Launching Coverage of Ajinomoto With Narrow Moat and Stable Moat Trend Ratings, FVE of JPY 2,500

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Equity Bottom-Up

Narrow-moat <a href="https://www.smartkarma.com/entities/8911" target="_blank" data-smartkarma-citation="entities:8911:1">Ajinomoto Co Inc (2802 JP)</a>'s second-quarter results improved quarter on quarter, with sales (up 7.5%) largely in line with our estimate while profits (up 9.3%) came in a touch above our expectations. In contrast to the first-quarter profit growth, driven by the moaty domestic food business, second-quarter profits were boosted by a recovery in the no-moat life support and healthcare segments. The results support our thesis, which calls for continuous margin expansion in the moaty domestic food business. On the contrary, profit contribution driven by expansion of overseas frozen-food sales (a growth driver in our assumptions) might not be realized until 2018. Given that sales and profits seem on track to meet our estimates and its guidance, we maintain our full-year forecasts and our fair value estimate of JPY 2,500.Gross margins contracted 36 basis points, mainly stemming from a deteriorated mix resulting from increased sales contribution from overseas food and animal nutrition sales, in addition to a contraction in domestic food margins. On the other hand, reduced administrative and research and development expenses helped lift operating margins. We expect a catch-up in lucrative healthcare sales in the second half to mitigate the gross margin gap, although the ongoing depreciation of the Japanese yen may remain a drag on the domestic food business' gross margins in the short term.The growth prospects of Ajinomoto's overseas consumer business in Thailand, the largest overseas market, remains clouded. While sales of instant noodles have recovered, its Birdy coffee beverage products continued struggling in the second quarter with an estimated high-single-digit decline. A 10% tax hike on ready-to-drink, or RTD, coffee products, which took effect in September, further depressed margins.Despite Ajinomoto’s plan to pass on taxes to consumers in November, we are concerned that the tax hike may curb consumption of RTD coffee products or steer demand towards three-in-one products, causing a drop in sales and hindering margin improvement. Ajinomoto holds a 55% share in RTD coffee beverages in Thailand.The overseas frozen food business, an area in which we see long-term growth potential, has seen some positive signs in terms of sales progress. The rollout of the Japanese frozen-food line seems to have got off to a good start in France, while Windsor’s new product launches in the U.S. retail channel saw solid 6% growth. While the factory location has caused production delays and boosted production costs, we expect costs to be normalized after the new plant commences operation in the fourth quarter.Analyst: Jeanie Chen

Narrow-moat Ajinomoto Co Inc (2802 JP)'s second-quarter results improved quarter on quarter, with sales (up 7.5%) largely in line with our estimate while profits (up 9.3%) came in a touch above our expectations. In contrast to the first-quarter profit growth, driven by the moaty domestic food business, second-quarter profits were boosted by a recovery in the no-moat life support and healthcare segments. The results support our thesis, which calls for continuous margin expansion in the moaty domestic food business. On the contrary, profit contribution driven by expansion of overseas frozen-food sales (a growth driver in our assumptions) might not be realized until 2018. Given that sales and profits seem on track to meet our estimates and its guidance, we maintain our full-year forecasts and our fair value estimate of JPY 2,500.Gross margins contracted 36 basis points, mainly stemming from a deteriorated mix resulting from increased sales contribution from overseas food and animal nutrition sales, in addition to a contraction in domestic food margins. On the other hand, reduced administrative and research and development expenses helped lift operating margins. We expect a catch-up in lucrative healthcare sales in the second half to mitigate the gross margin gap, although the ongoing depreciation of the Japanese yen may remain a drag on the domestic food business' gross margins in the short term.The growth prospects of Ajinomoto's overseas consumer business in Thailand, the largest overseas market, remains clouded. While sales of instant noodles have recovered, its Birdy coffee beverage products continued struggling in the second quarter with an estimated high-single-digit decline. A 10% tax hike on ready-to-drink, or RTD, coffee products, which took effect in September, further depressed margins.Despite Ajinomoto’s plan to pass on taxes to consumers in November, we are concerned that the tax hike may curb consumption of RTD coffee products or steer demand towards three-in-one products, causing a drop in sales and hindering margin improvement. Ajinomoto holds a 55% share in RTD coffee beverages in Thailand.The overseas frozen food business, an area in which we see long-term growth potential, has seen some positive signs in terms of sales progress. The rollout of the Japanese frozen-food line seems to have got off to a good start in France, while Windsor’s new product launches in the U.S. retail channel saw solid 6% growth. While the factory location has caused production delays and boosted production costs, we expect costs to be normalized after the new plant commences operation in the fourth quarter.Analyst: Jeanie Chen

A Rebound in Growth for Ajinomoto Driven by Recovery of No-Moat Businesses