yen and price increases in the Japanese market, while companies achieved success with such measures as SKU reduction, focusing management resources on strong brands, and efficiency gains in production systems.

Figure 20: OP, operating margin at 14 major food companies (bn JPY) 700 OP 7% 600 OPM (rhs) 6%

500 5%

400 4%

300 3%

200 2%

100 1%

0 0% FY09 FY10 FY11 FY12 FY13 FY14 FY15 FY16E FY17E FY18E Note 1: Nine companies in our coverage plus five others (Nippon Meat Packers (2282), Kewpie (2809), Yamazaki Baking (2212), Ezaki Glico (2206), Nisshin Seifun Group (2002)) Note 2: Bloomberg consensus forecasts used for companies not in our coverage Source: Company data, Bloomberg, Credit Suisse estimates

Overall OP at major Japanese food companies rose sharply, by 11% per year, from FY11 to FY15. We expect the rate to fall to 8% over the next three years. Nevertheless, this is a relatively strong rate of growth within the HPC sector. We see substantial scope for improvement as many companies still have low margins. Among the nine companies in our coverage, Morinaga Milk Industry (2264) has the lowest gross and operating margins. In response, the company has revised its product portfolio and embarked on an aggressive program of production and sales efficiency improvement. We are optimistic about this, as we think Morinaga has substantial scope for improvement. The company has the highest ratios of sales-to-advertising and promotion expenses (advertising costs, promotional spending). Aggressive restructuring started to have a visible impact from around last year, but we think there is still scope for improvement compared with rivals.

Food Industry 9 30 August 2016

Food company results rarely surprise as the sector is defensive with stable earnings. We do not think profit momentum will be strong at companies that have made some progress on profitability improvement efforts. However, we think earnings at companies that have substantial scope for improvement could well beat consensus. Similarly, we also think earnings at Morinaga Milk Industry (2264) and Morinaga & Co. (2201) will likely beat market expectations. We rank the food subsector relatively low in the consumer staples sector As discussed in our 15 January report 2016 investment strategy; Lion our top pick, our order of preference among subsectors is as follows: daily necessities > cosmetics > tobacco > food > beverages. Our view is basically unchanged today. Compared with the general daily necessities/cosmetics sectors, the Japanese food sector lags behind in terms of profitability, capital efficiency, and other financial indicators. Consumer staples need to have brand power in Asia, the most appealing population target. Aside from Yakult and Ajinomoto, there are few Japanese food companies with a strong presence in Asia. This category is highly reliant on customer tastes, so customers basically prefer local sales and production companies. Therefore, it is difficult to achieve economies of scale through measures such as increased exports. For reference, consider the following example: average gross margin is 53% and operating margin is 10% at major manufacturers of daily necessities, compared with 41% and 7% in the food sector.

Figure 21: Profitability comparison of food companies in our coverage (latest full-FY basis) OP Payroll A&P

OPM Ave. GPM (rhs) GPM Ave. (rhs) 25% 60%

50% 20%

40% 15% 41.2 30% 10% 7.3% 20% 5% 10%

0% 0% Morinaga Calbee Morinaga Yakult Meiji HD Kikkoman Ajinomoto Toyo Nissin & Co Milk Suisan Foods HD Source: Company data, SPEEDA, Credit Suisse Figure 22: Capital and investment efficiency comparison of food companies in our coverage (latest full-FY basis)

18% ROE ROA ROIC 16% 14% 12% 10% 8% 6% 4% 2% 0% Morinaga Calbee Morinaga Yakult Meiji HD Kikkoman Ajinomoto Toyo Nissin & Co Milk Suisan Foods HD

Source: Company data, SPEEDA, Credit Suisse

Food Industry 10 30 August 2016

Figure 23: Forecasts for food sector coverage Price Chg Mkt Mkt ------FY1------FY2------FY3------Company Code Rating TP 29-Aug to TP cap cap Forecasts CoE CS E Cons CS E Cons CS E Cons Morinaga & Co 2201 OUTPERFORM 1,000 823 21.5 223 2,219 OP 14,300 15,200 14,800 17,300 15,750 19,000 15,550 EPS (JPY) 38.4 40.7 39.2 46.1 41.9 50.7 44.4 Calbee 2229 NEUTRAL 4,400 4,020 9.5 538 5,351 OP 31,000 30,600 32,036 32,800 35,964 35,400 39,680 EPS (JPY) 133.3 132.5 140.9 145.2 163.4 157.2 180.0 Morinaga Milk 2264 OUTPERFORM 850 677 25.6 169 1,677 OP 16,400 17,000 - 18,500 - 20,500 - EPS (JPY) 33.2 37.6 - 41.3 - 46.5 - Yakult Honsha 2267 UNDERPERFORM 4,200 4,740 -11.4 834 8,296 OP 36,500 34,500 36,286 35,000 39,819 37,000 42,718 EPS (JPY) 169.4 153.7 163.8 155.5 178.4 164.6 191.5 Meiji Holdings 2269 OUTPERFORM 10,500 9,400 11.7 1,435 14,280 OP 74,500 89,000 87,329 100,000 97,271 107,000 107,444 EPS (JPY) 339.6 414.3 401.2 441.5 451.4 471.4 500.3 Kikkoman 2801 NEUTRAL 3,400 3,350 1.5 705 7,012 OP 31,500 31,000 32,451 33,000 35,474 34,500 38,068 EPS (JPY) 124.3 124.5 123.4 104.8 120.0 110.5 130.9 Ajinomoto 2802 NEUTRAL 2,400 2,265 6.0 1,295 12,888 OP 91,000 90,000 93,489 97,000 103,521 102,000 113,839 EPS (JPY) 89.1 88.3 99.8 95.3 115.1 100.9 130.7 Toyo Suisan 2875 NEUTRAL 4,300 4,240 1.4 470 4,678 OP 29,000 29,500 29,589 31,000 30,189 32,000 30,700 EPS (JPY) 200.7 205.6 201.8 205.6 203.8 212.5 207.7 Nissin Foods Holdings 2897 NEUTRAL 5,800 5,830 -0.5 685 6,814 OP 27,000 28,000 28,269 35,000 34,256 36,000 36,300 EPS (JPY) 203.7 204.6 212.7 246.2 244.1 255.5 257.2 Source: Company data, Thomson Reuters, I/B/E/S, Credit Suisse estimates

Figure 24: Comparison of global food & beverage companies (Credit Suisse forecasts) Mkt Div. Div. OP EBITDA OP EBITDA Company Rat- cap Stock Performance (%) PER (x) PBR (x) EV/EBITDA(x) ROE payout yield ROIC CAGR CAGR margin margin ing (USD b) 1m 3m 6m 1y FY1E FY2E FY1E FY2E FY1E FY2E FY2E FY2E FY2E FY2E FY0-3 FY0-3 FY0-3 FY0-3 Japan Food Morinaga & Co O 2.1 21.4 46.7 30.2 27.0 20.2 17.8 2.6 2.3 10.2 9.3 12.9% 17.3% 1.0% 14.5% 18.4% 12.1% 8.9% 11.9% Calbee N 5.2 -10.9 -1.6 -12.0 -13.2 30.3 27.7 4.0 3.7 12.6 12.0 13.2% 31.0% 1.1% 22.8% 8.0% 5.9% 12.0% 14.9% Morinaga Milk O 1.6 -11.2 0.6 27.5 17.9 18.0 16.4 1.2 1.2 7.6 7.2 7.1% 17.0% 1.0% 5.2% 12.7% 7.4% 3.2% 6.3% Yakult Honsha U 7.7 -4.0 -10.2 -12.1 -30.9 30.8 30.5 2.2 2.1 13.3 13.2 6.9% 21.2% 0.7% 6.9% -2.6% -1.8% 9.3% 15.5% Meiji Holdings O 13.5 -12.6 -5.3 3.8 -4.4 22.7 21.3 3.0 2.7 11.4 10.4 12.8% 22.6% 1.1% 12.5% 11.2% 8.0% 7.7% 11.1% Kikkoman N 6.3 -8.3 -12.4 -9.8 -15.2 26.9 32.0 2.7 2.5 15.5 15.0 7.9% 32.5% 1.0% 8.8% 1.9% 1.5% 8.1% 11.1% Ajinomoto N 12.6 -14.2 -11.6 -18.1 -14.3 25.7 23.8 2.1 2.1 9.6 9.2 8.9% 33.6% 1.4% 9.0% 3.9% 1.9% 8.2% 12.3% Toyo Suisan N 4.2 -7.4 -0.7 4.8 -4.8 20.6 20.6 1.6 1.5 7.6 7.2 7.4% 34.0% 1.7% 11.9% 4.2% 5.6% 7.7% 11.1% Nissin Foods N 6.2 -0.2 5.4 12.5 1.6 28.5 23.7 1.7 1.6 13.0 11.0 6.8% 34.5% 1.5% 6.9% 10.9% 7.1% 6.4% 9.7% US/Europe Food Nestle U 248.0 0.2 4.8 11.1 9.8 23.6 22.4 3.7 3.6 14.4 13.8 16.1% 72.7% 3.2% 12.6% 4.3% 3.5% 15.6% 19.8% Unilever N 134.7 1.0 13.2 15.4 36.1 23.4 21.0 7.3 6.6 15.6 14.1 31.2% 67.4% 3.2% 21.5% 10.6% 10.3% 15.4% 18.0% Danone U 50.2 -0.8 8.2 6.4 23.6 22.2 20.7 3.2 3.0 14.3 13.6 14.4% 55.6% 2.7% 10.6% 5.3% 4.7% 13.8% 17.3% Kraft Heinz O 107.4 2.1 4.8 14.5 18.0 26.7 22.4 1.8 1.8 16.2 14.7 8.0% 63.0% 2.8% 6.4% 13.4% 10.9% 30.0% 32.3% Mondelez Intl. O 68.8 -2.1 -3.8 6.2 0.6 23.6 20.5 2.6 2.5 17.5 15.9 12.3% 35.5% 1.7% 8.3% 11.0% 9.3% 15.6% 19.0% General Mills N 43.6 -1.4 12.7 20.4 24.1 24.3 22.6 8.8 8.1 15.5 14.6 35.8% 53.3% 2.4% 14.9% 4.1% 4.3% 18.2% 22.2% Kellogg O 29.0 -0.4 10.6 11.3 22.9 22.5 20.4 13.8 13.1 14.3 13.6 64.4% 0.0% 0.0% 18.9% 5.0% 4.4% 16.0% 20.3% The Hershey Co N 30.7 0.1 19.7 22.0 22.9 25.8 24.0 21.8 21.6 18.4 17.8 89.8% 52.9% 2.2% 32.5% 3.7% 3.4% 20.9% 24.2% Campbell Soup U 18.8 -2.9 -1.2 -2.1 26.5 20.4 19.5 11.0 9.1 12.6 12.1 46.6% 43.6% 2.2% 20.1% 6.7% 6.6% 19.1% 23.4% Mead Johnson O 15.5 -6.7 0.0 12.9 6.0 23.3 21.5 - - 15.6 14.7 - 48.4% 2.3% 92.5% 4.2% 4.5% 26.2% 29.2% EM F&B Thai Beverage N 18.3 -4.3 10.6 41.4 37.5 23.1 20.9 5.0 4.7 20.6 19.0 22.3% 65.0% 3.1% 15.3% 13.3% 11.3% 15.1% 17.2% Tingyi U 5.8 19.4 11.1 9.3 -33.8 31.4 27.6 1.9 1.8 7.6 7.2 6.6% 50.0% 1.8% 5.6% 0.8% -0.1% 6.1% 12.4% Want Want HD N 8.8 12.6 -2.2 3.9 -16.4 17.3 17.3 4.3 3.8 9.9 10.0 21.9% 50.0% 2.9% 31.5% 0.0% -0.6% 23.0% 27.5% China Resources N 7.2 13.8 8.7 48.1 49.9 30.5 27.4 2.6 2.5 14.8 13.4 9.0% 40.0% 1.5% 7.6% 14.0% 9.4% 8.1% 14.3% Tsingtao Brewery N 5.4 -2.4 -4.0 -5.0 -31.0 19.1 18.3 1.8 1.7 11.0 10.5 9.1% 31.0% 1.7% 11.7% 14.5% 6.5% 5.2% 8.0% China Mengniu O 7.8 19.0 20.7 37.9 7.5 21.7 18.7 2.2 2.0 12.8 11.9 10.5% 40.1% 2.1% 8.8% 10.2% 8.0% 5.7% 8.3% CJ CheilJedang O 4.5 -1.5 0.5 7.0 -2.8 15.3 12.7 1.5 1.3 8.0 7.1 10.1% 9.0% 0.7% 6.6% 14.7% 8.2% 6.5% 9.1% Orion N 3.9 -19.4 -23.3 -19.1 -20.0 21.7 19.4 2.8 2.5 10.5 9.5 12.8% 26.2% 1.3% 11.2% 8.8% 6.1% 13.7% 20.8% Note: Ratings: O=OUTPERFORM, N=NEUTRAL, U=UNDERPERFORM Source: Credit Suisse estimates

Food Industry 11 30 August 2016

Share price performance Defensive food sector stocks have outperformed over the past few years. From 2014, the food sector outperformed TOPIX, broadly on par with pharmaceuticals but following the HPC sector. However, in July 2016, share prices suddenly entered a correction phase even though many companies reported solid Apr–Jun results. Although this may have been partly due to sector rotation, we think investor acceptance of high valuations has reached its limit and that the rebound in food sector stocks will likely be weak. Basically, in our view investors to date have focused too closely on food sector stocks, and sector share prices already reflect the bulk of good news. In addition, food sector stocks still look overvalued relative to other sectors in Japan. However, Japanese stocks do not look overvalued from a global perspective in the aftermath of the recent share price correction (details to follow). In other words, we think further selling pressure driven by overvaluation alone looks unlikely. In our stock selection, we chiefly focus on: (1) shares of companies that no longer look overvalued but are still on track for longer-term growth, and (2) small cap stocks that do not look overvalued and do not yet fully reflect positives. Since 2015, Morinaga & Co. and Morinaga Milk Industry have outperformed the sector. However, these two companies now look undervalued, and we think there is substantial potential for share price upside given that investor interest was relatively low.

Figure 25: TOPIX-relative share price performance (since Figure 26: TOPIX-relative share price performance (2016) 2014)

(Index) (Index) 180 130 HPC Food Retail Pharma 170 HPC Food 125 Retail Pharma 160 120 150 140 115

130 110 120 105 110 100 100

90 95

Jul-14 Jul-15 Jul-16 Jul-16

Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Apr-16

Jan-14 Jun-16 Jun-14 Jan-15 Jun-15 Jan-16 Jan-16 Jun-16

Mar-16 Feb-14 Mar-14 Feb-15 Mar-15 Feb-16 Mar-16

Feb-16

Aug-14 Sep-14 Nov-14 Dec-14 Aug-15 Sep-15 Nov-15 Dec-15 Aug-16 Aug-16

May-16 May-15 May-16 May-14 Source: Bloomberg, Credit Suisse Source: Bloomberg, Credit Suisse

Figure 27: Food companies' TOPIX-relative performance Figure 28: Food companies' TOPIX-relative performance (since 2015): Morinaga & Co. has been the top performer (since 2016): Morinaga & Co. is the top performer (Index) (Index) 350 Morinaga & Co. Calbee Morinaga & Co. Calbee Morinaga Milk Yakult Honsha Morinaga Milk Yakult Honsha Meiji HD Kikkoman Meiji HD Kikkoman 200 Ajinomoto Toyo Suisan Ajinomoto Toyo Suisan Nissin Foods HD Ezaki Glico 250 Nissin Foods HD Ezaki Glico Yamazaki Baking Megmilk Snow Brand Yamazaki Baking Megmilk Snow Brand Nippon Ham Kewpie Nippon Ham Kewpie 150

150 100

50 50

Source: Bloomberg, Credit Suisse Source: Bloomberg, Credit Suisse

Food Industry 12 30 August 2016

Approach to food sector stock valuations In contrast to other consumer staple sector companies, food sector companies have little direct competition with foreign companies, as their businesses are highly localized and based on preferences and tastes. We therefore usually use domestic industry average multiples in our valuations of Japanese food stocks. However, as many companies are listed (around 140 altogether, with 80 on the First Section of the Tokyo Stock Exchange), we use the market-cap weighted average FY1E P/E of the 10 largest companies (P/E based on median value of the Bloomberg consensus forecast). We then add a premium or discount to the average multiple depending on the market environment and company characteristics. The ten major companies examined are Meiji Holdings (2269), Ajinomoto (2802), Yakult Honsha (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2875), Nippon Meat Packers (2282), Yamazaki Baking (2212), Calbee (2229), and Nisshin Seifun Group (2002). We add a premium for companies that have better products and/or are more competitive than rivals. We also do so if companies are in a phase in which profit growth momentum is higher than the industry average. Conversely, we apply a discount to stocks of companies where profits have notably deteriorated. Multiples also need to be adjusted to reflect factors such as market capitalization, profitability, and capital efficiency. In principle, food sector stocks are easy to value from a longer term perspective: they tend to be rated highly for their stable profits and sustained shareholder returns. We do not directly adopt valuations of overseas companies. However, we do use them as a reference to confirm whether domestic food sector companies are excessively over- or undervalued. We think current share price multiples in Japan look slightly off. Yakult Honsha and Kikkoman's medium-term growth rates are not that high relatively speaking, but they still trade on high multiples. Their other financial indicators are by no means superior. We have to conclude that both companies are still carrying high valuations due to their unique business models. For Calbee, on the other hand, it is understandable that is trading on a high multiple given its strong profitability and high capital efficiency. We normally place value on companies with strong profit momentum, partly in view of topline expansion in growth product categories and restructuring aimed at improving margins. If such a company is undervalued, the share price multiple will eventually increase. In view of this, we think Morinaga Milk Industry and Morinaga & Co. are the most appealing stocks in the food sector.

Figure 29: FY1E P/E, OP CAGR comparison over the next three years (PER FY1E, x) 35 33 31 Yakult Kikkoman Calbee Yamazaki Baking 29 27 Nissin Foods 25 Kewpie Ajinomoto Ezaki Glico 23 Nisshin Seifun Meiji 21 Toyo Suisan 19 Morinaga & Co Nippon Meat 17 Morinaga Milk Packers 15 -5 0 5 10 15 20 (OP CAGR, %)

Note 1: Bloomberg consensus forecasts used for companies not in our coverage (Nippon Meat Packers, Nisshin Seifun Group, Kewpie, Ezaki Glico, Yamazaki Baking) Note 2: EPS adjusted for companies with relatively large temporary extraordinary gains/losses, goodwill amortization. Source: Bloomberg, Credit Suisse estimates

Food Industry 13 30 August 2016

For reference, we look at past share price multiples of the European and US food sectors (including beverages). Since 2014, Japan's food sector surpassed the European and US markets and traded at a premium to the country's representative share price index (TOPIX). The sector peaked around April of 2016 and has undergone a major correction since then. However, Japanese food sector premiums are still high relative to Europe and the US, although Japanese food sector stocks already carry the lowest P/E multiples. Moreover, Japanese stock markets are lower than those in Europe and the US, due to concerns about the stronger yen. Because they are below the European and US food sectors, Japan food sector multiples are unlikely to fall further. However, we see little prospect of multiples increasing again. We recommend more selective investment henceforth.

Figure 30: P/Es in Japan, the US, and Europe Figure 31: Food and beverage share price premiums versus major share price indices (PER, x) TOPIX (%) TOPIX F&B 26 100 S&P500 TOPIX F&B S&P500 F&B 24 S&P500 F&B STOXX Euro600 80 STOXX Euro600 F&B 22 STOXX Euro600 F&B 60 20

18 40

16 20 14 0 12

10 -20

Note: Based on Bloomberg FY1 consensus estimates Note: Based on Bloomberg FY1 consensus estimates Source: Bloomberg, Credit Suisse Source: Bloomberg, Credit Suisse

Figure 32: Individual company P/Es (actual EPS basis) (PER, x) TOPIX Food Index Morinaga & Co Calbee Morinaga Milk Yakult Honsha Meiji HD 70 Kikkoman Ajinomoto Toyo Suisan Nissin Foods HD Ezaki Glico Yamazaki Baking 60 Megmilk Snow Brand Nippon Ham Kewpie 50

Source: Bloomberg, Credit Suisse

Food Industry 14 30 August 2016

Figure 33: Japan food & beverage valuations Price MKCP ADTV Stock Performance (%) PER (x) PBR (x) EV/EBITDA (x) ROE(%) Div.yld (%) Div.payout(%) 3yr EBITDA(%) FY1E OP(mn JPY) Company Ticker (29-Aug) (Mil.USD) 1m 3m 6m 1y FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E CAGR margin Cons CoF Noodle Nissin Foods HD 2897 JP 5,830 6,696 16 -0.2 5.4 12.5 1.6 27.9 23.9 1.7 1.6 13.6 11.7 6.1 6.8 1.4 1.6 39.0 38.9 8.8 10.2 28,500 27,000 Toyo Suisan 2875 JP 4,240 4,597 15 -7.4 -0.7 4.8 -4.8 20.8 20.4 1.6 1.5 8.6 8.3 7.7 7.5 1.4 1.4 29.5 29.4 4.8 11.1 29,400 29,000 Meat processing Nippon Meat Packers 2282 JP 2,271 4,530 28 -9.3 -9.8 -4.4 -18.8 16.2 13.5 1.2 1.2 8.2 7.3 7.6 8.6 1.9 2.2 30.6 30.4 6.4 5.8 49,000 49,000 Itoham Yonekyu HD 2296 JP 997 2,899 5 -5.8 0.7 - - 23.7 20.0 1.4 1.3 - - 5.9 6.7 1.3 1.5 29.7 29.0 12.2 3.6 18,250 18,000 Prima Meat Packers 2281 JP 337 832 2 3.1 15.4 23.0 -3.7 13.1 12.1 1.2 1.1 - - 9.5 9.4 1.2 1.2 15.5 14.4 13.5 5.1 10,600 9,000 S Foods 2292 JP 2,539 801 3 -8.1 -10.8 14.6 0.6 12.9 11.1 1.3 1.2 6.2 5.5 10.1 10.7 1.4 1.5 17.8 16.6 11.8 4.7 9,750 9,600 Seasoning Ajinomoto 2802 JP 2,265 12,665 62 -14.2 -11.6 -18.1 -14.3 22.8 19.5 2.1 1.9 9.1 8.4 9.0 10.0 1.3 1.5 30.2 29.5 4.0 13.2 94,000 91,000 Kikkoman 2801 JP 3,350 6,891 29 -8.3 -12.4 -9.8 -15.2 26.8 28.3 2.7 2.5 16.0 15.2 10.1 9.0 1.0 1.0 26.4 29.6 5.1 11.6 32,200 31,500 Kewpie 2809 JP 2,969 4,442 20 -6.2 1.6 17.5 12.6 25.2 21.6 2.0 1.9 9.3 8.6 7.9 8.8 1.2 1.4 29.7 29.8 6.8 8.9 30,109 29,000 House Foods 2810 JP 2,245 2,256 7 -11.0 1.8 4.4 1.5 32.7 32.9 1.0 1.0 7.9 7.2 3.0 3.0 1.3 1.3 43.7 44.0 10.7 8.2 10,900 10,400 Ariake Japan 2815 JP 4,900 1,572 6 -13.4 -25.2 -21.1 -1.1 22.9 19.8 2.4 2.3 10.9 9.4 10.5 11.5 1.3 1.4 30.4 28.2 10.8 24.5 10,000 9,654 Kagome 2811 JP 2,417 2,354 10 -13.4 -8.9 14.0 19.7 49.0 48.1 ------1.0 1.0 46.7 46.7 2.5 - 7,750 9,200 Fujicco 2908 JP 2,184 747 2 -26.1 -19.7 -3.1 -19.0 17.6 16.0 1.1 1.0 - - 6.2 6.4 1.6 1.8 28.3 29.3 7.5 12.5 5,240 5,100 Dairy product Yakult Honsha 2267 JP 4,740 8,153 23 -4.0 -10.2 -11.9 -30.7 29.2 26.6 2.2 2.1 13.2 12.2 7.6 7.8 0.7 0.7 19.7 18.5 1.1 16.4 36,400 36,500 Meiji HD 2269 JP 9,400 14,034 58 -12.6 -5.3 3.8 -4.4 22.8 20.8 3.1 2.8 10.6 9.8 13.4 13.3 1.2 1.5 27.9 30.5 7.8 11.2 85,600 74,500 Megmilk Snow Brand 2270 JP 3,320 2,297 15 -6.7 -4.2 23.8 43.7 19.4 17.3 1.6 1.5 9.3 8.4 8.3 8.6 1.0 1.2 19.9 20.9 10.0 5.8 18,000 15,000 Morinaga Milk 2264 JP 677 1,648 10 -11.2 0.6 27.5 17.9 20.4 ------16,400 Bakery, Confectionery Yamazaki Baking 2212 JP 2,361 5,085 21 -16.5 -11.6 10.5 15.6 28.7 27.0 1.8 1.7 6.7 6.5 6.3 6.4 0.7 0.8 20.7 21.7 4.9 7.0 35,000 34,000 Calbee 2229 JP 4,020 5,259 27 -10.9 -1.6 -12.0 -13.2 28.2 24.4 4.0 3.6 11.8 10.6 14.1 14.6 1.0 1.2 29.5 30.1 9.5 15.7 32,000 31,000 Ezaki Glico 2206 JP 5,520 3,747 18 -10.4 -6.9 -8.5 -10.0 22.6 19.8 1.9 1.8 10.4 9.2 8.2 9.0 0.8 0.9 17.4 17.0 12.8 9.9 23,000 20,000 Morinaga & Co 2201 JP 823 2,180 13 21.4 46.7 30.2 27.0 21.0 19.7 2.5 2.3 10.4 9.5 12.1 11.8 1.0 1.1 20.4 21.5 8.2 10.9 14,800 14,300 Kameda Seika 2220 JP 5,000 1,091 2 -11.8 -4.2 12.1 0.5 20.3 18.2 2.2 2.0 9.7 8.7 10.8 10.9 0.9 1.0 17.4 17.8 11.9 12.0 6,300 6,000 Seafood processing Nippon Suisan 1332 JP 425 1,152 18 -16.8 -32.5 -18.7 11.5 9.0 7.7 1.2 1.0 8.0 7.1 12.8 13.2 1.4 1.6 12.7 12.7 5.0 6.1 20,000 18,000 Nichirei 2871 JP 1,058 3,061 16 8.0 10.1 23.6 44.1 22.6 21.0 1.9 1.8 9.8 9.2 8.5 8.6 1.2 1.3 27.8 27.8 5.5 7.8 21,700 21,700 Food oil, flour milling Fuji Oil 2607 JP 2,103 1,801 8 -6.7 9.2 9.9 23.6 16.8 15.4 1.2 1.2 7.7 7.1 7.2 7.5 1.8 1.9 29.7 29.3 5.8 9.8 18,158 17,500 Nisshin Seifun Group 2002 JP 1,493 4,443 15 -12.0 -18.9 -19.1 -10.9 22.2 20.5 1.2 1.1 8.8 8.3 5.3 5.6 1.7 1.9 38.7 39.8 4.4 8.0 25,750 24,300 Food Average (top10) 24.8 22.4 2.0 1.9 10.3 9.5 Soft Drink Coca Cola West 2579 JP 2,388 2,595 10 -16.0 -23.6 -5.4 -1.0 26.1 25.2 1.0 1.0 6.2 6.2 3.8 3.8 1.8 1.9 48.0 46.9 1.0 8.6 18,000 20,500 Coca Cola East 2580 JP 1,848 2,307 7 -7.0 -14.4 -5.2 -14.2 25.5 23.5 1.0 1.0 7.0 6.5 3.9 4.1 1.7 1.7 44.1 40.6 7.9 - - 14,000 Suntory Food Bev 2587 JP 4,155 12,554 28 -7.2 -18.7 -13.2 -18.2 30.1 27.6 2.1 2.0 8.6 8.1 7.1 7.4 1.7 1.8 50.7 49.8 3.2 12.9 91,500 90,000 DyDo Drink 2590 JP 5,060 820 2 -5.2 -11.7 -1.4 -2.5 ------5,000 Itoen 2593 JP 3,130 2,730 13 -17.5 -14.0 -2.3 14.2 33.8 29.6 2.9 2.7 7.4 6.9 8.6 9.2 1.3 1.3 43.1 37.8 2.7 7.7 20,500 20,000 Beer Sapporo HD 2501 JP 2,558 1,971 12 -11.0 -13.0 -0.3 10.3 18.9 16.7 1.2 1.1 8.3 7.7 6.4 6.8 1.4 1.4 - 23.2 6.3 9.0 21,100 21,100 Asahi Group HD 2502 JP 3,409 16,120 52 -2.5 -8.0 2.8 -13.1 18.5 16.7 1.7 1.6 9.6 9.9 9.0 9.4 1.6 1.9 29.8 31.3 2.7 11.3 140,286 140,700 Kirin HD 2503 JP 1,689 15,095 54 -4.4 -7.6 13.6 -5.0 23.2 21.1 2.2 2.1 8.9 8.4 9.6 9.9 2.2 2.4 52.2 50.0 2.8 12.0 133,000 127,000 Beverage Average 20.5 21.5 1.8 1.7 8.6 8.3 Note 1: Food average is the market-cap weighted average for 10 major food companies (Meiji Holdings, Ajinomoto, Yakult Honsha, Kikkoman, Nissin Food Holdings, Toyo Suisan, Nippon Meat Packers, Yamazaki Baking, Calbee, and Nisshin Seifun Group) Note 2: Based on median values of Bloomberg consensus estimates Source: Bloomberg, Credit Suisse

Figure 34: Global food & beverage valuations Price MKCP ADTV Stock Performance (%) PER (x) PBR (x) EV/EBITDA (x) ROE(%) Div.yld(%) Div.payout(%) 3yr EBITDA(%) Company Ticker Cur. (29-Aug) (Mil.USD) 1m 3m 6m 1y FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E FY1E FY2E CAGR margin US/Europe Food Nestle NESN VX CHF 77.6 248,954 403 -0.1 4.5 10.7 9.4 22.8 21.4 3.7 3.5 14.8 13.9 16.2 16.5 3.0 3.1 67.6 66.4 6.6 19.3 Unilever UNA NA EUR 40.9 141,072 183 -1.3 0.5 3.2 14.3 21.8 20.3 6.8 6.1 14.4 13.3 31.1 29.9 3.1 3.3 68.1 67.3 6.7 18.2 Danone BN FP EUR 67.9 50,337 110 -1.4 7.6 5.8 23.0 22.1 20.1 3.1 2.9 13.6 11.9 14.3 14.4 2.5 2.6 54.7 53.3 9.8 17.9 Kraft Heinz KHC US USD 88.2 107,360 256 2.1 4.8 14.5 - 27.2 22.5 1.8 1.8 17.4 15.5 6.8 8.0 2.7 2.8 72.5 63.0 36.4 31.9 Mondelez Intl. MDLZ US USD 43.1 66,981 343 -2.1 -3.8 6.2 0.6 23.3 20.5 2.4 2.3 17.0 15.5 10.3 11.4 1.6 1.8 37.8 36.7 -16.4 19.5 General Mills GIS US USD 70.9 42,490 218 -1.4 12.7 20.4 24.1 22.8 20.5 8.0 7.3 14.1 12.9 35.2 35.9 2.7 2.9 61.3 58.9 6.1 23.0 Kellogg K US USD 82.4 28,851 169 -0.4 10.6 11.3 22.9 22.7 20.6 15.3 13.9 14.6 13.6 67.6 67.5 2.5 2.6 56.2 53.8 20.7 20.5 The Hershey Co HSY US USD 110.9 23,638 147 0.1 19.7 22.0 22.9 26.0 24.2 23.5 19.6 14.8 14.1 90.3 81.2 2.1 2.3 55.4 55.3 13.1 23.7 Campbell Soup CPB US USD 60.5 18,667 120 -2.9 -1.2 -2.1 26.5 20.4 19.2 11.3 9.8 12.5 11.9 55.3 50.8 2.1 2.2 43.4 43.2 10.4 22.7 Mead Johnson MJN US USD 83.3 15,373 128 -6.7 0.0 12.9 6.0 23.7 22.0 - - 15.8 14.8 - - 2.1 2.3 49.3 49.6 4.8 28.6 Average 23.7 21.7 4.0 3.8 15.1 14.0 US/Europe Bev AB InBev ABI BB EUR 112.6 203,452 182 -2.3 -1.2 8.7 15.1 31.9 25.1 4.8 4.5 14.9 13.5 9.7 15.1 4.0 4.2 101.1 83.7 6.0 39.4 SAB Miller SAB LN GBp 4,382 93,614 181 -0.7 2.3 4.9 43.5 25.2 23.0 3.8 3.6 17.1 16.0 11.7 15.2 2.3 2.5 57.0 57.7 12.4 37.7 Heineken HEIA NA EUR 79.2 51,234 57 -6.2 -5.6 6.8 12.8 21.1 19.5 3.1 2.8 11.3 10.7 14.6 14.5 1.8 1.9 37.3 36.9 5.6 24.4 Carlsberg CARLB DC DKK 625.0 14,443 25 -5.4 -3.4 5.3 23.6 21.8 18.5 2.0 1.9 9.8 9.1 9.4 10.4 1.5 1.9 32.7 35.3 50.0 20.0 Molson Coors TAP US USD 101.9 21,859 170 -0.3 1.7 19.5 51.7 31.4 18.7 2.2 2.0 21.1 12.5 7.0 10.8 1.6 1.7 50.6 32.5 48.5 25.0 Diageo DGE LN GBp 2,152 71,259 111 -0.4 14.3 15.7 24.4 21.0 19.6 5.7 5.1 15.7 14.6 26.9 25.8 2.9 3.0 60.7 59.5 10.3 34.4 Pernod Ricard RI FP EUR 103.0 30,700 55 0.7 4.8 4.9 10.9 19.9 18.7 2.0 1.9 14.2 13.4 9.9 9.9 1.8 1.9 36.0 36.0 14.8 28.9 The Coca-Cola KO US USD 43.3 186,970 573 -0.7 -3.3 0.4 9.8 22.7 21.7 7.4 7.3 17.9 17.6 32.6 33.7 3.2 3.4 73.3 74.0 5.5 33.4 PepsiCo PEP US USD 107.5 154,638 453 -1.3 5.4 9.8 14.9 22.6 20.8 12.7 12.6 14.1 13.4 56.1 60.4 2.8 3.0 62.2 61.4 9.7 20.7 Monster Beverage MNST US USD 157.0 29,894 193 -2.2 4.3 25.1 11.8 40.3 32.7 8.6 8.8 23.4 19.8 21.5 27.0 0.0 0.0 0.0 0.0 21.2 42.5 Dr Pepper DPS US USD 93.3 17,295 113 -5.3 1.2 1.9 21.0 21.3 19.7 8.6 8.8 12.3 11.8 40.2 44.5 2.3 2.4 48.4 48.0 4.6 25.7 Average 24.7 21.4 5.2 4.9 15.3 14.2 EM F&B Thai Beverage THBEV SP SGD 0.99 18,330 12 -4.3 10.6 41.4 37.5 22.7 20.8 5.0 4.6 19.7 18.5 22.2 22.3 2.8 3.0 63.5 62.0 11.0 17.9 Tingyi 322 HK HKD 7.85 5,786 11 17.0 8.9 7.1 -35.1 25.3 20.7 1.9 1.8 7.5 6.5 7.5 8.8 2.0 2.0 50.0 40.8 -0.3 11.2 Want Want HD 151 HK HKD 5.25 8,754 15 10.5 -4.0 1.9 -18.0 2.4 2.4 0.6 0.6 1.0 0.7 25.9 22.8 19.2 19.2 46.4 46.4 1.4 27.1 China Resources Beer 291 HK HKD 17.12 7,152 14 14.0 8.8 48.2 50.1 40.9 26.5 2.6 2.5 12.3 11.4 6.3 9.3 0.6 1.2 25.5 30.6 -6.7 14.6 Tsingtao Brewery 168 HK HKD 26.35 5,347 6 -3.7 -5.2 -6.2 -31.9 20.6 19.7 1.8 1.7 12.6 11.6 8.5 8.4 1.5 1.6 30.0 31.3 6.6 8.6 China Mengniu Dairy 2319 HK HKD 14.96 7,793 14 15.4 17.1 33.8 4.3 21.1 18.1 2.1 1.9 12.0 10.1 9.9 10.6 1.1 1.3 23.0 23.9 9.2 8.8 CJ CheilJedang 097950 KS KRW 387,500 4,536 14 -1.5 0.5 7.0 -2.8 16.2 12.7 1.6 1.5 7.1 6.2 10.0 11.4 0.6 0.6 10.4 8.2 10.4 9.7 Orion 001800 KS KRW 742,000 3,945 16 -19.4 -23.3 -19.1 -20.0 21.9 18.5 2.8 2.5 10.1 9.2 12.9 13.5 0.8 0.9 17.8 16.2 5.1 20.0 Fraser & Neave FNN SP SGD 2.10 2,281 0 -1.4 2.9 6.6 -0.5 30.0 30.0 1.3 1.3 8.4 7.9 4.4 4.3 1.9 1.9 57.1 57.1 26.0 12.9 Average 14.2 13.1 2.4 2.2 7.8 7.2 Note: Based on median values of Bloomberg consensus estimates Source: Bloomberg, Credit Suisse

Food Industry 15 30 August 2016

Risks Spending on food is rising in Japan Spending on food formerly accounted for around 23% of consumer spending in the Japanese market. The proportion started to increase in 2014, reaching 24.1% in January 2015 and rising to 25.6% in June 2016. Prices of imported raw materials have risen over the past few years due to the weaker yen and rising international prices (partly driven by rising demand in emerging markets). Also, procurement prices also trended upward in Japan due to a shortage of farmers. The year 2015 was unusual historically with a succession of price rises at food companies. Currently, prices of most commodities are on a downtrend. In addition, the yen is appreciating. This means cost-push inflation should end in 2H 2016.

Figure 35: Food as a percentage of total spending by Figure 36: Successive price hikes for foods from summer households of two or more people 2015 Company Price hike timing Price hike 27% monthly weight (%) 12-month moving average (%) Home-use wheat flour, Nissin Foods Holdings Jul 2015 Approx. 1-6% Yamazaki Baking Jul 2015 Ave. approx. 2.6% Bread 26% Pasco Shikishima Jul 2015 Approx. 2-5% Meiji Jul 2015 10-20% Chocolate 25% Morinaga Jul 2015 Approx. 5.9-10% and confectionery Lotte Jul 2015 Approx. 10% 24% Kagome Aug 2015 Approx. 4-10% Sauces, rice with green Bull-dog Sauce Aug 2015 3-9% tea, etc. 23% Nagatanien Jul 2015 Approx. 5-10% Domestically produced Asahi Breweries Sep 2015 9-44% 22% Western spirits 21%

20%

Source: Statistics Bureau (Ministry of Internal Affairs and Source: Nikkei (24 Sep 2015) Communications ), Credit Suisse

Companies that can benefit from both feedstock price declines and stronger yen The phase in which it would be possible to benefit from lower raw materials prices will likely happen in 1H FY2016, but we see a risk of increasing downward pressure on prices from food retailers and consumers. We therefore think prices will turn downwards, after a time lag. Healthcare-related products such as yogurt should fare relatively well, due to ongoing mix improvement. However, among ordinary products that are difficult to differentiate, products whose prices rise solely due to higher costs could struggle. Meanwhile, recent stronger yen trends could be a tailwind for companies with high exposure to Japan markets such as Meiji HD, Morinaga Milk, Morinaga & Co and Calbee when they import feedstocks from overseas.

Food Industry 16 30 August 2016

Figure 37: Key inputs and forex impact Key inputs Forex impact Meiji Holdings Cacao, powdered skim milk Every ¥1 rise against USD adds ¥300mn to OP (FY3/17 guidance premised on USD/JPY of 120) Every ¥1 rise against USD, EUR, and BRL erodes OP by ¥50mn, ¥50mn, and ¥250mn, respectively. Fermentation raw materials (corn, Ajinomoto Moreover, each ¥0.01 rise against THB has a ¥100mn negative impact on OP (FY3/17 guidance wheat, tapioca, sugarcane, etc) premised on USD/JPY of 110, EUR/JPY of 123, BRL/JPY of 3.2 and THB/JPY of 30.3) Powdered skim milk, packaging Devaluation of emerging currencies negative overall; yen strength not especially helpful as powdered Yakult materials (polystyrene) skim milk for domestic operation is mostly procured in Japan Every ¥1 rise against USD and EUR erodes OP by ¥100mn and ¥20mn, respectively (FY3/17 guidance Kikkoman Soy beans, wheat premised on USD/JPY of 110 and EUR/JPY of 125) Nissin Foods Holdings Wheat flour, palm oil Procurement/contracts structured such that input costs, forex have minimal impact Toyo Suisan Wheat flour, palm oil Every ¥1 rise against USD erodes OP by ¥100mn (FY3/17 guidance premised on USD/JPY of 112) Cacao, sugar, wheat flour, Morinaga & Co Every ¥1 rise against USD adds ¥30–40mn to OP (FY3/17 guidance premised on USD/JPY of 112) powdered skim milk Morinaga Milk Cheese, whey, coffee beans Every ¥1 rise against USD adds ¥200mn to OP (FY3/17 guidance premised on USD/JPY of 110) Calbee Potatoes, vegetable oil Every ¥1 rise against USD adds ¥100mn to RP (FY3/17 guidance premised on USD/JPY of 120) Source: Company data, Credit Suisse estimates

Figure 38: Yen-based costs for inputs (7 January 2011= 100)

250 Corn Wheat Soybean Sugar Coffee Cocoa Palm Oil Skimmed milk powder Crude oil 200

150

100

0 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16

Note: Indexed, using weekly data on international prices converted to yen using spot rates Source: Bloomberg, Credit Suisse

Food Industry 17 30 August 2016

HOLT The Japanese food industry has margins that are about 450 basis points lower than global food industry peers on average (compare Figures 39 and 40). This margin disadvantage is largely a function of much higher SG&A expense, which appears to have been a permanent feature through time. We attribute this to the extremely competitive environment in the Japanese food sector. With asset efficiency that is roughly similar to that of global peers', this low level of margin translates into industry CFROI® that hovers around the 2% level, well short of cost of capital. In contrast, the global food sector has managed to beat or exceed cost of capital with large cap majors with dominant industry positions and strong brands often earning returns well above this. In fact, all of the U.S. & European food majors featured in Figure 34 sport CFROI profiles that qualify them for an eCAP (empirical competitive advantage period) award in the HOLT framework, meaning that CFROI is both high and stable, which in turn is often matched by a premium valuation to the market.

Figure 39: Margins for the Japanese food sector Figure 40: Margins for the global food sector

Note: Dark yellow indicates EBITDA margin and light yellow shows Note: Dark yellow indicates EBITDA margin and light yellow shows adjusted margin adjusted margin Source: HOLT Source: HOLT

Figure 41: Total assets turnover for the Japanese food Figure 42: Total assets turnover for the global food sector sector

Source: HOLT Source: HOLT

Figure 43: CFROI for the Japanese food sector Figure 44: CFROI for the global food sector

Source: HOLT Source: HOLT

Food Industry 18 30 August 2016

While the Japanese foodmakers fall well short of achieving an eCAP award, our nine coverage companies have a CFROI of 4%, which matches the overall market and exceeds the 3% Japan food sector average (Figure 43) thanks to their higher relative margins. Looking forward, we see the most scope for upside to CFROI at our three OUTPERFORM rated companies—Morinaga & Co (shown below as example), Meiji Holdings, and Morinaga Milk, where CFROI is expected to increase by 150 basis points or more over the next three years from what historically was a low base. In contrast, CFROI improvement is more modest or negative for the remaining coverage companies, notably Yakult, where we expect a decline to be driven by reduced earnings in China on stiffer competition as well as sharp decline in the pharmaceutical business on price cuts. We rate the shares UNDERPERFORM accordingly.

Figure 45: EBITDA margin for Morinaga & Co. Figure 46: CFROI for Morinaga & Co. 14 8 12 7 6 10 5 8 4 3 6 2 4 1 0 2 -1 0 -2 2006 2008 2010 2012 2014 2016 2018 2006 2008 2010 2012 2014 2016 2018 Historical EBITDA Forecast CFROI Forecast CFROI Discount Rate Source: HOLT Source: HOLT

Figure 47: CFROI forecasts for food sector coverage 5-Year Last Ticker Company Rating Median Year 2016E 2017E 2018E Change 2201 Morinaga & Co Outperform 0.3% 2.7% 4.3% 5.1% 5.8% 3.1% 2269 Meiji Holdings Outperform -0.6% 2.9% 3.6% 4.4% 4.7% 1.8% 2264 Morinaga Milk Outperform -0.9% -0.6% -0.5% 0.3% 0.9% 1.5% 2801 Kikkoman Neutral 2.9% 3.6% 5.2% 4.0% 4.5% 0.9% 2875 Toyo Suisan Neutral 6.1% 3.8% 4.5% 4.3% 4.6% 0.7% 2229 Calbee Neutral 6.9% 8.0% 8.0% 8.0% 8.3% 0.3% 2897 Nissin Neutral 4.7% 4.0% 3.4% 3.8% 3.9% -0.1% 2802 Ajinomoto Neutral 2.1% 3.9% 2.5% 2.8% 3.2% -0.7% 2267 Yakult Underperform 5.8% 6.0% 5.1% 4.6% 4.7% -1.3% Median 2.9% 3.8% 4.3% 4.3% 4.6% 0.7% Source: Credit Suisse estimates, HOLT

Finally, with Japanese food stocks generally trading at high multiples versus the market, we find little differentiation on HOLT valuation across our coverage companies and chalk most of our relative enthusiasm for our OUTPERFORM rated names to the expected profitability/CFROI improvement noted above. Moreover, branded global majors appear more attractively valued on balance in HOLT, further highlighting the need to seek selective exposure in the space.

Food Industry 19

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Morinaga & Co (2201 / 2201 JP) Rating OUTPERFORM* Price (29 Aug 16, ¥) 823 INITIATION

Target price (¥) 1,000¹ Chg to TP (%) 21.5 Structural change still underway; scope for Market cap. (¥ bn) 214.60 (US$ 2.10) Enterprise value (¥ bn) 208.73 more improvement Number of shares (mn) 260.75 Free float (%) 60.0 ■ Initiate coverage: We initiate coverage on Morinaga & Co. with an 52-week price range 849 - 513 OUTPERFORM rating and ¥1,000 target price (potential return 21.5%). While *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. the confectionery business in Japan remains Morinaga’s key focus, it has plans ¹Target price is for 12 months. to further expand operations in the US and Asia. As Japan’s population has become increasingly health-conscious, we also forecast renewed growth for the Research Analysts nutritional jelly drink business, where Morinaga holds a 45% domestic market Masashi Mori share. The share price has rocketed up since the company reported steep 81 3 4550 9695 growth in 1Q profit and announced an upward revision to guidance. In our view, [email protected] though, valuations remain quite compelling, as Morinaga appears to have room for further structural reforms aimed at establishing a stronger earnings structure. ■ Investment themes: In FY3/16, Morinaga began executing a number of strategies toward improving profitability and achieving sustainably robust earnings. We expect it to remain committed to these strategies—namely, reinforcing the structure for product development, introducing thorough profit management, improving manufacturing efficiency, and reducing costs across the board. We believe there is scope to improve manufacturing and sales efficiency, and we regard Morinaga as one of a handful of companies able to sustain profit growth even if the domestic economy deteriorates sharply. We forecast OP CAGR of 18% over the next three years. We believe Morinaga will speed up overseas market development of the HI-CHEW brand, already well known in the US and Indonesia, and expect a profit contribution within three years. ■ Valuation/risks: We derive our target price by applying a P/E of roughly 25x to our FY3/17 EPS estimate. Although Morinaga's market cap and liquidity remain low, its profit momentum is high relative to peers, and as we expect the company to continue to benefit from its structural reforms for some time, we apply the Japan food sector average multiple. Downside risks: (1) a loss of sales momentum for core products in Japan; (2) heightened competition in the US and Indonesia; and (3) higher-than-projected input costs.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 181.9 190.0 194.0 196.0 1000 400 Operating profit (¥ bn) 11.5 15.2 17.3 19.0 800 300 Recurring profit (¥ bn) 12.1 15.7 17.8 19.5 600 200 Net income (¥ bn) 8.1 10.6 12.0 13.2 400 100 EPS (¥) 31.1 40.7 46.1 50.7 200 0 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 39.2 41.8 44.4 The price relative chart measures performance against the EPS growth (%) 112.7 31.0 13.2 10.0 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 18.4 20.2 17.8 16.2 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.2 0.9 1.0 1.1 EV/EBITDA(x) 8.5 9.9 8.7 7.8 Performance over 1M 3M 12M P/B (x) 2.0 2.6 2.3 2.1 Absolute (%) 21.4 45.1 27.0 ROE(%) 11.5 13.4 13.6 13.4 Relative (%) 22.1 50.0 42.3 Net debt/equity (%) 0.69 net cash net cash net cash

Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access

30 August 2016

Valuation and risks Share price valuation We derive our target price by applying a P/E of roughly 25x to our FY3/17 EPS estimate. Although its market cap and liquidity remain low, Morinaga’s profit momentum is high relative to its peers, and as we see the company continuing to benefit from its structural reforms for some time, we apply the Japan food sector average multiple We use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings (2269), Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 50 +2σ 49.4 10 +2σ 9.7 45 9 40 +1σ 36.4 35 +1σ 8.4 8 30 25 Ave. 23.4 7 Ave. 7.2 20 6 15 -1σ 5.9 -1σ 10.4 10 5 5 -2σ 4.6 0 -2σ -2.6 4 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates

Risks Downside risks include: (1) a loss of sales momentum for core products in Japan; (2) heightened competition in the US and Indonesia; and (3) higher-than-projected input costs. In Japan, the product mix has been improving on the back of increasing sales of value- added products; on the flip side, though, earnings could suffer if cooling consumer confidence causes demand to contract. Also, since the chocolate market as a whole is expanding, we see a risk of earnings deteriorating as competition heats up. While expecting Morinaga to continue aggressively promote sales of its core Hi Chew line in the US, we caution that competition is fierce in food retailing. If competition keeps escalating, it could be some time before the US business turns profitable.

Food Industry 21 30 August 2016

Company profile Confectionery business in Japan remains key focus, but looking to ramp up overseas expansion Morinaga was founded in 1899 by Taichiro Morinaga, whose dream was to deliver Western-confectionery with nutritional value to the people of Japan. Currently, the company has four core businesses: confectionery, foodstuffs, frozen desserts, and health products. In recent years, Morinaga has increased the pace of overseas development, having identified the US, Southeast Asia, and China as growth markets (as yet, though, these operations are not contributing to profit). In the US and China, Morinaga markets its distinctive chewy soft candy, HI-CHEW. It began producing HI-CHEW in China in 2004, and commenced local production in the US in August 2015. In Southeast Asia, the company established a joint venture in Indonesia in 2013. While the focus at present is on the low end of the Indonesian market, Morinaga also has its eye on the higher end of the market, where modern trade holds sway; in March this year, for example, the company launched a halal-certified version of HI-CHEW. The confectionery operation remains the company’s core business and centers on chocolate, biscuits, and caramel candy. Key brands include Milk Caramel, Chocoball, Dars, Ottotto, and HI-CHEW. In the frozen dessert business, Choco Monaka Jumbo is the mainstay brand, while in the health products business, the nutritional jelly Weider in Jelly is the top-seller. Weider in Jelly is Japan’s leading brand in this category, with a market share in excess of 40%.

Figure 3: Sales by business segment Figure 4: OP by business segment

Food Real Estate Real Estate Merchandise Other Services and Services and Services 4% Other Services 0% 1% Food 6% 0% Merchandise Health 4% Products 14%

Frozen Desserts Confectionery 18% & Foodstuffs 63% Food Manufacturing 90% Source: Company data (FY3/16A), Credit Suisse Source: Company data(FY3/16A), Credit Suisse Longer-term strategies, shareholder returns In its current medium-term plan, Morinaga targets OP of ¥8.0bn in FY3/18. However, the company has reached that goal already, with a jump in profit achieved in FY3/16. Morinaga has set itself a new goal of further improving profitability. The operating margin in FY3/16 was 6.3%, and Morinaga is now aiming for a margin of 10%, while not setting any time limit for doing so. Although capex overseas looks to have peaked for now, we expect growth-oriented spending to continue rising as the company works to cultivate new markets. In Japan, Morinaga has successfully improved its profitability, and we look for steady growth in profit to continue. Morinaga has no specific target for shareholder returns. We expect a transition to net cash in FY3/17, which will further solidify company finances. On that basis, we see a strong likelihood of Morinaga raising its DPS guidance.

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Figure 5: Dividend, buyback and dividend payout ratio Figure 6: Net debt, D/E ratios (JPY bn) (%) (JPY bn) (%) Dividend (LHS) Net debt D/E ratio (RHS) 3.5 100 25 70 Buyback (LHS) 90 20 3.0 Dividend payout ratio (RHS) 60 80 15 50 2.5 70 10 5 2.0 60 40 50 0 30 1.5 40 -5 -10 1.0 30 20 -15 20 10 0.5 -20 10 -25 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates Health products business Over the past five fiscal years, Morinaga's health products business has accounted for 12– 14% of total sales; in 1Q FY3/17, though, the weighting increased to 17%. This was due to brisk sales of the mainstay high-value-added jelly drink, Weider in Jelly, which is gaining recognition among the growing number of health-conscious consumers and as an aid in preventing heatstroke. Against this backdrop, sales at the health products business rose 25% YoY in 1Q FY3/17. According to Morinaga, Weider in Jelly held a 45% market share in FY3/16. Weider in Jelly’s support base is growing, as in marketing the company has enlisted famous sportspersons to help promote the product as a sports drink, also specifically touting its functions as a beauty aid and cold-prevention measure. The health products business started out in 1983, when Morinaga formed a business alliance with US company Weider Global Nutrition, a forerunner in the field of sports science. The business provides nutritional guidance to athletes and offers a range of products leveraging its expertise in supplement development. While there have always been health-minded consumers, their numbers are now rapidly increasing, and we believe Weider in Jelly has entered a new growth phase. Certainly, Weider in Jelly ranks among the most popular such products on Japan's leading e-commerce sites. As the target market is individuals concerned about their health, we see limited risk of deteriorating consumer sentiment causing demand to dwindle, leading to trading down.

Figure 7: Morinaga Weider in Jelly's monetary value share in the nutritional support drink category (%) 7 Morinaga Weider in Jelly 6 5 4 3 2 1 0

Note: Combined share of products ranked in top 20 Source: Nikkei POS data

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Figure 8: Most popular nutritional jelly products on Amazon Japan (as of 15 August) Weider in Jelly has three entries inside the top five

Source: Amazon.jp, Credit Suisse

Food Industry 24 30 August 2016

Figure 9: Most popular functional jelly products on Rakuten (as of 15 August) Weider in Jelly has three entries inside the top five

Source: Rakuten, Credit Suisse

Food Industry 25 30 August 2016

Earnings forecasts

Figure 10: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 181,868 2.2 11,456 92.9 12,062 84.7 8,092 112.6 31.1 112.7 17/3 CS E 190,000 4.5 15,200 32.7 15,700 30.2 10,600 31.0 40.7 31.0 CoE 188,900 3.9 14,300 24.8 14,800 22.7 10,000 23.6 38.4 23.6 IBES E 187,650 3.2 13,700 19.6 14,250 18.1 9,400 16.2 36.2 16.3 18/3 CS E 194,000 2.1 17,300 13.8 17,800 13.4 12,000 13.2 46.1 13.2 IBES E 192,950 2.8 14,550 6.2 15,200 6.7 10,050 6.9 38.6 6.8 19/3 CS E 196,000 1.0 19,000 9.8 19,500 9.6 13,200 10.0 50.7 10.0 IBES E 198,100 2.7 15,550 6.9 16,200 6.6 10,750 7.0 41.3 7.0 Source: Company data, I/B/E/S, Credit Suisse estimates We look for OP to rise 33% YoY to ¥15.2bn in FY3/17. We forecast 3% YoY sales growth for the confectionery business, fueled mainly by: (1) the launch of new products in the core Ototto and Dars lines in Japan, (2) solid sales of the high-polyphenol dark chocolate Carré de Chocolat, and (3) highly assertive sales expansion strategies for the US, Indonesia, China, and Taiwan. For the frozen dessert business, we project 4% YoY sales growth, aided by increased sales of premium products to convenience stores. We expect sales to rise 13% YoY at the health products segment due to heightened recognition for the core Weider in Jelly series. For the food manufacturing segment as a whole, we forecast profit growth of roughly 40% YoY, driven by the aforementioned increases in volume, along with (1) production efficiency improvements, (2) product standard and pricing modifications, and (3) greater efficiency in selling expenses, achieved in part by reducing SKUs. Morinaga attributes profitability improvements in FY3/16 to: (1) a 15% YoY reduction in newly developed (mostly low-priced) products, (2) a 10% sales weighting for high-value- added products, up from 3.6% in FY3/14, and (3) a 2015 review of pricing levels. Over the medium term (next three years), we forecast OP CAGR of 18%. We expect Morinaga to remain committed to improving profitability and achieving sustainably robust earnings, by such means as reinforcing the structure for product development, introducing thorough profit management, improving manufacturing efficiency, and reducing costs across the board. We believe there remains scope for improving manufacturing and sales efficiency, and regard Morinaga as one of a handful of companies able to sustain profit growth even if the domestic economy deteriorates sharply. In the overseas business, identified as a growth area, Morinaga began producing HI- CHEW in the US in August 2015, and in March 2016, it started manufacturing and selling halal-certified HI-CHEW in Indonesia. While the overseas business is yet to contribute to profit, we are impressed by the high degree of recognition it has amassed already. Sales are increasing quite smoothly, and we believe the overseas business will be contributing to profit within three years.

Food Industry 26 30 August 2016

Figure 11: OP and OPM Figure 12: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 20 12 20 ROIC (rhs) 16 OPM (rhs) 14 10 15 15 12 8 10 10 10 6 8 4 5 6 5 4 2 0 2 0 0

-5 0

FY3/06 FY3/07 FY3/02 FY3/03 FY3/04 FY3/05 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/17E FY3/18E FY3/19E

FY3/07 FY3/03 FY3/04 FY3/05 FY3/06 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/02

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

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Figure 13: Sales and OP forecasts by segment (¥mn) FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales by segment (JPYm) Food Manufacturing 136,578 134,825 141,729 153,765 168,234 172,431 180,400 184,300 186,200 Confectionery & Foodstuffs 89,535 90,809 94,143 102,808 116,871 115,145 118,600 119,900 119,900 Frozen Desserts 25,173 25,450 26,457 28,827 29,936 32,381 33,700 34,300 34,700 Health Products 21,868 18,565 21,127 22,129 21,426 24,905 28,100 30,100 31,600 Food Merchandise 17,112 8,762 7,618 7,416 6,395 6,213 6,400 6,500 6,500 Real Estate and Services 3,016 2,978 2,965 2,839 2,639 2,557 2,600 2,600 2,600 Other Services 628 625 572 582 659 665 600 600 700 Total 157,336 147,190 152,885 164,603 177,929 181,868 190,000 194,000 196,000 Sales (y-y,%) Food Manufacturing - -1.3 5.1 8.5 9.4 2.5 4.6 2.2 1.0 Confectionery & Foodstuffs - 1.4 3.7 9.2 13.7 -1.5 3.0 1.1 0.0 Frozen Desserts - 1.1 4.0 9.0 3.8 8.2 4.1 1.8 1.2 Health Products - -15.1 13.8 4.7 -3.2 16.2 12.8 7.1 5.0 Food Merchandise - -48.8 -13.1 -2.7 -13.8 -2.8 3.0 1.6 0.0 Real Estate and Services - -1.3 -0.4 -4.2 -7.0 -3.1 1.7 0.0 0.0 Other Services - -0.5 -8.5 1.7 13.2 0.9 -9.8 0.0 16.7 Total - -6.4 3.9 7.7 8.1 2.2 4.5 2.1 1.0 OP (JPY m) Food Manufacturing 5,451 1,958 1,910 3,085 5,482 10,863 15,400 17,600 19,300 Food Merchandise 350 304 484 542 508 522 550 550 550 Real Estate and Services 1,022 998 848 795 734 678 600 600 600 Other Services 234 168 175 202 81 54 50 50 50 Adjustment -405 -616 -723 -766 -866 -661 -1,400 -1,500 -1,500 Total 6,653 2,813 2,695 3,858 5,939 11,456 15,200 17,300 19,000 OP (y-y,%) Food Manufacturing - -64.1 -2.5 61.5 77.7 98.2 41.8 14.3 9.7 Food Merchandise - -13.1 59.2 12.0 -6.3 2.8 5.4 0.0 0.0 Real Estate and Services - -2.3 -15.0 -6.3 -7.7 -7.6 -11.5 0.0 0.0 Other Services - -28.2 4.2 15.4 -59.9 -33.3 -7.4 0.0 0.0 Total - -57.7 -4.2 43.2 53.9 92.9 32.7 13.8 9.8 OPM (%) Food Manufacturing 4.0 1.5 1.3 2.0 3.3 6.3 8.5 9.5 10.4 Food Merchandise 2.0 3.5 6.4 7.3 7.9 8.4 8.6 8.5 8.5 Real Estate and Services 33.9 33.5 28.6 28.0 27.8 26.5 23.1 23.1 23.1 Other Services 37.3 26.9 30.6 34.7 12.3 8.1 8.3 8.3 7.1 Total 4.2 1.9 1.8 2.3 3.3 6.3 8.0 8.9 9.7 Sales breakdown (%) Food Manufacturing 86.8 91.6 92.7 93.4 94.6 94.8 94.9 95.0 95.0 Food Merchandise 10.9 6.0 5.0 4.5 3.6 3.4 3.4 3.4 3.3 Real Estate and Services 1.9 2.0 1.9 1.7 1.5 1.4 1.4 1.3 1.3 Other Services 0.4 0.4 0.4 0.4 0.4 0.4 0.3 0.3 0.4 OP breakdown (%) Food Manufacturing 77.2 57.1 55.9 66.7 80.6 89.7 92.8 93.6 94.1 Food Merchandise 5.0 8.9 14.2 11.7 7.5 4.3 3.3 2.9 2.7 Real Estate and Services 14.5 29.1 24.8 17.2 10.8 5.6 3.6 3.2 2.9 Other Services 3.3 4.9 5.1 4.4 1.2 0.4 0.3 0.3 0.2 Source: Company data, Credit Suisse estimates

Food Industry 28 30 August 2016

Figure 14: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 10,830 12,992 8,302 10,377 4,765 11,602 26,714 27,029 30,566 32,855 Account receivable 16,917 15,835 19,100 20,176 18,172 19,035 19,329 20,040 20,099 20,276 Inventories 12,291 10,487 11,278 12,751 14,341 15,007 14,710 15,523 15,435 15,638 Other 6,462 6,178 6,864 7,071 6,142 5,355 5,849 5,849 5,849 5,849 Total current assets 46,500 45,492 45,544 50,375 43,420 50,999 66,602 68,430 71,937 74,607 Tangible fixed assets 63,961 66,502 66,149 75,543 76,402 72,754 71,683 70,383 68,583 66,783 Depreciable PP&E 33,086 32,545 34,205 41,104 45,611 41,753 42,486 - - - Land 30,263 30,295 30,238 30,313 30,645 30,843 28,912 - - - Construction in progress 612 3,662 1,706 4,126 146 158 285 - - - Intangible fixed assets 2,208 1,738 1,626 1,491 2,881 2,823 2,421 2,421 2,421 2,421 Investments & other assets 15,876 13,311 15,525 13,744 21,737 26,277 24,270 24,270 24,270 24,270 Investment securities 13,729 11,597 13,713 11,912 18,147 23,114 20,723 20,723 20,723 20,723 Other 2,147 1,714 1,812 1,832 3,590 3,163 3,547 3,547 3,547 3,547 Total fixed assets 82,046 81,552 83,301 90,779 101,021 101,855 98,376 97,074 95,274 93,474 Total assets 128,547 127,045 128,845 141,154 144,441 152,855 164,978 165,504 167,211 168,081 (Liabilities) Account payable 14,043 13,033 15,719 17,121 17,151 17,776 16,995 18,163 17,949 18,242 Short-term debt 1,524 1,179 21,468 5,121 732 1,300 494 1,102 1,180 1,268 Other 19,029 20,718 19,039 24,378 19,088 18,577 23,295 20,966 17,821 15,148 Total current liabilities 34,596 34,930 56,226 46,620 36,971 37,653 40,784 40,230 36,950 34,657 Long-term debt 23,753 23,803 3,500 25,601 26,488 26,424 26,737 20,053 17,045 11,079 Other 17,612 16,466 16,345 15,952 18,387 19,384 20,233 19,221 17,299 15,569 Total fixed liabilities 41,365 40,269 19,845 41,553 44,875 45,808 46,970 39,274 34,344 26,648 Total liabilities 75,961 75,199 76,072 88,174 81,847 83,461 87,755 79,504 71,294 61,306 (Net assets) Capital stock 18,612 18,612 18,612 18,612 18,612 18,612 18,612 18,612 18,612 18,612 Capital surplus 17,186 17,186 17,186 17,186 17,186 17,186 17,186 17,186 17,186 17,186 Retained earnings 15,588 16,470 15,986 15,840 22,369 23,080 29,611 38,389 48,307 59,165 Treasury stock -2,380 -2,458 -2,463 -2,522 -2,535 -2,551 -2,582 -2,582 -2,582 -2,582 Total shareholders' equity 49,007 49,811 49,322 49,117 55,632 56,328 62,828 71,605 81,523 92,381 Valuation and translation adjustments 3,072 1,543 3,060 3,457 4,314 9,998 11,729 11,729 11,729 11,729 Total equity capital 52,079 51,354 52,382 52,574 59,946 66,326 74,557 83,334 93,252 104,110 Minority interests 505 490 390 405 2,646 3,067 2,665 2,665 2,665 2,665 Total net assets 52,585 51,845 52,773 52,981 62,594 69,393 77,223 85,999 95,917 106,775 Total liabilities & net assets 128,547 127,045 128,845 141,154 144,441 152,855 164,978 165,504 167,211 168,081

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 49,726 52,585 51,845 52,773 52,981 62,594 69,393 77,223 85,999 95,917 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus -1 0 0 0 0 0 0 0 0 0 Net profits 3,466 2,449 1,081 1,419 8,090 3,806 8,092 10,600 12,000 13,200 Dividends from surplus -1,601 -1,595 -1,605 -1,570 -1,562 -1,562 -1,561 -1,822 -2,082 -2,342 Treasury stock -360 -78 -5 -59 -13 -16 -31 0 0 0 Valuation and translation adjustments 1,298 -1,529 1,517 397 857 5,684 1,731 0 0 0 Minority interests 34 -15 -100 15 2,241 421 -402 0 0 0 Other 23 28 40 6 0 -1,534 1 -2 0 0 Final balance 52,585 51,845 52,773 52,981 62,594 69,393 77,223 85,999 95,917 106,775 Source: Company data, Credit Suisse estimates

Food Industry 29 30 August 2016

Figure 15: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 160,878 157,336 147,190 152,885 164,603 177,929 181,868 190,000 194,000 196,000 COGS 85,048 81,557 76,128 78,386 86,794 96,788 94,269 96,100 97,400 97,600 Gross profit 75,830 75,778 71,062 74,499 77,808 81,140 87,598 93,900 96,600 98,400 SG&A 70,044 69,125 68,248 71,803 73,950 75,200 76,142 78,700 79,300 79,400 OP 5,785 6,653 2,813 2,695 3,858 5,939 11,456 15,200 17,300 19,000 Interest income and dividend 292 319 330 333 312 358 351 300 300 300 Interest expense 329 288 270 266 180 168 155 200 200 200 Other 225 196 267 211 456 401 410 400 400 400 RP 5,973 6,880 3,140 2,973 4,446 6,530 12,062 15,700 17,800 19,500 Extraordinary gains 10 248 1,001 342 9,308 23 563 0 0 0 Etrtraordinary losses 344 2,064 1,590 705 848 698 506 500 500 500 Pretax profit 5,639 5,064 2,551 2,610 12,906 5,855 12,119 15,200 17,300 19,000 Income taxes 2,140 2,580 1,471 1,284 4,766 1,959 4,183 4,600 5,300 5,800 Minority interests 33 33 0 -92 49 89 -156 0 0 0 NP 3,466 2,449 1,081 1,419 8,090 3,806 8,092 10,600 12,000 13,200 Tax rate 37.9% 50.9% 57.7% 49.2% 36.9% 33.5% 34.5% 30.3% 30.6% 30.5% Depreciation expense 5,235 4,996 5,506 5,594 6,808 6,581 6,130 5,800 5,800 5,800 Capital expenditure 3,358 4,972 7,585 13,010 14,517 2,393 7,406 4,500 4,000 4,000 R&D expense 2,375 2,240 2,399 2,329 1,984 2,005 2,152 2,300 2,300 2,300 To sales ratio (%) CGS 52.9 51.8 51.7 51.3 52.7 54.4 51.8 50.6 50.2 49.8 Gross profit 47.1 48.2 48.3 48.7 47.3 45.6 48.2 49.4 49.8 50.2 OP 3.6 4.2 1.9 1.8 2.3 3.3 6.3 8.0 8.9 9.7 RP 3.7 4.4 2.1 1.9 2.7 3.7 6.6 8.3 9.2 9.9 Pretax profit 3.5 3.2 1.7 1.7 7.8 3.3 6.7 8.0 8.9 9.7 NP 2.2 1.6 0.7 0.9 4.9 2.1 4.4 5.6 6.2 6.7 YoY (%) Sales revenue -3.7 -2.2 -6.4 3.9 7.7 8.1 2.2 4.5 2.1 1.0 Gross profit -1.2 -0.1 -6.2 4.8 4.4 4.3 8.0 7.2 2.9 1.9 OP 71.2 15.0 -57.7 -4.2 43.2 53.9 92.9 32.7 13.8 9.8 RP 68.8 15.2 -54.4 -5.3 49.5 46.9 84.7 30.2 13.4 9.6 Pretax profit 200.6 -10.2 -49.6 2.3 394.5 -54.6 107.0 25.4 13.8 9.8 NP 300.7 -29.3 -55.9 31.3 470.1 -53.0 112.6 31.0 13.2 10.0 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 3,466 2,449 1,081 1,419 8,090 3,806 8,092 10,600 12,000 13,200 Depreciation(+) 5,235 4,996 5,506 5,594 6,808 6,581 6,130 5,800 5,800 5,800 Account receivable(-) 529 1,082 -3,265 -1,076 2,004 -863 -294 -711 -59 -177 Inventories(-) 1,856 1,804 -791 -1,473 -1,590 -666 297 -813 88 -204 Account payable(+) -1,826 -1,010 2,686 1,402 30 625 -781 1,168 -214 293 Minority interests(+) 33 33 0 -92 49 89 -156 0 0 0 Other 2,659 -1,188 -338 -209 -7,707 1,610 3,427 0 0 0 Operating cashflow 11,952 8,166 4,879 5,565 7,684 11,182 16,715 16,044 17,615 18,912 (Investing activities) Capital expenditures(-) -2,945 -3,523 -7,472 -8,090 -3,267 -2,860 -2,214 -4,500 -4,000 -4,000 Other -200 -2,564 -345 2,409 -3,192 -162 123 0 0 0 Investing cashflow -3,145 -6,087 -7,817 -5,681 -6,459 -3,022 -2,091 -4,500 -4,000 -4,000 (Financing activities) Debt (+) -3,072 -295 -14 5,754 -3,502 504 -493 -6,076 -2,930 -5,878 Dividends (-) -1,601 -1,595 -1,605 -1,570 -1,562 -1,562 -1,561 -1,822 -2,082 -2,342 Other -817 -514 -226 -539 -700 -433 -257 0 0 0 Financing cashflow -5,490 -2,404 -1,845 3,645 -5,764 -1,491 -2,311 -7,898 -5,012 -8,220 (Cash & cash equivalents) Increases 3,317 -325 -4,783 3,529 -4,539 6,669 12,313 3,646 8,604 6,692 Beginning balance 7,480 10,830 12,992 8,302 10,377 4,765 11,602 26,714 27,029 30,566 Final balance 10,797 10,505 8,209 11,831 5,838 11,434 23,915 30,360 35,633 37,258 Adjustments 33 2,487 93 -1,454 -1,073 168 2,799 -3,331 -5,067 -4,403 Source: Company data, Credit Suisse estimates

Food Industry 30 30 August 2016

Figure 16: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 134.4 130.2 81.0 108.1 117.4 135.4 163.3 170.1 194.7 215.3 Quick ratio (%) 80.2 82.5 48.7 65.5 62.0 81.4 112.9 117.0 137.1 153.3 Adjusted quick ratio (%) 710.6 1,102.0 38.7 202.6 651.0 892.5 5,407.7 2,453.0 2,590.3 2,591.9 Fixed ratio (%) 157.5 158.8 159.0 172.7 168.5 153.6 131.9 116.5 102.2 89.8 Interest-bearing debt (¥mn) 25,277 24,982 24,968 30,722 27,220 27,724 27,231 21,155 18,225 12,347 Average debt interest rate (%) 1.2 1.1 1.1 1.0 0.6 0.6 0.6 0.8 1.0 1.3 Dependence on debt (%) 19.7 19.7 19.4 21.8 18.8 18.1 16.5 12.8 10.9 7.3 Net debt (¥mn) 14,447 11,990 16,666 20,345 22,455 16,122 517 -5,874 -12,341 -20,508 Equity capital ratio (%) 40.5 40.4 40.7 37.2 41.5 43.4 45.2 50.4 55.8 61.9 D/E ratio (%) 48.5 48.6 47.7 58.4 45.4 41.8 36.5 25.4 19.5 11.9 Long-term debt ratio (%) 94.0 95.3 14.0 83.3 97.3 95.3 98.2 94.8 93.5 89.7 Working capital (¥mn) 11,904 10,562 -10,682 3,755 6,449 13,346 25,818 28,199 34,988 39,950 Net interest expense (¥mn) -37 31 60 67 132 190 196 100 100 100 Cash plus marketable securities (¥mn) 10,830 12,992 8,302 10,377 4,765 11,602 26,714 27,029 30,566 32,855 Interest coverage ratio (x) 18.47 24.21 11.64 11.38 23.17 37.48 76.17 77.50 88.00 96.50 Financial leverage (x) 2.47 2.47 2.46 2.68 2.41 2.30 2.21 1.99 1.79 1.61 A/R to A/P ratio (%) 120.5 121.5 121.5 117.8 106.0 107.1 113.7 110.3 112.0 111.2 Dividend on equity (%) 3.2 3.1 3.1 3.0 2.8 2.5 2.2 2.3 2.4 2.4 (Profitability) ROE (%) 6.8 4.7 2.1 2.7 14.4 6.0 11.5 13.4 13.6 13.4 ROA (%) 4.5 5.2 2.2 2.0 2.7 4.0 7.2 9.2 10.4 11.3 Inventory turnover ratio (x) 12.2 13.8 13.5 12.7 12.2 12.1 12.2 12.6 12.5 12.6 A/R turnover ratio (x) 9.4 9.6 8.4 7.8 8.6 9.6 9.5 9.7 9.7 9.7 A/P turnover ratio (x) 10.8 11.6 10.2 9.3 9.6 10.2 10.5 10.8 10.7 10.8 Inventory turnover days (days) 30.0 26.4 27.0 28.7 30.0 30.1 29.8 29.0 29.1 28.9 A/R turnover days (days) 39.0 38.0 43.3 46.9 42.5 38.2 38.5 37.8 37.8 37.6 A/P turnover days (days) 33.9 31.4 35.6 39.2 38.0 35.8 34.9 33.8 34.0 33.7 Sales per employee (¥mn) 51.6 53.0 53.3 58.3 59.9 60.3 60.3 62.2 63.5 64.1 OP per employee (¥mn) 1.9 2.2 1.0 1.0 1.4 2.0 3.8 5.0 5.7 6.2 (Per share data) EPS (¥) 13.2 9.4 4.1 5.4 31.1 14.6 31.1 40.7 46.1 50.7 BPS (¥) 199.4 196.9 200.9 201.9 230.3 254.8 286.5 320.2 358.3 400.1 Sales per share (¥) 612.6 602.6 564.5 586.7 632.2 683.5 698.8 730.1 745.5 753.2 Operating cashflow per share (¥) 45.5 31.3 18.7 21.4 29.5 43.0 64.2 61.7 67.7 72.7 DPS (¥) 6.0 6.0 6.0 6.0 6.0 6.0 7.0 7.0 8.0 9.0 Dividend ratio (%) 45.5 64.0 144.7 110.2 19.3 41.0 22.5 17.2 17.3 17.7 (Growth) EPS growth (%) 301.5 -28.9 -55.8 31.4 470.5 -52.9 112.7 31.0 13.2 10.0 BPS growth (%) 6.5 -1.2 2.0 0.5 14.0 10.7 12.4 11.8 11.9 11.6 Total assets growth (%) 0.0 -1.2 1.4 9.6 2.3 5.8 7.9 0.3 1.0 0.5 Sustainable growth rate (%) 3.7 1.7 -0.9 -0.3 11.6 3.6 8.9 11.1 11.2 11.0 (Investment profitability) Capital invested (¥ mn) 93,444 91,623 72,227 94,127 104,821 112,134 121,527 122,608 127,597 130,759 NOPAT (¥ mn) 3,729 3,360 1,304 1,476 2,721 4,219 7,770 10,879 12,277 13,478 ROIC (%) 4.0 3.7 1.8 1.6 2.6 3.8 6.4 8.9 9.6 10.3 WACC (%) 2.3 2.3 2.3 2.2 2.3 2.2 2.3 2.6 2.7 2.9 EVA (¥ mn) 1,546 1,219 -371 -563 362 1,702 4,958 7,740 8,829 9,699 EVA spread (%) 1.7 1.3 -0.5 -0.6 0.3 1.5 4.1 6.3 6.9 7.4 (Cashflow) EBITDA (¥mn) 11,020 11,649 8,319 8,289 10,666 13,420 18,786 22,200 24,300 26,000 EBITDA margin (%) 6.8 7.4 5.7 5.4 6.5 7.5 10.3 11.7 12.5 13.3 FCF (¥mn) 8,807 2,079 -2,938 -116 1,225 8,160 14,624 11,544 13,615 14,912 Operating C/F to Investment C/F rate (%) 380.0 134.2 62.4 98.0 119.0 370.0 799.4 356.5 440.4 472.8 (Other) Employees numbers 3,078 2,854 2,670 2,573 2,927 2,978 3,056 3,056 3,056 3,056 Consolidated subsidiaries numbers 16 15 15 16 17 17 19 19 19 19 Equity method affiliates numbers 1 2 2 1 3 3 2 2 2 2 Average shares outstanding (mn) 262.6 261.1 260.8 260.6 260.4 260.3 260.3 260.2 260.2 260.2 End-of-period shares outstanding (mn) 261.2 260.8 260.7 260.4 260.3 260.3 260.2 260.2 260.2 260.2 Source: Company data, Credit Suisse estimates

Food Industry 31

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Morinaga Milk (2264 / 2264 JP) Rating OUTPERFORM* Price (29 Aug 16, ¥) 677 INITIATION

Target price (¥) 850¹ Chg to TP (%) 25.6 Growth potential of BtoB business merits attention Market cap. (¥ bn) 167.21 (US$ 1.63) Enterprise value (¥ bn) 260.58 ■ Initiating coverage: We initiate coverage of Morinaga Milk with an Number of shares (mn) 246.98 OUTPERFORM rating and a target price of ¥850 (potential return 25.6%). Free float (%) 65.0 Morinaga Milk’s core dairy products business is supported by the company’s 52-week price range 771 - 463 strong technological capabilities and its commitment to the highest quality. *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. Adding value to milk is its main differentiation strategy. In light of management’s ¹Target price is for 12 months. shift from a strong technology orientation to a greater emphasis on profitability, we view Morinaga Milk as the Japan food sector company with the biggest Research Analysts potential for improving profits. Masashi Mori ■ Investment theme: In FY3/17, Morinaga Milk has begun implementing 81 3 4550 9695 strategies to improve profitability, including optimizing its product portfolio and [email protected] revising its production and sales structures, as it seeks to move away from an earnings model that has been vulnerable to swings in raw material prices. We forecast a 13% CAGR for OP over the next three years. Expansion of the yogurt market has raised Japan’s awareness of the importance of lactobacilli, or lactic acid bacteria (LAB). From FY3/17, the company is seeking to strengthen external sales of its high-quality LAB, and we look for BtoB business to become a key growth driver. BtoB business is highly profitable and therefore has huge potential for contributing to future profits. Meanwhile, in its BtoC business, the company has abandoned the simple pursuit of larger sales volumes and instead seeks to increase sales efficiency through a process of greater selectivity and focus on core brands. ■ Valuation/risks: Our target price is based on a fair P/E of roughly 23x (one standard deviation above the company’s 10-year average) applied to our FY3/17 EPS estimate of ¥37.6. Considering management’s stronger focus on profits, we look for Morinaga Milk to achieve double-digit profit growth over the medium term. However, given the current relatively low levels of various financial indicators, we think the stock should be valued at a P/E below the Japan food sector average of 25x. Downside risks: (1) a rapid slowdown in Japan’s yogurt market, (2) weak growth in BtoB ingredient operations, and (3) higher-than- expected raw material prices.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 601.5 588.0 588.0 592.0 800 400 Operating profit (¥ bn) 14.3 17.0 18.5 20.5 600 300 Recurring profit (¥ bn) 15.0 17.6 19.1 21.1 200 Net income (¥ bn) 10.6 9.3 10.2 11.5 400 100 EPS (¥) 42.8 37.6 41.3 46.5 200 0 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 41.9 44.9 48.3 The price relative chart measures performance against the EPS growth (%) 153.9 -12.1 9.7 12.7 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 14.1 18.0 16.4 14.6 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.2 1.0 1.0 1.0 EV/EBITDA(x) 7.8 7.4 6.8 6.1 Performance over 1M 3M 12M P/B (x) 1.2 1.2 1.2 1.1 Absolute (%) -11.2 0.4 17.9 ROE(%) 8.4 7.0 7.3 7.7 Relative (%) -10.4 5.3 33.2 Net debt/equity (%) 77.1 68.8 58.9 47.1

Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates.

30 August 2016

Valuations and risks Share price valuations Our target price is based on a fair P/E of roughly 23x applied to our FY3/17 EPS estimate of ¥37.6. We expect profits to grow at a double-digit pace over the medium term as the company steps up its management focus on profit margins. Morinaga Milk has lagged other Japanese food companies in improving margins and capital efficiency, but we think recent initiatives will have a positive impact. We therefore use a multiple that is one standard deviation above the company’s 10-year average. Our multiple is below the food sector average (25x), but we view that as fair given Morinaga’s relatively weak financial indicators versus peers.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 35 10

30 +2σ 28.1 9 +2σ 8.6 25 +1σ 22.5 8 +1σ 7.6 20 Ave. 17.0 7 15 Ave. 6.5

-1σ 11.4 6 10 -1σ 5.5

5 -2σ 5.8 5 -2σ 4.5 0 4 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Downside risks include: (1) a rapid slowdown in Japan’s yogurt market, (2) weak growth in B-to-B ingredient operations, and (3) higher-than-expected raw material prices. Japan’s dairy industry continues to see raw milk production volumes decline, reflecting the aging of Japan’s society and the lack of successors to take over for retiring dairy farmers. At the same time, it faces the risk of cost increases caused by insufficient supply of raw materials. Meanwhile, the global market remains inundated by an excess supply of milk materials amid slowing growth in demand for dairy products in emerging countries. A sharp drop in material prices will benefit Morinaga Milk’s BtoC business by lowering costs. However, that positive would be accompanied by the risk of falling sales at its overseas milk raw materials sales business. In the future, it could become more difficult to secure high quality milk raw materials in an environment that places precedence on fulfilling needs for quantity over quality considerations. Dairy products are a national trade item. Consequently, dairy product makers cannot suddenly adjust prices and volumes and freely purchase required raw materials. To cope with that issue, Morinaga Milk has established a system that enables it to secure a steady supply of high-quality materials via (1) a procurement alliance with a raw materials producer in Oceania and (2) strong ties with companies in North America and Europe. In addition, milk and dairy products in Japan are subject to a tariff system designed to protect domestic agriculture. However, WTO, TPP, and FTA negotiations on agriculture products could cause major changes in this tariff system. Briefly stated, while those trade negotiations could facilitate easier procurement of milk raw materials from overseas, they also could lead to increased imports of competitive dairy products. In balance, the overall impact on Morinaga Milk’s business and profits is likely to be limited.

Food Industry 33 30 August 2016

Morinaga Milk's overall margins are sensitive to milk raw material prices. Prices for these raw materials fell significantly in 2009, the year following the outbreak of the global financial crisis, and consequently the company's OPM for FY09 and FY10 rose substantially. Although on somewhat of a lag, margins subsequently resumed their previous downtrend as raw material prices recovered. The company aims to build a portfolio that is resistant to market fluctuations, but if it fails in this, margins could remain unstable. Moreover, although milk raw material prices have been consistently low recently, another large rise would present a risk of margin contraction.

Figure 3: Morinaga Milk OPM and global milk price

(USD/100kg) World milk price (lhs) OPM (rhs) (%) 55 3.5

50 3.0 45 2.5 40 35 2.0 30 1.5 25 1.0 20 15 0.5 10 0.0 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Note: Global milk price in on a CY basis, Morinaga Milk OPM is on a FY basis (2015=FY3/16) Source: Company data, IFCN, Credit Suisse

Figure 4: Global milk & feed prices

(USD/100kg) 60 Milk Feed 50

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16 Jan-06 Source: IFCN, Credit Suisse

Figure 5: Milk / feed price ratio

(USD/100kg) 3.5 Milk/Feed price ratio

3.0 Average (2006-2015)

2.5

2.0

1.5

1.0

0.5

0.0

Jul-06 Jul-07 Jul-08 Jul-09 Jul-10 Jul-11 Jul-12 Jul-13 Jul-14 Jul-15 Jul-16

Jan-15 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-16 Jan-06 Source: IFCN, Credit Suisse

Food Industry 34 30 August 2016

Company overview Adding value to milk is Morinaga Milk’s main differentiation strategy Morinaga Milk’s roots date back to the 1917 founding of Nippon Rennyu Co., Ltd., and the company will celebrate its 100th anniversary in 2017. The company’s motto is to contribute to society by providing the excellent value of milk, and its core strengths lie in dairy products. On the basis of sales values, Morinaga Milk is the No.2 supplier of yogurt in Japan, No. 1 in chilled cup-type coffee drinks and chilled desserts, and No.3 in cheese and ice cream. While the contribution from overseas business is presently limited, the company is planning aggressive expansion. Its joint venture in Indonesia with a local pharmaceuticals company is that nation’s No.2 supplier of powdered milk. Its wholly owned subsidiary in Germany, Milei GmbH, was established in 1972 and produces whey protein, lactose, lactoferrin, and similar products. Milei possesses the technology to produce whey protein by refining whey, which is produced in large quantities as a by- product of cheese produced throughout Europe. Morinaga Milk prides itself on being among the world’s leading dairy product makers in terms of technological capabilities and product quality. Its reputation for technological expertise is certainly strong within Japan's dairy products industry. On the other hand, we believe it has considerable room to improve in the areas of marketing and management (especially the recognition of the importance of profits and shareholders), two areas where Morinaga Milk pales in comparison with competitors. Management itself has admitted that it has been told that its corporate culture is overly family-like and that it lacks an aggressive growth strategy.

Figure 6: Sales by business segment Figure 7: OP by business segment B-to-B Business 18% B-to-B International Business Business 39% 4% B-to-C Business Health and 46% Nutritional Food International Business Business 9% 0% Health and B-to-C Nutritional Business Food 69% Business 15%

Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse Much about milk remains unknown As is the case with probiotics, there remains plenty of room for new research and development related to milk and milk products. Morinaga Milk is therefore focusing on R&D that will enable it to maximize the nutritional qualities and effects of milk and milk products. Through its research on milk and breast milk, Morinaga Milk has succeeded in developing the production technologies for producing many milk-based derivatives that it has subsequently applied to many of its products. Some prime examples include Bifidobacterium longum BB536, which was originally discovered in the bodies of healthy, breast-fed babies; lactoferrin, an infection blocker found in breast milk; and peptides developed to increase the functionality of protein and to counter allergies to milk products. The company has also used its advanced technologies in such areas as aseptics (sterile packaging), fermentation, and packaging to develop high-value-added products that have enabled it to differentiate its product offerings from those of competitors.

Food Industry 35 30 August 2016

For example, it was the first company to overcome considerable technological hurdles to develop and market milk products for infants and young children that include lactoferrin as a nutritional additive. The company is also making a major effort to produce milk peptides, proteins with positive attributes that are found in milk and are expected to have a wide range of applications, from countering milk allergies to use in sports nutrition. These peptides have the potential to enhance the nutritional functions that are considered one of protein’s virtues. The categories of people who can benefit from the nutritional qualities of protein is wide-sweeping, including infants, athletes, and the elderly. Morinaga Milk has been engaged in R&D on nutritional foods, such as infant formula, and on the nutritional qualities of milk for almost 100 years. Nonetheless, much remains to be learned about milk and its constituent ingredients, and we think Morinaga Milk’s application of its extensive technological know-how to product development could garner considerable market interest. Longer-term management strategies and shareholder returns Morinaga Milk is in the early stages of its current five-year medium-term management plan, which concludes in FY3/20. The plan’s four basic policies are: (1) rebuilding business domains to support future growth, (2) improving asset efficiency and promoting rationalization, (3) strengthening the business base, and (4) making a difference in society. Numerical targets for FY3/20 include OP of ¥22.5bn, representing 57% growth from the FY3/16 result. The first of the four basic policies, rebuilding business domains, includes four specific initiatives expected to serve as pillars of future growth: (1) strengthen the functional and food ingredients business, (2) facilitate globalization, (3) develop the health and nutritional food business, and (4) improve the profitability of existing businesses (BtoC business). As will be discussed in greater detail later, Morinaga Milk has just begun the move to a management stance that emphasizes profitability, and we expect it to continue on that path. Our earnings forecasts only extend out over the next three years. Nonetheless, our FY3/19 OP forecast of ¥20.5bn indicates that management’s medium- term profit target is achievable. On a less positive note, Morinaga Milk’s financial condition and cash-flow generation pale in comparison with other sector companies. Also, we think management’s priorities will be on drastic business restructuring in the coming years. Consequently, we see little likelihood that it will seek to enhance shareholder returns in the near term.

Figure 8: Dividend, buyback and dividend payout ratio Figure 9: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) 3.0 Dividend (LHS) 100 120 140 Buyback (LHS) 90 120 2.5 100 Dividend payout ratio (RHS) 80 100 70 2.0 80 60 80 1.5 50 60 60 40 1.0 40 30 40 20 20 0.5 20 10 0 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

Food Industry 36 30 August 2016

Focusing on BtoB and overseas businesses BtoB business to push external sales of lactobacilli Morinaga Milk has made strengthening of its functional and food ingredients business (BtoB business) one of the core strategies of its current medium-term plan. The BtoB business accounted for 39% of consolidated OP in FY3/16, making it the company’s second largest earner, after the BtoC business. It also had the highest OPM among the company’s four core business domains. We think the BtoB business has the biggest growth potential of any of Morinaga Milk’s businesses and forecast its profit contribution will exceed that of the BtoC business in FY3/19. The BtoB business has two components. The first is the commercial foods business, which accounts for more than 80% of this business domain’s annual sales. The BtoB business’s main activity is the provision of dairy food ingredients, such as cream and cheese, to other food makers and confectionery shops. Demand in this market is supported by Japanese consumers’ increasing consumption of western foods, but we assume sales will enter a mild downturn over the next three years amid a lull in new sales to some convenience stores chains. The BtoB business’s second component is the functional ingredients business, which accounts for more than 10% of segment sales. The company sells its bifidobacteria and lactoferrin to other food and beverage makers as a raw material for use in their products. As a material for use in other companies’ BtoC products, absolute sales volumes of these functional ingredients are small in scale, but external sales of its high-quality lactic acid bacteria are highly profitable. Thanks to consumers’ growing health consciousness, demand for yogurt is undergoing structural expansion. The intake of lactic acid bacteria into the human body has until recently been limited to the consumption of yogurt, yogurt drinks, beverages containing lactic acid bacteria, and nutritional supplements. However, technological advances in recent years have made it possible to develop chocolates, soups and other food products that contain lactic acid bacteria. These new products greatly increase the future growth potential for sales of lactic acid bacteria. Considering that some people do not like the sour taste of yogurt, we think the development of products that enable the consumption of lactic acid bacteria without a sour taste represents a potentially large new market.

Figure 10: Annual per-household consumption Figure 11: Per-household annual consumption of yogurt expenditure on yogurt in Japan in the world (k JPY/yr) (kg Per Capita) Plain Yoghurt 12 4.0 Fruited Yoghurt Flavoured Yoghurt 3.5 Drinking Yoghurt 10

Thousands 3.0 8 2.5

6 2.0

1.5 4 1.0 2 0.5

0 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Source: MIC, Credit Suisse Source: Euromonitor, Credit Suisse

Food Industry 37 30 August 2016

This is new territory, so quantitative discussions are difficult. However, we see a strong likelihood for the development of a market for processed foods containing lactobacilli as differentiation products offered by restaurants and food makers. We anticipate the adoption of new products contributed to a 20% increase in functional ingredient sales in 1Q FY3/17. Morinaga Milk is presently in talks with several potential new customers. While these talks are in their early stages, we anticipate they will contribute to sustained growth in demand for functional ingredients. At a minimum, we think the growth rate achieved in 1Q FY3/17 will, on average, be sustained over the next three years. We therefore assume an 18% CAGR for sales of functional ingredients over that period. Lacking reference data for this industry, we have made the following estimates. We assume that Morinaga Milk's share of the market for lactobacilli functional ingredients will be the same as its 14% share of the general consumer yogurt market. We also assume that the scale of the functional ingredients market will be around ¥40bn, or less than 2% of the size of the ¥2.2tn market for milk and other dairy products. However, the growth potential is huge if one considers the potential adoption of these functional ingredients for use in confectionery (a ¥2.4tn market), soft drinks (¥3.7tn), and frozen and retort food products (¥1.2tn). It is said that lactobacilli must be consumed daily to produce the desired positive effects on the human body. We therefore think the market for this functional ingredient could be expanded by promoting its intake through inclusion in foods consumed regularly as part of an ordinary diet, without the need to eat yogurt every day. The two components of Morinaga Milk’s BtoB business were previously handled by separate business groups, but the food ingredients group was established in July 2015 with the purpose of creating new business by tapping into the potential needs of customers in each of the group’s two product areas. The company also added to its R&D organization by establishing the Food Ingredients & Technology Institute. We think this optimization of the business structure, from R&D to sales, increases the likelihood of success business development over the medium term. Future of international business in hands of German subsidiary Milei Morinaga Milk’s German subsidiary Milei produces whey protein, lactose, lactoferrin, and similar products. Milei has the technology to produce whey protein by refining whey, which is produced in large quantities as a by-product of cheese produced throughout Europe. It supplies its output of milk raw materials to global food makers in Europe and Asia. The international business accounted for 4% of Morinaga Milk’s sales in FY3/16, but its contribution to profits was essentially nil. Milei is the international business’s core unit. Although it has enjoyed solid demand for its whey protein concentrate, the main ingredient in powdered milk, insufficient production capacity has led to lost sales opportunities. Expecting demand to expand over the longer term, Morinaga Milk decided to invest in a new large plant for Milei. This plant is scheduled to be fully operational in autumn 2016. Milei’s sales plan targets 6% annual growth from FY13 sales of €126mn to €190mn in FY20. Our forecast for Milei is a bit more conservative, as we expect just 3% CAGR over the next three years. Milei’s product prices are highly vulnerable to swings in the market prices for milk raw materials (with very high-quality ingredients a notable exception), and our conservative forecast reflects recent price trends. Morinaga Milk’s recently established sales subsidiary in Singapore began full-scale operations in April 2016. US and European companies occupy most of the top spots in the global market share ranking for powdered milk. According to Morinaga Milk, the global leaders are taking more aggressive stances on market expansion in Southeast Asia, and many US and European companies are establishing production and development centers in Singapore. Morinaga Milk’s Singapore sales subsidiary appears to be in good position to serve as a base for developing business with these leading US and European companies.

Food Industry 38 30 August 2016

Meanwhile, expanding sales of the company’s final powdered milk products in the Asian market, including China, will be a bigger challenge. We therefore think the company is likely to focus its energies on strengthening its strategy centering on the export of Milei’s milk raw materials. Food ingredients, including those for powdered milk, are subject to extremely strict inspections, including safety checks. The combination of high-quality ingredients produced in Germany with Morinaga Milk’s expertise in quality assurance, such as temperature management technologies developed in Japan, will play an important role in Morinaga Milk’s development of business opportunities in the Southeast Asian market. At this time, we believe it prudent to base our forecasts on a conservative outlook for the growth trend in the company’s international business. That said, this business undoubtedly has considerable growth potential.

Figure 12: Scale of global market for infant-formula Figure 13: Market shares in global infant formula market powdered milk (2015) (bn USD) 30 Morinaga Other Nestle Milk 25% 22% 25 EMEA 1% Americas 20 APAC ex China Vinamilk China 1% 15 Wonder Sun Dairy 2% Mead 10 Johnson Biostime 16% 5 2% Mengniu Yili Danone 2% Friesland 0 2% Abbott 10% 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 18E Beingmate Campina 7% 4% 6% Source: Euromonitor forecasts, Credit Suisse Source: Euromonitor, Credit Suisse

Figure 14: European non-fat powdered milk price trend Figure 15: CME Dry Whey price trend (USD/LB) (EUR/MT) 3,500 80 3,000 70 60 2,500 50 2,000 40 1,500 30 1,000 20

500 10

0 0

Source: Bloomberg Source: Bloomberg

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Earnings forecasts

Figure 16: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 601,499 1.1 14,317 110.4 14,959 81.7 10,576 154.0 42.8 153.9 17/3 CS E 588,000 -2.2 17,000 18.7 17,600 17.7 9,300 -12.1 37.6 -12.1 CoE 590,000 -1.9 16,400 14.5 17,000 13.6 8,200 -22.5 33.2 -22.5 18/3 CS E 588,000 0.0 18,500 8.8 19,100 8.5 10,200 9.7 41.3 9.7 19/3 CS E 592,000 0.7 20,500 10.8 21,100 10.5 11,500 12.7 46.5 12.7 Source: Company data, Credit Suisse estimates We forecast Morinaga Milk’s FY3/17 OP will reach ¥17.0bn, up 19% YoY. Meanwhile we forecast a 2% decline in sales due to (1) the transfer of unprofitable businesses (the company sold off a household frozen foods wholesaler in November 2015), (2) a reduction in SKUs as part of the company’s effort to rationalize and increase efficiency of its production and sales systems (it aims to reduce the number of new product items by about 30%), and (3) price reductions for some products reflecting declines in prices of milk raw materials. With Morinaga Milk putting greater effort into expanding sales of differentiated products, we look for double-digit sales growth for Partheno, its thick Greek yogurt offering that has been enjoying expanding demand. Considering the improvement in product mix, we do not see weak sales growth as a cause for concern. We see three main profit growth drivers: (1) cost reductions generated by revisions to the company’s production and sales structures, (2) product mix improvement realized through expansion of the company’s differentiated product lineup, and (3) lower material costs. Morinaga Milk reorganized its sales structure in some parts of Japan in spring 2016 and continues to promote greater efficiencies in its sales structure. It recently established the Materials Strategy Department and Wellness Business Department as part of its efforts to build an organizational structure that can respond to customer needs in a timely manner. It has also begun to implement measures to improve operational efficiency and strengthen alliances in its production and sales structures. Management thus appears to be placing greater emphasis on improving profitability on a companywide basis from 2016. Looking out over the medium term, we forecast 13% average annual growth in OP over the next three years. In addition to profitability improvements, we forecast product mix improvement will be driven by continued topline growth for core BtoC products (Partheno, etc.) and expansion of the BtoB food ingredients business. While we expect continued profit margin improvement, our OPM forecast for FY3/19 of 3.5% is still very low on comparisons with other food makers. That said, we see considerable potential to improve profitability as investment in new facilities for its core overseas operations winds down and it strengthens efforts toward greater selectivity and focus on core brands in Japan.

Figure 17: OP and OP margin Figure 18: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 25 4.0 9 ROIC (rhs) 6 3.5 8 OPM (rhs) 20 5 3.0 7 6 4 15 2.5 5 2.0 3 10 1.5 4 1.0 3 2 5 2 0.5 1 1 0 0.0

0 0

FY3/09 FY3/02 FY3/03 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/19E FY3/17E FY3/18E

FY3/02 FY3/09 FY3/16 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15

FY3/03

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Food Industry 40 30 August 2016

Figure 19: Sales and OP forecasts by segment (¥mn) FY3/16 FY3/17E FY3/18E FY3/19E Sales by segment (JPYm) B-to-B Business 91,100 88,400 89,600 91,100 International Business 21,700 20,300 19,400 21,600 Health and Nutritional Food Business 44,100 46,400 47,700 48,700 B-to-C Business 349,800 338,000 336,000 335,000 Other, Elimination 94,800 94,900 95,300 95,600 Total 601,499 588,000 588,000 592,000 Sales (y-y,%) B-to-B Business - -3.0 1.4 1.7 International Business - -6.5 -4.4 11.3 Health and Nutritional Food Business - 5.2 2.8 2.1 B-to-C Business - -3.4 -0.6 -0.3 Other, Elimination - 0.1 0.4 0.3 Total - -2.2 0.0 0.7 OP (JPY m) B-to-B Business 4,900 6,000 6,900 8,000 International Business 0 300 500 800 Health and Nutritional Food Business 1,900 2,200 2,300 2,400 B-to-C Business 5,900 7,000 7,300 7,800 Other, Elimination 1,600 1,500 1,500 1,500 Total 14,317 17,000 18,500 20,500 OP (y-y,%) B-to-B Business - 22.4 15.0 15.9 International Business - - 66.7 60.0 Health and Nutritional Food Business - 15.8 4.5 4.3 B-to-C Business - 18.6 4.3 6.8 Total - 18.7 8.8 10.8 OPM (%) B-to-B Business 5.4 6.8 7.7 8.8 International Business 0.0 1.5 2.6 3.7 Health and Nutritional Food Business 4.3 4.7 4.8 4.9 B-to-C Business 1.7 2.1 2.2 2.3 Total 2.4 2.9 3.1 3.5 Sales breakdown (%) B-to-B Business 18.0 17.9 18.2 18.4 International Business 4.3 4.1 3.9 4.4 Health and Nutritional Food Business 8.7 9.4 9.7 9.8 B-to-C Business 69.0 68.5 68.2 67.5 OP breakdown (%) B-to-B Business 38.5 38.7 40.6 42.1 International Business 0.0 1.9 2.9 4.2 Health and Nutritional Food Business 14.9 14.2 13.5 12.6 B-to-C Business 46.4 45.2 42.9 41.1 Source: Company data, Credit Suisse estimates

Food Industry 41 30 August 2016

Figure 20: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 12,910 10,459 16,692 17,612 7,383 11,409 6,506 9,227 7,633 8,102 Account receivable 49,702 48,029 54,361 56,144 51,813 52,357 53,511 51,746 52,629 52,542 Inventories 35,347 32,203 35,980 38,892 42,391 51,016 52,349 50,523 51,436 51,326 Other 12,753 13,134 15,967 14,700 13,136 13,997 12,462 12,462 12,462 12,462 Total current assets 110,712 103,825 123,000 127,348 114,723 128,779 124,828 123,491 123,692 123,965 Tangible fixed assets 216,334 213,504 212,460 210,518 213,701 220,946 224,127 230,127 228,627 226,627 Depreciable PP&E 138,825 133,948 133,263 133,834 133,811 134,241 134,997 - - - Land 71,725 72,388 73,835 73,501 72,987 72,485 70,478 - - - Construction in progress 5,784 7,168 5,362 3,183 6,903 14,220 18,652 - - - Intangible fixed assets 5,517 5,399 5,461 5,827 6,730 6,829 6,719 6,719 6,719 6,719 Investments & other assets 25,315 25,664 25,268 24,803 25,422 26,801 23,176 23,176 23,176 23,176 Investment securities 14,051 13,976 14,311 14,515 16,024 17,136 15,468 15,468 15,468 15,468 Other 11,264 11,688 10,957 10,288 9,398 9,665 7,708 7,708 7,708 7,708 Total fixed assets 247,166 244,567 243,189 241,148 245,853 254,578 254,023 260,022 258,522 256,522 Total assets 357,880 348,394 366,190 368,498 360,578 383,357 378,852 383,513 382,214 380,487 (Liabilities) Account payable 59,365 57,586 58,155 59,192 59,068 59,380 57,368 57,064 57,216 57,529 Short-term debt 23,824 15,802 21,132 33,106 33,373 37,864 25,136 30,452 27,647 22,231 Other 54,833 55,182 68,717 67,168 66,246 65,718 65,300 65,300 65,300 65,300 Total current liabilities 138,022 128,570 148,004 159,466 158,687 162,962 147,804 152,816 150,163 145,060 Long-term debt 96,141 90,952 86,944 73,873 62,575 74,844 80,166 72,149 64,934 58,441 Other 20,081 18,560 17,306 18,409 18,356 20,264 21,511 21,511 21,511 21,511 Total fixed liabilities 116,222 109,512 104,250 92,282 80,931 95,108 101,677 93,660 86,445 79,952 Total liabilities 254,244 238,082 252,254 251,748 239,619 258,070 249,481 246,476 236,608 225,012 (Net assets) Capital stock 21,704 21,704 21,704 21,704 21,704 21,704 21,704 21,704 21,704 21,704 Capital surplus 19,442 19,442 19,442 19,442 19,442 19,442 19,518 19,518 19,518 19,518 Retained earnings 63,522 67,979 70,866 74,126 77,377 76,442 85,280 92,850 101,319 111,089 Treasury stock -1,129 -1,234 -1,241 -2,298 -2,285 -621 -585 -585 -585 -585 Total shareholders' equity 103,539 107,892 110,771 112,974 116,238 116,967 125,918 133,487 141,956 151,726 Valuation and translation adjustments -1,835 986 1,851 2,865 4,007 7,157 2,287 2,287 2,287 2,287 Total equity capital 101,704 108,878 112,622 115,839 120,245 124,124 128,205 135,774 144,243 154,013 Share warrant 142 153 183 196 197 196 204 204 204 204 Minority interests 1,788 1,277 1,128 713 516 965 959 1,059 1,159 1,259 Total net assets 103,635 110,310 113,933 116,750 120,959 125,286 129,370 137,037 145,606 155,476 Total liabilities & net assets 357,880 348,394 366,190 368,498 360,578 383,357 378,852 383,513 382,214 380,487 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 97,497 103,635 110,310 113,933 116,750 120,959 125,286 129,370 137,037 145,606 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus 0 0 0 0 0 0 76 0 0 0 Net profits 8,017 6,164 4,608 5,016 4,839 4,164 10,576 9,300 10,200 11,500 Dividends from surplus -1,528 -1,760 -1,759 -1,762 -1,740 -1,741 -1,745 -1,730 -1,730 -1,730 Treasury stock -593 -105 -7 -1,057 13 1,664 36 0 0 0 Valuation and translation adjustments 88 2,821 865 1,014 1,142 3,150 -4,870 0 0 0 Minority interests 9 -511 -149 -415 -197 449 -6 100 100 100 Other 145 66 65 21 152 -3,359 17 -3 0 0 Final balance 103,635 110,310 113,933 116,750 120,959 125,286 129,370 137,037 145,606 155,476 Source: Company data, Credit Suisse estimates

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Figure 21: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 585,116 583,019 578,299 591,197 599,273 594,834 601,499 588,000 588,000 592,000 COGS 405,346 398,469 399,781 412,554 421,845 422,281 419,454 399,800 399,300 401,800 Gross profit 179,770 184,550 178,518 178,643 177,428 172,552 182,045 188,200 188,700 190,200 SG&A 162,668 165,633 165,334 168,477 165,446 165,747 167,728 171,200 170,200 169,700 OP 17,102 18,917 13,184 10,166 11,982 6,805 14,317 17,000 18,500 20,500 Interest income and dividend 509 518 595 491 577 1,136 603 500 500 500 Interest expense 1,748 1,889 1,741 1,607 1,369 1,108 1,024 1,000 1,000 1,000 Equity in earnings of affiliates 143 141 56 54 122 125 103 100 100 100 Other 1,012 1,059 1,093 1,447 1,083 1,274 960 1,000 1,000 1,000 RP 17,018 18,746 13,187 10,551 12,395 8,232 14,959 17,600 19,100 21,100 Extraordinary gains 491 1,016 771 1,188 837 1,119 5,699 1,000 1,000 1,000 Etrtraordinary losses 3,434 9,069 6,102 3,105 4,572 3,256 4,874 3,000 3,000 3,000 Pretax profit 14,075 10,694 7,857 8,635 8,660 6,096 15,784 15,600 17,100 19,100 Income taxes 5,954 4,503 3,055 3,557 3,793 1,831 5,129 6,200 6,800 7,500 Minority interests 103 26 192 60 27 100 79 100 100 100 NP 8,017 6,164 4,608 5,016 4,839 4,164 10,576 9,300 10,200 11,500 Tax rate 42.3% 42.1% 38.9% 41.2% 43.8% 30.0% 32.5% 39.7% 39.8% 39.3% Depreciation expense 16,683 17,424 17,276 17,674 15,631 16,810 17,561 18,000 18,500 19,000 Capital expenditure 16,200 15,500 18,700 16,100 16,700 25,700 25,400 24,000 17,000 17,000 R&D expense 4,650 4,872 4,839 4,915 4,991 4,958 4,965 5,000 5,000 5,000 To sales ratio (%) CGS 69.3 68.3 69.1 69.8 70.4 71.0 69.7 68.0 67.9 67.9 Gross profit 30.7 31.7 30.9 30.2 29.6 29.0 30.3 32.0 32.1 32.1 Depreciation expense 2.9 3.0 3.0 3.0 2.6 2.8 2.9 3.1 3.1 3.2 R&D expense 0.8 0.8 0.8 0.8 0.8 0.8 0.8 0.9 0.9 0.8 SG&A 27.8 28.4 28.6 28.5 27.6 27.9 27.9 29.1 28.9 28.7 OP 2.9 3.2 2.3 1.7 2.0 1.1 2.4 2.9 3.1 3.5 RP 2.9 3.2 2.3 1.8 2.1 1.4 2.5 3.0 3.2 3.6 Pretax profit 2.4 1.8 1.4 1.5 1.4 1.0 2.6 2.7 2.9 3.2 NP 1.4 1.1 0.8 0.8 0.8 0.7 1.8 1.6 1.7 1.9 YoY (%) Sales revenue 0.2 -0.4 -0.8 2.2 1.4 -0.7 1.1 -2.2 0.0 0.7 Gross profit 5.6 2.7 -3.3 0.1 -0.7 -2.7 5.5 3.4 0.3 0.8 OP 48.4 10.6 -30.3 -22.9 17.9 -43.2 110.4 18.7 8.8 10.8 RP 51.5 10.2 -29.7 -20.0 17.5 -33.6 81.7 17.7 8.5 10.5 Pretax profit 72.6 -24.0 -26.5 9.9 0.3 -29.6 158.9 -1.2 9.6 11.7 NP 88.5 -23.1 -25.2 8.9 -3.5 -13.9 154.0 -12.1 9.7 12.7

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 8,017 6,164 4,608 5,016 4,839 4,164 10,576 9,300 10,200 11,500 Depreciation(+) 16,683 17,424 17,276 17,674 15,631 16,810 17,561 18,000 18,500 19,000 Account receivable(-) -315 1,673 -6,332 -1,783 4,331 -544 -1,154 1,765 -882 86 Inventories(-) -250 3,144 -3,777 -2,912 -3,499 -8,625 -1,333 1,826 -913 110 Account payable(+) -3,159 -1,779 569 1,037 -124 312 -2,012 -304 152 313 Minority interests(+) 103 26 192 60 27 100 79 100 100 100 Other 8,561 4,402 10,862 2,017 863 -3,549 4,609 0 0 0 Operating cashflow 29,497 30,913 23,342 21,055 21,946 8,543 28,223 30,587 27,056 31,009 (Investing activities) Capital expenditures(-) -14,233 -15,745 -15,046 -14,399 -15,756 -17,802 -22,382 -24,000 -17,000 -17,000 Other -1,354 -1,643 825 1,087 -174 160 148 0 0 1 Investing cashflow -15,587 -17,388 -14,221 -13,312 -15,930 -17,642 -22,234 -24,000 -17,000 -16,999 (Financing activities) Debt (+) 3,379 -13,211 1,322 -1,097 -11,031 16,760 -7,406 -2,701 -10,020 -11,909 Dividends (-) -1,528 -1,760 -1,759 -1,762 -1,740 -1,741 -1,745 -1,730 -1,730 -1,730 Other -6,613 -988 -2,452 -4,000 -5,440 -2,132 -1,298 0 0 1 Financing cashflow -4,762 -15,959 -2,889 -6,859 -18,211 12,887 -10,449 -4,431 -11,750 -13,639 (Cash & cash equivalents) Increases 9,148 -2,434 6,232 884 -12,195 3,788 -4,460 2,156 -1,694 371 Beginning balance 4,172 12,910 10,459 16,692 17,612 7,383 11,409 6,506 9,227 7,633 Final balance 13,320 10,476 16,691 17,576 5,417 11,171 6,949 8,662 7,533 8,004 Adjustments -410 -17 1 36 1,966 238 -443 565 100 98 Source: Company data, Credit Suisse estimates

Food Industry 43 30 August 2016

Figure 22: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 80.2 80.8 83.1 79.9 72.3 79.0 84.5 80.8 82.4 85.5 Quick ratio (%) 45.4 45.5 48.0 46.3 37.3 39.1 40.6 39.9 40.1 41.8 Adjusted quick ratio (%) 54.2 66.2 79.0 53.2 22.1 30.1 25.9 30.3 27.6 36.4 Fixed ratio (%) 243.0 224.6 215.9 208.2 204.5 205.1 198.1 191.5 179.2 166.6 Interest-bearing debt (¥mn) 119,965 106,754 108,076 106,979 95,948 112,708 105,302 102,601 92,581 80,672 Average debt interest rate (%) 1.5 1.7 1.6 1.5 1.3 1.1 0.9 1.0 1.0 1.2 Dependence on debt (%) 33.5 30.6 29.5 29.0 26.6 29.4 27.8 26.8 24.2 21.2 Net debt (¥mn) 107,055 96,295 91,384 89,367 88,565 101,299 98,796 93,374 84,948 72,570 Equity capital ratio (%) 28.4 31.3 30.8 31.4 33.3 32.4 33.8 35.4 37.7 40.5 D/E ratio (%) 118.0 98.0 96.0 92.4 79.8 90.8 82.1 75.6 64.2 52.4 Long-term debt ratio (%) 80.1 85.2 80.4 69.1 65.2 66.4 76.1 70.3 70.1 72.4 Working capital (¥mn) -27,310 -24,745 -25,004 -32,118 -43,964 -34,183 -22,976 -29,325 -26,470 -21,094 Net interest expense (¥mn) -1,239 -1,371 -1,146 -1,116 -792 28 -421 -500 -500 -500 Cash plus marketable securities (¥mn) 12,910 10,459 16,692 17,612 7,383 11,409 6,506 9,227 7,633 8,102 Interest coverage ratio (x) 10.07 10.29 7.91 6.63 9.17 7.17 14.57 17.50 19.00 21.00 Financial leverage (x) 3.52 3.20 3.25 3.18 3.00 3.09 2.96 2.82 2.65 2.47 A/R to A/P ratio (%) 83.7 83.4 93.5 94.9 87.7 88.2 93.3 90.7 92.0 91.3 Dividend on equity (%) 1.5 1.7 1.6 1.5 1.5 1.4 1.4 1.3 1.2 1.2 (Profitability) ROE (%) 8.1 5.9 4.2 4.4 4.1 3.4 8.4 7.0 7.3 7.7 ROA (%) 4.8 5.4 3.7 2.8 3.3 1.8 3.8 4.5 4.8 5.4 Inventory turnover ratio (x) 16.6 17.3 17.0 15.8 14.7 12.7 11.6 11.4 11.5 11.5 A/R turnover ratio (x) 11.8 11.9 11.3 10.7 11.1 11.4 11.4 11.2 11.3 11.3 A/P turnover ratio (x) 9.6 10.0 10.0 10.1 10.1 10.0 10.3 10.3 10.3 10.3 Inventory turnover days (days) 22.0 21.1 21.5 23.1 24.8 28.7 31.4 31.9 31.6 31.7 A/R turnover days (days) 30.9 30.6 32.3 34.1 32.9 32.0 32.1 32.7 32.4 32.4 A/P turnover days (days) 38.0 36.6 36.5 36.2 36.0 36.3 35.4 35.5 35.5 35.4 Sales per employee (¥mn) 102.7 103.4 102.7 104.2 105.4 105.2 106.9 105.0 105.0 105.7 OP per employee (¥mn) 3.0 3.4 2.3 1.8 2.1 1.2 2.5 3.0 3.3 3.7 (Per share data) EPS (¥) 31.8 24.6 18.4 20.0 19.6 16.9 42.8 37.6 41.3 46.5 BPS (¥) 405.3 434.4 449.3 469.1 486.8 502.4 518.6 549.2 583.5 623.0 Sales per share (¥) 2,319.6 2,323.8 2,307.2 2,361.7 2,426.5 2,407.8 2,434.1 2,378.5 2,378.5 2,394.7 Operating cashflow per share (¥) 116.9 123.2 93.1 84.1 88.9 34.6 114.2 123.7 109.4 125.4 DPS (¥) 7.0 7.0 7.0 7.0 7.0 7.0 7.0 7.0 7.0 7.0 Dividend ratio (%) 22.0 28.5 38.1 34.9 35.7 41.5 16.4 18.6 17.0 15.0 (Growth) EPS growth (%) 88.8 -22.7 -25.2 9.0 -2.2 -14.0 153.9 -12.1 9.7 12.7 BPS growth (%) 7.0 7.2 3.4 4.4 3.8 3.2 3.2 5.9 6.2 6.8 Total assets growth (%) 2.8 -2.7 5.1 0.6 -2.1 6.3 -1.2 1.2 -0.3 -0.5 Sustainable growth rate (%) 6.3 4.2 2.6 2.9 2.6 2.0 7.0 5.7 6.0 6.6 (Investment profitability) Capital invested (¥ mn) 217,926 218,390 216,872 208,121 201,176 219,232 229,882 229,434 230,689 233,965 NOPAT (¥ mn) 10,534 11,646 8,760 6,861 7,411 5,740 10,382 10,906 11,806 13,118 ROIC (%) 4.8 5.3 4.0 3.3 3.7 2.6 4.5 4.8 5.1 5.6 WACC (%) 1.6 1.8 1.7 1.7 1.7 1.6 1.6 1.7 1.8 1.9 EVA (¥ mn) 6,978 7,821 4,980 3,286 3,925 2,269 6,669 7,094 7,762 8,745 EVA spread (%) 3.2 3.6 2.3 1.6 2.0 1.0 2.9 3.1 3.4 3.7 (Cashflow) EBITDA (¥mn) 33,785 36,341 30,460 27,840 27,613 23,615 31,878 35,000 37,000 39,500 EBITDA margin (%) 5.8 6.2 5.3 4.7 4.6 4.0 5.3 6.0 6.3 6.7 FCF (¥mn) 13,910 13,525 9,121 7,743 6,016 -9,099 5,989 6,587 10,056 14,010 Operating C/F to Investment C/F rate (%) 189.2 177.8 164.1 158.2 137.8 48.4 126.9 127.4 159.2 182.4 (Other) Employees numbers 5,653 5,627 5,639 5,712 5,664 5,649 5,602 5,602 5,602 5,602 Consolidated subsidiaries numbers 30 30 30 30 30 29 30 30 30 30 Equity method affiliates numbers 4 4 4 4 3 2 1 1 1 1 Average shares outstanding (mn) 252.3 250.9 250.6 250.3 247.0 247.0 247.1 247.2 247.2 247.2 End-of-period shares outstanding (mn) 251.0 250.7 250.6 247.0 247.0 247.1 247.2 247.2 247.2 247.2 Source: Company data, Credit Suisse estimates

Food Industry 44

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Yakult Honsha (2267 / 2267 JP) Rating UNDERPERFORM* Price (29 Aug 16, ¥) 4,740 INITIATION

Target price (¥) 4,200¹ Chg to TP (%) -11.4 Market cap. (¥ bn) 783.69 (US$ 7.66) Forecast sluggish profit growth near term Enterprise value (¥ bn) 755.78 Number of shares (mn) 165.33 ■ Initiate coverage: We initiate coverage of Yakult Honsha with a ¥4,200 target Free float (%) 55.0 price (potential return −11.4%) and an UNDERPERFORM rating. The company 52-week price range 6,780 - 4,655 generates nearly half of its overall profits in Asian markets, centered on China *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. and Indonesia. Growth in China has slowed in recent years due to stiffer ¹Target price is for 12 months. competition, so a rebound in this market will probably take time. Yakult generates more than 20% of its OP in the Americas including Mexico and Brazil, Research Analysts but growth in the region has stalled due to higher penetration rates and slower Masashi Mori macroeconomic growth. Pharmaceuticals too, have been hit by weak profits. A 81 3 4550 9695 muted share price suggests equity markets have already priced in sluggish [email protected] earnings. We take a bearish stance on Yakult relative to the sector, as the stock’s valuations continue to appear somewhat demanding. ■ Investment theme: Asian markets are the main focus for investors. In Indonesia, where door-to-door delivery accounts for around 50% of sales, Yakult’s business base remains stable (impervious to consumer sentiment and weather factors). In the effective absence of rivals, we expect Yakult to maintain double-digit volume growth for now. China, however, poses issues. Sales growth slowed to high single-digits for the first time in 2015. We expect heated competition with comparable products in the general retail channel to continue. ■ Valuation and risks: We derive our target price by applying a P/E of roughly 28x to our FY3/17 EPS estimate. We see little prospect for Yakult to regain its share price premium in the near term due to sluggish earnings, and regard the company’s historical 10-year average valuations minus one standard deviation, a level close to the domestic food sector average, as reasonable. Upside risks: (1) substantial improvement in China market growth, (2) greater-than-expected expansion in Brazil, Mexico and other Latin American markets; (3) margin improvement in Japan; (4) sharply higher sales of generics at the pharmaceutical business; and (5) further softening in input costs.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 390.4 377.0 381.0 390.0 10000 140 Operating profit (¥ bn) 40.1 34.5 35.0 37.0 8000 120 Recurring profit (¥ bn) 50.6 43.9 44.5 46.7 6000 100 4000 80 Net income (¥ bn) 28.8 25.4 25.7 27.2 EPS (¥) 174.5 153.7 155.5 164.6 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 163.8 178.4 191.5 The price relative chart measures performance against the EPS growth (%) 15.2 -11.9 1.2 5.8 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 28.6 30.8 30.5 28.8 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.0 0.7 0.7 0.7 EV/EBITDA(x) 12.7 12.9 12.4 11.6 Performance over 1M 3M 12M P/B (x) 2.5 2.2 2.1 2.0 Absolute (%) -4.0 -12.9 -30.9 ROE(%) 8.8 7.4 7.1 7.1 Relative (%) -3.3 -8.0 -15.6 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates.

CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access

30 August 2016

Valuation and risks Share price valuation We derive our target price by applying a P/E of roughly 28x to our FY3/17 EPS estimate. For now we see little sign of the previous share price premium being restored, in view of lackluster growth at the overseas beverages business, and the outlook for more tough times at the pharmaceutical business. We base our multiple on Yakult’s historical 10-year average valuations minus one standard deviation. We regard the level as reasonable, as it is close to the average domestic food sector forward multiple of roughly 25x.

Figure 1: P/E (12-month forward CS forecasts base) Figure 2: EV/EBITDA (12-month forward CS forecasts base)

(x) (x) 50 21

19 45 +2σ 44.4 +2σ 18.5 17 40 +1σ 15.5 +1σ 38.8 15

35 13 Ave. 12.5 Ave. 33.2 11 30 -1σ 9.5 -1σ 27.6 9 25 7 -2σ 6.6 -2σ 22.0 20 5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Upside risks include: (1) substantial improvement in China market growth, (2) greater- than-expected expansion in Brazil, Mexico and other Latin American markets; (3) margin improvement in Japan; (4) sharply higher sales of generics at the pharmaceutical business; and (5) further softening in input costs. Awareness of probiotics is on the rise in Japan as consumers increasingly focus on the value of lactic acid bacterium. Yakult had placed a greater priority on developing overseas markets so far in terms of managerial resources, but it is now stepping up moves to prop up the Japanese market. The company aims to beef up its sales channels centered on the door-to-door delivery model, product portfolio, and marketing strategy. Yakult’s Japan business could re-enter a phase of profit growth if its renewed investment in the above proves successful. We take a neutral stance on Yakult’s strategy in this regard, so success here would imply an upside earnings risk versus our outlook.

Food Industry 46 30 August 2016

Corporate profile Yakult represents Japan in probiotics Yakult traces its origins back to Minoru Shirota, a medical doctor and the company’s founder, who successfully created/cultured a special strain of the bacterium Lactobacillus casei Shirota during research at the Kyoto Imperial University’s School of Medicine in 1930. He began selling beverages in Fukuoka City under the trademark of Yakult in 1935. After the war, Shirota expanded Yakult’s beverage sales agency network all over Japan. Yakult Honsha was established in 1955 to oversee the network of agencies nationwide. Yakult later diversified into other beverages and food products and also entered the market for cosmetics and pharmaceuticals. As a result of the company’s proactive involvement in overseas business development, it now sells its products in over 30 countries (daily global fermented milk beverage sales volume of 30mn units). The company also boasts a broad sales network consisting of a unique door-to-door sales force of “Yakult Ladies” and general retail stores. Yakult currently generates nearly half of its profits in Asian markets, particularly China and Indonesia. Yakult generates more than 20% of its profits in the Americas including Mexico and Brazil, but growth in the region has stalled in recent years. Sluggish profits in pharmaceuticals mean that Asian markets will remain Yakult’s largest profit driver over the foreseeable future.

Figure 3: Sales by business segment Figure 4: OP by business segment

Others Pharma 5% Others 8% Pharma 2% 9% Japan (Bev) Europe (Bev) 17% 2% Europe (Bev) Japan (Bev) 1% 48%

Asia/Oceania (Bev) 24% Americas (Bev) 23%

Americas Asia/Oceania (Bev) (Bev) 48% 13%

Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse Longer-term strategy and shareholder returns The FY3/21 OP target outlined in the long-term vision “Yakult Vision 2020” is ¥50.0bn (OPM 10%; FY3/17 OP target reduced from ¥43.0bn to ¥36.5bn). The company’s vision statement calls for (1) global value promotion activities for probiotics, Yakult’s mainstay product, (2) R&D capability bolstering for scientifically proven new products, and (3) contribution to people’s health globally through innovation focused on oncology. Yakult’s dividend policy places the utmost priority on maintaining stable dividends. Based on the company’s 1) solid financial base, 2) stable cash flow, and 3) a business model requiring little or no large M&A deals or capital investment, we note significant room for improving shareholder returns. However, given the company’s conservative outlook on financial strategy, we think there is little likelihood of the company stepping up shareholder returns. At present, we anticipate Yakult to merely raise dividends gradually.

Food Industry 47 30 August 2016

Figure 5: Dividend, buyback and dividend payout ratio Figure 6: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) 45.0 Dividend (LHS) 100 10 45 0 40.0 90 40 Buyback (LHS) -10 35.0 80 35 70 -20 30.0 Dividend payout ratio 30 (RHS) 60 -30 25.0 25 50 -40 20.0 20 40 -50 15.0 15 30 -60 10 10.0 20 -70 -80 5 5.0 10 -90 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates Trends in the overseas beverage business We believe beverage business in emerging markets is the largest profit driver for Yakult. Growth in sales volume is still strong across the Americas region. However, room for growth is gradually narrowing due to a steady rise in penetration rates in Mexico. Also, sales in Brazil swung to negative growth in 2015 in tandem with the ongoing macroeconomic deterioration. We believe it will take time for Yakult to revert to a growth trajectory in the region. Under these conditions, investors are likely to look for growth in Asian markets, particularly in China and Indonesia. Both India and Vietnam represent substantial long-term growth prospects, but these markets are still not sufficiently mature.

Figure 7: Sales breakdown at the overseas beverage Figure 8: Sales breakdown of China business by region business by country/region Other Europe Americas 6% 3% Brazil 11% China Guangzhou 38% 38% Other regions 45%

Mexico 19%

Indonesia Shanghai Other Asia Beijing 11% 12% 11% 6%

Source: Credit Suisse assumptions (based on FY3/16 results) Source: Credit Suisse assumptions (based on FY3/16 results)

Food Industry 48 30 August 2016

Figure 9: Penetration rate for Yakult products in key markets versus targeted population (2015 population ratio) 9% 7.7% 8% 7% 6.5% 6% 5% 4.1% 4% 2.7% 3% 2.5% 2.3% 2.0% 2% 1.5% 1.1% 0.9% 1.2% 1% 0.3% 0.2% 0.5% 0%

Source: Company data, Credit Suisse Indonesia is probably the most promising market for Yakult, considering (1) its door-to- door delivery model (using “Yakult Ladies”) accounts for around half of total sales and sales trends remain firm (impervious to consumer sentiment or weather factors), (2) a bolstered production structure following the startup of Plant 2 in 2014, and (3) a strong OTC sales capability stemming from successful employee training. The company, which has no effective rivals in the market, is highly likely to maintain double-digit volume growth in Indonesia in the near term, as long as there is no significant macroeconomic deterioration. As of end-2015, average daily sales volume in Indonesia was 4.34mn bottles, a penetration rate of 2.7% measured against target population. Yakult has set itself a long- term target of 8mn bottles per day and a penetration rate of 5%. Of the 42 urban markets in Indonesia where Yakult’s products are sold, the company has achieved a penetration rate of over 5% in 14 of these markets (as of October 2015) with Jakarta at the top. There are still regions in Indonesia not covered by Yakult. The only action it needs to take going forward is to steadily expand its sales area in line with its local slogan of equating perseverance with strength. We forecast Indonesia to outstrip China in terms of sales volume and emerge as the largest overseas market for Yakult in 2018.

Figure 10: Trends in daily sales volume and the number of Yakult Ladies in Indonesia (mn units/day) (ppl) 7 7,000 Average daily sales volume 6 6,000 Number of Yakult Lady (RHS) 5 5,000 4 4,000 3 3,000 2 2,000 1 1,000 0 0 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 18E

Source: Company data, Credit Suisse assumptions and estimates

Food Industry 49 30 August 2016

China, however, poses issues. After its full-fledged entry into the market around 2005, Yakult registered double-digit growth in sales volume for a while, but growth slowed to the high single-digits for the first time in 2015. We forecast an annual volume growth rate of 8% over the next three years and believe Yakult is unlikely to return to a period of double- digit growth. The five main reasons for our slightly pessimistic outlook compared with guidance are: (1) difficulty in bolstering Yakult’s door-to-door delivery model due to Chinese regulations and wage inflation, (2) stiffer competition in retail store sales (with many comparable products hitting store shelves), (3) expectations for stepped up expansion into the hinterland, as penetration rates are already high in Shanghai and Guangzhou, but for strong momentum to offset slower growth in coastal cities appearing unlikely in the near term, (4) a sustained shift to e-commerce in the food category weighing down offline growth (Yakult is considering entry into e-commerce), and (5) risk of stiffer competition with other health-oriented products amid an overall rise in health awareness. For reference, the combined sales and OP of China Mengniu Dairy (2319 HK), Bright Dairy & Food (600597 CH), and Inner Mongolia Yili Industrial Group (600887 CH) are projected to grow 7.4% and 11.5%, respectively, over the next three years (median Bloomberg estimates). Also, OPM is expected to rise from 6.5% in 2015 to 7.3% in 2018. Taking this into account, we think it may be difficult for Yakult to sustain double-digit topline growth. However, the above may not serve as valid reference for earnings, as that probably hinges on competitive conditions in the future.

Figure 11: Average daily sales volume and ratio of door-to-door delivery in China (mn units/day) (%) Average daily sales volume 7 18% % of door-to-door delivery (RHS) 6 16% 14% 5 12% 4 10% 3 8% 6% 2 4% 1 2% 0 0% 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 18E

Source: Company data, Credit Suisse assumptions and estimates

Figure 12: OPM trends at major Chinese dairy product Figure 13: Sales and OP growth rates at major Chinese companies dairy product companies (bn CNY) (%) (%) (%) Sales YoY growth rate 12 EBIT EBIT margin (RHS) 8% 45 70 EBIT YoY growth rate (RHS) 60 10 6% 40 35 50 8 4% 40 30 6 2% 30 25 4 0% 20 20 10 2 -2% 15 0 0 -4% 10 -10 -2 -6% 5 -20 0 -30 -4 -8% 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 18E 03 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 18E

Note 1: Combined sales and OP of the three leading Chinese milk Note 1: Combined sales and OP of the three leading Chinese milk beverage makers beverage makers Note 2: Median Bloomberg estimates Note 2: Median Bloomberg estimates Source: Credit Suisse Source: Credit Suisse

Food Industry 50 30 August 2016

Earnings forecasts

Figure 14: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 390,412 6.1 40,057 14.8 50,629 11.0 28,843 15.1 174.5 15.2 17/3 CS E 377,000 -3.4 34,500 -13.9 43,900 -13.3 25,400 -11.9 153.7 -11.9 CoE 389,000 -0.4 36,500 -8.9 46,000 -9.1 28,000 -2.9 169.4 -2.9 IBES E 380,573 -2.5 36,286 -9.4 45,559 -10.0 27,204 -5.7 163.8 -6.1 18/3 CS E 381,000 1.1 35,000 1.4 44,500 1.4 25,700 1.2 155.5 1.2 IBES E 388,747 2.1 39,819 9.7 49,133 7.8 29,624 8.9 178.4 8.9 19/3 CS E 390,000 2.4 37,000 5.7 46,700 4.9 27,200 5.8 164.6 5.8 IBES E 399,505 2.8 42,718 7.3 52,233 6.3 31,782 7.3 191.5 7.4 Source: Company data, I/B/E/S, Credit Suisse estimates We forecast FY3/17 OP of ¥34.5bn (−14% YoY) to fall short of guidance. We forecast 3% YoY growth in domestic beverages due to (1) a boost from price revisions (price of Yakult 400 raised in May), (2) sales growth driven by stepped up marketing outlay for existing products, and (3) weather factors. We also forecast 31% YoY growth in OP due in part to a rebound in one-off cost increases a year earlier. In the overseas beverage business, we anticipate strong growth in sales volume centered on Asia, but look for a double-digit profit decline due a stronger yen. We forecast a 44% YoY profit decline at the pharmaceutical business. The drop is mainly attributable to our outlook for a 25% sales drop for Yakult’s mainstay anticancer agent “Elplat” driven by the impact of drug price revisions (we anticipate a 16% price cut) and volume decline due to generic alternatives (9% decline). Yakult is working to widen the application of Elplat to pancreatic and gastric cancer treatment, but ongoing competition with generics in Elplat’s main application (colorectal cancer) signals a sustained downtrend in Elplat sales in the medium term. Yakult, which has a diverse generics portfolio, has initiated moves to counter the Elplat sales decline by ramping up sales of generic drugs. We expect this to stem the sales downtrend at the pharmaceutical business in FY3/18 and subsequent years. However, we note that sales decline for the lucrative Elplat is likely to make this task a lot harder.

Figure 15: OP and OPM Figure 16: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 45 12 10 ROIC (rhs) 12 40 OPM (rhs) 10 10 35 8 30 8 8 25 6 6 20 6 15 4 4 4 10 2 5 2 2 0 0

0 0

FY3/3

FY3/11 FY3/12 FY3/02 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/13 FY3/14 FY3/15 FY3/16

FY3/3

FY3/17E FY3/18E FY3/19E

FY3/10 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/02

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Food Industry 51 30 August 2016

Figure 17: Sales and OP forecasts by segment (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales by segment (JPYm) Japan (Bev) 180,469 189,778 188,040 191,849 200,471 197,250 198,959 204,900 206,000 206,700 Americas (Bev) 34,595 37,585 39,039 38,822 49,247 54,643 52,736 43,600 43,100 43,700 Asia/Oceania (Bev) 22,475 25,477 31,953 41,250 60,986 79,176 97,121 90,300 94,100 102,200 Europe (Bev) 9,671 8,608 8,002 7,472 8,632 8,891 8,621 7,700 7,200 7,200 Pharmaceuticals 35,079 38,878 39,373 37,072 35,324 32,560 34,813 30,000 30,300 30,700 Others 14,246 17,197 18,581 17,436 18,042 17,789 20,315 20,000 20,000 20,000 Eliminations -5,857 -11,579 -12,437 -14,711 -22,380 -22,332 -22,156 -19,500 -19,700 -20,500 Total 290,678 305,944 312,552 319,193 350,322 367,980 390,412 377,000 381,000 390,000 OP (JPYm) Japan (Bev) 8,581 11,009 9,863 9,547 9,783 11,622 9,534 12,500 12,500 13,000 Americas (Bev) 7,662 8,298 8,797 8,667 11,454 12,798 12,778 11,300 11,200 11,400 Asia/Oceania (Bev) 4,284 4,101 5,526 9,595 16,753 20,396 26,980 23,000 24,000 26,100 Europe (Bev) 584 570 150 281 -336 -182 618 0 0 0 Pharmaceuticals 10,625 10,243 10,145 8,982 8,550 5,842 5,361 3,000 2,900 2,700 Others 3 -668 627 706 1,326 669 1,406 500 500 500 Eliminations -12,749 -13,154 -14,293 -14,712 -15,504 -16,249 -16,623 -15,800 -16,100 -16,700 Total 18,990 20,401 20,817 23,068 32,026 34,898 40,057 34,500 35,000 37,000 Sales y-y (%) Japan (Bev) 7.0% 5.2% -0.9% 2.0% 4.5% -1.6% 0.9% 3.0% 0.5% 0.3% Americas (Bev) -18.4% 8.6% 3.9% -0.6% 26.9% 11.0% -3.5% -17.3% -1.1% 1.4% Asia/Oceania (Bev) 11.1% 13.4% 25.4% 29.1% 47.8% 29.8% 22.7% -7.0% 4.2% 8.6% Europe (Bev) -25.2% -11.0% -7.0% -6.6% 15.5% 3.0% -3.0% -10.7% -6.5% 0.0% Pharmaceuticals -0.4% 10.8% 1.3% -5.8% -4.7% -7.8% 6.9% -13.8% 1.0% 1.3% Total -1.0% 5.3% 2.2% 2.1% 9.8% 5.0% 6.1% -3.4% 1.1% 2.4% OP y-y (%) Japan (Bev) 110.5% 28.3% -10.4% -3.2% 2.5% 18.8% -18.0% 31.1% 0.0% 4.0% Americas (Bev) -28.6% 8.3% 6.0% -1.5% 32.2% 11.7% -0.2% -11.6% -0.9% 1.8% Asia/Oceania (Bev) 71.1% -4.3% 34.7% 73.6% 74.6% 21.7% 32.3% -14.8% 4.3% 8.7% Europe (Bev) -422.7% -2.4% -73.7% 87.3% -219.6% -45.8% -439.6% - - - Pharmaceuticals -12.3% -3.6% -1.0% -11.5% -4.8% -31.7% -8.2% -44.0% -3.3% -6.9% Total 13.4% 7.4% 2.0% 10.8% 38.8% 9.0% 14.8% -13.9% 1.4% 5.7% OPM (%) Japan (Bev) 4.8% 5.8% 5.2% 5.0% 4.9% 5.9% 4.8% 6.1% 6.1% 6.3% Americas (Bev) 22.1% 22.1% 22.5% 22.3% 23.3% 23.4% 24.2% 25.9% 26.0% 26.1% Asia/Oceania (Bev) 19.1% 16.1% 17.3% 23.3% 27.5% 25.8% 27.8% 25.5% 25.5% 25.5% Europe (Bev) 6.0% 6.6% 1.9% 3.8% -3.9% -2.0% 7.2% 0.0% 0.0% 0.0% Pharmaceuticals 30.3% 26.3% 25.8% 24.2% 24.2% 17.9% 15.4% 10.0% 9.6% 8.8% Total 6.5% 6.7% 6.7% 7.2% 9.1% 9.5% 10.3% 9.2% 9.2% 9.5% Sales breakdown (%) Japan (Bev) 60.9% 59.8% 57.9% 57.5% 53.8% 50.5% 48.2% 51.7% 51.4% 50.4% Americas (Bev) 11.7% 11.8% 12.0% 11.6% 13.2% 14.0% 12.8% 11.0% 10.8% 10.6% Asia/Oceania (Bev) 7.6% 8.0% 9.8% 12.4% 16.4% 20.3% 23.5% 22.8% 23.5% 24.9% Europe (Bev) 3.3% 2.7% 2.5% 2.2% 2.3% 2.3% 2.1% 1.9% 1.8% 1.8% Pharmaceuticals 11.8% 12.2% 12.1% 11.1% 9.5% 8.3% 8.4% 7.6% 7.6% 7.5% Others 4.8% 5.4% 5.7% 5.2% 4.8% 4.6% 4.9% 5.0% 5.0% 4.9% OP breakdown (%) Japan (Bev) 27.0% 32.8% 28.1% 25.3% 20.6% 22.7% 16.8% 24.9% 24.5% 24.2% Americas (Bev) 24.1% 24.7% 25.1% 22.9% 24.1% 25.0% 22.5% 22.5% 21.9% 21.2% Asia/Oceania (Bev) 13.5% 12.2% 15.7% 25.4% 35.2% 39.9% 47.6% 45.7% 47.0% 48.6% Europe (Bev) 1.8% 1.7% 0.4% 0.7% -0.7% -0.4% 1.1% 0.0% 0.0% 0.0% Pharmaceuticals 33.5% 30.5% 28.9% 23.8% 18.0% 11.4% 9.5% 6.0% 5.7% 5.0% Others 0.0% -2.0% 1.8% 1.9% 2.8% 1.3% 2.5% 1.0% 1.0% 0.9% Source: Company data, Credit Suisse estimates

Food Industry 52 30 August 2016

Figure 18: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 85,903 88,837 79,119 90,576 110,081 120,349 121,846 117,705 121,211 122,644 Account receivable 49,280 49,073 52,531 53,169 57,002 55,853 56,285 54,143 55,800 56,270 Inventories 31,102 27,739 31,203 27,434 29,383 31,630 28,055 28,817 28,738 29,457 Other 16,046 17,634 15,042 14,277 15,137 18,380 15,645 15,645 15,645 15,645 Allowance for doubtful accounts -615 -453 -301 -323 -327 -254 -204 -204 -204 -204 Total current assets 181,716 182,830 177,594 185,133 211,276 225,959 221,629 216,106 221,190 223,813 Tangible fixed assets 130,391 133,717 136,962 150,612 184,207 205,595 201,798 203,798 204,798 205,798 Depreciable PP&E 91,894 90,168 88,647 100,510 122,713 154,693 160,032 - - - Land 33,929 34,629 34,002 38,148 37,832 37,670 37,233 - - - Construction in progress 4,568 8,920 14,313 11,954 23,662 13,232 4,533 - - - Intangible fixed assets 4,941 5,911 5,903 6,302 6,089 6,482 5,381 5,381 5,381 5,381 Investments & other assets 72,841 70,369 76,753 96,127 117,997 141,307 148,724 148,724 148,724 148,724 Investment securities 60,739 57,288 65,279 87,512 108,704 131,558 139,992 139,992 139,992 139,992 Other 12,102 13,081 11,474 8,615 9,293 9,749 8,732 8,732 8,732 8,732 Total fixed assets 208,175 209,998 219,619 253,042 308,294 353,384 355,904 357,903 358,903 359,903 Total assets 389,891 392,828 397,213 438,175 519,570 579,344 577,534 574,009 580,093 583,716 (Liabilities) Account payable 21,452 22,167 24,638 24,371 24,991 23,718 24,652 23,354 24,258 24,368 Short-term debt 9,962 7,653 8,629 59,441 35,961 44,856 46,645 23,532 15,190 6,322 Other 31,499 33,355 38,714 37,406 47,970 47,147 40,316 40,316 40,316 40,316 Total current liabilities 62,913 63,175 71,981 121,218 108,922 115,721 111,613 87,202 79,763 71,007 Long-term debt 51,916 49,946 47,796 6,173 74,278 74,834 69,757 66,269 55,003 41,253 Other 26,139 28,735 25,193 23,685 28,337 26,576 30,699 29,164 27,706 26,321 Total fixed liabilities 78,055 78,681 72,989 29,858 102,615 101,410 100,456 95,433 82,709 67,573 Total liabilities 140,969 141,856 144,970 151,077 211,537 217,131 212,069 182,635 162,473 138,580 (Net assets) Capital stock 31,117 31,117 31,117 31,117 31,117 31,117 31,117 31,117 31,117 31,117 Capital surplus 41,229 41,192 41,290 41,507 41,584 41,536 41,534 41,534 41,534 41,534 Retained earnings 187,991 200,996 210,536 223,040 241,617 268,076 290,723 310,835 331,081 352,497 Treasury stock -8,431 -9,050 -8,697 -7,658 -40,549 -40,731 -41,213 -41,213 -41,213 -41,213 Total shareholders' equity 251,907 264,256 274,247 288,006 273,769 299,999 322,162 342,273 362,519 383,935 Valuation and translation adjustments -28,040 -38,369 -45,621 -26,163 1,060 25,014 9,634 9,634 9,634 9,634 Total equity capital 223,867 225,886 228,626 261,843 274,830 325,013 331,796 351,907 372,153 393,569 Minority interests 25,055 25,085 23,616 25,255 33,203 37,199 33,667 39,467 45,467 51,567 Total net assets 248,922 250,971 252,242 287,098 308,033 362,212 365,464 391,374 417,620 445,136 Total liabilities & net assets 389,891 392,828 397,213 438,175 519,570 579,344 577,534 574,009 580,093 583,716

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 226,965 248,922 250,971 252,242 287,098 308,033 362,212 365,464 391,374 417,620 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus 94 -37 98 217 77 -48 -2 0 0 0 Net profits 13,248 13,168 13,291 16,379 22,543 25,056 28,843 25,400 25,700 27,200 Dividends from surplus -4,754 -4,026 -6,501 -8,102 -6,029 -6,284 -8,710 -5,288 -5,454 -5,784 Treasury stock 522 -619 353 1,039 -32,891 -182 -482 0 0 0 Valuation and translation adjustments 7,826 -10,329 -7,252 19,458 27,223 23,954 -15,380 0 0 0 Minority interests 3,738 30 -1,469 1,639 7,948 3,996 -3,532 5,800 6,000 6,100 Other 1,283 3,862 2,751 4,226 2,064 7,687 2,515 -2 0 0 Final balance 248,922 250,971 252,242 287,098 308,033 362,212 365,464 391,374 417,620 445,136 Source: Company data, Credit Suisse estimates

Food Industry 53 30 August 2016

Figure 19: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 290,678 305,944 312,552 319,193 350,322 367,980 390,412 377,000 381,000 390,000 COGS 133,103 138,404 142,521 147,545 156,332 164,990 171,611 167,800 168,800 172,400 Gross profit 157,575 167,540 170,031 171,648 193,990 202,990 218,801 209,200 212,200 217,600 SG&A 138,585 147,139 149,214 148,580 161,964 168,092 178,744 174,700 177,200 180,600 OP 18,990 20,401 20,817 23,068 32,026 34,898 40,057 34,500 35,000 37,000 Interest income and dividend 2,357 2,552 3,091 3,106 3,444 4,003 4,442 4,000 4,000 4,000 Interest expense 807 811 695 720 756 808 914 1,000 1,000 1,000 Equity in net income of affiliates 2,275 2,130 2,529 2,129 2,839 3,305 3,314 3,400 3,500 3,700 Other 1,909 1,516 2,242 1,841 1,982 4,209 3,730 3,000 3,000 3,000 RP 24,724 25,788 27,984 29,424 39,535 45,608 50,629 43,900 44,500 46,700 Extraordinary gains 606 503 2,348 1,420 1,346 600 509 500 500 500 Etrtraordinary losses 3,712 4,888 4,384 2,907 1,424 1,091 1,397 1,000 1,000 1,000 Pretax profit 21,619 21,402 25,948 27,937 39,458 45,117 49,741 43,400 44,000 46,200 Income taxes 5,686 5,267 8,568 8,508 12,387 14,591 15,095 12,200 12,300 12,900 Minority interests 2,684 2,966 4,087 3,048 4,526 5,470 5,803 5,800 6,000 6,100 NP 13,248 13,168 13,291 16,379 22,543 25,056 28,843 25,400 25,700 27,200 Tax rate 26.3% 24.6% 33.0% 30.5% 31.4% 32.3% 30.3% 28.1% 28.0% 27.9% Depreciation expense 18,912 19,628 18,337 19,434 20,077 22,793 24,364 24,000 24,000 24,000 Capital expenditure 19,979 23,969 25,007 33,587 50,163 40,370 27,402 26,000 25,000 25,000 R&D expense 9,621 11,480 12,414 10,760 11,165 12,134 12,677 12,000 12,000 12,000 To sales ratio (%) CGS 45.8 45.2 45.6 46.2 44.6 44.8 44.0 44.5 44.3 44.2 Gross profit 54.2 54.8 54.4 53.8 55.4 55.2 56.0 55.5 55.7 55.8 OP 6.5 6.7 6.7 7.2 9.1 9.5 10.3 9.2 9.2 9.5 RP 8.5 8.4 9.0 9.2 11.3 12.4 13.0 11.6 11.7 12.0 Pretax profit 7.4 7.0 8.3 8.8 11.3 12.3 12.7 11.5 11.5 11.8 NP 4.6 4.3 4.3 5.1 6.4 6.8 7.4 6.7 6.7 7.0 YoY (%) Sales revenue -1.0 5.3 2.2 2.1 9.8 5.0 6.1 -3.4 1.1 2.4 Gross profit 1.8 6.3 1.5 1.0 13.0 4.6 7.8 -4.4 1.4 2.5 OP 13.4 7.4 2.0 10.8 38.8 9.0 14.8 -13.9 1.4 5.7 RP -2.5 4.3 8.5 5.1 34.4 15.4 11.0 -13.3 1.4 4.9 Pretax profit 64.5 -1.0 21.2 7.7 41.2 14.3 10.2 -12.7 1.4 5.0 NP 17.0 -0.6 0.9 23.2 37.6 11.1 15.1 -11.9 1.2 5.8 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 13,248 13,168 13,291 16,379 22,543 25,056 28,843 25,400 25,700 27,200 Depreciation(+) 18,912 19,628 18,337 19,434 20,077 22,793 24,364 24,000 24,000 24,000 Account receivable(-) -690 207 -3,458 -638 -3,833 1,149 -432 2,142 -1,657 -470 Inventories(-) 111 3,363 -3,464 3,769 -1,949 -2,247 3,575 -762 79 -720 Account payable(+) -1,393 715 2,471 -267 620 -1,273 934 -1,298 904 111 Equity in earnings of affiliates(-) -2,275 -2,130 -2,529 -2,129 -2,839 -3,305 -3,314 -3,400 -3,500 -3,700 Minority interests(+) 2,684 2,966 4,087 3,048 4,526 5,470 5,803 5,800 6,000 6,100 Other 8,938 3,070 4,709 3,291 9,434 7,764 2,376 0 0 0 Operating cashflow 39,535 40,987 33,444 42,887 48,579 55,407 62,149 51,882 51,526 52,521 (Investing activities) Capital expenditures(-) -15,275 -32,328 -19,187 -21,078 -21,068 -44,181 -20,567 -26,000 -25,000 -25,000 Other -4,695 10,703 -9,108 -22,472 -28,877 -5,885 -16,871 0 0 0 Investing cashflow -19,970 -21,625 -28,295 -43,550 -49,945 -50,066 -37,438 -26,000 -25,000 -25,000 (Financing activities) Debt (+) 5,083 -4,279 -1,174 9,189 44,625 9,451 -3,288 -26,601 -19,608 -22,618 Dividends (-) -4,754 -4,026 -6,501 -8,102 -6,029 -6,284 -8,710 -5,288 -5,454 -5,784 Other -3,072 -4,108 -1,606 -703 -35,091 -4,801 -3,026 0 0 0 Financing cashflow -2,743 -12,413 -9,281 384 3,505 -1,634 -15,024 -31,889 -25,062 -28,402 (Cash & cash equivalents) Increases 16,822 6,949 -4,132 -279 2,139 3,707 9,687 -6,007 1,464 -881 Beginning balance 66,352 85,903 88,837 79,119 90,576 110,081 120,349 121,846 117,705 121,211 Final balance 83,174 92,852 84,705 78,840 92,715 113,788 130,036 115,839 119,169 120,330 Adjustments 2,729 -4,015 -5,586 11,736 17,366 6,561 -8,190 1,866 2,042 2,315 Source: Company data, Credit Suisse estimates

Food Industry 54 30 August 2016

Figure 20: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 288.8 289.4 246.7 152.7 194.0 195.3 198.6 247.8 277.3 315.2 Quick ratio (%) 214.9 218.3 182.9 118.6 153.4 152.3 159.6 197.1 221.9 252.0 Adjusted quick ratio (%) 862.3 1,160.8 916.9 152.4 306.1 268.3 261.2 500.2 798.0 1,939.9 Fixed ratio (%) 93.0 93.0 96.1 96.6 112.2 108.7 107.3 101.7 96.4 91.4 Interest-bearing debt (¥mn) 61,878 57,599 56,425 65,614 110,239 119,690 116,402 89,801 70,193 47,575 Average debt interest rate (%) 1.4 1.4 1.2 1.2 0.9 0.7 0.8 1.0 1.3 1.7 Dependence on debt (%) 15.9 14.7 14.2 15.0 21.2 20.7 20.2 15.6 12.1 8.2 Net debt (¥mn) -24,025 -31,238 -22,694 -24,962 158 -659 -5,444 -27,904 -51,018 -75,070 Equity capital ratio (%) 57.4 57.5 57.6 59.8 52.9 56.1 57.5 61.3 64.2 67.4 D/E ratio (%) 27.6 25.5 24.7 25.1 40.1 36.8 35.1 25.5 18.9 12.1 Long-term debt ratio (%) 83.9 86.7 84.7 9.4 67.4 62.5 59.9 73.8 78.4 86.7 Working capital (¥mn) 118,803 119,655 105,613 63,915 102,354 110,238 110,016 128,904 141,426 152,806 Net interest expense (¥mn) 1,550 1,741 2,396 2,386 2,688 3,195 3,528 3,000 3,000 3,000 Cash plus marketable securities (¥mn) 85,903 88,837 79,119 90,576 110,081 120,349 121,846 117,705 121,211 122,644 Interest coverage ratio (x) 26.45 28.30 34.40 36.35 46.92 48.14 48.69 38.50 39.00 41.00 Financial leverage (x) 1.74 1.74 1.74 1.67 1.89 1.78 1.74 1.63 1.56 1.48 A/R to A/P ratio (%) 229.7 221.4 213.2 218.2 228.1 235.5 228.3 231.8 230.0 230.9 Dividend on equity (%) 2.2 1.8 2.9 3.3 2.2 2.1 2.7 1.5 1.5 1.5 (Profitability) ROE (%) 6.2 5.9 5.8 6.7 8.4 8.4 8.8 7.4 7.1 7.1 ROA (%) 5.1 5.2 5.3 5.5 6.7 6.4 6.9 6.0 6.1 6.4 Inventory turnover ratio (x) 9.3 10.4 10.6 10.9 12.3 12.1 13.1 13.3 13.2 13.4 A/R turnover ratio (x) 5.9 6.2 6.2 6.0 6.4 6.5 7.0 6.8 6.9 7.0 A/P turnover ratio (x) 13.1 14.0 13.4 13.0 14.2 15.1 16.1 15.7 16.0 16.0 Inventory turnover ratio (x) 2.2 2.3 2.3 2.2 2.1 1.9 1.9 1.9 1.9 1.9 Inventory turnover days (days) 39.1 35.1 34.4 33.5 29.6 30.3 27.9 27.5 27.6 27.2 A/R turnover days (days) 61.4 58.7 59.3 60.4 57.4 56.0 52.4 53.5 52.7 52.4 A/P turnover days (days) 27.8 26.0 27.3 28.0 25.7 24.2 22.6 23.2 22.8 22.8 Sales per employee (¥mn) 17.0 17.6 17.2 16.8 17.5 17.3 17.3 16.3 16.4 16.8 OP per employee (¥mn) 1.1 1.2 1.1 1.2 1.6 1.6 1.8 1.5 1.5 1.6 (Per share data) EPS (¥) 77.1 76.6 77.3 95.0 134.4 151.6 174.5 153.7 155.5 164.6 BPS (¥) 1,300 1,313 1,329 1,518 1,662 1,966 2,008 2,129 2,252 2,382 Sales per share (¥) 1,692 1,779 1,818 1,852 2,089 2,226 2,363 2,281 2,305 2,360 Operating cashflow per share (¥) 230.1 238.3 194.6 248.8 289.7 335.2 376.1 313.9 311.8 317.8 DPS (¥) 20.0 22.0 22.0 23.0 24.0 25.0 50.0 32.0 33.0 35.0 Dividend ratio (%) 25.9 28.7 28.5 24.2 17.9 16.5 28.6 20.8 21.2 21.3 (Growth) EPS growth (%) 17.3 -0.7 1.0 22.9 41.5 12.8 15.2 -11.9 1.2 5.8 BPS growth (%) 8.7 1.0 1.2 14.2 9.5 18.3 2.1 6.1 5.8 5.8 Total assets growth (%) 7.7 0.8 1.1 10.3 18.6 11.5 -0.3 -0.6 1.1 0.6 Sustainable growth rate (%) 4.6 4.2 4.2 5.1 6.9 7.0 6.3 5.9 5.6 5.6 (Investment profitability) Capital invested (¥ mn) 301,922 304,567 301,615 291,701 377,445 426,423 432,252 447,340 454,862 461,142 NOPAT (¥ mn) 17,079 18,129 17,139 18,804 25,280 28,696 32,807 29,403 29,899 31,498 ROIC (%) 5.7 6.0 5.7 6.4 6.7 6.7 7.6 6.6 6.6 6.8 WACC (%) 3.7 3.8 3.8 3.8 3.3 3.3 3.4 3.6 3.9 4.1 EVA (¥ mn) 5,775 6,536 5,624 7,837 12,706 14,600 18,124 13,081 12,382 12,732 EVA spread (%) 1.9 2.1 1.9 2.7 3.4 3.4 4.2 2.9 2.7 2.8 (Cashflow) EBITDA (¥mn) 37,902 40,029 39,154 42,502 52,103 58,591 65,321 59,400 59,900 61,900 EBITDA margin (%) 13.0 13.1 12.5 13.3 14.9 15.9 16.7 15.8 15.7 15.9 FCF (¥mn) 19,565 19,362 5,149 -663 -1,366 5,341 24,711 25,882 26,526 27,521 Operating C/F to Investment C/F rate (%) 198.0 189.5 118.2 98.5 97.3 110.7 166.0 199.5 206.1 210.1 (Other) Employees numbers 16,876 17,859 18,563 19,435 20,492 22,036 23,192 23,192 23,192 23,192 Consolidated subsidiaries numbers 68 81 79 79 78 74 74 74 74 74 Equity method affiliates numbers 4 4 4 4 4 4 4 4 4 4 Average shares outstanding (mn) 171.8 172.0 171.9 172.4 167.7 165.3 165.3 165.3 165.3 165.3 End-of-period shares outstanding (mn) 172.2 172.0 172.1 172.5 165.3 165.3 165.3 165.3 165.3 165.3 Source: Company data, Credit Suisse estimates

Food Industry 55

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Meiji Holdings (2269 / 2269 JP) Rating OUTPERFORM* Price (29 Aug 16, ¥) 9,400 INITIATION

Target price (¥) 10,500¹ Chg to TP (%) 11.7 Market cap. (¥ bn) 1,384.00 (US$ 13.52) Probiotics leader poised for stable long-term growth Enterprise value (¥ bn) 1,458.57 Number of shares (mn) 147.23 ■ Initiating coverage: We initiate coverage of Meiji Holdings with an Free float (%) 70.0 OUTPERFORM rating and a ¥10,500 target price (potential return 11.7%). 52-week price range 10,880 - 8,250 Meiji has been the main driver of growth in Japan’s probiotics market over *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. the past several years. The company’s functional yogurt remains popular, ¹Target price is for 12 months. and the fresh and fermented dairy segment generates half of the company’s

Research Analysts profits. Greater selection and focus in the brand portfolio has boosted margins, resulting in higher profitability and capital efficiency for the Masashi Mori 81 3 4550 9695 company as a whole. [email protected] ■ Investment theme: The Japanese yogurt and chocolate markets are expanding amid increasing health consciousness. Meiji Holdings is the largest player in both categories. We expect skillful brand marketing to help Meiji achieve growth in excess of the market. The yogurt market is at risk of escalating competition, but we expect the market to continue growing steadily at around 3% due to: (1) consumer health consciousness, (2) an aging population, and (3) increasing demand for simple breakfast foods. The global yogurt market has grown at an annual rate of around 7% over the past five years. We expect Meiji’s OP to post CAGR of 11% over the next three years. ■ Valuation/risks: Our target price is derived by applying a P/E of roughly 25x to our FY3/17 EPS estimate. While we believe that earnings momentum and the upbeat market environment justify a premium to the sector, the high current valuation means such a premium is unlikely to be attached for now. We therefore use the Japanese food sector average to set our target price. Downside risks: (1) sharp slowing of growth in probiotics yogurt, (2) escalating competition in the yogurt market, and (3) lower demand in the baby formula and sports nutrition businesses.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 1,223.7 1,263.0 1,283.0 1,305.0 12000 400 10000 300 Operating profit (¥ bn) 77.8 89.0 100.0 107.0 8000 200 Recurring profit (¥ bn) 81.8 92.5 103.5 110.5 6000 100 4000 0 Net income (¥ bn) 62.6 61.0 65.0 69.4 EPS (¥) 425.1 414.3 441.5 471.4 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 401.2 451.4 500.3 The price relative chart measures performance against the EPS growth (%) 102.6 -2.5 6.6 6.8 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 21.3 22.7 21.3 19.9 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.0 1.0 1.1 1.1 EV/EBITDA(x) 12.1 11.0 9.8 9.0 Performance over 1M 3M 12M P/B (x) 3.3 3.0 2.7 2.5 Absolute (%) -12.6 -6.1 -4.4 ROE(%) 16.1 14.1 13.5 13.0 Relative (%) -11.9 -1.3 10.8 Net debt/equity (%) 28.4 16.3 5.7 net cash

Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates.

30 August 2016

Valuation and risks Share price valuation Our target price is derived by applying a P/E of roughly 25x to our FY3/17 EPS estimate. While we believe that earnings momentum and the upbeat market environment justify a premium to the sector average, the high current valuation makes this unlikely for now. We therefore use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings, Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 40 12 35 +2σ 34.6 +2σ 11.4 30 +1σ 27.7 10 +1σ 9.5 25 Ave. 20.8 8 20 Ave. 7.6

15 -1σ 13.9 6 -1σ 5.7 10 -2σ 7.0 4 5 -2σ 3.8

0 2 09/4 10/4 11/4 12/4 13/4 14/4 15/4 16/4 09/4 10/4 11/4 12/4 13/4 14/4 15/4 16/4 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Downside risks: (1) sharp slowing of growth in probiotics yogurt, (2) escalating competition in the yogurt market, and (3) lower demand in the baby formula and sports nutrition businesses. In some strong product categories, growth has been slowing recently in the wake of recent sharp growth. Products with high penetration rates are at risk of faster growth deceleration. In the stable-growth yogurt and chocolate markets, competitors are developing products and stepping up marketing, so we assume that margins are at risk of deterioration due to increased competition.

Food Industry 57 30 August 2016

Company profile Probiotics firm drawing the greatest market attention Meiji Holdings was established in April 2009 as a joint holding company for Meiji Seika Kaisha, Ltd., and Meiji Dairies Corporation, Japan’s largest companies in the confectionery and dairy products fields. In April 2011, realignment of the businesses within the Meiji group created the food business (Meiji Co., Ltd.) and the pharmaceuticals business (Meiji Seika Pharma, Co., Ltd.), and this remains the structure now. The core business domains are dairy products, confectionery, nutritionals and functional foods, and pharmaceuticals. Meiji Holdings has been the undisputed driver of growth in Japan’s probiotics market over the past several years. The company’s functional yogurts have been popular for many years, so that the fermented dairy business generates half of its profits. Margins in other food businesses are increasing as well, reflecting success in focusing on sales of products with strong brands. The pharmaceuticals business currently accounts for only around 10% of company-wide profits. The basic strategy is to achieve differentiation in three key areas: anti-infective drugs, drugs for central nervous system (CNS) disorders, and generic drugs.

Figure 3: Sales by business segment Figure 4: OP by business segment

Pharmaceuticals Pharmaceuticals 11% 12% Fresh and Other Fermented 4% Dairy 35% Other Nutritionals 24% 12% Fresh and Fermented Dairy 50%

Confectionery Nutritionals 15% 6% Processed Food Confectionery 13% Processed Food 11% 7% Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse Longer term strategy and shareholder returns Meiji Group 2020 Vision, the long-term business strategy, calls for OP of ¥75bn and ROE of 10% in FY3/21. However, these targets were already met in FY3/16, rendering the plan’s targets effectively meaningless. Consequently, we forego discussion of the plan’s details. We do note that the target dividend payout ratio for shareholder returns is 30%.

Figure 5: Dividend, buyback and dividend payout ratio Figure 6: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Dividend (LHS) Net debt D/E ratio (RHS) (%) 250 80 16.0 Buyback (LHS) 100 90 70 14.0 Dividend payout ratio (RHS) 200 80 12.0 60 70 150 50 10.0 60 8.0 50 100 40 40 30 6.0 50 30 4.0 20 20 0 10 2.0 10 -50 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

Food Industry 58 30 August 2016

Yogurt and chocolate sales growing due to health appeal Japan’s yogurt market: 6% CAGR over the past five years One point of differentiation for Meiji’s yogurt (or fermented dairy) business is its huge library of bacterial strains. Meiji has approximately 5,621 strains of lactobacilli and bifidobacterium (combined total as of March 2016). Although quantitative comparison with competitors is not possible, we believe that Meiji has the highest number of strains in the world. Probiotics, which are used to improve the gut environment and promote general health, have a relatively short history, so there is still little compelling evidence of benefits or efficacy. Probiotics naturally have low recognition in emerging nations, and recognition in industrialized nations is not that high either, but attention is growing. Probiotics are also said to have esthetic effects in addition to health benefits, leading us to still see significant room for growth. According to a survey by Nikkan Keizai Tsushin, Japan’s yogurt market first exceeded ¥300bn in 2002, spurred by media reports on the health benefits of fermented dairy products. Growth subsequently weakened, but the yogurt market resumed growth in 2009 due to the launch of several yogurt drinks. Around 2012, Meiji’s R-1 probiotic yogurt attracted media attention, boosting the growth rate for the overall yogurt market. The market has grown at an annual rate of 6% over the past five years compared with 3% annual growth over 10 years. The yogurt market was worth just under ¥400bn in 2015.

Figure 7: Domestic yogurt market size (sales basis) Figure 8: Company shares in domestic yogurt market (sales basis) (Ybn) (%) 450 100 Others 400 90 Ohayo-milk 350 80 70 Ezaki Glico 300 60 250 Danone 50 200 Yakult 40 150 30 Megmilk 100 20 Snow Brand Morinaga 50 10 Milk 0 0 Meiji HD 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 16E 17E 01 02 03 04 05 06 07 08 09 10 11 12 13 14

Source: Nikkan Keizai Tsushin, Credit Suisse estimates Source: Nikkan Keizai Tsushin, Credit Suisse The largest driver of market growth is yogurt drinks. The main products in this category are Meiji’s R-1, LG21, and PA-3 drinks; Megmilk Snow Brand’s (2270) Megumi series; and Morinaga’s (2264) lactoferrin and Aloe Bene products, which share a beauty theme. More non-dairy companies have entered the market in recent years, creating the risk of greater competition in the future. Meanwhile, products high in calcium and protein, such as Greek yogurt and strained yogurt, are seeing growing sales to older consumers and athletes, so we believe there is considerable room for penetration in the high-price range. Demand for these products is also expanding along with growth in the market for cereal, including granola. Theoretically, this could broaden to the product and consumption scenes, and we believe there is little reason for concern at this point. Japan’s per-capita yogurt consumption volume is higher than in the US and UK, but still lower than yogurt consumption volume in France and Bulgaria. We therefore believe there is still room for growth in consumption volume in Japan. We expect the yogurt market to continue growing at a stable rate of around 3%, underpinned by growing health

Food Industry 59 30 August 2016 consciousness on the part of consumers, the aging of Japan’s population, and growing demand for simple breakfast foods. The global yogurt market has grown in value at an average annual rate of about 7% over the past five years.

Figure 9: Annual per-household consumption expenditure Figure 10: Global annual per-capita yogurt consumption on yogurt in Japan (k JPY/yr) (kg Per Capita) Plain Yoghurt 12 4.0 Fruited Yoghurt Flavoured Yoghurt 3.5 Drinking Yoghurt 10

3.0 Thousands 8 2.5

6 2.0

1.5 4 1.0 2 0.5

0 0.0 00 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15 01 02 03 04 05 06 07 08 09 10 11 12 13 14 15

Source: MIC, Credit Suisse Source: Euromonitor, Credit Suisse

Figure 11: Annual per-capita yogurt consumption by country (2015) (kg Per Capita) 25

Source: Euromonitor, Credit Suisse Chocolate market: 4% CAGR over the past five years Growth in Japan’s chocolate market is coming mainly from health-promoting chocolates. The health and beauty benefits provided by the antioxidant properties of cacao polyphenols, which are contained in chocolate and cocoa, has been gaining broader recognition in recent years. This has put the spotlight on chocolate with a higher percentage of cacao. Some visitors to Japan are even purchasing cacao products as souvenirs or gifts for friends, relatives, and co-workers in their home countries. As the largest participant in the domestic chocolate market, Meiji Holdings is positioned to benefit from such upturns in the external environment. Because Japanese food culture differs from Western Europe's, simple comparison is not possible. However, Japan actually has the lowest per-capital chocolate consumption in monetary value among the industrialized nations. Assuming more products with strong health appeal come onto the market and consumer awareness of this segment continues to increase, we see significant room for market expansion.

Food Industry 60 30 August 2016

Figure 12: Domestic confectionery market size Figure 13: Domestic chocolate market share (based on 2014 sales)

(JPY bn) Chocolate Rice snacks (JPY bn) 550 Snacks Candy 3,350 Other Meiji HD 500 Biscuit Confectionery total (RHS) 3,300 31% 28%

450 3,250

400 3,200

350 3,150

300 3,100

250 3,050 Morinaga 200 3,000 & Co. Lotte 18% 7% Nestle Ezaki 8% Glico 8% Source: All Nippon Kashi Association, Credit Suisse Source: Nikkan Keizai Tsushin, Credit Suisse

Figure 14: Annual per-capita chocolate consumption volume by country (2015) (kg Per Capita) 10 9 8 7 6 5 4 3 2 1 0

Source: Euromonitor, Credit Suisse

Food Industry 61 30 August 2016

Earnings forecasts

Figure 15: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 1,223,746 5.4 77,781 50.9 81,826 52.7 62,580 102.6 425.1 1.3 17/3 CS E 1,263,000 3.2 89,000 14.4 92,500 13.0 61,000 -2.5 414.3 -2.5 CoE 1,251,000 2.2 74,500 -4.2 74,200 -9.3 50,000 -20.1 339.6 -20.1 IBES E 1,258,917 2.9 86,971 11.8 88,739 8.4 58,977 -5.8 399.6 -6.0 18/3 CS E 1,283,000 1.6 100,000 12.4 103,500 11.9 65,000 6.6 441.5 6.6 IBES E 1,291,987 2.6 96,807 11.3 98,632 11.1 66,338 12.5 449.3 12.4 19/3 CS E 1,305,000 1.7 107,000 7.0 110,500 6.8 69,400 6.8 471.4 6.8 IBES E 1,323,313 2.4 106,722 10.2 109,150 10.7 73,146 10.3 497.0 10.6 Source: Company data, I/B/E/S, Credit Suisse estimates We look for FY3/17 OP of ¥89.0bn, above company guidance for ¥74.5bn. We believe the fermented dairy business (mainly probiotic yogurt) will be the largest contributor to sales growth. We look for probiotic yogurt sales to rise 15% YoY and yogurt sales to increase 6%. Also, with the overall market for commercially available cheese growing due to shifting consumer preferences, we expect the company’s sales in this business to rise 6%. We look for upbeat growth in the confectionery business, supported by higher sales of cocoa polyphenol-rich chocolate (up 7%), which has market gained traction amid growing health consciousness. In addition to benefits from higher food business sales, we expect positive contributions form efficiency gains and lower raw materials prices. Over the medium term, we expect three-year OP CAGR of 11%. We look for stable profit growth from FY3/18 onward, with continued growth in the consumption of health-oriented products (e.g., yogurt and chocolate) offsetting negative growth of inbound tourist demand for baby formula.

Figure 16: OP and OP margin Figure 17: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) (%) 120 9 18 ROE 12 8 16 ROIC (rhs) 100 10 7 14 OPM (rhs) 80 6 12 8 5 10 60 6 4 8 40 3 6 4 2 20 4 1 2 2 0 0

0 0

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/17E FY3/18E FY3/19E

FY3/15 FY3/11 FY3/12 FY3/13 FY3/14 FY3/16

FY3/10

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Food Industry 62 30 August 2016

Figure 18: Sales and OP forecasts by segment (¥mn) FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales by segment (JPYm) Food 1,015,265 1,021,806 1,061,398 1,092,000 1,106,000 1,122,000 Fresh and Fermented Dairy 481,400 479,400 511,700 532,000 543,000 557,000 Processed Food 195,200 194,500 191,600 181,000 181,000 180,000 Confectionery 156,500 158,900 160,400 165,000 170,000 173,000 Nutritionals 86,500 85,300 95,700 94,000 92,000 92,000 Other 328,400 340,300 349,300 360,000 360,000 360,000 Elimination -232,900 -236,900 -247,600 -240,000 -240,000 -240,000 Pharmaceuticals 135,105 141,338 164,542 173,000 179,000 185,000 Elimination (intra-company transactions) -2,294 -1,992 -2,194 -2,000 -2,000 -2,000 Total 1,148,076 1,161,152 1,223,746 1,263,000 1,283,000 1,305,000 Sales (y-y,%) Food - 0.6 3.9 2.9 1.3 1.4 Fresh and Fermented Dairy - -0.4 6.7 4.0 2.1 2.6 Processed Food - -0.4 -1.5 -5.5 0.0 -0.6 Confectionery - 1.5 0.9 2.9 3.0 1.8 Nutritionals - -1.4 12.2 -1.8 -2.1 0.0 Other - 3.6 2.6 3.1 0.0 0.0 Elimination - 1.7 4.5 -3.1 0.0 0.0 Pharmaceuticals - 4.6 16.4 5.1 3.5 3.4 Total - 1.1 5.4 3.2 1.6 1.7 OP (JPY m) Food 28,190 41,664 68,289 81,600 89,200 96,700 Fresh and Fermented Dairy 22,600 28,300 41,900 55,400 61,200 67,300 Processed Food 2,200 3,500 6,000 6,500 6,700 7,000 Confectionery 5,600 9,500 12,700 13,000 13,800 14,200 Nutritionals 2,700 4,600 9,700 11,000 11,800 12,500 Other -2,000 400 3,200 3,200 3,400 3,700 Elimination -3,000 -4,700 -5,300 -7,500 -7,700 -8,000 Pharmaceuticals 8,356 10,076 10,118 7,900 11,300 10,800 Elimination (intra-company transactions) -50 -198 -626 -500 -500 -500 Total 36,496 51,543 77,781 89,000 100,000 107,000 OP (y-y,%) Food - 47.8 63.9 19.5 9.3 8.4 Fresh and Fermented Dairy - 25.2 48.1 32.2 10.5 10.0 Processed Food - 59.1 71.4 8.3 3.1 4.5 Confectionery - 69.6 33.7 2.4 6.2 2.9 Nutritionals - 70.4 110.9 13.4 7.3 5.9 Other - -120.0 700.0 0.0 6.3 8.8 Elimination - 56.7 12.8 41.5 2.7 3.9 Pharmaceuticals - 20.6 0.4 -21.9 43.0 -4.4 Total - 41.2 50.9 14.4 12.4 7.0 OPM (%) Food 2.8 4.1 6.4 7.5 8.1 8.6 Fresh and Fermented Dairy 4.7 5.9 8.2 10.4 11.3 12.1 Processed Food 1.1 1.8 3.1 3.6 3.7 3.9 Confectionery 3.6 6.0 7.9 7.9 8.1 8.2 Nutritionals 3.1 5.4 10.1 11.7 12.8 13.6 Other -0.6 0.1 0.9 0.9 0.9 1.0 Pharmaceuticals 6.2 7.1 6.1 4.6 6.3 5.8 Total 3.2 4.4 6.4 7.0 7.8 8.2 Sales breakdown (%) Fresh and Fermented Dairy 34.8 34.2 34.7 35.3 35.6 36.0 Processed Food 14.1 13.9 13.0 12.0 11.9 11.6 Confectionery 11.3 11.3 10.9 11.0 11.1 11.2 Nutritionals 6.3 6.1 6.5 6.2 6.0 5.9 Other 23.7 24.3 23.7 23.9 23.6 23.3 Pharmaceuticals 9.8 10.1 11.2 11.5 11.7 12.0 OP breakdown (%) Fresh and Fermented Dairy 57.1 50.1 50.1 57.1 56.6 58.3 Processed Food 5.6 6.2 7.2 6.7 6.2 6.1 Confectionery 14.2 16.8 15.2 13.4 12.8 12.3 Nutritionals 6.8 8.2 11.6 11.3 10.9 10.8 Other -5.1 0.7 3.8 3.3 3.1 3.2 Pharmaceuticals 21.1 17.9 12.1 8.1 10.4 9.4 Source: Company data, Credit Suisse estimates

Food Industry 63 30 August 2016

Figure 19: Consolidated balance sheet and change in net assets (¥mn) FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 21,759 14,662 16,902 19,577 22,489 31,883 34,292 44,022 55,273 Account receivable 146,377 168,699 175,803 163,135 172,762 181,493 182,809 185,036 187,076 Inventories 105,150 112,012 121,192 121,661 130,049 123,603 130,894 129,264 132,309 Other 28,390 27,158 27,314 24,698 26,718 25,940 25,940 25,940 25,940 Total current assets 301,676 322,531 341,211 329,071 352,018 362,919 373,935 384,261 400,599 Tangible fixed assets 334,869 311,184 312,124 325,644 353,044 349,314 352,314 353,314 354,314 Depreciable PP&E 249,468 236,963 237,970 240,636 269,760 264,955 - - - Land 66,451 65,255 68,655 68,247 71,036 72,837 - - - Construction in progress 18,950 8,966 5,499 16,761 12,248 11,522 - - - Intangible fixed assets 9,726 8,040 7,746 8,167 31,711 29,100 26,489 23,878 21,267 Investments & other assets 70,096 108,228 124,431 116,578 140,593 114,781 114,781 114,781 114,781 Investment securities 34,926 42,212 53,931 60,333 79,171 80,234 80,234 80,234 80,234 Other 35,170 66,016 70,500 56,245 61,422 34,547 34,547 34,547 34,547 Total fixed assets 414,692 427,453 444,302 450,390 525,349 493,196 493,584 491,973 490,362 Total assets 716,368 749,985 785,514 779,461 877,367 856,115 867,519 876,234 890,961 (Liabilities) Account payable 92,157 109,136 109,460 94,327 104,279 104,006 107,483 107,419 109,294 Short-term debt 110,232 150,179 98,523 64,959 88,584 49,831 30,461 26,052 13,013 Other 98,944 93,185 101,781 102,180 105,712 122,859 121,630 117,981 114,442 Total current liabilities 301,333 352,500 309,764 261,466 298,575 276,696 259,574 251,453 236,749 Long-term debt 86,895 59,418 110,773 136,680 135,487 97,997 78,398 47,039 23,519 Other 34,609 39,576 44,366 53,192 63,002 62,269 61,646 58,564 55,636 Total fixed liabilities 121,504 98,994 155,139 189,872 198,489 160,266 140,044 105,603 79,155 Total liabilities 422,838 451,494 464,904 451,339 497,065 436,963 399,618 357,055 315,904 (Net assets) Capital stock 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 30,000 Capital surplus 98,852 98,852 98,851 98,852 98,853 98,502 98,502 98,502 98,502 Retained earnings 172,128 174,494 185,436 198,957 223,166 277,869 325,619 375,897 430,575 Treasury stock -9,255 -9,268 -9,299 -9,451 -9,577 -9,727 -9,727 -9,727 -9,727 Total shareholders' equity 291,725 294,078 304,988 318,358 342,442 396,645 444,394 494,672 549,350 Valuation and translation adjustments -3,942 -2,488 8,394 2,089 27,898 12,229 12,229 12,229 12,229 Total equity capital 287,782 291,590 313,383 320,447 370,340 408,874 456,623 506,901 561,579 Minority interests 5,748 6,901 7,226 7,674 9,961 10,278 11,278 12,278 13,478 Total net assets 293,530 298,491 320,609 328,121 380,302 419,152 467,901 519,179 575,057 Total liabilities & net assets 716,368 749,985 785,514 779,461 877,367 856,115 867,519 876,234 890,961

FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 297,771 293,530 298,491 320,609 328,121 380,302 419,152 467,901 519,179 Capital stock 0 0 0 0 0 0 0 0 0 Capital surplus 0 0 -1 1 1 -351 0 0 0 Net profits 9,552 6,805 16,646 19,060 30,891 62,580 61,000 65,000 69,400 Dividends from surplus -8,910 -5,982 -5,949 -5,979 -5,971 -8,554 -13,250 -14,722 -14,722 Treasury stock -130 -13 -31 -152 -126 -150 0 0 0 Valuation and translation adjustments -4,482 1,454 10,882 -6,305 25,809 -15,669 0 0 0 Minority interests -2,137 1,153 325 448 2,287 317 1,000 1,000 1,200 Other 1,866 1,544 246 439 -710 677 -1 0 0 Final balance 293,530 298,491 320,609 328,121 380,302 419,152 467,901 519,179 575,057 Source: Company data, Credit Suisse estimates

Food Industry 64 30 August 2016

Figure 20: Consolidated profit and loss and cash flow statements (¥mn) FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 1,111,000 1,109,275 1,126,520 1,148,076 1,161,152 1,223,746 1,263,000 1,283,000 1,305,000 COGS 732,931 738,500 743,835 754,013 757,766 778,184 794,000 802,000 810,000 Gross profit 378,068 370,774 382,684 394,062 403,386 445,562 469,000 481,000 495,000 SG&A 348,109 350,585 356,825 357,566 351,842 367,780 380,000 381,000 388,000 OP 29,959 20,189 25,859 36,496 51,543 77,781 89,000 100,000 107,000 Interest income and dividend 894 957 918 987 1,106 2,427 2,500 2,500 2,500 Interest expense 2,209 1,979 1,549 1,288 1,116 983 1,000 1,000 1,000 Other 1,807 2,715 3,903 2,894 2,049 2,601 2,000 2,000 2,000 RP 30,451 21,882 29,131 39,089 53,582 81,826 92,500 103,500 110,500 Extraordinary gains 1,799 685 2,540 1,589 2,821 20,454 5,000 0 0 Etrtraordinary losses 14,325 7,978 6,457 6,991 7,747 7,069 5,000 5,000 5,000 Pretax profit 17,925 14,588 25,214 33,687 48,657 95,210 92,500 98,500 105,500 Income taxes 8,339 7,537 8,367 14,694 17,184 31,606 30,500 32,500 34,900 Minority interests 34 245 200 -67 582 1,023 1,000 1,000 1,200 NP 9,552 6,805 16,646 19,060 30,891 62,580 61,000 65,000 69,400 Tax rate 46.5% 51.7% 33.2% 43.6% 35.3% 33.2% 33.0% 33.0% 33.1% Depreciation expense 41,337 40,871 40,821 40,972 41,885 42,077 43,000 44,000 44,000 Capital expenditure 44,897 39,948 42,063 52,589 98,351 45,513 46,000 45,000 45,000 R&D expense 23,418 23,823 26,199 26,067 26,100 27,300 27,000 27,000 27,000 To sales ratio (%) CGS 66.0 66.6 66.0 65.7 65.3 63.6 62.9 62.5 62.1 Gross profit 34.0 33.4 34.0 34.3 34.7 36.4 37.1 37.5 37.9 OP 2.7 1.8 2.3 3.2 4.4 6.4 7.0 7.8 8.2 Pretax profit 1.6 1.3 2.2 2.9 4.2 7.8 7.3 7.7 8.1 NP 0.9 0.6 1.5 1.7 2.7 5.1 4.8 5.1 5.3 YoY (%) Sales revenue 0.4 -0.2 1.6 1.9 1.1 5.4 3.2 1.6 1.7 Gross profit 1.6 -1.9 3.2 3.0 2.4 10.5 5.3 2.6 2.9 OP 4.1 -32.6 28.1 41.1 41.2 50.9 14.4 12.4 7.0 Pretax profit -25.6 -18.6 72.8 33.6 44.4 95.7 -2.8 6.5 7.1 NP -27.0 -28.8 144.6 14.5 62.1 102.6 -2.5 6.6 6.8 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 9,552 6,805 16,646 19,060 30,891 62,580 61,000 65,000 69,400 Depreciation(+) 41,337 40,871 40,821 40,972 41,885 42,077 43,000 44,000 44,000 Account receivable(-) 8,212 -22,322 -7,104 12,668 -9,627 -8,731 -1,316 -2,226 -2,041 Inventories(-) 6,148 -6,862 -9,180 -469 -8,388 6,446 -7,291 1,631 -3,046 Account payable(+) -3,007 16,979 324 -15,133 9,952 -273 3,477 -64 1,875 Minority interests(+) 34 245 200 -67 582 1,023 1,000 1,000 1,200 Other -4,532 -5,472 8,605 6,529 21,192 2,033 0 0 0 Operating cashflow 57,995 30,597 50,622 63,847 86,487 105,155 99,870 109,340 111,388 (Investing activities) Capital expenditures(-) -36,717 -35,669 -31,011 -42,111 -57,822 -37,726 -46,000 -45,000 -45,000 Other 4,277 -8,645 -8,493 -5,182 -35,000 27,917 0 0 0 Investing cashflow -32,440 -44,314 -39,504 -47,293 -92,822 -9,809 -46,000 -45,000 -45,000 (Financing activities) Debt (+) 58,741 12,470 -301 -7,657 22,432 -76,243 -38,970 -35,767 -36,558 Dividends (-) -8,910 -5,982 -5,949 -5,979 -5,971 -8,554 -13,250 -14,722 -14,722 Other -69,401 -1,627 -3,161 -4,558 -9,615 -274 0 0 0 Financing cashflow -19,570 4,861 -9,411 -18,194 6,846 -85,071 -52,220 -50,490 -51,280 (Cash & cash equivalents) Increases 5,985 -8,856 1,707 -1,640 511 10,275 1,650 13,851 15,108 Beginning balance 16,682 21,759 14,662 16,902 19,577 22,489 31,883 34,292 44,022 Final balance 22,667 12,903 16,369 15,262 20,088 32,764 33,533 48,142 59,130 Adjustments -908 1,759 533 4,315 2,401 -881 759 -4,120 -3,857 Source: Company data, Credit Suisse estimates

Food Industry 65 30 August 2016

Figure 21: Financial indicators FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 100.1 91.5 110.2 125.9 117.9 131.2 144.1 152.8 169.2 Quick ratio (%) 55.8 52.0 62.2 69.9 65.4 77.1 83.6 91.1 102.4 Adjusted quick ratio (%) 19.7 9.8 17.2 30.1 25.4 64.0 112.6 169.0 424.8 Fixed ratio (%) 144.1 146.6 141.8 140.6 141.9 120.6 108.1 97.1 87.3 Interest-bearing debt (¥mn) 197,127 209,597 209,296 201,639 224,071 147,828 108,858 73,091 36,532 Average debt interest rate (%) 1.3 1.0 0.7 0.6 0.5 0.5 0.8 1.1 1.8 Dependence on debt (%) 27.5 27.9 26.6 25.9 25.5 17.3 12.5 8.3 4.1 Net debt (¥mn) 175,368 194,935 192,394 182,062 201,582 115,945 74,567 29,069 -18,741 Equity capital ratio (%) 40.2 38.9 39.9 41.1 42.2 47.8 52.6 57.8 63.0 D/E ratio (%) 68.5 71.9 66.8 62.9 60.5 36.2 23.8 14.4 6.5 Long-term debt ratio (%) 44.1 28.3 52.9 67.8 60.5 66.3 72.0 64.4 64.4 Working capital (¥mn) 343 -29,969 31,447 67,605 53,443 86,223 114,361 132,809 163,850 Net interest expense (¥mn) -1,315 -1,022 -631 -301 -10 1,444 1,500 1,500 1,500 Cash plus marketable securities (¥mn) 21,759 14,662 16,902 19,577 22,489 31,883 34,292 44,022 55,273 Interest coverage ratio (x) 13.97 10.69 17.29 29.10 47.18 81.60 91.50 102.50 109.50 Financial leverage (x) 2.49 2.57 2.51 2.43 2.37 2.09 1.90 1.73 1.59 A/R to A/P ratio (%) 158.8 154.6 160.6 172.9 165.7 174.5 170.1 172.3 171.2 Dividend on equity (%) 3.1 2.1 2.0 1.9 1.7 2.2 3.1 3.1 2.8 (Profitability) ROE (%) 3.3 2.3 5.5 6.0 8.9 16.1 14.1 13.5 13.0 ROA (%) 4.1 2.8 3.4 4.7 6.2 9.0 10.3 11.5 12.1 Inventory turnover ratio (x) 10.3 10.2 9.7 9.5 9.2 9.6 9.9 9.9 10.0 A/R turnover ratio (x) 7.4 7.0 6.5 6.8 6.9 6.9 6.9 7.0 7.0 A/P turnover ratio (x) 11.9 11.0 10.3 11.3 11.7 11.8 11.9 11.9 12.0 Inventory turnover days (days) 35.6 35.7 37.8 38.6 39.6 37.8 36.8 37.0 36.6 A/R turnover days (days) 49.4 51.8 55.8 53.9 52.8 52.8 52.6 52.3 52.0 A/P turnover days (days) 30.8 33.1 35.4 32.4 31.2 31.1 30.6 30.6 30.3 Sales per employee (¥mn) 76.5 73.5 74.7 76.9 73.5 74.1 76.8 78.0 79.3 OP per employee (¥mn) 2.1 1.3 1.7 2.4 3.3 4.7 5.4 6.1 6.5 (Per share data) EPS (¥) 64.8 46.2 113.0 129.4 209.8 425.1 414.3 441.5 471.4 BPS (¥) 1,885 1,910 2,053 2,176 2,515 2,777 3,102 3,443 3,815 Sales per share (¥) 7,538 7,529 7,646 7,794 7,886 8,312 8,579 8,715 8,864 Operating cashflow per share (¥) 393.5 207.7 343.6 433.4 587.3 714.2 678.4 742.7 756.6 DPS (¥) 40.0 40.0 40.0 40.0 50.0 90.0 90.0 100.0 100.0 Dividend ratio (%) 61.7 86.6 35.4 30.9 23.8 21.2 21.7 22.6 21.2 (Growth) EPS growth (%) -27.1 -28.7 144.6 14.5 62.1 102.6 -2.5 6.6 6.8 BPS growth (%) -0.7 1.3 7.5 6.0 15.6 10.4 11.7 11.0 10.8 Total assets growth (%) -1.9 4.7 4.7 -0.8 12.6 -2.4 1.3 1.0 1.7 Sustainable growth rate (%) 1.3 0.3 3.6 4.2 6.8 12.7 11.0 10.4 10.2 (Investment profitability) Capital invested (¥ mn) 409,286 390,584 468,522 510,319 568,829 569,140 596,667 612,504 640,734 NOPAT (¥ mn) 16,988 11,070 19,886 22,208 34,665 53,698 60,995 68,345 72,942 ROIC (%) 4.2 2.8 4.2 4.4 6.1 9.4 10.2 11.2 11.4 WACC (%) 2.9 2.7 2.7 2.7 2.7 3.2 3.5 3.8 4.1 EVA (¥ mn) 5,272 409 7,217 8,177 19,338 35,591 40,083 45,154 46,987 EVA spread (%) 1.3 0.1 1.5 1.6 3.4 6.3 6.7 7.4 7.3 (Cashflow) EBITDA (¥mn) 71,296 61,060 66,680 77,468 93,428 119,858 132,000 144,000 151,000 EBITDA margin (%) 6.4 5.5 5.9 6.7 8.0 9.8 10.5 11.2 11.6 FCF (¥mn) 25,555 -13,717 11,118 16,554 -6,335 95,346 53,870 64,340 66,388 Operating C/F to Investment C/F rate (%) 178.8 69.0 128.1 135.0 93.2 1072.0 217.1 243.0 247.5 (Other) Employees numbers 14,861 15,338 14,819 15,033 16,559 16,456 16,456 16,456 16,456 Consolidated subsidiaries numbers 52 53 54 48 59 59 59 59 59 Average shares outstanding (mn) 147.4 147.3 147.3 147.3 147.2 147.2 147.2 147.2 147.2 End-of-period shares outstanding (mn) 152.7 152.7 152.7 147.3 147.2 147.2 147.2 147.2 147.2 Source: Company data, Credit Suisse estimates

Food Industry 66

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Kikkoman (2801 / 2801 JP) Rating NEUTRAL* Price (29 Aug 16, ¥) 3,350 INITIATION

Target price (¥) 3,400¹ Chg to TP (%) 1.5 Market cap. (¥ bn) 645.96 (US$ 6.31) "Soy Sauce Company" seeks global expansion Enterprise value (¥ bn) 652.83 Number of shares (mn) 192.82 ■ Initiating coverage: We initiate coverage of Kikkoman at NEUTRAL with a Free float (%) 65.0 ¥3,400 target price (potential return 1.5%). The world's largest soy sauce 52-week price range 4,225 - 3,155 manufacturer, Kikkoman is also involved in the wholesale food business *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. centered on Japanese food and in expanding the business globally. As the ¹Target price is for 12 months. domestic market is saturated and local brands are strong in Asia, we think

Research Analysts North America and Europe will be the key growth drivers in Kikkoman's sales. We also expect sales growth in Latin America over the longer term. Masashi Mori 81 3 4550 9695 Asian growth opportunities are also present if customers upgrade to high- [email protected] quality soy sauce. ■ Investment theme: Japanese-style food is becoming increasingly popular worldwide supported by a trend toward healthier lifestyles. Outside of Japan, there were nearly 90,000 Japanese restaurants in 2015, up 60% from 2013. While there is a wide variety of Japanese eateries around the world, if demand for authentic Japanese food increases, the scope for growth in wholesale sales of Japanese food and the company's high-quality soy sauce will likely increase. We look for an OP CAGR of 2% over the next three years and 4% on a forex-neutral basis. ■ Valuation/risks: Our target price is based on a fair P/E of roughly 33x (10- year average) applied to our adjusted FY3/17 EPS estimate. Kikkoman shares look strongly overvalued, but we see little risk that the company's stable growth, which is underpinned by the worldwide Japanese food boom, will eventually collapse. Upside risks: (1) accelerating sales momentum in Asia as consumers trade up to higher value products, (2) rapid growth in soy sauce use across Latin America, and (3) larger-than-expected cost savings in the domestic business. Downside risks: (1) the end of the boom in Japanese cuisine, (2) rapid gains for the yen, and (3) steeper-than-expected increases in raw material prices.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 408.4 393.0 405.0 418.0 6000 180 Operating profit (¥ bn) 32.6 31.0 33.0 34.5 5000 Recurring profit (¥ bn) 31.0 29.5 31.0 32.5 4000 130 Net income (¥ bn) 20.0 24.0 20.2 21.3 3000 EPS (¥) 102.7 124.5 104.8 110.5 2000 80 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 123.4 120.0 130.9 The price relative chart measures performance against the EPS growth (%) 31.3 21.2 -15.8 5.4 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 36.0 26.9 32.0 30.3 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 0.9 1.0 1.0 1.0 EV/EBITDA(x) 16.7 15.0 14.3 13.5 Performance over 1M 3M 12M P/B (x) 3.2 2.7 2.5 2.4 Absolute (%) -8.3 -15.8 -15.2 ROE(%) 8.7 10.3 8.1 8.1 Relative (%) -7.6 -11.0 0.1 Net debt/equity (%) 13.3 2.8 net cash net cash

30 August 2016

Valuation and risks Share price valuation Our target price is based on a fair P/E of roughly 33x (10-year average) applied to our adjusted FY3/17 EPS estimate. We anticipate stable growth in the Japanese food wholesale business and in high-quality soy sauce, supported by the worldwide Japanese food boom. As there is little risk this business model will eventually collapse, we think the current multiple is sustainable even though the stock looks strongly overvalued. However, further upside looks unlikely with the stock currently over one standard deviation above the past 10-year average on an EV/EBITDA basis.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 80 20 +2σ 72.2 70 18 60 +2σ 16.7 16 50 +1σ 52.4 14 40 +1σ 13.4 12 30 Ave. 32.6 10 Ave. 10.1 20 -1σ 12.8 10 8 -1σ 6.9 0 6

-10 -2σ -7.0 4 -2σ 3.6

-20 2 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Upside risks include: (1) accelerating sales momentum in Asia as consumers trade up to higher value products, (2) rapid growth in soy sauce use across Latin America, and (3) larger-than-expected cost savings in the domestic business. Downside risks include: (1) the end of the boom in Japanese cuisine, (2) rapid gains for the yen, and (3) steeper-than- expected increases in raw material prices.

Food Industry 68 30 August 2016

Corporate profile World's largest soy sauce maker Kikkoman is the largest soy sauce manufacturer, both in Japan and abroad. Founded in 1917, the company began exports, chiefly to North America, in the post-war era. Americans enjoyed the flavor of soy sauce when they visited Japan, and the company's conviction that it would also be popular overseas prompted it to develop an overseas business. In 1957, the company moved into the US in earnest starting off with soy sauce sales. Leveraging the special properties of soy sauce, Kikkoman made efforts to popularize soy sauce so that people would grow accustomed to using it with local ingredients and dishes. Consumers gradually became aware of how well soy sauce complemented meat dishes, out of which the idea of teriyaki sauce was born. After North America, the company moved into Europe in 1973. It then developed an Asia business in the 1980s. Today, the company's products are used in over a hundred countries. In overseas markets, in addition to the manufacture and sales of ingredients especially soy sauce, the company is developing a food wholesaling business centered on Japanese food. Because the domestic market is saturated and local brands are strong in Asia, North America and Europe will likely be key markets for driving growth in Kikkoman's sales.

Figure 3: Sales by business segment Figure 4: OP by business segment Asia & Asia & Oceania Oceania 7% 8% Europe Japan 6% 26% Europe 11% Japan 43%

North America 44% North America 55% Note: Excludes holding companies and accounting adjustments Note: Excludes holding companies and accounting adjustments Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse

Longer-term strategy and shareholder returns The company's current medium-term plan calls for OP of ¥36bn (operating margin 8.2%) in FY3/18 (the last year covered by the plan) and ROE of at least 9.0%. Ongoing growth abroad and rising productivity in Japan should support increasing profitability. In the overseas soy sauce business, there is still room for further market penetration in North America and Europe, and we expect stable growth to continue. In shareholder returns, the company has committed to a dividend payout ratio (DPR) of at least 30% and indicated that it plans to take a flexible approach to share buybacks. We think it should be able to achieve this as its finances and cash flow are sound. Given the company's basic strategy of organic growth especially in overseas markets, we see little likelihood of major acquisitions. Instead, Kikkoman will likely use its cash to steadily boost shareholder returns.

Food Industry 69 30 August 2016

Figure 5: Dividend, buyback and dividend payout ratio Figure 6: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) 16.0 Dividend (LHS) 100 80 80 70 14.0 90 70 Buyback (LHS) 60 80 12.0 50 60 Dividend payout ratio 70 40 50 10.0 (RHS) 60 30 40 8.0 50 20 6.0 40 10 30 30 0 4.0 20 20 -10 10 2.0 10 -20 -30 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

Aims to leverage Japanese food boom Backed by the worldwide trend toward healthier lifestyles, there were nearly 90,000 Japanese restaurants outside of Japan in 2015, up 60% from 2013 (Ministry of Agriculture, Forestry and Fisheries estimates). Given our premise that this is not a temporary boom, we think there is still substantial scope for expansion as annual per-capita soy sauce consumption in Europe and the US is low compared with Asia. The company's medium-term targets are sales growth of at least 4% in North America and 10% in Europe. Given current penetration rates and other factors, we think this looks achievable. However, the company is also aiming for at least 10% growth in Asia and Australia, where stiff competition with local products means achievement of the target might not be easy. Strictly speaking, Kikkoman manufactures brewed soy sauce. As chemical soy sauce is the mainstay in China and elsewhere in Asia, Kikkoman does not compete head-to-head in these markets. The number of Japanese restaurants has been increasing worldwide, but there are also many Asian-owned restaurants that serve food similar to Japanese dishes. With this wide variety of Japanese eateries has come a wide range of ingredients and seasonings being used. Looking ahead, we think opportunities for growth in sales of the company's soy sauce might emerge if the number of high-quality Japanese restaurants increases, especially in Asia. In emerging markets, sales are expanding due to pricing that facilitates purchasing in smaller containers. We think the success or failure of these initiatives will be key to market growth in Asia.

Food Industry 70 30 August 2016

Figure 7: Japanese restaurants outside Japan Figure 8: Annual per-capita soy sauce consumption Region 2013 2015 Growth rate (USD per capita) North America 17,000 25,100 48% 12 Latin America 2,900 3,100 7% 10.3 Asia 27,000 45,300 68% 10 Oceania 700 1,850 164% 8 7.0 Europe 5,500 10,550 92% Russia 1,200 1,850 54% 6 Middle East 250 600 140% 4 3.6 Africa 150 300 100% 2.7 2.6 2.4 1.9 1.6 2 1.2 Total 54,700 88,650 62% 0.4 0

Source: MAFF, Credit Suisse Source: EuroMonitor, Credit Suisse

Figure 9: Market structure of Japanese restaurants in Singapore High- Operators Japanese class Food from Japan 5% Seasonings from Japan Price band SGD250–500

Chains, pubs Operators Japanese, locals 45％ Food Locally sourced Seasonings from Japan Price band SGD15–50

Imitation Operators Locals. Chinese, Korean, Thai, etc. restaurants Food Locally sourced Seasonings Locally sourced 50％ Price band SGD5–10 * Buffet-style all-you-can-eat around SGD30

Source: Weekly Diamond Magazine (16 May 2015)

Figure 10: Soy sauce exports from Japan (quantity and yen value)

(liter, mn) (JPY, mn) 30 7,000 Quantity 25 6,000 Value (RHS) 5,000 20 4,000 15 3,000 10 2,000

5 1,000

0 0

Source: Trade Statistics of Japan, Credit Suisse

Food Industry 71 30 August 2016

Earnings forecasts

Figure 11: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 408,372 10.0 32,598 28.5 31,029 27.4 19,964 29.8 102.7 31.3 17/3 CS E 393,000 -3.8 31,000 -4.9 29,500 -4.9 24,000 20.2 124.5 21.2 CoE 403,500 -1.2 31,500 -3.4 29,000 -6.5 24,000 20.2 124.3 21.0 IBES E 402,558 -1.4 32,451 -0.5 30,689 -1.1 23,724 18.8 123.4 20.2 18/3 CS E 405,000 3.1 33,000 6.5 31,000 5.1 20,200 -15.8 104.8 -15.8 IBES E 420,058 4.3 35,474 9.3 33,961 10.7 23,269 -1.9 120.0 -2.7 19/3 CS E 418,000 3.2 34,500 4.5 32,500 4.8 21,300 5.4 110.5 5.4 IBES E 439,401 4.6 38,068 7.3 36,768 8.3 25,244 8.5 130.9 9.1 Source: Company data, I/B/E/S, Credit Suisse estimates

We forecast FY3/17 OP of ¥31bn (−5% YoY, slightly missing the guidance of ¥31.5bn). While topline growth should be firm (especially in overseas business), we see an impact from the stronger yen and rising input costs. We look for OP growth of 2% per year over the next three years (4% on a forex-neutral basis). We think medium-term profit growth of 7% per year looks possible in the domestic business, despite the small scope for growth. Our reasoning includes: (1) the company will expand its range of differentiated products such as soy sauce sold in hermetically sealed containers; (2) we expect sustained growth in sales of soy milk, for which the company has the lion's share of this market, buoyed by the trend toward healthier lifestyles; and (3) efforts to boost margins through logistics efficiency gains and labor productivity growth. Overseas, while the stronger yen seems likely to have an impact, we think sales will continue to grow steadily. We look for 3% medium term profit growth in North America, 6% in Europe, and 3% in Asia & Oceania.

Figure 12: OP and OPM Figure 13: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 40 9 12 ROIC (rhs) 9 35 8 OPM (rhs) 8 10 30 7 7 25 6 8 6 5 5 20 6 4 4 15 3 4 3 10 2 2 5 1 2 1 0 0

0 0

FY3/16 FY3/02 FY3/03 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15

FY3/17E FY3/18E FY3/19E

FY3/08 FY3/15 FY3/03 FY3/04 FY3/05 FY3/06 FY3/07 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/16

FY3/02

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Food Industry 72 30 August 2016

Figure 14: Sales and OP forecasts by segment (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales (¥mn) Japan 160,069 159,541 157,011 163,858 170,714 169,714 176,552 179,000 182,000 184,500 North America 98,350 96,001 96,571 104,227 131,490 153,521 176,945 163,000 170,000 178,000 Europe 12,686 12,313 12,982 14,136 19,488 21,882 23,644 23,000 24,000 26,000 Asia & Oceania 13,792 14,426 15,820 16,733 20,339 25,290 29,162 27,800 28,800 29,800 Overseas Others 2,998 3,269 2,968 3,281 3,146 3,160 4,522 3,200 3,200 3,200 Kikkoman (Holding Company) 11,075 11,572 11,724 12,288 13,895 14,209 14,307 14,200 14,500 14,500 Eliminations -13,249 -13,661 -13,838 -14,278 -15,904 -16,435 -16,760 -17,200 -17,500 -18,000 Total 285,721 283,463 283,239 300,245 343,168 371,339 408,372 393,000 405,000 418,000 Sales (YoY,%) Japan 0.7 -0.3 -1.6 4.4 4.2 -0.6 4.0 1.4 1.7 1.4 North America -2.9 -2.4 0.6 7.9 26.2 16.8 15.3 -7.9 4.3 4.7 Europe -5.4 -2.9 5.4 8.9 37.9 12.3 8.1 -2.7 4.3 8.3 Asia & Oceania -1.0 4.6 9.7 5.8 21.6 24.3 15.3 -4.7 3.6 3.5 Total -1.1 -0.8 -0.1 6.0 14.3 8.2 10.0 -3.8 3.1 3.2 OP (¥ mn) Japan 8,450 7,168 5,306 7,030 5,268 3,783 8,083 8,600 9,200 9,600 North America 8,432 8,071 8,054 8,779 11,514 13,761 16,638 15,800 16,900 17,900 Europe 1,567 1,524 1,754 1,790 2,912 3,225 3,304 3,200 3,400 3,700 Asia & Oceania 1,348 1,203 1,423 1,470 1,862 2,128 2,469 2,400 2,500 2,600 Overseas Others 1,174 1,075 960 1,037 1,241 1,429 1,555 1,600 1,600 1,600 Kikkoman (Holding Company) 2,839 3,517 3,595 3,383 5,094 5,270 4,409 3,400 3,500 3,500 Eliminations -2,695 -3,350 -3,330 -3,682 -4,045 -4,226 -3,861 -4,000 -4,100 -4,400 Total 21,115 19,208 17,764 19,808 23,847 25,370 32,598 31,000 33,000 34,500 OP (YoY,%) Japan 73.0 -15.2 -26.0 32.5 -25.1 -28.2 113.7 6.4 7.0 4.3 North America -5.1 -4.3 -0.2 9.0 31.2 19.5 20.9 -5.0 7.0 5.9 Europe -11.5 -2.7 15.1 2.1 62.7 10.7 2.4 -3.1 6.3 8.8 Asia & Oceania 4.7 -10.8 18.3 3.3 26.7 14.3 16.0 -2.8 4.2 4.0 Total 17.7 -9.0 -7.5 11.5 20.4 6.4 28.5 -4.9 6.5 4.5 OPM (%) Japan 5.3 4.5 3.4 4.3 3.1 2.2 4.6 4.8 5.1 5.2 North America 8.6 8.4 8.3 8.4 8.8 9.0 9.4 9.7 9.9 10.1 Europe 12.4 12.4 13.5 12.7 14.9 14.7 14.0 13.9 14.2 14.2 Asia & Oceania 9.8 8.3 9.0 8.8 9.2 8.4 8.5 8.6 8.7 8.7 Total 7.4 6.8 6.3 6.6 6.9 6.8 8.0 7.9 8.1 8.3 Sales breakdown (%) Japan 53.5 53.7 52.9 52.1 47.5 43.8 41.5 43.6 43.1 42.3 North America 32.9 32.3 32.5 33.1 36.6 39.6 41.6 39.7 40.2 40.8 Europe 4.2 4.1 4.4 4.5 5.4 5.6 5.6 5.6 5.7 6.0 Asia & Oceania 4.6 4.9 5.3 5.3 5.7 6.5 6.9 6.8 6.8 6.8 OP breakdown (%) Japan 35.5 31.8 25.2 29.9 18.9 12.8 22.2 24.6 24.8 24.7 North America 35.4 35.8 38.2 37.4 41.3 46.5 45.6 45.1 45.6 46.0 Europe 6.6 6.8 8.3 7.6 10.4 10.9 9.1 9.1 9.2 9.5 Asia & Oceania 5.7 5.3 6.7 6.3 6.7 7.2 6.8 6.9 6.7 6.7 Overseas Others 4.9 4.8 4.6 4.4 4.4 4.8 4.3 4.6 4.3 4.1 Kikkoman (Holding Company) 11.9 15.6 17.0 14.4 18.3 17.8 12.1 9.7 9.4 9.0 Source: Company data, Credit Suisse estimates

Food Industry 73 30 August 2016

Figure 15: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 26,798 30,378 48,072 30,729 28,695 34,838 36,529 37,063 38,203 39,139 Account receivable 41,596 39,029 42,274 45,496 47,370 50,219 52,010 49,190 52,145 52,294 Inventories 32,231 30,983 34,225 37,620 42,432 49,009 48,457 46,899 49,134 49,557 Other 14,654 9,476 9,456 12,957 15,147 16,183 9,783 9,783 9,783 9,783 Allowance for doubtful accounts -689 -421 -223 -205 -422 -500 -485 -485 -485 -485 Total current assets 114,590 109,445 133,804 126,597 133,222 149,749 146,294 142,450 148,780 150,289 Tangible fixed assets 97,955 96,323 99,170 103,693 105,017 104,695 104,951 103,951 102,951 101,951 Depreciable PP&E 74,201 77,063 76,050 78,303 81,392 81,541 80,593 - - - Land 16,059 15,548 19,764 20,039 20,706 21,093 22,312 - - - Construction in progress 7,695 3,712 3,356 5,351 2,919 2,061 2,046 - - - Intangible fixed assets 29,669 27,782 26,879 25,468 23,198 22,404 16,564 16,564 16,564 16,564 Goodwill 27,414 25,189 23,514 21,792 18,392 17,139 11,275 10,164 9,053 7,942 Other 2,255 2,593 3,365 3,676 4,806 5,265 5,289 5,289 5,289 5,289 Investments & other assets 68,959 65,315 71,517 81,879 87,666 101,916 97,860 97,860 97,860 97,860 Investment securities 54,542 51,944 59,536 70,858 75,609 86,483 86,109 86,109 86,109 86,109 Other 17,163 14,843 13,760 11,753 12,795 16,192 12,516 12,516 12,516 12,516 Allowances -2,746 -1,472 -1,779 -732 -738 -759 -765 -765 -765 -765 Total fixed assets 196,584 189,421 197,567 211,041 215,881 229,016 219,376 218,375 217,375 216,375 Total assets 311,175 298,867 331,371 337,639 349,103 378,766 365,671 360,825 366,155 366,664 (Liabilities) Account payable 14,507 14,626 15,474 16,161 18,193 20,766 20,279 19,750 20,626 20,836 Short-term debt 10,110 5,125 26,480 7,395 13,027 7,543 6,922 2,385 1,306 3,281 Other 21,241 21,753 19,160 22,797 24,398 25,270 30,366 30,366 30,366 30,366 Total current liabilities 45,858 41,504 61,114 46,353 55,618 53,579 57,567 52,501 52,298 54,483 Long-term debt 82,093 79,678 87,705 85,694 63,111 61,382 59,358 41,551 33,240 16,620 Other 16,137 15,084 15,198 17,735 19,967 25,373 23,069 23,069 23,069 23,069 Total fixed liabilities 98,230 94,762 102,903 103,429 83,078 86,755 82,427 64,620 56,309 39,689 Total liabilities 144,089 136,266 164,018 149,782 138,696 140,335 139,995 117,121 108,607 94,172 (Net assets) Capital stock 11,599 11,599 11,599 11,599 11,599 11,599 11,599 11,599 11,599 11,599 Capital surplus 21,212 21,210 21,209 21,227 21,377 21,405 13,912 13,912 13,912 13,912 Retained earnings 151,579 156,248 162,149 170,099 178,260 190,440 208,035 225,865 239,509 254,253 Treasury stock -4,066 -5,214 -5,275 -10,352 -10,121 -20,680 -30,833 -30,833 -30,833 -30,833 Total shareholders' equity 180,324 183,843 189,682 192,573 201,115 202,765 202,713 220,543 234,187 248,931 Valuation and translation adjustments -15,046 -23,113 -23,920 -6,085 8,040 33,743 20,970 20,970 20,970 20,970 Total equity capital 165,278 160,730 165,762 186,488 209,155 236,508 223,683 241,513 255,157 269,901 Share warrant 185 179 179 115 36 0 0 0 0 0 Minority interests 1,623 1,690 1,410 1,174 1,203 1,922 1,991 2,191 2,391 2,591 Total net assets 167,086 162,600 167,352 187,856 210,407 238,431 225,675 243,704 257,548 272,492 Total liabilities & net assets 311,175 298,867 331,371 337,639 349,103 378,766 365,671 360,825 366,155 366,664

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 161,817 167,086 162,600 167,352 187,856 210,407 238,431 225,675 243,704 257,548 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus 0 -2 -1 18 150 28 -7,493 0 0 0 Net profits 8,602 7,770 8,983 11,012 12,559 15,382 19,964 24,000 20,200 21,300 Dividends from surplus -3,105 -3,101 -3,082 -3,081 -4,002 -4,008 -4,697 -6,170 -6,556 -6,556 Treasury stock -255 -1,148 -61 -5,077 231 -10,559 -10,153 0 0 0 Valuation and translation adjustments -30 -8,067 -807 17,835 14,125 25,703 -12,773 0 0 0 Minority interests -21 67 -280 -236 29 719 69 200 200 200 Other 78 -5 0 33 -541 759 2,327 -1 0 0 Final balance 167,086 162,600 167,352 187,856 210,407 238,431 225,675 243,704 257,548 272,492 Source: Company data, Credit Suisse estimates

Food Industry 74 30 August 2016

Figure 16: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 285,690 283,463 283,239 300,200 343,168 371,339 408,372 393,000 405,000 418,000 CGS 166,925 168,148 168,670 176,987 204,917 225,379 248,215 238,000 245,000 253,000 Gross profit 118,765 115,315 114,569 123,213 138,251 145,960 160,156 155,000 160,000 165,000 SG&A 97,680 96,107 96,805 103,396 114,404 120,590 127,558 124,000 127,000 130,500 OP 21,084 19,207 17,763 19,816 23,846 25,369 32,598 31,000 33,000 34,500 Interest and dividend income 747 812 721 929 1,024 898 880 1,000 500 500 Interest expense 1,543 1,446 1,505 1,570 1,511 1,137 1,067 1,000 1,000 1,000 Equity in earnings of affiliates 500 19 232 695 1,082 1,075 984 0 0 0 Other -1,652 -1,841 -1,969 -1,161 -1,759 -1,841 -2,366 -1,500 -1,500 -1,500 RP 19,136 16,751 15,242 18,709 22,682 24,364 31,029 29,500 31,000 32,500 Extraordinary gains 412 2,307 1,865 1,891 8,973 3,427 21 200 0 0 Etrtraordinary losses 4,718 5,610 1,676 2,889 9,377 3,969 797 600 500 500 Pretax profit 14,830 13,447 15,431 17,711 22,278 23,823 30,253 29,100 30,500 32,000 Income taxes 6,143 5,593 6,396 6,596 9,711 8,330 10,087 4,900 10,100 10,500 Minority interests 85 83 51 102 5 110 201 200 200 200 NP 8,602 7,770 8,983 11,012 12,559 15,382 19,964 24,000 20,200 21,300 Tax rate 41.4% 41.6% 41.4% 37.2% 43.6% 35.0% 33.3% 16.8%0 33.1%0 32.8%0 Depriciation expense 12,036 12,092 12,607 12,161 12,983 12,901 11,936 12,500 12,000 12,000 Capital expenditure 15,623 14,489 18,014 14,199 17,265 13,087 14,795 11,500 11,000 11,000 R&D expense 3,771 3,530 3,567 3,727 3,564 3,598 3,662 3,500 3,500 3,500 To sales ratio (%) CGS 58.4 59.3 59.6 59.0 59.7 60.7 60.8 60.6 60.5 60.5 Gross profit 41.6 40.7 40.4 41.0 40.3 39.3 39.2 39.4 39.5 39.5 OP 7.4 6.8 6.3 6.6 6.9 6.8 8.0 7.9 8.1 8.3 RP 6.7 5.9 5.4 6.2 6.6 6.6 7.6 7.5 7.7 7.8 Pretax profit 5.2 4.7 5.4 5.9 6.5 6.4 7.4 7.4 7.5 7.7 NP 3.0 2.7 3.2 3.7 3.7 4.1 4.9 6.1 5.0 5.1 YoY (%) Sales revenue -30.8 -0.8 -0.1 6.0 14.3 8.2 10.0 -3.8 3.1 3.2 Gross profit -24.9 -2.9 -0.6 7.5 12.2 5.6 9.7 -3.2 3.2 3.1 OP 3.5 -8.9 -7.5 11.6 20.3 6.4 28.5 -4.9 6.5 4.5 RP 6.5 -12.5 -9.0 22.7 21.2 7.4 27.4 -4.9 5.1 4.8 Pretax profit -11.4 -9.3 14.8 14.8 25.8 6.9 27.0 -3.8 4.8 4.9 NP 213.3 -9.7 15.6 22.6 14.0 22.5 29.8 20.2 -15.8 5.4

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 8,602 7,770 8,983 11,012 12,559 15,382 19,964 24,000 20,200 21,300 Depreciation(+) 12,036 12,092 12,607 12,161 12,983 12,901 11,936 12,500 12,000 12,000 Account receivable(-) -1,072 2,567 -3,245 -3,222 -1,874 -2,849 -1,791 2,820 -2,955 -149 Inventories(-) -3,267 1,248 -3,242 -3,395 -4,812 -6,577 552 1,558 -2,235 -424 Account payable(+) 653 119 848 687 2,032 2,573 -487 -529 876 210 Equity in earnings of affiliates(-) -500 -19 -232 -695 -1,082 -1,075 -984 0 0 0 Minority interests(+) 85 83 51 102 5 110 201 200 200 200 Other 1,466 674 614 8,088 5,856 11,193 8,270 0 0 0 Operating cashflow 18,003 24,534 16,384 24,738 25,667 31,658 37,661 40,549 28,086 33,137 (Investing activities) Capital expenditures(-) -15,111 -13,239 -15,454 -16,684 -14,307 -12,579 -12,192 -11,500 -11,000 -11,000 Other 3,152 5,437 -9,178 986 5,778 7,538 -3,663 0 0 0 Investing cashflow -11,959 -7,802 -24,632 -15,698 -8,529 -5,041 -15,855 -11,500 -11,000 -11,000 (Financing activities) Debt (+) -5,071 -7,400 29,382 -21,096 -16,951 -7,213 -2,645 -22,344 -9,389 -14,645 Dividends (-) -3,105 -3,101 -3,082 -3,081 -4,002 -4,008 -4,697 -6,170 -6,556 -6,556 Other -346 -992 -503 -5,154 -678 -10,345 -10,459 0 0 0 Financing cashflow -8,522 -11,493 25,797 -29,331 -21,631 -21,566 -17,801 -28,514 -15,945 -21,201 (Cash & cash equivalents) Increases -2,478 5,239 17,549 -20,291 -4,493 5,051 4,005 535 1,141 936 Beginning balance 28,985 26,798 30,378 48,072 30,729 28,695 34,838 36,529 37,063 38,203 Final balance 26,507 32,037 47,927 27,781 26,236 33,746 38,843 37,064 38,203 39,139 Adjustments 291 -1,659 145 2,948 2,459 1,092 -2,314 -1 0 0 Source: Company data, Credit Suisse estimates

Food Industry 75 30 August 2016

Figure 17: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 249.9 263.7 218.9 273.1 239.5 279.5 254.1 271.3 284.5 275.8 Quick ratio (%) 149.1 167.2 147.8 164.4 136.8 158.8 153.8 164.3 172.8 167.8 Adjusted quick ratio (%) 265.1 592.7 181.5 415.5 220.3 461.9 527.7 1,553.7 2,924.5 1,192.9 Fixed ratio (%) 118.9 117.9 119.2 113.2 103.2 96.8 98.1 90.4 85.2 80.2 Interest-bearing debt (¥mn) 92,203 84,803 114,185 93,089 76,138 68,925 66,280 43,936 34,547 19,901 Average debt interest rate (%) 1.6 1.6 1.5 1.5 1.8 1.6 1.6 1.8 2.5 3.7 Dependence on debt (%) 29.6 28.4 34.5 27.6 21.8 18.2 18.1 12.2 9.4 5.4 Net debt (¥mn) 65,405 54,425 66,113 62,360 47,443 34,087 29,751 6,873 -3,656 -19,238 Equity capital ratio (%) 53.1 53.8 50.0 55.2 59.9 62.4 61.2 66.9 69.7 73.6 D/E ratio (%) 55.8 52.8 68.9 49.9 36.4 29.1 29.6 18.2 13.5 7.4 Long-term debt ratio (%) 89.0 94.0 76.8 92.1 82.9 89.1 89.6 94.6 96.2 83.5 Working capital (¥mn) 68,732 67,941 72,690 80,244 77,604 96,170 88,727 89,948 96,482 95,806 Net interest expense (¥mn) -796 -634 -784 -641 -487 -239 -187 0 -500 -500 Cash plus marketable securities (¥mn) 26,798 30,378 48,072 30,729 28,695 34,838 36,529 37,063 38,203 39,139 Interest coverage ratio (x) 14.1 13.8 12.3 13.2 16.5 23.1 31.4 32.0 33.5 35.0 Financial leverage (x) 1.9 1.9 2.0 1.8 1.7 1.6 1.6 1.5 1.4 1.4 A/R to A/P ratio (%) 286.7 266.8 273.2 281.5 260.4 242 256 249 253 251 Dividend on equity (%) 1.9 1.9 1.9 1.7 2.0 1.8 2.0 2.7 2.6 2.5 (Profitability) ROE (%) 5.3 4.8 5.5 6.3 6.3 6.9 8.7 10.3 8.1 8.1 ROA (%) 6.8 6.3 5.6 5.9 6.9 7.0 8.8 8.5 9.1 9.4 Inventory turnover ratio (x) 9.3 9.0 8.7 8.4 8.6 8.1 8.4 8.2 8.4 8.5 A/R turnover ratio (x) 7.0 7.0 7.0 6.8 7.4 7.6 8.0 7.8 8.0 8.0 A/P turnover ratio (x) 20.1 19.5 18.8 19.0 20.0 19.1 19.9 19.6 20.1 20.2 Inventory turnover ratio (x) 2.9 2.9 2.9 3.0 3.3 3.5 3.9 3.8 3.9 4.1 Inventory turnover days (days) 39.1 40.7 42.0 43.7 42.6 44.9 43.6 44.3 43.3 43.1 A/R turnover days (days) 52.5 51.9 52.4 53.4 49.4 48.0 45.7 47.0 45.7 45.6 A/P turnover days (days) 18.1 18.8 19.4 19.2 18.3 19.1 18.3 18.6 18.2 18.1 Sales per employee (¥mn) 54.5 53.8 53.5 55.6 61.9 64.4 69.0 66.2 68.3 70.5 OP per employee (¥mn) 4.0 3.6 3.4 3.7 4.3 4.4 5.5 5.2 5.6 5.8 (Per share data) EPS (¥) 41.6 37.7 43.8 54.9 62.8 78.2 102.7 124.5 104.8 110.5 BPS (¥) 800.8 783.6 808.4 933.7 1045.6 1210.8 1160.0 1252.5 1323.3 1399.7 Sales per share (¥) 1383.2 1376.7 1381.0 1495.7 1716.5 1,887.8 2,100.0 2,038.1 2,100.4 2,167.8 Operating cashflow per share (¥) 87.2 119.2 79.9 123.3 128.4 160.9 193.7 210.3 145.7 171.9 DPS (¥) 15.0 15.0 15.0 20.0 20.0 24.0 32.0 32.0 34.0 34.0 Dividend ratio (%) 36.0 39.7 34.2 36.5 31.8 30.7 31.2 25.7 32.5 30.8 (Growth) EPS growth (%) 206.5 -9.4 16.1 25.3 14.5 24.5 31.3 21.2 -15.8 5.4 BPS growth (%) 3.4 -2.1 3.2 15.5 12.0 15.8 -4.2 8.0 5.6 5.8 Total assets growth (%) 0.1 -4.0 10.9 1.9 3.4 8.5 -3.5 -1.3 1.5 0.1 Sustainable growth rate (%) 3.4 2.9 3.6 4.0 4.3 4.8 6.0 7.7 5.5 5.6 (Investment profitability) Capital invested (¥ mn) 263,508 255,492 268,665 289,917 292,233 323,263 306,110 306,132 311,466 309,590 NOPAT (¥ mn) 11,676 10,154 9,383 12,144 13,070 16,000 20,808 24,533 21,069 22,172 ROIC (%) 4.4 4.0 3.5 4.2 4.5 4.9 6.8 8.0 6.8 7.2 WACC (%) 3.6 3.7 3.5 3.7 3.9 4.0 4.0 4.3 4.6 4.8 EVA (¥ mn) 2,075 613 68 1,504 1,603 3,165 8,559 11,222 6,892 7,345 EVA spread (%) 0.8 0.2 0.0 0.5 0.5 1.0 2.8 3.7 2.2 2.4 (Cashflow) EBITDA (¥mn) 33,120 31,299 30,370 31,977 36,829 38,270 44,534 43,500 45,000 46,500 EBITDA margin (%) 11.6 11.0 10.7 10.7 10.7 10.3 10.9 11.1 11.1 11.1 FCF (¥mn) 6,044 16,732 -8,248 9,040 17,138 26,617 21,806 29,049 17,086 22,137 Operating C/F to Investment C/F rate (%) 150.5 314.5 66.5 157.6 300.9 628.0 237.5 352.6 255.3 301.2 (Other) Employees numbers 5,263 5,268 5,316 5,473 5,622 5,912 5,933 5,933 5,933 5,933 Consolidated subsidiaries numbers 43 41 41 43 46 49 51 52 52 52 Equity method affiliates numbers 21 21 21 21 21 19 19 3 3 3 Average shares outstanding (mn) 206.5 205.9 205.1 200.7 199.9 196.7 194.5 192.8 192.8 192.8 End-of-period shares outstanding (mn) 206.4 205.1 205.1 199.7 200.0 195.3 192.8 192.8 192.8 192.8 Source: Company data, Credit Suisse estimates

Food Industry 76

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods

Ajinomoto (2802 / 2802 JP) Rating NEUTRAL* Price (29 Aug 16, ¥) 2,265 INITIATION

Target price (¥) 2,400¹ Chg to TP (%) 6.0 Elite food maker seeks to maximize use of all Market cap. (¥ bn) 1,289.10 (US$ 12.60) Enterprise value (¥ bn) 1,323.06 assets at its disposal Number of shares (mn) 569.14 ■ Initiating coverage: We initiate coverage of Ajinomoto with a NEUTRAL rating Free float (%) 66.4 and target price of ¥2,400 (potential return 6%). In recent years, Ajinomoto has 52-week price range 3,158 - 2,265

*Stock ratings are relative to the coverage universe in each been aggressively optimizing its product portfolio, by lowering the sales analyst's or each team's respective sector. composition of bulk businesses that are vulnerable to swings in material prices ¹Target price is for 12 months. and raising the weighting of more highly differentiated specialty products with stable growth prospects. Leveraging its core world-class amino acid Research Analysts technologies, Ajinomoto is targeting growth in three business domains: foods, Masashi Mori bioscience/fine chemicals, and pharmaceuticals/healthcare. It also has been 81 3 4550 9695 [email protected] focusing on developing markets in emerging countries, especially those for the highly differentiated products of its seasonings business. ■ Investment themes: We see three main sources for future growth at Ajinomoto: (1) expanding sales of its seasonings and processed foods in emerging markets, (2) broadening its product portfolio in developed nations, for example through its recent acquisitions of a coffee business in Japan and a frozen foods business in the US, and (3) strengthening its medical and healthcare-related businesses. Another defining characteristic of Ajinomoto is management’s keen awareness of the importance of shareholder returns, as indicated by its commitment to deliver a total payout to shareholders of at least 50% during its current medium-term plan. We expect Ajinomoto to maintain stable profit growth over the next three years, with its OP increasing at a 4% CAGR (+7% on a fixed forex rate basis). ■ Valuation/risks: We derive our target price by applying a P/E of roughly 25x to our FY3/17 EPS estimate (adjusted for goodwill amortization, etc). We think all conceivable positives are priced in already, thus we apply a share price multiple on par with the food sector average. Upside risks: (1) greater-than-expected margin improvement at the domestic operation; (2) higher sales in Southeast Asia, driven by premiumization; and (3) swifter growth in sales of core products in the Americas (US, Brazil). Downside risks: (1) escalating competition in Japan and Southeast Asia; (2) weaker demand for frozen foods in the US; and (3) a steeper-than-expected rise in input costs.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 1,186.0 1,143.0 1,177.0 1,214.0 4000 180 Operating profit (¥ bn) 91.0 90.0 97.0 102.0 3000 Recurring profit (¥ bn) 94.3 92.5 99.5 104.5 2000 130 Net income (¥ bn) 63.6 51.3 55.4 58.6 1000 EPS (¥) 108.1 88.3 95.3 100.9 0 80 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 99.8 115.1 130.6 The price relative chart measures performance against the EPS growth (%) 37.7 -18.4 8.0 5.8 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 23.5 25.7 23.8 22.5 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.1 1.3 1.4 1.6 EV/EBITDA(x) 10.7 9.8 9.3 9.0 Performance over 1M 3M 12M P/B (x) 2.4 2.1 2.1 2.1 Absolute (%) -14.2 -15.3 -14.3 ROE(%) 9.8 8.2 8.9 9.4 Relative (%) -13.4 -10.5 1.0 Net debt/equity (%) 6.7 5.4 6.1 5.0

30 August 2016

Valuation and risks Share price valuation We derive our target price by applying a P/E of roughly 25x to our FY3/17 EPS estimate (adjusted for goodwill amortization, etc). As Japan’s leading food company, we expect Ajinomoto to continue recording steady growth in earnings (excluding the impact of forex, input price swings and other uncertainties). However, we think Ajinomoto’s share price fully reflects all currently expected positives and do not see any significant improvements in profitability or capital efficiency in the near term. Consequently, we think the Japan food sector (Ajinomoto, Meiji Holdings (2269), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) average multiple represents fair value for Ajinomoto.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 40 14 +2σ 36.7 35 12 +2σ 11.8 30 +1σ 29.4 10 25 +1σ 9.7 Ave. 22.1 20 8 Ave. 7.5 15 -1σ 14.8 6 10 -1σ 5.3 -2σ 7.5 4 5 -2σ 3.2

0 2 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Upside risks include: (1) greater-than-expected margin improvement at the domestic operation; (2) higher sales in Southeast Asia, driven by premiumization; and (3) swifter growth in sales of core products in the Americas (US, Brazil). Downside risks: (1) escalating competition in Japan and Southeast Asia; (2) weaker demand for frozen foods in the US; and (3) a steeper-than-expected rise in input costs. Ajinomoto has been strategically shifting the composition of its product portfolio toward specialty products that are less susceptible to swings in market prices. In FY3/14, such products accounted for 91% of profits, and management is targeting 93% in FY3/17. Among the company’s commodity bulk products, which now account for less than 10% of profits, the core product is feed-use amino acids, which Ajinomoto includes in its animal nutrition business. Commodity products (lysine, threonine, and tryptophan) accounted for 65% of animal nutrition business OP in FY3/16 and the company intends to reduce that figure to 40% by FY3/21. Meanwhile, it plans to expand the profit contribution from such specialty products as AjiPro®-L, which helps improve the nutrition of dairy cows and enhance their milk production. Downside earnings risk would likely increase if (1) deterioration in the industrywide supply-demand balance results in lower prices of commodity products and (2) changes in material prices lead to a contraction of lysine spreads.

Ajinomoto (2802 / 2802 JP) 78 30 August 2016

Figure 3: Lysine spread (between soybean meal and corn prices)

($/ton) Spread (lhs) ($/ton) 350 600 Soybean price (rhs) Corn price (rhs) 300 500

250 400 200 300 150 200 100

50 100

0 0 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16

Source: Bloomberg

Ajinomoto (2802 / 2802 JP) 79 30 August 2016

Company profile Japan’s largest food maker; strengthening lineup of specialty products Ajinomoto traces its roots to the launch of the umami seasoning AJI-NO-MOTO® back in 1909. The company has since grown into Japan's largest food maker (profit basis), with its products sold in more than 130 countries and regions around the world. In recent years, Ajinomoto has been aggressively optimizing its product portfolio, lowering the sales composition of bulk businesses (animal nutrition, umami seasonings for processed food makers, etc.) that are vulnerable to swings in material prices and raising the weighting of more highly differentiated specialty products with stable growth prospects. Targeting stable profit growth through a “pursuit of specialty,” Ajinomoto aims to join the ranks of the world’s leading food companies. Leveraging its world-class amino acid technologies—the company’s main differentiating factor—Ajinomoto is targeting growth in three business domains: foods, bioscience/fine chemicals, and pharmaceuticals/healthcare.

Figure 4: Sales by business segment Figure 5: OP by business segment

Others Others 8% Pharmaceuticals 1% 6% Domestic food Domestic food Pharmaceuticals Bioscience products products 8% products & fine 33% 34% chemicals Bioscience 13% products & fine chemicals 12%

Overseas food Overseas food products products 39% 46% Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse

Adeptly modifying sales and product strategies to fit regional characteristics We see three main sources for future growth at Ajinomoto: (1) expanding sales of its seasonings and processed foods in emerging markets, (2) broadening its product portfolio in advanced nations, for example through recent acquisitions of a coffee business in Japan and a frozen foods business in the US, and (3) strengthening its medical and healthcare-related businesses. In its core Japan food products business, Ajinomoto is aggressively working to create new opportunities in the commercial-use market, a growth category. The company expects this market to expand about 5% in FY16. Diversifying lifestyle and eating habits are contributing to continued growth in the market for prepared takeout foods (replacements for home-cooked meals). With B-to-C products targeted at ordinary consumers basically a saturated market, Ajinomoto seeks to expand its B-to-B-to-C business (sales of functional ingredients for prepared takeout foods, etc.). It also seeks to enhance food quality by improving its nutritional value by increasing protein and amino acid content. The recently acquired coffee business in Japan presents opportunities for creating synergies with operations overseas, in particular in Thailand. Japan’s coffee market, meanwhile, continues to grow at moderate pace. We think revision of the company’s product and sales strategies will open up new market development opportunities. In 2015, Ajinomoto acquired all shares of its coffee products joint venture in Japan with Mondelez International of the US. At the announcement of the acquisition, Ajinomoto said it planned to leverage the two companies’ common strengths in powdered products to expand business into new product and market domains. Japan’s coffee market continues

Ajinomoto (2802 / 2802 JP) 80 30 August 2016 to grow at moderate pace, and we think revision of product and sales strategies will open up new market development opportunities. We also see opportunities for creating synergies with Ajinomoto’s overseas operations, especially in Thailand. Emerging markets will be the biggest driver of future sales growth. However, Ajinomoto must grasp and respond to differing conditions in each country and region. Thailand has been the company’s top priority to date, but the Thai market has already reached the saturation point and future topline annual growth is likely to slow to just 1% on a local- currency basis. However, Indonesia, Vietnam, and the Philippines are in the midst of growth phases that we expect will generate around 10% annual sales growth. In Brazil, macroeconomic conditions are challenging, but Ajinomoto’s Brazil operations are mainly involved in low-price food products, sales of which hold up well in tough economic climates. The success of this product strategy helped Ajinomoto's Brazil operations achieve largely stable sales volumes in 2015. Our medium-term earnings forecasts assume that volume sales in Brazil will continue on a largely flat trend. The North American frozen food business’ product strategy is focusing on Japanese and Asian foods, which combine high sales growth potential with high profit margins. Meanwhile, it is strengthening its sales mix and profit structure by reducing the sales weighting of frozen Mexican foods, which face stiff competition and deliver low profit margins. When the current reconstruction of the product portfolio winds down, the North American frozen food business could achieve 3–5% sales growth over the medium term.

Figure 6: Sales breakdown for domestic food segment Figure 7: Sales breakdown for overseas food segment (FY3/16A) Europe 8% Other Coffee Americas Thailand products 9% 25% 27%

Seasonings & processed USA Indonesia foods 24% 8% 50%

Vietnam Frozen foods 8% Brazil 23% Phillipines 5% Other Asia 9% 4%

Source: Company data (FY3/16A), Credit Suisse Source: Credit Suisse assumptions

Longer-term strategiy, shareholder returns Ajinomoto is targeting OP of ¥150bn in FY3/21 (FY3/17 guidance ¥91bn) and EPS growth of about 10% a year. The company plans to announce a new three-year plan at the start of FY3/18, and management has indicated that, in addition to financial targets, it plans to strengthen nonfinancial targets, such as ESG. We think the company’s financial strategies indicate Ajinomoto’s management is among the food sector's leaders in awareness of the need to balance sales growth with shareholder returns. Management has set a target dividend payout ratio of 30% and says it will flexibly use share buybacks to achieve its goal of a 50% total payout to shareholders. We think an awareness of the need to increase shareholder returns and improve capital efficiency will remain a common trait of Ajinomoto management teams well into the future.

Ajinomoto (2802 / 2802 JP) 81 30 August 2016

Figure 8: Dividend, buyback and dividend payout ratio Figure 9: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) 80.0 Dividend (LHS) 100 120 45 Buyback (LHS) 100 40 70.0 90 Dividend payout ratio (RHS) 80 80 35 60.0 60 70 30 50.0 40 60 25 20 40.0 50 20 40 0 30.0 15 -20 30 20.0 -40 10 20 -60 5 10.0 10 -80 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

Eyeing growth in Japan’s prepared takeout food market According to Japan’s Foodservice Industry Research Institute, the domestic dine-out food services market expanded 2.2% YoY in 2015, to ¥25,182bn. The industry overcame a food contamination incident early in the year and posted relatively steady growth, supported by increases in spending per customer, visitors to Japan, and corporate entertainment spending. Looking ahead, however, we see an uncertain economic outlook that will likely lead to more defensive consumer spending behavior, which makes it difficult to forecast sustained expansion of the dine-out market. On the other hand, the prepared-food retail industry, which includes delicatessens, takeout lunch shops, and other retailers of fast food primarily for takeout, expanded by 5.4% in 2015, to ¥7,138bn. This industry’s growth is being supported by structural changes, such as (1) consumers increasing tendency to curtail spending on dining out in favor of eating at home and (2) the change in Japanese household composition toward more single-person and senior couple households, which together have increased the number of consumers taking advantage of the availability of prepared takeout foods as replacements for home- cooked meals. Elderly consumers in particular have become more aware of the convenience and good taste of these prepared takeout foods, which has broadened the trend toward these items appearing regularly on dining tables in Japanese homes.

Figure 10: Market size in Japan’s dine-out industry Figure 11: Market size in the prepared-food retail industry

(¥ trn) (¥ trn) 30 7

25 6 5 20 4 15 3 10 2

5 1

0 0

Source: Foodservice Industry Research Institute Source: Foodservice Industry Research Institute

Ajinomoto (2802 / 2802 JP) 82 30 August 2016

Ajinomoto sees this trend toward greater consumption of prepared takeout foods as a new growth driver in the commercial-use food products market. It forecasts market for commercial-use food products will expand 5% in 2016. The growth in sales of these prepared takeout foods at convenience stores is particularly conspicuous. Ajinomoto sees the expanding menu of these items and increasing demand for better taste as factors that will support growth in demand for its functional ingredients. Ajinomoto is targeting this B- to-B-to-C business and plans to expand transactions with the central kitchens of large retailers, such as convenience stores. Meanwhile, we still see opportunities for it to grow its B-to-B business if it can take advantage of an elevation in the restaurant industry’s cost-consciousness spurred by rising personnel costs and a severe competitive environment.

Figure 12: Market growth trends for Japan’s dining-out Figure 13: Shares of domestic food expenditures and prepared takeout food industries (%) Dining out (1997=100) Dining out Home-meal replacement 166 50 Dining out and Home-meal replacement 170 158 160 150 151 45.045.244.9 44.6 44.9 145 146 44.1 44.344.1 44.144.0 142 144 141 142 144 45 150 138 42.842.843.042.8 134 135 137 132 41.2 40.7 140 130 40.6 130 118 40 37.7 36.536.6 36.636.836.6 120 35.8 36.0 35.9 35.8 35.4 35.535.435.2 35.535.635.135.3 110 100 35 33.4 98 100 94 93 89 88 87 33.5 100 85 84 84 84 85 84 83 85 90 81 81 79 80 31.8 30 28.4 80 70 27.8

2013 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2014 2015

Source: Foodservice Industry Research Institute Source: Foodservice Industry Research Institute

Ajinomoto (2802 / 2802 JP) 83 30 August 2016

Earnings forecasts

Figure 14: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 1,185,980 17.8 91,045 22.2 94,333 13.9 63,592 36.8 108.1 37.7 17/3 CS E 1,143,000 -3.6 90,000 -1.1 92,500 -1.9 51,300 -19.3 88.3 -18.4 CoE 1,186,000 0.0 91,000 0.0 91,600 -2.9 51,000 -19.8 89.1 -17.6 IBES E 1,147,823 -3.2 93,489 2.7 96,867 2.7 56,541 -11.1 99.8 -7.8 18/3 CS E 1,177,000 3.0 97,000 7.8 99,500 7.6 55,400 8.0 95.3 8.0 IBES E 1,212,428 5.6 103,521 10.7 106,841 10.3 63,646 12.6 115.1 15.4 19/3 CS E 1,214,000 3.1 102,000 5.2 104,500 5.0 58,600 5.8 100.9 5.8 IBES E 1,242,864 2.5 113,839 10.0 116,344 8.9 71,208 11.9 130.6 13.5 Source: Company data, I/B/E/S, Credit Suisse estimates We forecast that Ajinomoto’s FY3/17 OP will total ¥90.0bn, down 1% YoY and slightly below guidance. We also forecast double-digit growth at the core Japan food products segment, which we expect to expand sales of household-use and commercial-use frozen foods and also benefit from expansion of the commercial-use market for functional foods. The international food products segment should sustain sales growth in real terms, on (1) expanding demand for its seasonings and processed foods in Asian markets (Thailand, Vietnam, Indonesia, etc.) as well as in Brazil, and (2) expansion of the US frozen foods market, where the company’s product strategy is focusing on the growth categories of Japanese and Asian foods while reducing the weighting of Mexican and Italian frozen foods, two product categories subject to particularly fierce competition. However, considering the negative impact of forex trends, our FY3/17 OP forecast for the segment is almost 5% lower than the company's. Overall, we forecast Ajinomoto’s OP will rise at a 4% CAGR rate for over the next three years (+7% on a fixed forex rate basis). We forecast Japan food products segment sales will increase at a 3% CAGR and OP at 10% CAGR, as the segment continues to strengthen its lineup of commercial-use foods in growth categories while generating synergies with the coffee business acquired in 2015 (through cooperation with sales divisions in other segments and shared purchasing of raw materials with overseas operations). The international food products segment is (1) strengthening its restaurant sales channels, (2) expanding sales of seasonings, and (3) introducing new categories of processed foods with the aim of delivering tastier foods in overseas markets. The segment’s specific endeavors in each country are tailored to the pace of growth in the country concerned and to its consumers’ tastes and preferences. In Southeast Asian markets such as Myanmar, Ajinomoto is developing new business from scratch while in India, Pakistan and other parts of South Asia it is bolstering its business platform. Our three-year CAGR forecasts (on a local-currency basis) for Ajinomoto’s main overseas markets are as follows: Thailand +1%, Indonesia +11%, Brazil +10%, Vietnam +9%, the Philippines +8%, and the US +3%. We expect life support segment OP to increase at a 2% CAGR as Ajinomoto increases the weight of specialty products at the animal nutrition business. Finally, we project a +4% CAGR for OP at the healthcare segment, which is expanding the market for its amino acids used in pharmaceuticals and food products while investing aggressively in future growth.

Ajinomoto (2802 / 2802 JP) 84 30 August 2016

Figure 15: OP and OP margin Figure 16: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 120 9 12 ROIC (rhs) 9 8 OPM (rhs) 8 100 10 7 8 7 80 6 6 6 5 5 60 4 4 4 40 3 2 3 2 20 0 2 1 -2 1 0 0

-4 0

FY3/12 FY3/13 FY3/02 FY3/03 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/11 FY3/14 FY3/15 FY3/16

FY3/17E FY3/18E FY3/19E

FY3/11 FY3/12 FY3/04 FY3/05 FY3/06 FY3/07 FY3/08 FY3/09 FY3/10 FY3/13 FY3/14 FY3/15 FY3/16

FY3/03

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Ajinomoto (2802 / 2802 JP) 85 30 August 2016

Figure 17: Sales and OP forecasts by segment (¥mn) FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales by segment (JPY, mn) Domestic food products 289,250 291,916 397,069 409,700 422,200 434,600 Overseas food products 329,766 384,102 463,905 433,000 447,000 464,000 Bioscience products & fine chemicals 142,423 149,129 142,415 141,800 144,900 148,700 Pharmaceuticals 74,132 78,388 89,596 95,000 98,000 101,000 Others 115,786 103,095 92,994 63,500 64,900 65,700 Total 951,359 1,006,630 1,185,980 1,143,000 1,177,000 1,214,000 OP by segment (JPY, mn) Domestic food products 25,326 24,059 30,658 35,500 38,400 41,100 Overseas food products 25,186 31,987 41,965 39,700 42,500 44,900 Bioscience products & fine chemicals 4,233 15,777 11,809 11,900 12,400 12,600 Pharmaceuticals 2,081 253 5,609 5,800 6,100 6,300 Others 4,979 2,441 1,002 -2,900 -2,400 -2,900 Total 61,807 74,519 91,045 90,000 97,000 102,000 Sales YoY (%) by segment Domestic food products - 0.9% 36.0% 3.2% 3.1% 2.9% Overseas food products - 16.5% 20.8% -6.7% 3.2% 3.8% Bioscience products & fine chemicals - 4.7% -4.5% -0.4% 2.2% 2.6% Pharmaceuticals - 5.7% 14.3% 6.0% 3.2% 3.1% Others - -11.0% -9.8% -31.7% 2.2% 1.2% Total - 5.8% 17.8% -3.6% 3.0% 3.1% OP YoY (%) by segment Domestic food products - -5.0% 27.4% 15.8% 8.2% 7.0% Overseas food products - 27.0% 31.2% -5.4% 7.1% 5.6% Bioscience products & fine chemicals - 272.7% -25.2% 0.8% 4.2% 1.6% Pharmaceuticals - -87.8% 2117.0% 3.4% 5.2% 3.3% Others - -51.0% -59.0% -389.4% -17.2% 20.8% Total - 20.6% 22.2% -1.1% 7.8% 5.2% OPM (%) by segment Domestic food products 8.8% 8.2% 7.7% 8.7% 9.1% 9.5% Overseas food products 7.6% 8.3% 9.0% 9.2% 9.5% 9.7% Bioscience products & fine chemicals 3.0% 10.6% 8.3% 8.4% 8.6% 8.5% Pharmaceuticals 2.8% 0.3% 6.3% 6.1% 6.2% 6.2% Others 4.3% 2.4% 1.1% -4.6% -3.7% -4.4% Total 6.5% 7.4% 7.7% 7.9% 8.2% 8.4% Sales breakdown (%) Domestic food products 30.4% 29.0% 33.5% 35.8% 35.9% 35.8% Overseas food products 34.7% 38.2% 39.1% 37.9% 38.0% 38.2% Bioscience products & fine chemicals 15.0% 14.8% 12.0% 12.4% 12.3% 12.2% Pharmaceuticals 7.8% 7.8% 7.6% 8.3% 8.3% 8.3% Others 12.2% 10.2% 7.8% 5.6% 5.5% 5.4% OP breakdown (%) Domestic food products 41.0% 32.3% 33.7% 39.4% 39.6% 40.3% Overseas food products 40.7% 42.9% 46.1% 44.1% 43.8% 44.0% Bioscience products & fine chemicals 6.8% 21.2% 13.0% 13.2% 12.8% 12.4% Pharmaceuticals 3.4% 0.3% 6.2% 6.4% 6.3% 6.2% Others 8.1% 3.3% 1.1% -3.2% -2.5% -2.8% Source: Company data, Credit Suisse estimates

Food Industry 86 30 August 2016

Figure 18: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 98,105 142,312 150,327 186,918 132,416 168,294 221,242 191,496 213,756 210,315 Account receivable 196,189 195,465 206,952 197,568 200,115 202,980 181,860 185,447 189,116 193,169 Inventories 146,808 135,310 147,657 159,817 163,527 183,661 180,247 175,360 183,092 184,860 Other 47,889 44,580 38,611 42,863 53,526 54,275 43,161 43,161 43,161 43,161 Allowance for doubtful accounts -1,643 -1,238 -1,173 -1,095 -1,375 -1,291 -1,191 -1,191 -1,191 -1,191 Total current assets 487,351 516,432 542,375 586,074 548,209 607,919 625,319 594,273 627,935 630,314 Tangible fixed assets 411,839 388,050 388,683 351,224 359,370 383,269 386,201 408,201 420,201 432,201 Depreciable PP&E 300,442 270,868 265,944 273,594 294,613 315,867 310,169 - - - Land 98,628 98,167 96,139 51,065 47,068 47,583 53,772 - - - Construction in progress 12,766 19,013 26,598 26,562 17,689 19,819 22,260 - - - Intangible fixed assets 73,634 65,488 59,188 38,691 52,322 120,656 136,011 126,459 116,907 107,355 Goodwill 34,106 29,586 25,080 4,779 19,327 71,396 89,450 82,575 75,700 68,825 Other 39,528 35,901 34,107 33,912 32,994 49,260 46,561 43,884 41,207 38,530 Investments & other assets 109,412 107,447 106,808 115,749 133,263 143,244 115,732 115,732 115,732 115,732 Investment securities 88,917 83,105 84,491 94,357 107,621 125,440 96,133 96,133 96,133 96,133 Other 21,227 25,330 23,106 21,670 25,945 18,103 19,919 19,919 19,919 19,919 Allowances -732 -988 -789 -278 -303 -299 -320 -320 -320 -320 Total fixed assets 594,886 560,986 554,681 505,666 544,956 647,170 637,944 650,392 652,840 655,288 Total assets 1,082,238 1,077,418 1,097,057 1,091,741 1,093,165 1,255,090 1,263,264 1,244,665 1,280,775 1,285,602 (Liabilities) Account payable 99,164 103,420 112,965 108,903 104,711 114,488 90,459 98,760 97,424 101,175 Short-term debt 30,886 21,525 22,196 35,776 36,651 135,868 17,645 4,767 33,221 25,081 Other 98,186 93,396 104,294 110,862 94,167 108,238 124,730 124,730 124,730 124,730 Total current liabilities 228,236 218,341 239,455 255,541 235,529 358,594 232,834 228,257 255,374 250,987 Long-term debt 114,788 109,271 104,837 81,434 104,428 74,146 245,206 220,685 218,479 216,294 Other 96,034 99,515 102,605 63,055 97,700 78,860 88,921 88,921 88,921 88,921 Total fixed liabilities 210,822 208,786 207,442 144,489 202,128 153,006 334,127 309,606 307,400 305,215 Total liabilities 439,058 427,127 446,897 400,030 437,658 511,600 566,962 537,864 562,774 556,201 (Net assets) Capital stock 79,863 79,863 79,863 79,863 79,863 79,863 79,863 79,863 79,863 79,863 Capital surplus 182,719 182,716 162,381 112,757 83,443 53,725 26,031 26,031 26,031 26,031 Retained earnings 394,672 414,189 444,728 482,501 501,945 536,170 582,824 582,824 582,824 582,824 Treasury stock -2,437 -2,514 -2,219 -2,817 -31,085 -4,070 -6,944 -6,944 -6,944 -6,944 Total shareholders' equity 654,817 674,254 684,753 672,304 634,168 665,689 681,775 681,774 681,774 681,774 Valuation and translation adjustments -52,047 -66,063 -79,404 -37,017 -39,218 3,886 -57,529 -57,529 -57,529 -57,529 Total equity capital 602,770 608,193 605,350 635,287 594,951 669,576 624,247 624,245 624,245 624,245 Minority interests 40,409 42,099 44,809 56,423 60,557 73,913 72,056 82,556 93,756 105,156 Total net assets 643,178 650,291 650,159 691,710 655,507 743,489 696,302 706,801 718,001 729,401 Total liabilities & net assets 1,082,238 1,077,418 1,097,057 1,091,741 1,093,165 1,255,090 1,263,264 1,244,665 1,280,775 1,285,602

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Changes in net assets) Beginning balance 618,653 643,178 650,291 650,159 691,710 655,507 743,489 696,302 706,801 718,001 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus -4 -3 -20,335 -49,624 -29,314 -29,718 -27,694 0 0 0 Net profits 16,646 30,400 41,754 48,373 42,159 46,495 63,592 51,300 55,400 58,600 Dividends from surplus -11,753 -13,461 -13,221 -12,830 -15,277 -14,649 -19,675 -17,431 -18,593 -20,917 Treasury stock -59 -77 295 -598 -28,268 27,015 -2,874 0 0 0 Valuation and translation adjustments 12,027 -14,016 -13,341 42,387 -2,201 43,104 -61,415 0 0 0 Minority interests 6,990 1,690 2,710 11,614 4,134 13,356 -1,857 10,500 11,200 11,400 Other 678 2,580 2,006 2,229 -7,436 2,379 2,736 -33,870 -36,807 -37,683 Final balance 643,178 650,291 650,159 691,710 655,507 743,489 696,302 706,801 718,001 729,401 Source: Company data, Credit Suisse estimates

Food Industry 87 30 August 2016

Figure 19: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 1,170,876 1,207,695 1,197,313 1,172,442 951,359 1,006,630 1,185,980 1,143,000 1,177,000 1,214,000 CGS 785,578 804,716 793,524 788,105 635,594 659,509 768,865 738,400 760,300 784,200 Gross profit 385,298 402,978 403,788 384,337 315,765 347,121 417,115 404,600 416,700 429,800 SG&A 321,264 333,604 331,203 313,104 253,957 272,601 326,069 314,600 319,700 327,800 OP 64,034 69,374 72,584 71,232 61,807 74,519 91,045 90,000 97,000 102,000 Interest and dividend income 2,174 2,171 2,821 2,901 3,196 4,020 4,164 4,000 4,000 4,000 Interest expense 3,468 2,440 2,167 1,931 2,032 2,140 2,269 2,000 2,000 2,000 Equity in earnings of affiliates 3,461 2,990 2,401 3,058 3,360 5,177 1,558 1,500 1,500 1,500 Other 1,420 -1,596 280 1,907 2,469 1,232 -165 -1,000 -1,000 -1,000 RP 67,621 70,499 75,919 77,167 68,800 82,808 94,333 92,500 99,500 104,500 Extraordinary gains 3,368 3,220 7,088 49,141 8,621 12,858 45,337 5,000 5,000 5,000 Etrtraordinary losses 26,198 25,275 10,915 25,481 4,860 16,617 39,352 8,000 8,000 8,000 Pretax profit 44,791 48,444 72,091 100,828 72,561 79,049 100,318 89,500 96,500 101,500 Income taxes 22,422 12,568 24,512 45,731 22,972 23,673 27,047 27,700 29,900 31,500 Minority interests 5,721 5,475 5,823 6,722 7,429 8,880 9,678 10,500 11,200 11,400 NP 16,646 30,400 41,754 48,373 42,159 46,495 63,592 51,300 55,400 58,600 Tax rate 50.1% 25.9% 34.0% 45.4% 31.7% 29.9% 27.0% 30.9%0 31.0%0 31.0%0 Depreciation expense 55,382 49,825 43,717 42,463 45,746 43,376 50,920 48,000 48,000 48,000 Capital expenditure 44,117 45,772 56,778 61,605 50,647 50,930 58,867 70,000 60,000 60,000 R&D expense 35,633 36,906 34,836 32,626 31,962 32,200 32,500 29,0000 29,0000 29,0000 To sales ratio (%) CGS 67.1 66.6 66.3 67.2 66.8 65.5 64.8 64.6 64.6 64.6 Gross profit 32.9 33.4 33.7 32.8 33.2 34.5 35.2 35.4 35.4 35.4 OP 5.5 5.7 6.1 6.1 6.5 7.4 7.7 7.9 8.2 8.4 Pretax profit 3.8 4.0 6.0 8.6 7.6 7.9 8.5 7.8 8.2 8.4 NP 1.4 2.5 3.5 4.1 4.4 4.6 5.4 4.5 4.7 4.8 YoY (%) Sales revenue -1.6 3.1 -0.9 -2.1 -18.9 5.8 17.8 -3.6 3.0 3.1 Gross profit 7.9 4.6 0.2 -4.8 -17.8 9.9 20.2 -4.0 3.0 3.1 OP 56.8 8.3 4.6 -1.9 -13.2 20.6 22.2 -1.1 7.8 5.2 RP 160.8 4.3 7.7 1.6 -10.8 20.4 13.9 -1.9 7.6 5.0 Pretax profit 1275.6 8.2 48.8 39.9 -28.0 8.9 26.9 -10.8 7.8 5.2 NP - 82.6 37.3 15.9 -12.8 10.3 36.8 -19.3 8.0 5.8

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 16,646 30,400 41,754 48,373 42,159 46,495 63,592 51,300 55,400 58,600 Depreciation(+) 55,382 49,825 43,717 42,463 45,746 43,376 50,920 48,000 48,000 48,000 Account receivable(-) -6,805 724 -11,487 9,384 -2,547 -2,865 21,120 -3,587 -3,670 -4,053 Inventories(-) 531 11,498 -12,347 -12,160 -3,710 -20,134 3,414 4,887 -7,733 -1,768 Account payable(+) 4,079 4,256 9,545 -4,062 -4,192 9,777 -24,029 8,301 -1,336 3,752 Minority interests(+) 5,721 5,475 5,823 6,722 7,429 8,880 9,678 10,500 11,200 11,400 Other 33,831 13,528 18,708 839 -18,508 28,907 2,082 0 0 0 Operating cashflow 105,924 112,716 93,312 88,501 63,017 109,259 125,219 119,401 101,862 115,931 (Investing activities) Capital expenditures(-) -61,625 -44,122 -49,060 -65,736 -53,255 -48,931 -55,826 -70,000 -60,000 -60,000 Other -1,702 -1,760 7,359 80,937 -10,242 -91,460 2,002 0 0 0 Investing cashflow -63,327 -45,882 -41,701 15,201 -63,497 -140,391 -53,824 -70,000 -60,000 -60,000 (Financing activities) Debt (+) -2,682 -14,878 -3,763 -9,823 23,869 68,935 52,837 -37,398 26,246 -10,324 Dividends (-) -11,753 -13,461 -13,221 -12,830 -15,277 -14,649 -19,675 -17,431 -18,593 -20,917 Other -3,576 2,446 -20,472 -51,766 -63,840 -1,464 -36,450 0 0 0 Financing cashflow -18,011 -25,893 -37,456 -74,419 -55,248 52,822 -3,288 -54,829 7,653 -31,242 (Cash & cash equivalents) Increases 24,586 40,941 14,155 29,283 -55,728 21,690 68,107 -5,428 49,515 24,690 Beginning balance 70,216 98,105 142,312 150,327 186,918 132,416 168,294 221,242 191,496 213,756 Final balance 94,802 139,046 156,467 179,610 131,190 154,106 236,401 215,814 241,011 238,446 Adjustments 3,303 3,266 -6,140 7,308 1,226 14,188 -15,159 -24,318 -27,255 -28,131 Source: Company data, Credit Suisse estimates

Food Industry 88 30 August 2016

Figure 20: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 213.5 236.5 226.5 229.3 232.8 169.5 268.6 260.4 245.9 251.1 Quick ratio (%) 128.9 154.7 149.2 150.5 141.2 103.5 173.1 165.1 157.8 160.8 Adjusted quick ratio (%) 317.6 661.1 677.3 522.5 361.3 123.9 1,253.9 4,016.8 643.4 838.5 Fixed ratio (%) 98.7 92.2 91.6 79.6 91.6 96.7 102.2 104.2 104.6 105.0 Interest-bearing debt (¥mn) 145,674 130,796 127,033 117,210 141,079 210,014 262,851 225,453 251,699 241,375 Average debt interest rate (%) 2.4 1.8 1.7 1.6 1.6 1.2 1.0 0.8 0.8 0.8 Dependence on debt (%) 13.5 12.1 11.6 10.7 12.9 16.7 20.8 18.1 19.7 18.8 Net debt (¥mn) 47,569 -11,516 -23,294 -69,708 8,663 41,720 41,609 33,957 37,943 31,060 Equity capital ratio (%) 55.7 56.4 55.2 58.2 54.4 53.3 49.4 50.2 48.7 48.6 D/E ratio (%) 24.2 21.5 21.0 18.4 23.7 31.4 42.1 36.1 40.3 38.7 Long-term debt ratio (%) 78.8 83.5 82.5 69.5 74.0 35.3 93.3 97.9 86.8 89.6 Working capital (¥mn) 259,115 298,091 302,920 330,533 312,680 249,325 392,485 366,015 372,561 379,328 Net interest expense (¥mn) -1,294 -269 654 970 1,164 1,880 1,895 2,000 2,000 2,000 Cash plus marketable securities (¥mn) 98,105 142,312 150,327 186,918 132,416 168,294 221,242 191,496 213,756 210,315 Interest coverage ratio (x) 19.09 29.32 34.80 38.39 31.99 36.70 41.96 47.00 50.50 53.00 Financial leverage (x) 1.80 1.77 1.81 1.72 1.84 1.87 2.02 1.99 2.05 2.06 A/R to A/P ratio (%) 197.8 189.0 183.2 181.4 191.1 177.3 201.0 187.8 194.1 190.9 Dividend on equity (%) 2.0 2.2 2.2 2.1 2.5 2.3 3.0 2.8 3.0 3.4 (Profitability) ROE (%) 2.8 5.0 6.9 7.8 6.9 7.4 9.8 8.2 8.9 9.4 ROA (%) 6.0 6.4 6.7 6.5 5.7 6.3 7.2 7.2 7.7 7.9 Inventory turnover ratio (x) 8.0 8.6 8.5 7.6 5.9 5.8 6.5 6.4 6.6 6.6 A/R turnover ratio (x) 6.1 6.2 6.0 5.8 4.8 5.0 6.2 6.2 6.3 6.4 A/P turnover ratio (x) 12.1 11.9 11.1 10.6 8.9 9.2 11.6 12.1 12.0 12.2 Inventory turnover days (days) 45.8 42.6 43.1 47.9 62.0 62.9 56.0 56.8 55.6 55.3 A/R turnover days (days) 60.1 59.2 61.3 63.0 76.3 73.1 59.2 58.6 58.1 57.5 A/P turnover days (days) 30.3 30.6 33.0 34.5 41.0 39.7 31.5 30.2 30.4 29.9 Sales per employee (¥mn) 43.3 43.7 42.5 42.1 34.5 34.2 36.7 34.3 35.4 36.5 OP per employee (¥mn) 2.4 2.5 2.6 2.6 2.2 2.5 2.8 2.7 2.9 3.1 (Per share data) EPS (¥) 23.9 43.6 61.3 74.3 68.7 78.5 108.1 88.3 95.3 100.9 BPS (¥) 863.7 871.6 894.6 1004.4 1002.3 1131.4 1074.4 1074.4 1074.4 1074.4 Sales per share (¥) 1677.7 1730.6 1757.1 1802.0 1549.5 1700.4 2016.8 1967.2 2025.7 2089.4 Operating cashflow per share (¥) 151.8 161.5 136.9 136.0 102.6 184.6 212.9 205.5 175.3 199.5 DPS (¥) 16.0 16.0 16.0 18.0 20.0 24.0 28.0 30.0 32.0 36.0 Dividend ratio (%) 67.1 36.7 26.1 24.2 29.1 30.6 25.9 34.0 33.6 35.7 (Growth) EPS growth (%) -262.8 82.6 40.7 21.3 -7.6 14.4 37.7 -18.4 8.0 5.8 BPS growth (%) 3.0 0.9 2.6 12.3 -0.2 12.9 -5.0 0.0 0.0 0.0 Total assets growth (%) 2.3 -0.4 1.8 -0.5 0.1 14.8 0.7 -1.5 2.9 0.4 Sustainable growth rate (%) 0.9 3.2 5.1 5.9 4.9 5.1 7.3 5.4 5.9 6.0 (Investment profitability) Capital invested (¥ mn) 813,592 816,979 812,792 779,776 797,079 822,582 958,374 933,851 931,645 929,460 NOPAT (¥ mn) 34,417 52,408 49,674 41,638 46,223 56,692 67,516 62,491 67,290 70,690 ROIC (%) 4.2 6.4 6.1 5.3 5.8 6.9 7.0 6.7 7.2 7.6 WACC (%) 3.2 3.2 3.2 3.2 3.1 2.9 2.8 2.8 2.8 2.8 EVA (¥ mn) 8,154 26,218 23,568 16,510 21,234 32,587 40,916 35,956 41,392 44,662 EVA spread (%) 1.0 3.2 2.9 2.1 2.7 4.0 4.3 3.9 4.4 4.8 (Cashflow) EBITDA (¥mn) 119,416 119,199 116,301 113,695 107,553 117,895 141,965 138,000 145,000 150,000 EBITDA margin (%) 10.2 9.9 9.7 9.7 11.3 11.7 12.0 12.1 12.3 12.4 FCF (¥mn) 42,597 66,834 51,611 103,702 -480 -31,132 71,395 49,401 41,862 55,931 Operating C/F to Investment C/F rate (%) 167.3 245.7 223.8 -582.2 99.2 77.8 232.6 170.6 169.8 193.2 (Other) Employees numbers 27,215 28,084 28,245 27,518 27,579 31,312 33,295 33,295 33,295 33,295 Consolidated subsidiaries numbers 100 95 93 86 89 99 96 95 95 95 Equity method affiliates numbers 10 10 10 11 12 8 4 5 5 5 Average shares outstanding (mn) 697.9 697.8 681.4 650.6 614.0 592.0 588.1 581.0 581.0 581.0 End-of-period shares outstanding (mn) 697.9 697.8 676.7 632.5 593.6 591.8 581.0 581.0 581.0 581.0 Source: Company data, Credit Suisse estimates

Food Industry 89

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Toyo Suisan (2875 / 2875 JP) Rating NEUTRAL* Price (29 Aug 16, ¥) 4,240 INITIATION

Target price (¥) 4,300¹ Chg to TP (%) 1.4 Aiming to regain former lead in North, Central Market cap. (¥ bn) 433.03 (US$ 4.23) Enterprise value (¥ bn) 316.09 American markets Number of shares (mn) 102.13 Free float (%) 80.0 ■ Initiating coverage: We initiate coverage of Toyo Suisan with a NEUTRAL 52-week price range 4,605 - 3,730 rating and ¥4,300 target price (potential return 1.4%). Toyo Suisan is a major

*Stock ratings are relative to the coverage universe in each Japanese instant noodle maker and the largest such company in the US and analyst's or each team's respective sector. ¹Target price is for 12 months. Mexico. Instant noodles generate nearly 80% of its profits. The company has longer-term plans for full-fledged development of its instant noodle business in Research Analysts emerging markets such as Latin America, India, and Nigeria. Masashi Mori 81 3 4550 9695 ■ Investment themes: We expect the main growth driver to be the company’s [email protected] instant noodle business overseas, especially in the US and Mexico. The stock looks appealing because instant noodles are highly profitable and the company has substantial market shares in North and Central America, where population growth is expected. However, recent growth has been sluggish, due mainly to stiffer competition and the trend toward healthier lifestyles. At present, we see no sign of a full-fledged recovery. That said, the company's earnings base is stable due to firm domestic business. Although Toyo Suisan's finances are solid, the company has not been keen to boost shareholder returns. Market expectations of improvement appear low, but if management changes its attitude, we think investors could respond positively. ■ Valuation/risks: We derive our target price by applying a P/E of around 21.0x (one standard deviation above the mean for the past 10 years) to our FY3/17 EPS forecast. Upside risks: (1) a rapid turnaround in sales in the US and Mexico, (2) renewed growth in the instant noodle market in Japan due to deteriorating consumer confidence, and (3) lower-than-expected prices for key raw materials such as wheat and cooking oil. Downside risks: (1) contraction in the instant noodle market as consumers become more health conscious, (2) deteriorating margins in North America due to intensifying competition in the food retail market, and (3) rapid gains for the yen.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 383.3 391.0 401.0 407.0 6000 160 Operating profit (¥ bn) 28.3 29.5 31.0 32.0 5000 140 Recurring profit (¥ bn) 29.5 30.8 32.5 33.5 4000 120 Net income (¥ bn) 18.4 21.0 21.0 21.7 3000 100 EPS (¥) 179.8 205.6 205.6 212.5 2000 80 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 201.8 203.8 207.7 The price relative chart measures performance against the EPS growth (%) 8.7 14.4 — 3.3 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 22.5 20.6 20.6 20.0 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.5 1.4 1.7 1.7 EV/EBITDA(x) 7.6 7.5 7.1 6.7 Performance over 1M 3M 12M P/B (x) 1.6 1.6 1.5 1.4 Absolute (%) -7.4 -1.3 -4.8 ROE(%) 7.3 8.0 7.6 7.4 Relative (%) -6.7 3.5 10.4 Net debt/equity (%) net cash net cash net cash net cash

Source: Company data, Thomson Reuters, IFIS, Credit Suisse estimates.

30 August 2016

Valuation and risks Share price valuation We base our target price on a fair-value P/E of roughly 21x applied to our FY3/17 EPS estimate. We think investors will continue to tolerate relatively high multiples for stocks in the defensive food sector. However, although Toyo Suisan is likely to generate stable profit growth, we see little prospect of a rapid rise in profits. Also, with consumers worldwide switching to healthier lifestyles, we think the instant noodle category lacks investment appeal at the moment. Our multiple is the 10-year average plus one standard deviation, but this is below the 25x average for the Japanese food sector in light of the above factors.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 9 +2σ 8.4 25 +2σ 25.0 8

7 +1σ 6.9 +1σ 20.8 20 6 Ave. 5.4 Ave. 16.7 5 15 4 -1σ 12.5 -1σ 3.8

10 3 -2σ 8.4 -2σ 2.3 2

5 1 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates Risks Upside risks include: (1) a rapid turnaround in sales in the US and Mexico, (2) renewed growth in the instant noodle market in Japan due to deteriorating consumer confidence, and (3) lower-than-expected prices for key raw materials such as wheat and cooking oil. Downside risks include: (1) contraction in the instant noodle market as consumers become more health conscious, (2) declining margins in North America due to intensifying competition in the food retail market, and (3) rapid gains for the yen.

Food Industry 91

30 August 2016

Corporate profile Major instant noodle maker, strong in North America Toyo Suisan is a major Japanese instant noodle maker. It is the largest such company in the US and Mexico. Instant noodles generate nearly 80% of the company's profits. It also manufactures chilled and frozen food, mainly for the domestic market. The domestic food market seems unlikely to expand further over the longer term due to structural issues. We therefore expect the company’s instant noodle business overseas, especially in the US and Mexico, to be its main growth driver. The business is highly profitable, and the company has substantial market shares in both countries, where populations are expected to increase. However, recent growth has been sluggish, due mainly to stiffer competition and the trend toward healthier lifestyles. The company has longer-term plans for full-fledged development of its instant noodle business in emerging markets such as Latin America, India, and Nigeria.

Figure 3: Sales by business segment Figure 4: OP by business segment

Refrigerated Fishery Foods Other Other Storage Fishery Foods 12% 9% 1% Refrigerated 6% -1% Storage Processed Food 4% 3%

Processed Noodles for Frozen/Chilled Food overseas 5% 20% Foods 13%

Noodles for Frozen/Chilled overseas Foods 42% 18% Noodles for Noodles for domestic domestic 34% 32%

Source: Company data (FY3/16 A), Credit Suisse Source: Company data(FY3/16 A), Credit Suisse Longer-term strategy, shareholder returns The company's current medium-term plan calls for OP in FY3/19 (the last year the plan covers) of ¥30.5bn (OPM 7.1%). The company is aiming for operating cash flow totaling around ¥100.0bn over the next three years. It plans to use over ¥18.0bn for shareholder returns (maintaining a stable dividend and possibly implementing flexible share buybacks), around ¥30.0bn for facilities and equipment replacement, and around ¥54.0bn for investment in growth. We believe the company should have no difficulty meeting these targets. We forecast operating cash flow of ¥106.0bn and a dividend of ¥204. Although Toyo Suisan's finances are solid, the company has not been keen to boost shareholder returns. Market expectations in this regard appear low, but if management changes its attitude, we think investors could respond positively.

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30 August 2016

Figure 5: Dividend, buyback and dividend payout ratio Figure 6: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) Dividend (LHS) 12.0 100 40 60 Buyback (LHS) 90 20 10.0 Dividend payout ratio (RHS) 50 80 0 70 8.0 -20 40 60 -40 30 6.0 50 -60 40 4.0 -80 20 30 -100 20 10 2.0 -120 10 -140 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

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30 August 2016

Instant noodle business overseas Way ahead of all rivals in the US, Mexico Toyo Suisan has the lion's shares of the US and Mexican instant noodle markets (roughly 70% and 90%, respectively). Instant noodles have become established enough in Mexico to be considered a national dish. Incidentally, Maruchan instant noodles are so popular in Mexico that the brand name has come to be used as a verb meaning to do something quickly. Toyo Suisan entered the US market in 1972. The company has steadily expanded its sales channels, beating Nissin Food Products (2897), which entered the market earlier, to gain the lion's share. The Mexican market expanded naturally. Migrant workers from Mexico brought home instant noodles purchased in the US, and their low price and ease of preparation made them increasingly popular. In the mid-1990s, the peso crashed, and whereas some rivals pulled out of the Mexican market, Toyo Suisan continued to ship products from its US plants, which led to a substantial increase in its market presence. Most purchasers in the US are Hispanics or Asians. Instant noodles are also a staple among university students, whose spending on food is limited. They have a presence as a typical "college food". In recent years, however, sales have struggled due to a worsening market and increasingly competitive environment. The focus ahead will be on how far this can be changed via the development of new products, for example, noodles that fit the trend toward healthier lifestyles and noodles with flavors that appeal to Hispanic customers.

Figure 7: US instant noodle market shares (2015) Figure 8: Mexico instant noodle market shares (2015)

Other Other 5% Nongshim 6% Nissin 10% 7% Toyo Suisan Toyo Suisan 67% 88%

Nissin 17%

Source: Company data, Credit Suisse assumptions Source: Company data, Credit Suisse assumptions

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30 August 2016

Figure 9: Sales and OP in overseas noodles segment

(USD mn) OP (USD mn) 160 Sales (RHS) 800 140 700 120 600 100 500 80 400 60 300 40 200 20 100 0 0

Source: Company data, Credit Suisse estimates

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30 August 2016

Earnings forecasts

Figure 10: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 383,276 0.5 28,314 12.9 29,489 10.7 18,363 8.6 179.8 8.7 17/3 CS E 391,000 2.0 29,500 4.2 30,800 4.4 21,000 14.4 205.6 14.4 CoE 395,000 3.1 29,000 2.4 30,000 1.7 20,500 11.6 200.7 11.6 IBES E 389,158 1.5 29,422 3.9 30,613 3.8 20,522 11.8 201.2 11.9 18/3 CS E 401,000 2.6 31,000 5.1 32,500 5.5 21,000 0.0 205.6 0.0 IBES E 396,837 2.0 29,989 1.9 31,212 2.0 20,872 1.7 202.9 0.8 19/3 CS E 407,000 1.5 32,000 3.2 33,500 3.1 21,700 3.3 212.5 3.3 IBES E 404,313 1.9 30,522 1.8 31,762 1.8 21,204 1.6 206.6 1.8 Source: Company data, I/B/E/S, Credit Suisse estimates We forecast FY3/17 OP of ¥29.5bn (+4% YoY, slightly beating guidance). We think lower raw materials prices will be the main growth driver. We look for OP growth of 4% per year over the next three years. We think profit growth of around 5% per year looks possible due to steady growth in sales of core products at the domestic instant noodles and low- temperature food segments as well as higher productivity. At the domestic instant noodles business, we think volume growth in cup noodles and price revisions will largely cancel out higher fixed costs due to new plants openings. We look for instant noodle business overseas to remain broadly flat. We think sales (on a local currency basis) will remain flat in the US, but will grow by 3% in Mexico over the medium term. Business was tough in 2015, due to stiffer competition in the US and adverse forex developments (a weaker peso) in Mexico. However, we think sales will gradually pick up. New products that fit the trend toward healthier lifestyles and appeal to younger consumers will likely drive sales. That said, over the next three years we do not expect sales to reach the same level as the historical high recorded in 2012. We expect higher promotional spending and labor costs, but think profits will gradually start to pick up, supported by lower prices for raw materials such as wheat. However, we think FY3/19 OP will be 20% lower than the historical high of $14bn recorded in FY3/11.

Figure 11: OP and OPM Figure 12: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 35 14 16 ROIC (rhs) 14 30 12 14 OPM (rhs) 12 25 10 12 10 10 20 8 8 8 15 6 6 6 10 4 4 4 5 2 2 2 0 0

0 0

FY3/06 FY3/07 FY3/02 FY3/03 FY3/04 FY3/05 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/17E FY3/18E FY3/19E

FY3/07 FY3/03 FY3/04 FY3/05 FY3/06 FY3/08 FY3/09 FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16

FY3/02

FY3/18E FY3/19E FY3/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

Food Industry 96

30 August 2016

Figure 13: Sales and OP forecasts by segment (¥mn) FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales (¥mn) Fishery Foods 33,355 32,555 32,361 33,455 34,514 33,075 32,000 33,000 33,000 Noodles for overseas 50,191 57,559 70,650 75,422 86,045 77,346 72,000 73,000 73,000 Noodles for domestic 101,755 106,638 116,974 124,780 117,397 123,873 132,000 135,500 138,000 Frozen/Chilled Foods 63,378 63,372 62,069 63,950 66,875 67,971 70,000 71,000 72,000 Processed Food 18,333 17,235 17,746 18,455 18,307 19,782 22,000 23,000 24,000 Refrigerated Storage 12,842 14,821 14,918 15,259 15,575 16,206 17,000 17,500 18,000 Other 26,037 28,783 29,726 40,934 42,608 44,978 46,000 48,000 49,000 Adjustment 17 22 79 -27 -65 41 0 0 0 Total 305,911 320,988 344,527 372,231 381,259 383,276 391,000 401,000 407,000 Sales (YoY,%) Fishery Foods - -2.4 -0.6 3.4 3.2 -4.2 -3.3 3.1 0.0 Noodles for overseas - 14.7 22.7 6.8 14.1 -10.1 -6.9 1.4 0.0 Noodles for domestic - 4.8 9.7 6.7 -5.9 5.5 6.6 2.7 1.8 Frozen/Chilled Foods - 0.0 -2.1 3.0 4.6 1.6 3.0 1.4 1.4 Processed Food - -6.0 3.0 4.0 -0.8 8.1 11.2 4.5 4.3 Refrigerated Storage - 15.4 0.7 2.3 2.1 4.1 4.9 2.9 2.9 Other - 10.5 3.3 37.7 4.1 5.6 2.3 4.3 2.1 Total - 4.9 7.3 8.0 2.4 0.5 2.0 2.6 1.5 OP (¥ mn) Fishery Foods 707 864 49 -160 -769 -171 100 200 300 Noodles for overseas 7,447 8,286 13,162 13,127 12,162 12,142 11,400 11,600 11,600 Noodles for domestic 11,640 10,706 12,022 12,142 9,208 10,011 11,200 12,100 12,800 Frozen/Chilled Foods 4,287 3,607 3,567 3,344 3,535 3,853 4,000 4,200 4,400 Processed Food 543 578 -85 206 488 883 800 700 700 Refrigerated Storage 550 1,152 1,146 1,224 1,211 1,655 1,700 1,600 1,500 Other 1,202 1,460 1,366 1,303 52 371 1,000 1,100 1,300 Adjustment -567 -1,141 -1,605 -591 -813 -431 -700 -500 -600 Total 25,811 25,514 29,623 30,595 25,075 28,314 29,500 31,000 32,000 OP (YoY,%) Fishery Foods - 22.2 -94.3 - - - - 100.0 50.0 Noodles for overseas - 11.3 58.8 -0.3 -7.4 -0.2 -6.1 1.8 0.0 Noodles for domestic - -8.0 12.3 1.0 -24.2 8.7 11.9 8.0 5.8 Frozen/Chilled Foods - -15.9 -1.1 -6.3 5.7 9.0 3.8 5.0 4.8 Processed Food - 6.4 - - 136.9 80.9 -9.4 -12.5 0.0 Refrigerated Storage - 109.5 -0.5 6.8 -1.1 36.7 2.7 -5.9 -6.3 Other - 21.5 -6.4 -4.6 -96.0 613.5 169.5 10.0 18.2 Total - -1.2 16.1 3.3 -18.0 12.9 4.2 5.1 3.2 OPM (%) Fishery Foods 2.1 2.7 0.2 -0.5 -2.2 -0.5 0.3 0.6 0.9 Noodles for overseas 14.8 14.4 18.6 17.4 14.1 15.7 15.8 15.9 15.9 Noodles for domestic 11.4 10.0 10.3 9.7 7.8 8.1 8.5 8.9 9.3 Frozen/Chilled Foods 6.8 5.7 5.7 5.2 5.3 5.7 5.7 5.9 6.1 Processed Food 3.0 3.4 -0.5 1.1 2.7 4.5 3.6 3.0 2.9 Refrigerated Storage 4.3 7.8 7.7 8.0 7.8 10.2 10.0 9.1 8.3 Other 4.6 5.1 4.6 3.2 0.1 0.8 2.2 2.3 2.7 Total 8.4 7.9 8.6 8.2 6.6 7.4 7.5 7.7 7.9 Sales breakdown (%) Fishery Foods 10.9 10.1 9.4 9.0 9.1 8.6 8.2 8.2 8.1 Noodles for overseas 16.4 17.9 20.5 20.3 22.6 20.2 18.4 18.2 17.9 Noodles for domestic 33.3 33.2 34.0 33.5 30.8 32.3 33.8 33.8 33.9 Frozen/Chilled Foods 20.7 19.7 18.0 17.2 17.5 17.7 17.9 17.7 17.7 Processed Food 6.0 5.4 5.2 5.0 4.8 5.2 5.6 5.7 5.9 Refrigerated Storage 4.2 4.6 4.3 4.1 4.1 4.2 4.3 4.4 4.4 Other 8.5 9.0 8.6 11.0 11.2 11.7 11.8 12.0 12.0 OP breakdown (%) Fishery Foods 2.7 3.2 0.2 -0.5 -3.0 -0.6 0.3 0.6 0.9 Noodles for overseas 28.2 31.1 42.1 42.1 47.0 42.2 37.7 36.8 35.6 Noodles for domestic 44.1 40.2 38.5 38.9 35.6 34.8 37.1 38.4 39.3 Frozen/Chilled Foods 16.3 13.5 11.4 10.7 13.7 13.4 13.2 13.3 13.5 Processed Food 2.1 2.2 -0.3 0.7 1.9 3.1 2.6 2.2 2.1 Refrigerated Storage 2.1 4.3 3.7 3.9 4.7 5.8 5.6 5.1 4.6 Other 4.6 5.5 4.4 4.2 0.2 1.3 3.3 3.5 4.0

Food Industry 97

30 August 2016

Source: Company data, Credit Suisse estimates

Figure 14: Consolidated balance sheet and change in net assets (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Assets) Cash,cash equivalents & securities 47,134 57,648 60,208 77,997 88,282 106,331 112,564 117,579 119,141 122,704 Account receivable 39,004 39,785 48,746 45,948 48,989 46,788 48,899 48,808 50,103 50,195 Inventories 17,258 16,167 20,837 20,174 23,086 23,565 20,723 22,590 22,211 22,736 Other 5,753 5,644 4,912 5,747 5,047 5,041 5,390 5,390 5,390 5,390 Allowance for doubtful accounts -543 -524 -511 -507 -501 -485 -490 -490 -490 -490 Total current assets 108,609 118,724 134,196 149,361 164,904 181,243 187,088 193,877 196,354 200,535 Tangible fixed assets 101,709 95,499 97,581 102,262 119,179 120,669 124,940 134,440 145,940 156,440 Depreciable PP&E 70,137 66,519 66,808 69,632 84,097 85,576 83,639 - - - Land 30,409 28,646 28,595 28,995 32,090 32,913 35,584 - - - Construction in progress 1,162 332 2,176 3,633 2,989 2,177 5,716 - - - Intangible fixed assets 2,169 1,727 2,051 2,349 2,408 3,232 3,054 3,054 3,054 3,054 Goodwill 1,091 1,363 1,758 1,839 1,912 2,100 2,623 2,623 2,623 2,623 Other 1,077 363 293 510 495 1,131 431 431 431 431 Investments & other assets 16,754 16,581 17,585 20,915 22,293 28,789 30,312 30,312 30,312 30,312 Investment securities 14,690 14,160 14,947 18,385 20,114 26,745 28,105 28,105 28,105 28,105 Other 2,064 2,422 2,638 2,530 2,179 2,044 2,207 2,207 2,207 2,207 Total fixed assets 120,633 113,808 117,218 125,527 143,882 152,690 158,308 167,806 179,306 189,806 Total assets 229,242 232,532 251,414 274,889 308,787 333,933 345,396 361,683 375,660 390,341 (Liabilities) Account payable 18,697 18,904 21,997 21,711 24,331 24,770 23,975 25,864 26,557 27,602 Short-term debt 1,766 1,997 337 212 201 227 274 638 835 615 Other 21,476 21,094 24,531 25,244 26,137 22,863 26,240 26,240 26,240 26,240 Total current liabilities 41,939 41,995 46,865 47,167 50,669 47,860 50,489 52,742 53,632 54,457 Long-term debt 64 12 0 0 30 0 0 0 0 0 Other 16,950 17,717 17,883 18,550 21,151 26,123 28,707 27,272 25,908 24,613 Total fixed liabilities 17,014 17,729 17,883 18,550 21,181 26,123 28,707 27,272 25,908 24,613 Total liabilities 58,954 59,725 64,749 65,718 71,851 73,984 79,196 80,014 79,540 79,070 (Net assets) Capital stock 18,969 18,969 18,969 18,969 18,969 18,969 18,969 18,969 18,969 18,969 Capital surplus 22,516 22,516 22,516 22,516 22,516 22,516 22,517 22,517 22,517 22,517 Retained earnings 136,951 144,769 158,052 171,246 189,404 200,821 213,567 228,439 242,290 256,841 Treasury stock -8,086 -8,111 -8,129 -8,145 -8,207 -8,220 -8,225 -8,225 -8,225 -8,225 Total shareholders' equity 170,350 178,143 191,408 204,586 222,683 234,087 246,830 261,700 275,551 290,102 Valuation and translation adjustments -9,340 -15,020 -14,898 -5,902 881 15,620 8,599 8,599 8,599 8,599 Total equity capital 161,010 163,123 176,510 198,684 223,564 249,707 255,429 270,299 284,150 298,701 Minority interests 9,278 9,682 10,152 10,487 13,371 10,241 10,770 11,370 11,970 12,570 Total net assets 170,288 172,807 186,665 209,172 236,936 259,949 266,200 281,669 296,120 311,271 Total liabilities & net assets 229,242 232,532 251,414 274,889 308,787 333,933 345,396 361,683 375,660 390,341 (Changes in net assets) Beginning balance 158,688 170,288 172,807 186,665 209,172 236,936 259,949 266,200 281,669 296,120 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus 1,104 0 0 0 0 0 1 0 0 0 Net profits 18,506 12,415 16,119 17,280 22,723 16,901 18,363 21,000 21,000 21,700 Dividends from surplus -3,057 -4,598 -4,086 -4,086 -5,615 -5,095 -5,611 -6,128 -7,149 -7,149 Treasury stock -929 -25 -18 -16 -62 -13 -5 0 0 0 Valuation and translation adjustments -1,643 -5,680 122 8,996 6,783 14,739 -7,021 0 0 0 Minority interests -2,380 404 470 335 2,884 -3,130 529 600 600 600 Other -1 3 1,251 -2 1,051 -389 -5 -3 0 0 Final balance 170,288 172,807 186,665 209,172 236,936 259,949 266,200 281,669 296,120 311,271 Source: Company data, Credit Suisse estimates

Food Industry 98

30 August 2016

Figure 15: Consolidated profit and loss and cash flow statements (¥mn) FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E Sales revenue 315,337 305,911 320,988 344,527 372,231 381,259 383,276 391,000 401,000 407,000 COGS 195,467 191,118 202,610 214,908 230,221 244,924 240,490 244,000 251,000 254,000 Gross profit 119,870 114,793 118,378 129,619 142,010 136,335 142,786 147,000 150,000 153,000 SG&A 88,748 88,982 92,863 99,995 111,414 111,259 114,472 117,500 119,000 121,000 OP 31,121 25,811 25,514 29,623 30,595 25,075 28,314 29,500 31,000 32,000 Interest and dividend income 583 425 430 652 601 700 834 900 900 900 Interest expense 27 20 8 5 4 260 277 300 300 300 Other 868 975 1,053 937 884 733 793 800 800 800 RP 32,545 27,191 26,989 31,997 32,243 26,630 29,489 30,800 32,500 33,500 Extraordinary gains 158 501 69 133 4,383 1,217 1,082 1,500 0 0 Extraordinary losses 1,900 5,965 629 3,193 323 205 1,765 500 500 500 Pretax profit 30,802 21,727 26,429 28,937 36,304 27,641 28,805 31,800 32,000 33,000 Income taxes 11,500 8,662 9,787 11,171 13,024 10,256 9,586 10,200 10,400 10,700 Minority interests 796 648 523 486 556 483 855 600 600 600 NP 18,506 12,415 16,119 17,280 22,723 16,901 18,363 21,000 21,000 21,700 Tax rate 37.3% 39.9% 37.0% 38.6% 35.9% 37.1% 33.3% 32.1% 32.5% 32.4% Depreciation expense 8,957 10,633 10,206 10,945 10,615 11,608 11,226 12,500 13,500 14,500 Capital expenditure 26,654 10,122 12,059 16,366 24,622 10,167 19,085 22,000 25,000 25,000 To sales ratio (%) CGS 62.0 62.5 63.1 62.4 61.8 64.2 62.7 62.4 62.6 62.4 Gross profit 38.0 37.5 36.9 37.6 38.2 35.8 37.3 37.6 37.4 37.6 Depreciation expense 2.8 3.5 3.2 3.2 2.9 3.0 2.9 3.2 3.4 3.6 SG&A 28.1 29.1 28.9 29.0 29.9 29.2 29.9 30.1 29.7 29.7 OP 9.9 8.4 7.9 8.6 8.2 6.6 7.4 7.5 7.7 7.9 RP 10.3 8.9 8.4 9.3 8.7 7.0 7.7 7.9 8.1 8.2 Pretax profit 9.8 7.1 8.2 8.4 9.8 7.2 7.5 8.1 8.0 8.1 NP 5.9 4.1 5.0 5.0 6.1 4.4 4.8 5.4 5.2 5.3 YoY (%) Sales revenue -2.1 -3.0 4.9 7.3 8.0 2.4 0.5 2.0 2.6 1.5 Gross profit 5.7 -4.2 3.1 9.5 9.6 -4.0 4.7 3.0 2.0 2.0 OP 24.6 -17.1 -1.2 16.1 3.3 -18.0 12.9 4.2 5.1 3.2 RP 21.8 -16.5 -0.7 18.6 0.8 -17.4 10.7 4.4 5.5 3.1 Pretax profit 25.9 -29.5 21.6 9.5 25.5 -23.9 4.2 10.4 0.6 3.1 NP 33.8 -32.9 29.8 7.2 31.5 -25.6 8.6 14.4 0.0 3.3

FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Operating activities) NP 18,506 12,415 16,119 17,280 22,723 16,901 18,363 21,000 21,000 21,700 Depreciation(+) 8,957 10,633 10,206 10,945 10,615 11,608 11,226 12,500 13,500 14,500 Account receivable(-) 187 -781 -8,961 2,798 -3,041 2,201 -2,111 91 -1,295 -92 Inventories(-) 2,684 1,091 -4,670 663 -2,912 -479 2,842 -1,867 380 -525 Account payable(+) -1,742 207 3,093 -286 2,620 439 -795 1,889 693 1,046 Minority interests(+) 796 648 523 486 556 483 855 600 600 600 Other 51 3,974 3,216 1,498 -1,190 1,572 2,988 0 0 0 Operating cashflow 29,254 28,120 19,510 33,367 29,337 32,641 33,262 34,113 34,778 37,128 (Investing activities) Capital expenditures(-) -23,092 -4,423 -12,288 -15,626 -27,532 -13,098 -15,497 -22,000 -25,000 -25,000 Other -2,180 -5,845 -18,801 -4,332 -989 -26,878 -17,198 0 0 0 Investing cashflow -25,272 -10,268 -31,089 -19,958 -28,521 -39,976 -32,695 -22,000 -25,000 -25,000 (Financing activities) Debt (+) 97 179 -1,672 -125 19 -4 47 364 197 -220 Dividends (-) -3,057 -4,598 -4,086 -4,086 -5,615 -5,095 -5,611 -6,128 -7,149 -7,149 Other -2,764 -1,769 1,067 -354 -642 -3,888 -348 0 0 0 Financing cashflow -5,724 -6,188 -4,691 -4,565 -6,238 -8,987 -5,912 -5,763 -6,952 -7,369 (Cash & cash equivalents) Increases -1,742 11,664 -16,270 8,844 -5,422 -16,322 -5,345 6,349 2,825 4,759 Beginning balance 50,000 47,134 57,648 60,208 77,997 88,282 106,331 112,564 117,579 119,141 Final balance 48,258 58,798 41,378 69,052 72,575 71,960 100,986 118,913 120,404 123,900 Adjustments -1,124 -1,150 18,830 8,945 15,707 34,371 11,578 -1,334 -1,264 -1,195 Source: Company data, Credit Suisse estimates

Food Industry 99

30 August 2016

Figure 16: Financial indicators FY3/10 FY3/11 FY3/12 FY3/13 FY3/14 FY3/15 FY3/16 FY3/17E FY3/18E FY3/19E (Safety) Current ratio (%) 259.0 282.7 286.3 316.7 325.5 378.7 370.6 367.6 366.1 368.2 Quick ratio (%) 205.4 232.0 232.5 262.8 270.9 319.9 319.8 315.5 315.6 317.5 Fixed ratio (%) 74.9 69.8 66.4 63.2 64.4 61.1 62.0 62.1 63.1 63.5 Interest-bearing debt (¥mn) 1,830 2,009 337 212 231 227 274 638 835 615 Average debt interest rate (%) 1.5 1.0 0.7 1.8 1.8 113.5 110.6 65.8 40.7 41.4 Dependence on debt (%) 0.8 0.9 0.1 0.1 0.1 0.1 0.1 0.2 0.2 0.2 Net debt (¥mn) -45,304 -55,639 -59,871 -77,785 -88,051 -106,104 -112,290 -116,941 -118,306 -122,089 Equity capital ratio (%) 70.2 70.2 70.2 72.3 72.4 74.8 74.0 74.7 75.6 76.5 D/E ratio (%) 1.1 1.2 0.2 0.1 0.1 0.1 0.1 0.2 0.3 0.2 Long-term debt ratio (%) 3.5 0.6 0.0 0.0 13.0 0.0 0.0 0.0 0.0 0.0 Working capital (¥mn) 66,670 76,729 87,331 102,194 114,235 133,383 136,599 141,135 142,722 146,078 Net interest expense (¥mn) 556 405 422 647 597 440 557 600 600 600 Cash plus marketable securities (¥mn) 47,134 57,648 60,208 77,997 88,282 106,331 112,564 117,579 119,141 122,704 Financial leverage (x) 1.42 1.43 1.42 1.38 1.38 1.34 1.35 1.34 1.32 1.31 A/R to A/P ratio (%) 208.6 210.5 221.6 211.6 201.3 188.9 204.0 188.7 188.7 181.9 Dividend on equity (%) 2.0 2.8 2.4 2.2 2.7 2.2 2.2 2.3 2.6 2.5 (Profitability) ROE (%) 12.0 7.7 9.5 9.2 10.8 7.1 7.3 8.0 7.6 7.4 ROA (%) 13.9 11.2 10.5 11.3 10.5 7.8 8.3 8.3 8.4 8.4 Inventory turnover ratio (x) 17.0 18.3 17.3 16.8 17.2 16.3 17.3 18.1 17.9 18.1 A/R turnover ratio (x) 8.1 7.8 7.3 7.3 7.8 8.0 8.0 8.0 8.1 8.1 A/P turnover ratio (x) 16.1 16.3 15.7 15.8 16.2 15.5 15.7 15.7 15.3 15.0 Inventory turnover days (days) 21.5 19.9 21.0 21.7 21.2 22.3 21.1 20.2 20.4 20.2 A/R turnover days (days) 45.3 47.0 50.3 50.2 46.5 45.8 45.6 45.6 45.0 45.0 A/P turnover days (days) 22.6 22.4 23.3 23.2 22.6 23.5 23.2 23.3 23.9 24.3 Sales per employee (¥mn) 82.1 74.6 79.9 83.4 84.2 82.4 81.7 83.3 85.4 86.7 OP per employee (¥mn) 8.1 6.3 6.4 7.2 6.9 5.4 6.0 6.3 6.6 6.8 (Per share data) EPS (¥) 181.3 121.5 157.8 169.1 222.5 165.5 179.8 205.6 205.6 212.5 BPS (¥) 1575.7 1596.6 1727.7 1944.9 2188.9 2445.0 2501.0 2646.6 2782.2 2924.7 Sales per share (¥) 3089.8 2993.9 3141.8 3372.4 3644.2 3733.0 3752.8 3828.5 3926.4 3985.1 Operating cashflow per share (¥) 286.6 275.2 191.0 326.6 287.2 319.6 325.7 334.0 340.5 363.5 DPS (¥) 40.0 40.0 40.0 50.0 50.0 50.0 60.0 60.0 70.0 70.0 Dividend ratio (%) 22.1 32.9 25.4 29.6 22.5 30.2 33.4 29.2 34.0 32.9 (Growth) EPS growth (%) 33.7 -33.0 29.8 7.2 31.5 -25.6 8.7 14.4 0.0 3.3 BPS growth (%) 9.2 1.3 8.2 12.6 12.5 11.7 2.3 5.8 5.1 5.1 Total assets growth (%) 4.8 1.4 8.1 9.3 12.3 8.1 3.4 4.7 3.9 3.9 Sustainable growth rate (%) 9.4 5.1 7.1 6.5 8.3 5.0 4.8 5.7 5.0 5.0 (Investment profitability) Capital invested (¥ mn) 178,024 180,852 194,393 217,234 244,745 275,830 284,136 297,571 310,058 323,314 NOPAT (¥ mn) 20,046 16,107 16,729 19,247 20,293 16,472 19,304 20,513 21,533 22,232 ROIC (%) 11.3 8.9 8.6 8.9 8.3 6.0 6.8 6.9 6.9 6.9 WACC (%) 3.5 3.5 3.5 3.5 3.5 3.6 3.6 3.6 3.6 3.5 EVA (¥ mn) 13,872 9,844 9,945 11,660 11,745 6,650 9,165 9,838 10,488 10,778 EVA spread (%) 7.8 5.4 5.1 5.4 4.8 2.4 3.2 3.3 3.4 3.3 (Cashflow) EBITDA (¥mn) 40,078 36,444 35,720 40,568 41,210 36,683 39,540 42,000 44,500 46,500 EBITDA margin (%) 12.7 11.9 11.1 11.8 11.1 9.6 10.3 10.7 11.1 11.4 FCF (¥mn) 3,982 17,852 -11,579 13,409 816 -7,335 567 12,113 9,778 12,128 Operating C/F to Investment C/F rate (%) 115.8 273.9 62.8 167.2 102.9 81.7 101.7 155.1 139.1 148.5 (Other) Employees numbers 4,156 4,047 3,985 4,275 4,566 4,687 4,696 4,696 4,696 4,696 Consolidated subsidiaries numbers 20 19 21 21 22 22 22 22 22 22 Equity method affiliates numbers 1 1 1 1 1 1 1 1 1 1 Average shares outstanding (mn) 102.1 102.2 102.2 102.2 102.1 102.1 102.1 102.1 102.1 102.1 End-of-period shares outstanding (mn) 102.2 102.2 102.2 102.2 102.1 102.1 102.1 102.1 102.1 102.1 Source: Company data, Credit Suisse estimates

Food Industry 100

30 August 2016 Asia Pacific/Japan Equity Research Packaged Foods (Food (Japan)) / MARKET WEIGHT

Nissin Foods Holdings (2897 / 2897 JP) Rating NEUTRAL* Price (29 Aug 16, ¥) 5,830 INITIATION

Target price (¥) 5,800¹ Chg to TP (%) -0.51 Master of noodles pursuing a bold vision Market cap. (¥ bn) 629.79 (US$ 6.15) Enterprise value (¥ bn) 579.96 Number of shares (mn) 108.03 ■ Initiating coverage: We initiate our coverage for Nissin Foods Holdings with Free float (%) 65.0 a NEUTRAL rating and a target price of ¥5,800 (potential return –0.5%). The 52-week price range 6,580 - 5,040 leader in instant noodles in Japan, the company is also aggressively *Stock ratings are relative to the coverage universe in each analyst's or each team's respective sector. expanding overseas. Not afraid to dream big, it is targeting a market ¹Target price is for 12 months. capitalization of ¥1tn by 2020. The instant noodles businesses in Japan and

Research Analysts China generate the majority of profits. Masashi Mori ■ Investment themes: In Japan, we expect steady growth driven by the core 81 3 4550 9695 [email protected] franchise in the cup noodles category and strong brand marketing expertise. Product differentiation is critical in developing the Chinese market, where the group has a share of around 60% in the market for conventional cup noodles. This market has grown by 39% p.a. in the past three years as middle-class consumers in the major cities have traded up to cup noodles, and the company intends to focus on the related product category. The company has a top share in the developing Brazilian market, and is targeting growth in Asia as well (outside China). We expect a CAGR of 11% in OP over the next three years due to a focus on high-margin core brands as the group invests further to expand both its domestic and overseas operations. ■ Valuation/risks: Our target price is based on our FY3/17 EPS forecast (adjusted for exceptional items) and a P/E of about 25x (the Japanese food sector average). Upside risks: (1) accelerating growth in domestic operations, (2) rising sales momentum in China as consumers trade up to higher value products, and (3) wider-than-expected uptake of instant cup noodles in Brazil. Downside risks: (1) intensifying competition in the domestic market, (2) an accelerating slump in demand in Asia, and (3) steeper-than-expected increases in raw material prices.

Share price performance Financial and valuation metrics

Year 3/16A 3/17E 3/18E 3/19E Price (LHS) Rebased Rel (RHS) Sales (¥ bn) 468.1 498.0 515.0 530.0 8000 120 Operating profit (¥ bn) 26.4 28.0 35.0 36.0 7000 100 Recurring profit (¥ bn) 30.7 31.4 39.6 40.6 6000 Net income (¥ bn) 26.9 22.1 26.6 27.6 5000 80 EPS (¥) 245.5 204.6 246.2 255.5 4000 60 Sep-14 Jan-15 May-15 Sep-15 Jan-16 May-16 Change from previous EPS (%) n.a. IBES Consensus EPS (¥) n.a. 212.7 244.1 257.2 The price relative chart measures performance against the EPS growth (%) 46.2 -16.7 20.4 3.8 TOPIX which closed at 1313.24 on 29/08/16 P/E (x) 21.5 28.5 23.7 22.8 On 29/08/16 the spot exchange rate was ¥102.35/US$1 Dividend yield (%) 1.5 1.4 1.5 1.5 EV/EBITDA(x) 11.7 13.2 11.2 10.6 Performance over 1M 3M 12M P/B (x) 1.6 1.7 1.6 1.5 Absolute (%) -0.2 4.9 1.6 ROE(%) 7.4 6.0 7.0 6.9 Relative (%) 0.5 9.7 16.8 Net debt/equity (%) net cash net cash net cash net cash

30 August 2016

Valuation and risks

Share price valuation Our target price is based on a fair P/E of roughly 25x (average for Japanese food sector) applied to our FY3/17 EPS estimate (adjusted to exclude negative effects from pension accounting). We use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings (2269), Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Foods Holdings, Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price. We forecast double-digit OP growth over the medium term. However, we see the sector- average P/E as appropriate because Nissin’s aggressive plans for market expansion could lead to a larger-than-expected increase in upfront investment costs. Consequently, we think the Japan food sector average multiple represents fair value for Nissin Foods Holdings. The multiple is slightly lower than the company’s 10-year average plus one standard deviation.

Figure 1: P/E (12-month forward CS estimates base) Figure 2: EV/EBITDA (12-month forward CS estimates base)

(x) (x) 40 15 +2σ 35.3 35 +2σ 14.3 13 30 +1σ 29.4 +1σ 11.8 11 25 Ave. 23.5 Ave. 9.4 20 9 -1σ 17.7 15 7 -1σ 6.9

-2σ 11.8 10 5 -2σ 4.5

5 3 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 06/5 07/5 08/5 09/5 10/5 11/5 12/5 13/5 14/5 15/5 16/5 Source: Bloomberg, Credit Suisse estimates Source: Bloomberg, Credit Suisse estimates

Risks Upside risks include: (1) accelerating growth in domestic operations, (2) rising sales momentum in China as consumers trade up to higher value products, and (3) wider-than- expected uptake of instant cup noodles in Brazil. Downside risks include: (1) intensifying competition in the domestic market, (2) an accelerating slump in demand in Asia, and (3) steeper-than-expected increases in raw material prices. Wheat is the principal raw material for the instant noodles business. In general terms, the cost of materials is presumed to account for the highest proportion of sales in the domestic instant noodles franchise. Japan is a net wheat importer, and the government revises the official price for wheat imported by the flour-milling industry semi-annually (based on a law that allows the Ministry of Agriculture, Forestry and Fisheries (MAFF) to maintain a stable balance between supply and demand for staple foods through price controls). In April 2016, the official price of wheat was reduced by 7%. The company should benefit from cheaper input costs for FY3/17, but there is a risk of raw material costs rising sharply if wheat prices were to inflate again.

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Figure 3: Composition of sales for Japanese instant Figure 4: Japanese government price for imported wheat noodles business (¥000s/ton)

OP 80 10% 70

Raw material 60 costs 50 40% SG&A 40 expence 30 32% 20

10 Mfg. costs (depreciation 0 expenses Direct labor

etc.) costs

FYOct-08 FYOct-06 FYOct-07 FYOct-09 FYOct-10 FYOct-11 FYOct-12 FYOct-13 FYOct-14 FYOct-15

FYApr-13 FYApr-08 FYApr-09 FYApr-10 FYApr-11 FYApr-12 FYApr-14 FYApr-15 FYApr-16 10% 8% FYApr-07 Source: Credit Suisse assumptions Source: Company data, Credit Suisse

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Company profile Japan’s largest player in instant noodles Founded in 1948, Nissin was the originator of instant ramen. It is still market leader today, and has also developed this overseas franchise aggressively. Outside the instant noodles sector, the company produces a wide range of products, including frozen and chilled foods, confectionery, and fermented dairy items. It moved to a holding company structure under Nissin Foods Holdings in 2008. Within the group umbrella, there are six domestic operating companies and four overseas companies operating in different regions. The overarching philosophy of the Nissin Foods Group is summed up as “Earth Food Creator.” Nissin has never been one to shy away from big dreams: its stated aim by 2020 is to reach a market capitalization of ¥1tn. The instant noodles businesses in Japan (Nissin Foods and Myojo Foods) and China generate the majority of profits.

Figure 5: Sales by business segment Figure 6: OP by business segment

China EMEA Asia EMEA Other North Asia 9% -1% 1% 1% domestic America -6% China business 3% Other North 12% -2% domestic America business 10% Nissin Food 1% Confectionery Nissin Food Products and beverage Products 48% Confectionery business 80% and beverage 4% business 8% Chilled and frozen foods Chilled and 2% frozen foods 13% Myojo Foods Myojo Foods 4% 9% Source: Company data (FY3/16A), Credit Suisse Source: Company data (FY3/16A), Credit Suisse

Long-term strategy, shareholder returns The target for adjusted OP (excluding effects from pension accounting) in FY3/21, the final year of the current medium-term business plan, is ¥40bn. The latter figure assumes strong top-line revenue growth in Japan and overseas supporting a five-year CAGR of 10%. Over the five-year period, the plan assumes (1) total capex of about ¥150bn, mostly to reinforce production capacity in Japan and overseas, and (2) total M&A of around ¥100bn. The five strategic themes of the group’s efforts to improve profitability are (1) globalization of the core “Cup Noodles” brand, which enjoys global recognition and generates higher margins than bagged noodles, (2) developing a stronger sales presence in BRICs markets, (3) developing the confectionery and cereals operations into a second core earnings driver, (4) bolstering the chilled foods and soft drinks businesses, and (5) cultivating international management talent within the group. In terms of shareholder returns, the company expects to maintain a dividend payout ratio of at least 40%. Financial stability has enabled the group to look at investing aggressively to achieve more rapid growth over the medium and long term. We infer that any significant increase in shareholder returns is unlikely.

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Figure 7: Dividend, buyback and dividend payout ratio Figure 8: Net debt, D/E ratios (JPY bn) (%) (JPY bn) Net debt D/E ratio (RHS) (%) 45.0 Dividend (LHS) 100 0 10 Buyback (LHS) 9 40.0 90 -20 Dividend payout ratio (RHS) 8 35.0 80 70 7 30.0 -40 60 6 25.0 50 -60 5 20.0 40 4 15.0 -80 30 3 2 10.0 20 -100 5.0 10 1 -120 0 0.0 0

Source: Company data, Credit Suisse estimates Note: Positive indicates net debt Source: Company data, Credit Suisse estimates

Trends in domestic instant noodles market The instant noodles market in Japan has been virtually flat in volume terms for the past ten years. Simplicity and convenience have helped cup noodles to grow at 1.4% per year even as bagged noodles have dwindled steadily, but the overall market has stayed roughly flat. According to research published by Nikkan Keizai Tsushin, based on ex-factory shipment values, the market expanded 4% in FY2015 (April 2015 to March 2016) to around ¥550bn. This marked a rebound from the previous year’s fall, taking the market value to an 11-year high. The growth was attributable to price increases and the popularity of certain products. Further robust growth in demand is expected in FY2016 as more consumers begin to tighten their purse strings. We think the market can achieve steady value growth due to the brand marketing power of Nissin Foods, for which cup noodles are the leading product category.

Figure 9: Japanese instant noodles market (production volumes)

(1bn pieces) Fresh-type noodles Cup instant noodles Packaged instant noodles 6

0 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 2014 Source: WINA, Credit Suisse

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Figure 10: Shares of bag-type instant noodles market Figure 11: Shares of cup-type instant noodles market (FY2015) (FY2015) Other 11% Other Nissin 17% Foods Myojo 27% Shokuhin Nissin Myojo 8% Foods 42% Shokuhin 7% Ace Cook Ace Cook 10% 2%

Sanyo Foods 6% Toyo Sanyo Suisan Foods 19% Toyo 29% Suisan 23%

Source: Nikkan Keizai Tsushin (ex-factory shipment values) Source: Nikkan Keizai Tsushin (ex-factory shipment values)

Trends in overseas instant noodles market A greater cultural affinity with noodles means Asia dominates the global market for instant noodles. China is by far the largest market, with a global share (production volume-based) of about 40%, followed by Indonesia, Japan and Vietnam. The global market for instant noodles on a production volume basis has grown at 0.3% per year over the past five years. The main factor acting as a drag on growth is the impact of fierce competition, the drive to eat healthier foods, and higher incomes in the two leading markets of China and Indonesia. Demand for instant noodles has fallen in both countries in each of the past two years. High barriers to entry have reinforced a trend toward the development of oligopolies by the major players in the larger markets. In China, the top five companies have an aggregate market share of a little under 80%; the corresponding figure in Indonesia is almost 100%. In China, whose industry structure is thought to include more than 300 local manufacturers, fierce competition makes it a struggle for Japanese producers to gain share.

Figure 12: Share of instant noodles demand by country Figure 13: Aggregate share of leading five instant noodles (volume basis, CY2015) players in major markets Russia Others (%) 96 96 96 2% Nigeria 11% 100 91 93 92 94 90 86 Brazil 2% 90 84 85 78 2% 80 Thailand 70 China/HK 3% 60 41% 50 India 40 3% 30 Philippines Korea 20 4% 4% 10 US Vietnam 0 4% 5% Japan Indonesia 6% 13%

Source: WINA, Credit Suisse Source: EuroMonitor (2014, value basis), Credit Suisse

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Product differentiation is a particularly critical factor in developing the Chinese market. The group has gained a share of around 60% in the market for conventional cup noodles, and this has translated into an excellent commercial opportunity. According to management, the market in China for conventional cup noodles has been growing at 39% per year over the past three years as middle-class consumers in the major cities have traded up to the product. Nissin Foods is the brand leader in this category, even according to our own e- commerce data, and we have to assume the same applies in other retail channels. A negative factor is that the high level of brand recognition in the major cities implies little scope for further sales expansion. In the future, we think the company will struggle to achieve substantial growth in profits in China as it tries to extend its cup noodle franchise into new cities due to the high upfront marketing investment and higher fixed costs associated with building market presence. The most promising overseas market is Brazil, where Nissin Foods leads the market with a share of more than 60%. Cup noodles account for an extremely low 4% of the Brazilian market, and this proportion is likely to increase in the future. The higher margins on cup noodles imply significant long-term potential in Brazil as the product mix improves. In the short term, however, we think the contribution to earnings will be limited due to the need to invest in marketing. Southeast Asia and India are also promising markets, but the strength of Nestle and local manufacturers in these markets makes it unclear for now whether Nissin Foods could be successful. There are few indications in these markets as yet that consumers are prepared to trade up from instant noodles sold in bags to cup noodles. Any growth phase where the company can leverage its strengths in cup noodles is some way off, in our opinion. In conclusion, the key question concerning the prospects for the overseas instant noodles business is when we might see a more substantial contribution to earnings growth from (1) expansion into new urban markets in China with cup noodles, and (2) higher penetration of cup noodles within the Brazilian noodles market.

Figure 14: Per capital annual consumption of instant noodles by country, comparing five-year historical growth rates and total demand

(2010-15 volume CAGR, %)

6 East Asia & Other South East Asia 5

4 Philippines Brazil Thailand 3 India 2 Malaysia Korea

1 China Mexico US Japan Vietnam 0

-1 Russia Indonesia -2 Nigeria

-3 0 10 20 30 40 50 60 70 80 (Consumption per head, pieces)

Note: Size of circles proportional to total consumption in CY2015 (40.4bn units in China) Source: Company data, Credit Suisse based on data from WINA and IMF

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Figure 15: Popular cup noodle varieties on sale on Tmall

Source: Company data, Credit Suisse

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Figure 16: Estimated market shares of top instant noodles players in China from EC data (as of late May 2016)

Bag-type instant noodle market share (袋装方便面) tmall.com(天猫) jd.com (京东) Tingyi Tingyi 9% 6% UPC UPC 14% 23% Other Other 39% 40%

Nong Shim Nong 14% Shim YumYum 11% 3% Baixiang Samyang Gong Zai Samyang 4% Gong Zai 1% Nissin Wugu Nissin Mian 15% Mian 4% 11% 2% 2% 2% Cup-type instant noodle market share (杯装方便面) tmall.com(天猫) jd.com (京东) Other Tingyi Tingyi Other YumYum 6% 13% 13% 21% 4%

Gong Zai UPC Mian 13% Wugu 17% 5% UPC 24%

Gong Zai Mian 10% Nong Nong Shim Nissin Shim Nissin 15% 32% 3% 24%

Source: Credit Suisse assumptions based on company's website

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Earnings forecasts

Figure 17: Earnings forecast summary Sales Operating profit Recurring profit Net profit EPS ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥mn YoY (%) ¥ YoY (%) Consolidated 16/3 Actual 468,084 8.5 26,399 8.6 30,733 -6.8 26,884 45.3 245.5 46.2 17/3 CS E 498,000 6.4 28,000 6.1 31,400 2.2 22,100 -17.8 204.6 -16.7 CoE 500,000 6.8 27,000 2.3 31,000 0.9 22,000 -18.2 203.7 -17.0 IBES E 494,234 5.6 28,247 7.0 32,165 4.7 22,532 -16.2 208.5 -15.1 18/3 CS E 515,000 3.4 35,000 25.0 39,600 26.1 26,600 20.4 246.2 20.4 IBES E 507,578 2.7 33,544 18.8 37,725 17.3 26,146 16.0 240.2 15.2 19/3 CS E 530,000 2.9 36,000 2.9 40,600 2.5 27,600 3.8 255.5 3.8 IBES E 524,705 3.4 35,275 5.2 39,429 4.5 27,302 4.4 251.3 4.6 Source: Company data, I/B/E/S, Credit Suisse estimates Our OP forecast of ¥28.0bn (+6% YoY) for FY3/17 is higher than the current guidance. We are forecasting 32% YoY growth in OP from the domestic operations, which is higher than current guidance. The differences are mainly a function of (1) expected mix improvements due to focusing resources on growing core brands that enjoy fatter margins, (2) full-year contributions from acquisitions in the confectionery business, and (3) gains from a change in the method of depreciation. We are forecasting 39% YoY growth in OP from overseas operations, which is lower than current guidance. We think the gain from full consolidation of the Brazilian operations will be offset to an extent by (1) higher costs in North America due to fiercer competition, (2) continued softness in demand in Asia (outside China) and EMEA, and (3) the impact of the stronger yen. Over the medium term, we forecast annual growth over the next three years of 11% in OP and 13% in adjusted OP. We expect domestic operations to achieve annual growth of 13%, supported by the substantial expansion of profits in FY3/17. Similarly, we expect annual growth of 7% from overseas operations. Although the group should achieve steady volume growth due to its aggressive program of global investment, we think the substantial upfront costs of expansion will constrain earnings growth to the mid-to-high single digits.

Figure 18: OP and OP margin Figure 19: ROE, ROIC and OPM (JPY b) (%) Operating profits OP margin (RHS) (%) ROE (%) 40 12 9 ROIC (rhs) 12 35 8 OPM (rhs) 10 10 30 7 25 8 6 8 5 20 6 6 4 15 4 10 3 4 2 2 5 2 0 0 1

0 0

FY03/06 FY03/07 FY03/02 FY03/03 FY03/04 FY03/05 FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16

FY03/17E FY03/18E FY03/19E

FY03/06 FY03/13 FY03/03 FY03/04 FY03/05 FY03/07 FY03/08 FY03/09 FY03/10 FY03/11 FY03/12 FY03/14 FY03/15 FY03/16

FY03/02

FY03/18E FY03/19E FY03/17E Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

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Figure 20: Sales and OP forecasts by segment (¥mn) FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E Sales by segment (JPYm) Nissin Food Products 196,080 199,284 200,841 210,906 215,760 223,612 234,000 242,000 248,000 Myojo Foods 42,569 42,005 39,335 39,561 39,191 41,609 43,000 43,000 44,000 Chilled and frozen foods 51,353 53,434 52,565 54,789 56,626 59,810 60,000 61,000 62,000 Confectionery and beverage business 31,400 33,500 34,100 36,000 34,300 38,600 49,000 53,000 56,000 Other domestic business 1,600 1,900 2,500 2,600 3,000 3,500 3,000 3,000 3,000 North America 26,454 24,431 25,916 32,219 35,745 48,280 59,000 61,000 63,000 China 18,373 18,694 20,848 29,903 34,509 40,883 36,300 37,200 38,800 Asia 4,800 4,500 4,100 5,500 7,800 7,200 8,700 9,500 9,800 EMEA 2,400 2,800 2,700 5,900 4,700 4,600 5,000 5,300 5,400 Total 374,932 380,674 382,793 417,620 431,575 468,084 498,000 515,000 530,000 Sales (y-y,%) Nissin Food Products 2.7 1.6 0.8 5.0 2.3 3.6 4.6 3.4 2.5 Myojo Foods -4.1 -1.3 -6.4 0.6 -0.9 6.2 3.3 0.0 2.3 Chilled and frozen foods 3.6 4.1 -1.6 4.2 3.4 5.6 0.3 1.7 1.6 Confectionery and beverage business 0.3 6.7 1.8 5.6 -4.7 12.5 26.9 8.2 5.7 Other domestic business 0.0 18.8 31.6 4.0 15.4 16.7 -14.3 0.0 0.0 North America -7.0 -7.6 6.1 24.3 10.9 35.1 22.2 3.4 3.3 China 0.3 1.7 11.5 43.4 15.4 18.5 -11.2 2.5 4.3 Asia - -6.3 -8.9 34.1 41.8 -7.7 20.8 9.2 3.2 EMEA - 16.7 -3.6 118.5 -20.3 -2.1 8.7 6.0 1.9 Total 1.0 1.5 0.6 9.1 3.3 8.5 6.4 3.4 2.9 OP (JPY m) Nissin Food Products 22,773 23,468 23,810 25,688 23,636 23,967 28,600 30,400 32,000 Myojo Foods 2,427 2,753 1,712 1,963 1,424 1,373 1,500 1,600 1,700 Chilled and frozen foods 1,814 1,565 818 472 -203 715 1,300 1,400 1,500 Confectionery and beverage business 700 900 600 1,200 1,300 1,300 2,900 3,200 3,400 Other domestic business 900 1,200 -200 0 -100 -200 1,400 1,000 1,000 North America 1,376 -340 236 543 662 1,060 2,100 2,100 2,200 China 988 1,042 1,835 2,845 3,277 4,143 3,300 2,600 2,400 Asia 0 -200 -500 -1,600 -2,200 -2,000 -1,300 -1,100 -1,100 EMEA 200 300 300 -100 -100 -400 -200 -100 -100 Adjustment 3,408 -4,334 -4,558 -3,232 -3,405 -3,587 -11,600 -6,100 -7,000 Total 34,537 26,211 23,954 27,705 24,301 26,399 28,000 35,000 36,000 OP (y-y,%) Nissin Food Products -6.1 3.1 1.5 7.9 -8.0 1.4 19.3 6.3 5.3 Myojo Foods -11.6 13.4 -37.8 14.7 -27.5 -3.6 9.2 6.7 6.3 Chilled and frozen foods 5.2 -13.7 -47.7 -42.3 - - 81.8 7.7 7.1 Confectionery and beverage business -58.8 28.6 -33.3 100.0 8.3 0.0 123.1 10.3 6.3 Other domestic business 0.0 33.3 ------28.6 0.0 North America -20.1 - - 130.1 21.9 60.1 98.1 0.0 4.8 China -43.4 5.5 76.1 55.0 15.2 26.4 -20.3 -21.2 -7.7 Asia ------EMEA - 50.0 0.0 ------Total 26.3 -24.1 -8.6 15.7 -12.3 8.6 6.1 25.0 2.9 OPM (%) Nissin Food Products 11.6 11.8 11.9 12.2 11.0 10.7 12.2 12.6 12.9 Myojo Foods 5.7 6.6 4.4 5.0 3.6 3.3 3.5 3.7 3.9 Chilled and frozen foods 3.5 2.9 1.6 0.9 -0.4 1.2 2.2 2.3 2.4 Confectionery and beverage business 2.2 2.7 1.8 3.3 3.8 3.4 5.9 6.0 6.1 Other domestic business 56.3 63.2 -8.0 0.0 -3.3 -5.7 46.7 33.3 33.3 North America 5.2 -1.4 0.9 1.7 1.9 2.2 3.6 3.4 3.5 China 5.4 5.6 8.8 9.5 9.5 10.1 9.1 7.0 6.2 Asia 0.0 -4.4 -12.2 -29.1 -28.2 -27.8 -14.9 -11.6 -11.2 EMEA 8.3 10.7 11.1 -1.7 -2.1 -8.7 -4.0 -1.9 -1.9 Total 9.2 6.9 6.3 6.6 5.6 5.6 5.6 6.8 6.8 Sales breakdown (%) Nissin Food Products 52.3 52.4 52.5 50.5 50.0 47.8 47.0 47.0 46.8 Myojo Foods 11.4 11.0 10.3 9.5 9.1 8.9 8.6 8.3 8.3 Chilled and frozen foods 13.7 14.0 13.7 13.1 13.1 12.8 12.0 11.8 11.7 Confectionery and beverage business 8.4 8.8 8.9 8.6 7.9 8.2 9.8 10.3 10.6 Other domestic business 0.4 0.5 0.7 0.6 0.7 0.7 0.6 0.6 0.6 North America 7.1 6.4 6.8 7.7 8.3 10.3 11.8 11.8 11.9 China 4.9 4.9 5.4 7.2 8.0 8.7 7.3 7.2 7.3 Asia 1.3 1.2 1.1 1.3 1.8 1.5 1.7 1.8 1.8 EMEA 0.6 0.7 0.7 1.4 1.1 1.0 1.0 1.0 1.0 OP breakdown (%) Nissin Food Products 73.2 76.8 83.5 83.0 85.3 79.9 72.2 74.0 74.4 Myojo Foods 7.8 9.0 6.0 6.3 5.1 4.6 3.8 3.9 4.0 Chilled and frozen foods 5.8 5.1 2.9 1.5 -0.7 2.4 3.3 3.4 3.5 Confectionery and beverage business 2.2 2.9 2.1 3.9 4.7 4.3 7.3 7.8 7.9 Other domestic business 2.9 3.9 -0.7 0.0 -0.4 -0.7 3.5 2.4 2.3 North America 4.4 -1.1 0.8 1.8 2.4 3.5 5.3 5.1 5.1 China 3.2 3.4 6.4 9.2 11.8 13.8 8.3 6.3 5.6 Asia 0.0 -0.7 -1.8 -5.2 -7.9 -6.7 -3.3 -2.7 -2.6 EMEA 0.6 1.0 1.1 -0.3 -0.4 -1.3 -0.5 -0.2 -0.2 Source: Company data, Credit Suisse estimates

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Figure 21: Consolidated balance sheet and change in net assets (¥mn) FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E (Assets) Cash,cash equivalents & securities 89,957 73,492 78,435 70,416 91,648 113,518 90,914 78,938 83,216 78,772 Account receivable 43,606 47,125 46,490 47,072 51,298 54,491 61,391 61,644 63,618 64,455 Inventories 14,471 14,293 17,506 19,351 20,958 23,068 27,168 26,723 27,865 28,089 Other 8,075 9,463 9,645 10,115 11,284 10,852 11,797 11,797 11,797 11,797 Allowance for doubtful accounts -299 -246 -261 -280 -369 -422 -347 -347 -347 -347 Total current assets 155,810 144,127 151,815 146,674 174,819 201,507 190,923 178,755 186,149 182,766 Tangible fixed assets 109,278 125,882 126,360 133,787 147,620 147,249 168,886 196,886 219,886 236,886 Depreciable PP&E 60,031 73,365 76,868 77,024 92,268 90,240 104,121 - - - Land 46,946 49,542 47,999 52,429 51,063 51,097 52,694 - - - Construction in progress 2,301 2,975 1,493 4,334 4,289 5,912 12,071 - - - Intangible fixed assets 4,850 4,465 3,939 4,677 6,309 8,212 42,290 40,090 37,890 35,690 Investments & other assets 138,471 135,274 132,602 160,992 150,720 155,773 150,968 150,968 150,968 150,968 Investment securities 119,287 115,927 117,635 138,571 131,843 135,441 145,246 145,246 145,246 145,246 Other 19,184 19,347 14,967 22,421 18,877 20,332 5,722 5,722 5,722 5,722 Total fixed assets 252,599 265,621 262,901 299,456 304,649 311,234 362,145 387,944 408,744 423,544 Total assets 408,410 409,748 414,717 446,132 479,469 512,743 553,068 566,699 594,893 606,310 (Liabilities) Account payable 40,400 41,422 44,876 43,652 43,461 44,896 51,324 51,185 53,004 53,612 Short-term debt 2,796 2,808 3,325 6,997 5,308 4,023 18,457 9,547 15,628 4,939 Other 44,892 43,425 42,664 47,160 51,398 54,108 61,104 62,937 64,825 66,770 Total current liabilities 88,088 87,655 90,865 97,809 100,167 103,027 130,885 123,669 133,457 125,321 Long-term debt 10,021 13,140 13,101 7,839 9,974 9,893 13,041 19,562 18,583 17,654 Other 38,350 31,358 24,093 25,457 27,027 29,970 37,453 39,326 41,292 43,357 Total fixed liabilities 48,371 44,498 37,194 33,296 37,001 39,863 50,494 58,887 59,875 61,011 Total liabilities 136,459 132,153 128,059 131,105 137,168 142,890 181,380 182,556 193,332 186,332 (Net assets) Capital stock 25,122 25,122 25,122 25,122 25,122 25,122 25,122 25,122 25,122 25,122 Capital surplus 48,416 48,416 48,416 48,416 48,416 48,417 48,177 48,177 48,177 48,177 Retained earnings 223,857 236,831 247,138 257,067 263,585 273,319 293,803 307,261 324,679 343,097 Treasury stock -20,448 -20,393 -21,855 -21,798 -21,710 -21,684 -35,836 -35,836 -35,836 -35,836 Total shareholders' equity 276,947 289,976 298,821 308,807 315,413 325,174 331,267 344,724 362,142 380,560 Valuation and translation adjustments -10,695 -18,322 -18,398 -2,227 17,325 36,608 28,774 28,774 28,774 28,774 Total equity capital 266,252 271,654 280,423 306,580 332,738 361,782 360,041 373,498 390,916 409,334 Share warrant 204 428 658 899 1,180 1,518 1,859 1,859 1,859 1,859 Minority interests 5,494 5,512 5,575 7,546 8,381 6,551 9,786 8,786 8,786 8,786 Total net assets 271,950 277,594 286,656 315,025 342,299 369,851 371,688 384,143 401,561 419,979 Total liabilities & net assets 408,410 409,748 414,717 446,132 479,469 512,743 553,068 566,699 594,893 606,310

FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E (Changes in net assets) Beginning balance 285,568 271,950 277,594 286,656 315,025 342,299 369,851 371,688 384,143 401,561 Capital stock 0 0 0 0 0 0 0 0 0 0 Capital surplus -1,339 0 0 0 0 1 -240 0 0 0 Net profits 20,496 20,756 18,538 18,855 19,268 18,505 26,884 22,100 26,600 27,600 Dividends from surplus -6,008 -7,764 -8,302 -8,280 -8,295 -8,279 -8,279 -8,642 -9,182 -9,182 Treasury stock -6,093 55 -1,462 57 88 26 -14,152 0 0 0 Valuation and translation adjustments 5,251 -7,627 -76 16,171 19,552 19,283 -7,834 0 0 0 Minority interests -446 18 63 1,971 835 -1,830 3,235 -1,000 0 0 Other -25,479 206 301 -405 -4,174 -154 2,223 -3 0 0 Final balance 271,950 277,594 286,656 315,025 342,299 369,851 371,688 384,143 401,561 419,979 Source: Company data, Credit Suisse estimates

Food Industry 112 30 August 2016

Figure 22: Consolidated profit and loss and cash flow statements (¥mn) FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E Sales revenue 371,178 374,932 380,674 382,793 417,620 431,575 468,084 498,000 515,000 530,000 COGS 203,037 203,203 213,707 211,347 231,310 242,916 260,496 274,000 282,000 290,000 Gross profit 168,141 171,729 166,967 171,446 186,310 188,659 207,587 224,000 233,000 240,000 SG&A 140,800 137,192 140,756 147,492 158,605 164,359 181,188 196,000 198,000 204,000 OP 27,341 34,537 26,211 23,954 27,705 24,300 26,399 28,000 35,000 36,000 Interest income and dividend 2,911 2,675 2,645 2,672 2,980 2,764 2,343 2,500 2,500 2,500 Interest expense 198 214 217 213 250 247 343 300 300 300 equity in net income of affiliates 1,471 1,510 1,146 1,888 2,153 2,929 2,781 2,200 2,400 2,400 Other 1,269 -2,090 -1,686 2,663 2,252 3,234 -449 -1,000 0 0 RP 32,794 36,418 28,099 30,964 34,840 32,980 30,733 31,400 39,600 40,600 Extraordinary gains 136 1,004 6,035 877 3,492 3,090 12,811 500 0 0 Etrtraordinary losses 1,776 2,739 2,514 2,449 6,607 7,056 6,566 1,500 1,000 1,000 Pretax profit 31,154 34,683 31,620 29,392 31,725 29,014 36,978 30,400 38,600 39,600 Income taxes 10,271 13,596 12,887 10,195 12,435 10,296 10,091 8,200 11,900 11,900 Minority interests 388 329 193 343 20 214 2 100 100 100 NP 20,496 20,756 18,538 18,855 19,268 18,505 26,884 22,100 26,600 27,600 Tax rate 33.0% 39.2% 40.8% 34.7% 39.2% 35.5% 27.3% 27.0% 30.8% 30.1% Depreciation expense 9,577 12,827 14,955 14,344 14,516 15,439 17,499 16,000 17,000 18,000 Capital expenditure 18,447 30,810 18,936 21,582 27,527 27,527 32,785 44,000 40,000 35,000 R&D expense 3,806 4,081 4,384 4,320 5,313 6,431 7,183 7,000 7,000 7,000 To sales ratio (%) CGS 54.7 54.2 56.1 55.2 55.4 56.3 55.7 55.0 54.8 54.7 Gross profit 45.3 45.8 43.9 44.8 44.6 43.7 44.3 45.0 45.2 45.3 OP 7.4 9.2 6.9 6.3 6.6 5.6 5.6 5.6 6.8 6.8 NP 5.5 5.5 4.9 4.9 4.6 4.3 5.7 4.4 5.2 5.2 YoY (%) Sales revenue 2.5 1.0 1.5 0.6 9.1 3.3 8.5 6.4 3.4 2.9 Gross profit 5.3 2.1 -2.8 2.7 8.7 1.3 10.0 7.9 4.0 3.0 OP 16.1 26.3 -24.1 -8.6 15.7 -12.3 8.6 6.1 25.0 2.9 RP 14.1 11.1 -22.8 10.2 12.5 -5.3 -6.8 2.2 26.1 2.5 Pretax profit 33.3 11.3 -8.8 -7.0 7.9 -8.5 27.4 -17.8 27.0 2.6 NP 29.0 1.3 -10.7 1.7 2.2 -4.0 45.3 -17.8 20.4 3.8

FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E (Operating activities) NP 20,496 20,756 18,538 18,855 19,268 18,505 26,884 22,100 26,600 27,600 Depreciation(+) 9,577 12,827 14,955 14,344 14,516 15,439 17,499 16,000 17,000 18,000 Account receivable(-) 850 -3,519 635 -582 -4,226 -3,193 -6,900 -253 -1,973 -837 Inventories(-) 754 178 -3,213 -1,845 -1,607 -2,110 -4,100 445 -1,142 -224 Account payable(+) -2,763 1,022 3,454 -1,224 -191 1,435 6,428 -139 1,819 608 Minority interests(+) 388 329 193 343 20 214 2 100 100 100 Other 12,946 -825 -812 4,042 4,586 2,992 -849 0 0 0 Operating cashflow 40,777 29,258 32,604 32,045 30,213 30,353 36,183 36,052 40,004 42,846 (Investing activities) Capital expenditures(-) -15,275 -32,328 -19,187 -21,078 -21,068 -15,068 -39,136 -44,000 -40,000 -35,000 Other 12,936 -1,112 6,356 -10,173 11,561 10,228 -6,623 0 0 0 Investing cashflow -2,339 -33,440 -12,831 -31,251 -9,507 -4,840 -45,759 -44,000 -40,000 -35,000 (Financing activities) Debt (+) 2,025 3,131 478 -1,590 446 -1,366 17,582 -2,389 5,102 -11,618 Dividends (-) -6,008 -7,764 -8,302 -8,280 -8,295 -8,279 -8,279 -8,642 -9,182 -9,182 Other -34,126 -77 -1,618 -200 -676 1,623 -12,313 0 0 0 Financing cashflow -38,109 -4,710 -9,442 -10,070 -8,525 -8,022 -3,010 -11,031 -4,080 -20,800 (Cash & cash equivalents) Increases 329 -8,892 10,331 -9,276 12,181 17,491 -12,586 -18,979 -4,076 -12,953 Beginning balance 83,549 89,957 73,492 78,435 70,416 91,648 113,518 90,914 78,938 83,216 Final balance 83,878 81,065 83,823 69,159 82,597 109,139 100,932 71,935 74,862 70,263 Adjustments 6,079 -7,573 -5,388 1,257 9,051 4,379 -10,018 7,003 8,354 8,509 Source: Company data, Credit Suisse estimates

Food Industry 113 30 August 2016

Figure 23: Financial indicators FY03/10 FY03/11 FY03/12 FY03/13 FY03/14 FY03/15 FY03/16 FY03/17E FY03/18E FY03/19E (Safety) Current ratio (%) 176.9 164.4 167.1 150.0 174.5 195.6 145.9 284.0 139.5 145.8 Quick ratio (%) 151.6 137.6 137.5 120.1 142.7 163.1 116.4 223.4 110.0 114.3 Fixed ratio (%) 94.9 97.8 93.8 97.7 91.6 86.0 100.6 103.9 104.6 103.5 Interest-bearing debt (¥mn) 12,817 15,948 16,426 14,836 15,282 13,916 31,498 29,109 34,211 22,593 Average debt interest rate (%) 1.7 1.5 1.3 1.4 1.7 1.7 1.5 1.0 0.9 1.1 Dependence on debt (%) 3.1 3.9 4.0 3.3 3.2 2.7 5.7 5.1 5.8 3.7 Net debt (¥mn) -77,140 -57,544 -62,009 -55,580 -76,366 -99,602 -59,416 -49,829 -49,005 -56,178 Equity capital ratio (%) 65.2 66.3 67.6 68.7 69.4 70.6 65.1 65.9 65.7 67.5 D/E ratio (%) 4.8 5.9 5.9 4.8 4.6 3.8 8.7 7.8 8.8 5.5 Long-term debt ratio (%) 78.2 82.4 79.8 52.8 65.3 71.1 41.4 92.8 54.3 78.1 Working capital (¥mn) 67,722 56,472 60,950 48,865 74,652 98,480 60,038 115,818 52,692 57,445 Net interest expense (¥mn) 2,713 2,461 2,428 2,459 2,730 2,517 2,000 2,200 2,200 2,200 Cash plus marketable securities (¥mn) 89,957 73,492 78,435 70,416 91,648 113,518 90,914 78,938 83,216 78,772 Interest coverage ratio (x) 152.79 173.89 132.98 125.00 122.74 109.57 83.80 101.67 125.00 128.33 Financial leverage (x) 1.53 1.51 1.48 1.46 1.44 1.42 1.54 1.52 1.52 1.48 A/R to A/P ratio (%) 107.9 113.8 103.6 107.8 118.0 121.4 119.6 120.4 120.0 120.2 Dividend on equity (%) 2.2 2.9 3.0 2.8 2.6 2.4 2.3 2.4 2.4 2.3 (Profitability) ROE (%) 7.5 7.7 6.7 6.4 6.0 5.3 7.4 6.0 7.0 6.9 ROA (%) 6.7 8.4 6.4 5.6 6.0 4.9 5.0 5.0 6.0 6.0 Inventory turnover ratio (x) 25.0 26.1 23.9 20.8 20.7 19.6 18.6 18.5 18.9 18.9 A/R turnover ratio (x) 8.4 8.3 8.1 8.2 8.5 8.2 8.1 8.1 8.2 8.3 A/P turnover ratio (x) 8.9 9.2 8.8 8.6 9.6 9.8 9.7 9.7 9.9 9.9 Inventory turnover ratio (x) 3.5 3.2 3.0 2.9 3.0 2.9 3.0 2.7 2.5 2.3 Inventory turnover days (days) 14.6 14.0 15.2 17.6 17.6 18.6 19.6 19.7 19.3 19.3 A/R turnover days (days) 43.3 44.2 44.9 44.6 43.0 44.7 45.2 45.1 44.4 44.1 A/P turnover days (days) 41.1 39.8 41.4 42.2 38.1 37.4 37.5 37.6 36.9 36.7 Sales per employee (¥mn) 50.2 50.4 50.6 49.9 51.6 50.4 46.9 44.5 46.0 47.3 OP per employee (¥mn) 3.7 4.6 3.5 3.1 3.4 2.8 2.6 2.5 3.1 3.2 (Per share data) EPS (¥) 177.0 187.6 168.0 171.1 174.8 167.9 245.5 204.6 246.2 255.5 BPS (¥) 2,406.3 2,454.7 2,545.3 2,782.2 3,018.8 3,282 3,333 3,457 3,619 3,789 Sales per share (¥) 3,206 3,388 3,449 3,474 3,789 3,915 4,275 4,610 4,767 4,906 Operating cashflow per share (¥) 352.2 264.4 295.4 290.8 274.1 275.4 330.4 333.7 370.3 396.6 DPS (¥) 60.0 70.0 75.0 75.0 75.0 75.0 80.0 80.0 85.0 85.0 Dividend ratio (%) 33.9 37.3 44.7 43.8 42.9 44.7 32.6 39.1 34.5 33.3 (Growth) EPS growth (%) 36.2 6.0 -10.4 1.9 2.2 -4.0 46.2 -16.7 20.4 3.8 BPS growth (%) 5.2 2.0 3.7 9.3 8.5 8.7 1.6 3.7 4.7 4.7 Total assets growth (%) -0.1 0.3 1.2 7.6 7.5 6.9 7.9 2.5 5.0 1.9 Sustainable growth rate (%) 5.0 4.8 3.7 3.6 3.4 2.9 5.0 3.7 4.6 4.6 (Investment profitability) Capital invested (¥ mn) 314,623 316,152 317,617 339,876 369,739 401,645 410,535 412,824 450,791 470,344 NOPAT (¥ mn) 20,164 20,646 15,209 18,618 19,524 19,653 20,892 21,324 25,870 26,861 ROIC (%) 6.4 6.5 4.8 5.5 5.3 4.9 5.1 5.2 5.7 5.7 WACC (%) 3.1 3.1 3.1 3.1 3.1 3.1 3.0 3.0 3.0 3.0 EVA (¥ mn) 10,472 10,979 5,512 8,190 8,152 7,251 8,655 9,040 12,564 12,591 EVA spread (%) 3.3 3.5 1.7 2.4 2.2 1.8 2.1 2.2 2.8 2.7 (Cashflow) EBITDA (¥mn) 36,918 47,364 41,166 38,298 42,221 40,639 45,098 45,200 53,200 55,200 EBITDA margin (%) 9.9 12.6 10.8 10.0 10.1 9.4 9.6 9.1 10.3 10.4 FCF (¥mn) 38,438 -4,182 19,773 794 20,706 25,513 -9,576 -7,948 4 7,846 Operating C/F to Investment C/F rate (%) 1743.4 87.5 254.1 102.5 317.8 627.1 79.1 81.9 100.0 122.4 (Other) Employees numbers 7,388 7,505 7,533 7,822 8,357 8,767 11,200 11,200 11,200 11,200 Consolidated subsidiaries numbers 43 43 43 44 45 49 54 54 54 54 Equity method affiliates numbers 2 3 3 4 5 5 4 4 4 4 Average shares outstanding (mn) 115.8 110.7 110.4 110.2 110.2 110.2 109.5 108.0 108.0 108.0 End-of-period shares outstanding (mn) 110.7 110.7 110.2 110.2 110.2 110.2 108.0 108.0 108.0 108.0 Source: Company data, Credit Suisse estimates

Food Industry 114 30 August 2016

Companies Mentioned (Price as of 29-Aug-2016) Ajinomoto (2802.T, ¥2,265, NEUTRAL, TP ¥2,400) Asahi Group Holdings (2502.T, ¥3,409) Calbee (2229.T, ¥4,020) Ezaki Glico (2206.T, ¥5,520) Fujiya (2211.T, ¥200) House Foods Grp (2810.T, ¥2,245) Kewpie (2809.T, ¥2,969) Kikkoman (2801.T, ¥3,350, NEUTRAL, TP ¥3,400) Kotobuki Spirits (2222.T, ¥2,194) MEGMILK SNOW BRD (2270.T, ¥3,320) Meiji Holdings (2269.T, ¥9,400, OUTPERFORM, TP ¥10,500) Morinaga & Co (2201.T, ¥823, OUTPERFORM, TP ¥1,000) Morinaga Milk (2264.T, ¥677, OUTPERFORM, TP ¥850) Nippon Meat Packers (2282.T, ¥2,271) Nisshin Seifun Group (2002.T, ¥1,493) Nissin Foods Holdings (2897.T, ¥5,830, NEUTRAL, TP ¥5,800) Otsuka Pharmaceutical (Unlisted) Suntory Beverage & Food (2587.T, ¥4,155) Toyo Suisan (2875.T, ¥4,240, NEUTRAL, TP ¥4,300) UHA Mikakuto (Unlisted) Yakult Honsha (2267.T, ¥4,740, UNDERPERFORM, TP ¥4,200) Yamazaki Baking (2212.T, ¥2,361) Refer to Figures 24, 33, 34 and 36 for other companies mentioned

Disclosure Appendix Important Global Disclosures I, Masashi Mori, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for Ajinomoto (2802.T)

2802.T Closing Price Target Price Date (¥) (¥) Rating 02-Oct-13 1,300 1,400 N 24-Feb-14 1,557 1,500 18-Apr-14 1,526 NR * Asterisk signifies initiation or assumption of coverage.

NEUTRAL N O T RAT ED

3-Year Price and Rating History for Kikkoman (2801.T)

2801.T Closing Price Target Price Date (¥) (¥) Rating 18-Apr-14 1,985 NR * Asterisk signifies initiation or assumption of coverage.

N O T RAT ED

Food Industry 115 30 August 2016

3-Year Price and Rating History for Nissin Foods Holdings (2897.T)

2897.T Closing Price Target Price Date (¥) (¥) Rating 18-Apr-14 4,735 NR * Asterisk signifies initiation or assumption of coverage.

N O T RAT ED

3-Year Price and Rating History for Toyo Suisan (2875.T)

2875.T Closing Price Target Price Date (¥) (¥) Rating 20-Nov-13 2,956 3,600 O 18-Apr-14 3,260 NR * Asterisk signifies initiation or assumption of coverage.

OUTPERFORM N O T RAT ED

3-Year Price and Rating History for Yakult Honsha (2267.T)

2267.T Closing Price Target Price Date (¥) (¥) Rating 25-Sep-13 4,870 5,000 N 18-Apr-14 5,250 NR * Asterisk signifies initiation or assumption of coverage.

NEUTRAL N O T RAT ED

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian

Food Industry 116 30 August 2016 ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.

Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward.

Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

Credit Suisse's distribution of stock ratings (and banking clients) is:

Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 54% (50% banking clients) Neutral/Hold* 30% (23% banking clients) Underperform/Sell* 16% (44% banking clients) Restricted 0% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

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Target Price and Rating Valuation Methodology and Risks: (12 months) for Ajinomoto (2802.T)

Method: We derive our ¥2,400 target price for Ajinomoto by applying a P/E of roughly 25x to our FY3/17 EPS estimate (adjusted for goodwill amortization, etc). As Japan's leading food company, we expect Ajinomoto to continue recording steady growth in earnings (excluding the impact of forex, input price swings and other uncertainties). However, we think Ajinomoto's share price fully reflects all currently expected positives and do not see any significant improvements in profitability or capital efficiency in the near term. Consequently, we think the Japan food sector (Ajinomoto, Meiji Holdings, (2269), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) average multiple represents fair value for Ajinomoto. We base our NEUTRAL rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months. Risk: Upside risks to our ¥2,400 target price and our NEUTRAL rating for Ajinomoto include: (1) greater-than-expected margin improvement at the domestic operation; (2) higher sales in Southeast Asia, driven by premiumization; and (3) swifter growth in sales of core products in the Americas (US, Brazil). Downside risks are: (1) escalating competition in Japan and Southeast Asia; (2) weaker demand for frozen foods in the US; and (3) a steeper-than-expected rise in input costs.

Food Industry 117 30 August 2016

Target Price and Rating Valuation Methodology and Risks: (12 months) for Kikkoman (2801.T) Method: Our ¥3,400 target price for Kikkoman is based on a fair P/E of roughly 33x (10-year average) applied to our adjusted FY3/17 EPS estimate. The shares look overvalued, but multiples are likely to remain high for the time being as the long-term investment theme should remain intact – the company offers good prospects for stable growth from high-quality soy sauce and Japanese food wholesaling, supported by the global boom in Japanese cuisine. Upside potential looks limited, as the stock is trading on an EV/EBITDA multiple one standard deviation above the 10-year average. We base our NEUTRAL rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months.

Risk: Upside risks to our ¥3,400 target price and our NEUTRAL rating for Kikkoman include: (1) accelerating sales momentum in Asia as consumers trade up to higher value products, (2) rapid growth in soy sauce use across Latin America, and (3) larger-than-expected cost savings in the domestic business. Downside risks include: (1) the end of the boom in Japanese cuisine, (2) rapid gains for the yen, and (3) steeper-than-expected increases in raw material prices.

Target Price and Rating Valuation Methodology and Risks: (12 months) for Meiji Holdings (2269.T) Method: Our ¥10,500 target price for Meiji Holdings is based on a fair P/E of roughly 25x applied to our FY3/17 EPS estimate. While we believe that earnings momentum and the upbeat market environment justify a premium to the sector average, the high current valuation makes this unlikely for now. We therefore use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings, Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price. We base our OUTPERFORM rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months.

Risk: Downside risks to our ¥10,500 target price and OUTPERFORM rating for Meiji Holdings include: (1) rapidly slowing growth for probiotic yoghurt, (2) intensifying competition in the yoghurt market, and (3) a contraction in demand for powdered milk and sports nutrition supplements.

Target Price and Rating Valuation Methodology and Risks: (12 months) for Morinaga & Co (2201.T) Method: We derive our ¥1,000 target price for Morinaga & Co. by applying a P/E of roughly 25x (food sector average) to our FY3/17 EPS estimate. Although its market cap and liquidity remain low, Morinaga's profit momentum is high relative to its peers, and as we see the company continuing to benefit from its structural reforms for some time, we apply the Japan food sector average multiple. We use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings (2269), Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Food Holdings (2897), Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price. We base our OUTPERFORM rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months.

Risk: Downside risks to our ¥1,000 target price and NEUTRAL rating for Ajinomoto include: (1) a loss of sales momentum for core products in Japan; (2) heightened competition in the US and Indonesia; and (3) higher-than-projected input costs. Target Price and Rating Valuation Methodology and Risks: (12 months) for Morinaga Milk (2264.T)

Method: Our ¥850 target price for Morinaga Milk is based on a fair P/E of roughly 23x applied to our FY3/17 EPS estimate. We expect profits to grow at a double-digit pace over the medium term as the company steps up its management focus on profit margins. Morinaga Milk has lagged other Japanese food companies in improving margins and capital efficiency, but we think recent initiatives will have a positive impact. We therefore use a multiple that is one standard deviation above the company's 10-year average. Our multiple is below the food sector average, but we view that as fair given Morinaga's relatively weak financial indicators versus peers. We base our OUTPERFORM rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months. Risk: Downside risks to our ¥850 target price and our OUTPERFORM rating for Morinaga Milk include (1) a rapid slowdown in Japan’s yoghurt market, (2) weak growth in B-to-B ingredient operations, and (3) higher-than-expected raw material prices.

Target Price and Rating Valuation Methodology and Risks: (12 months) for Nissin Foods Holdings (2897.T)

Method: Our ¥5,800 target price for Nissin Foods Holdings is based on a fair P/E of roughly 25x (average for Japanese food sector) applied to our FY3/17 EPS estimate. We use the market cap weighted average FY1E P/E (based on median values of Bloomberg consensus estimates) for the Japanese food sector average (Meiji Holdings (2269), Ajinomoto (2802), Yakult (2267), Kikkoman (2801), Nissin Foods Holdings, Toyo Suisan (2876), NH Foods (2282), Yamazaki Baking (2212), Calbee (2229), Nissin Seifun (2002)) to set our target price. We forecast double-digit OP growth over the medium term. However, we use the sector-average P/E because Nissin's aggressive plans for market

Food Industry 118 30 August 2016

expansion could lead to a larger-than-expected increase in upfront investment costs. Our multiple is slightly lower than the company's 10- year average plus one standard deviation. We base our NEUTRAL rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months. Risk: Upside risks to our ¥5,800 target price and NEUTRAL rating for Nissin Foods Holdings include: (1) accelerating growth in domestic operations, (2) rising sales momentum in China as consumers trade up to higher value products, and (3) wider-than-expected uptake of instant cup noodles in Brazil. Downside risks include: (1) intensifying competition in the domestic market, (2) an accelerating slump in demand in Asia, and (3) steeper-than-expected increases in raw material prices. Target Price and Rating Valuation Methodology and Risks: (12 months) for Toyo Suisan (2875.T)

Method: Our ¥4,300 target price for Toyo Suisan is based on a fair P/E of roughly 21x applied to our FY3/17 EPS estimate. We think investors will continue to tolerate relatively high multiples for stocks in the defensive food sector. However, although Toyo Suisan is likely to generate stable profit growth, we see little prospect of a rapid rise in profits. Also, with consumers worldwide switching to healthier lifestyles, we think the instant noodle category lacks investment appeal at the moment. Our multiple is the 10-year average plus one standard deviation, but is below the average for the Japanese food sector of 25x, in light of the above factors. We base our NEUTRAL rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months. Risk: Upside risks to our ¥4,300 target price and our NEUTRAL rating for Toyo Suisan include (1) a rapid turnaround in sales in the US and Mexico, (2) renewed growth in the instant noodle market in Japan due to deteriorating consumer confidence, and (3) lower-than-expected prices for key raw materials such as wheat and cooking oil. Downside risks include (1) contraction in the instant noodle market as consumers become more health conscious, (2) deteriorating margins in North America due to intensifying competition in the food retail market, and (3) rapid gains for the yen. Target Price and Rating Valuation Methodology and Risks: (12 months) for Yakult Honsha (2267.T) Method: We derive our ¥4,200 target price for Yakult Honsha by applying a P/E of roughly 28x to our FY3/17 EPS estimate. For now we see little sign of the previous share price premium being restored, in view of lackluster growth at the overseas beverages business, and the outlook for more tough times at the pharmaceutical business. Our fair-value P/E is one standard-deviation below Yakult Honsha’s average for the past ten years, and close to the Japan food sector average. We base our UNDERPERFORM rating on our expectations for total returns and comparisons with our coverage universe over the next 12 months. Risk: Upside risks to our ¥4,200 target price and our UNDERPERFORM rating for Yakult Honsha include: (1) renewed growth in the China business; (2) greater-than-expected expansion in Brazil, Mexico and other Latin American markets; (3) margin improvement in Japan; (4) sharply higher sales of generics at the pharmaceutical business; and (5) further softening in input costs.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections.

See the Companies Mentioned section for full company names The subject company (2897.T, 2502.T) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse provided investment banking services to the subject company (2897.T) within the past 12 months. Credit Suisse has received investment banking related compensation from the subject company (2897.T) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (2269.T, 2801.T, 2802.T, 2897.T, 2502.T, 2229.T, 2587.T) within the next 3 months.

For other important disclosures concerning companies featured in this report, including price charts, please visit the website at https://rave.credit- suisse.com/disclosures or call +1 (877) 291-2683. For a history of recommendations for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to https://rave.credit-suisse.com/disclosures/view/report?i=245447&v=-2t93te5dxznft2rmsw4fdgm00 . Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares.

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