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