Nippon Paint Holdings Co., Ltd. (4612) Earnings Call Transcript

Thank you very much for waiting. Now we would like to begin the telephone conference for fiscal year 2025 second quarter financial results of Nippon Paint Holdings. In this telephone conference, a simultaneous interpretation between Japanese and English is provided. Wakatsuki-san, Tanaka-san, the floor is yours.

Thank you, and hello, everyone. I am Wakatsuki, Co-President of Nippon Paint Holdings. Thank you so much for your attendance today despite your busy schedules. I will now explain the highlights of our financial results for the second quarter of FY 2025. We're also joined by the media today. First, Page 3. This is a summary of the second quarter of 2025. As you can see, on Tanshin basis, revenue was JPY 446.7 billion. After adjusting for the change in the trading business model in China, it grew by 5.7%. Operating profit was JPY 69.7 billion, growing by 36.2%, and they are new record highs. As for new consolidation, India and AOC contributed 3 months' worth of results, and margins also improved by 3.8 points, partly due to AOC's contribution. While the exchange rate impact on revenue was a significant negative of 9% year-on-year, as you can see on bottom right, which is JPY 38.8 billion impact in revenue and JPY 5.2 billion impact on OP, the 14% contribution from India and AOC more than offset this. In OP, it had JPY 18.1 billion impact; and revenue, [ JPY 60.43 billion impact ], where contributions were made. And these highlighted the positive aspects of our Asset Assembler model. Overall, as indicated in the summary on this page at the top, market conditions globally were not favorable. Especially considering the period was from April to June, the environment was highly volatile centered on the negative sentiment caused by the Trump tariffs. Our group strictly controlled prices, costs and sales management expenses across all regions, refrained from aggressive sales expansion, which led to moderate revenue, improved margins compared to our initial forecast and satisfactory numbers in terms of profit, which is our top priority. On a non-GAAP basis, that is excluding the impact of foreign exchange and one-off factors, revenue growth was plus 0.6%, operating profit was plus 6.9%, margin improved by 1 point. China decorative TUC saw an 11% decline in revenue, making the first decline since the current classification was introduced. This was primarily due to the extremely challenging market conditions as well as the impact of our efforts to strengthen credit management levels, including accounts receivable and market inventory levels. Including TUB, market continues to be in a difficult situation. But together with the strong automotive sector, we were able to significantly improve the margin and grow in terms of margin. We believe this reflects our prudent vigilance with our outlook to the market situation. Looking back on the first half, we believe that we were able to fully leverage our strength in local production for local consumption and stable products and achieved steady profit growth despite the extremely difficult environment. However, whether in decorative or industrial applications or in AOC's formulation business, we're not immune to the overall market conditions, and we expect the pressure on volumes to remain high. Looking ahead to the second half, we will continue to pursue profitable growth while carefully controlling costs. That said, we have now revised the performance guidance from the April announcement. As suggested in the regional overview on the next page, while sales are expected to be slightly more challenging compared to the April forecast, margins are generally showing an upward trend. And we aim to achieve profit and maintain sound operations. Page 4 and 5, they provide updated forecast by region. They were updated from initiatives perspective. In summary, revenue forecasts have been revised downward slightly for Japan, China, DuluxGroup Europe, the Americas and AOC. In China, while the decorative market remained challenging, the automotive market has been revised upward due to an increase in market share. On the other hand, operating margin is largely in line or slightly above the April forecast as commented on the far right. The main factors include a general decline in RMCC ratio and tight cost control. Page 6. There are regional variations in raw material trends, but no major fluctuations are expected overall. Gross profit margin is up 1.4 points year-on-year. I will skip Page 7. Page 8 gives the summary of operating results in major segments. I will elaborate further during the Q&A, but would like to briefly comment on each region. Japan segment saw weak volume in both decorative and industrial segments, while automotive and marine sales were positive, resulting in higher revenue and profit. We assume the difficult market conditions to persist for decorative and industrial segments. As noted on Page 4, full year revenue forecast was revised downward. Next, NIPSEA China was as covered earlier so I will skip. NIPSEA except China saw higher growth in both revenue and profit on a non-GAAP basis, excluding M&A, in comparison to Tanshin basis. This is mainly due to foreign exchange. Overall, including Indonesia, market conditions were not necessarily favorable. Nevertheless, higher profit is achieved, including in Turkey. As for Turkey, through sales campaign and flow-through of price increases, it is back to the growth trend for both revenue and profit even on a non-GAAP basis. Even after applying IAS 29 hyperinflation accounting on a non-GAAP basis, strong OP margin of 17.2% is achieved. But overall, it remains to be one of few highly volatile markets within our group. Dulux Pacific. Market was almost flat, but thanks to mix improvement, revenue increased and OP margin improved. The profit grew by around 6% on a non-GAAP basis. There may be some signs of improvement in market conditions such as in Australia, including rate cut. And if improvements materialize, we believe that we will be the first to benefit. As for Europe, France revenues were lower driven by market conditions, but with other areas growing, overall, profitability is improving. And revenue is almost flat in Americas. While automotive production volume declined, revenue was almost flat. We raised prices in decorative business in Q1, but as interest rate was not lowered in the U.S., demand in general declined and profit was lower for Americas, unfortunately. Finally, as per AOC, it is contributing fully for 3 months for the first time, but PPA is excluded since it is not yet finalized. Concerning market conditions, unfortunately, rate was not cut in the U.S., contrary to expectations. Demand is also weakening in Europe. On the other hand, extremely high margin is maintained, contributing significantly to credibility. PPA finalization is likely to be in Q4, at which time, 10 months of amortization since March when consolidation started, amortization will be booked for 10 months and one-off inventory step-up costs are expected. Please do bear that in mind. The amount assumed in October for PPA is included in the guidance, which remains unchanged. The amount at the moment is slightly above JPY 9 billion in total, of which onetime cost is a little over JPY 2 billion. But please note that this is subject to change after PPA finalization. Please move on to Page 9. There are two main topics. The first is the publication of the integrated report at the end of June. We were able to publish 1 month earlier than last year. The report is even more focused on investor perspective than before. We would like to continue to enhance dialogue with investors. We would appreciate your comments and feedback. The second point is what we announced at the end of June, which is the full scale operation of Tokyo Innovation Center. The other day, we held completion ceremony. We are proud of the design of the center that centralizes functions as much as possible after they were dispersed, following the company split by line of business in Japan so that the center can serve as the hub for knowledge, creation and technology. With that, I thank you for your attention and look forward to your questions.

[Operator Instructions] And now we would like to take questions from the Japanese channel. The first question is from Goldman Sachs Securities, Ikeda-san.

This is Ikeda from Goldman Sachs Securities. I have a question regarding the situation in China, I would like the latest update. So the competitors, from one aspect, while the market is growing at a high single digit in terms of TUC, but you were declining by 11%. That's a huge gap, especially you worked on credit management level. So in what level, in what cities did you work on that initiative? And in the second half, I imagine that you are assuming an improvement. So do you see this situation as a one-off factor by channel or by sell-in/sell-through? Can you please give us an update on the latest situation in China?

Ikeda-san, thank you for your question. First of all, in terms of how we look at the market situation, some competitors are making announcements and I understand the content of their announcements. The outlook by the local team is that the market is growing negatively. If you look at the heat map, it's in light blue. That is minus 5% to minus 10% negative growth while we are showing minus 11% in the results. In terms of the competitive environment, it's not that we are inferior. As I said earlier, this includes one-off factors. As I have been saying, in the TUC sector, the market has been in a difficult situation, especially given the Chinese government policy. We do not hear from the local team that the policy is affecting positively, and I think we share the same image with the local players, too. I assume Ikeda-san has some other data, too. The other point is, so we shouldn't misunderstand the big picture. And among our competitors, in the first quarter -- until the first quarter, basically, they were making a negative growth. In the second quarter of 2024, it was also negative. That's where they started, whereas we have been enjoying positive growth. So we have a difference of how we started the year. In the overall first half, that is the perspective we should have in judging the situation and also in judging the second half of the year. In terms of credit management, I would like to reserve the details, but this is mainly related to TUC distributors. Some of our customers are having larger, longer receivables. So for such customers, we decided to tighten credit control. And in terms of inventory, when the inventory level is relatively high, we decided to again perform a tighter control. So whether this is correct or not, that is another question. But in China, we are continuing to have a difficult outlook. So we are working to ensure sound operation with vigilance. Based on local decision, we have been implementing these measures and this may affect the revenue in short run. And in terms of the overall market situation, housing distribution is not improving from Tier 0 to Tier 2. And also in lower tier cities, we are having negative performance. But from Tier 0 to Tier 2, they account for 80%, so that's the majority. That is why we are exposed to a more negative impact. Overall, the other point is price competition. We have been observing price competition here and there. As our policy, as we've been saying since last year, for example, in Q3 of last fiscal year, the sentiment was negative and aggressive promotion and discount was performed but was unaccepted by the market. From our viewpoint, rather than going after market share, we would like to focus on growth with profit. So in terms of profit, we believe that we have been able to achieve a satisfactory margin level. So overall, in the second half of the year, as you pointed out, according to our current outlook, we have to achieve a significant improvement even though we have slightly reduced the full year outlook. In Q3 and Q4, we have a lower base from last year because growth rate in Q3 and Q4 were only moderate last year. So we are aiming to raise the growth rate this year. So if I were to say something, the revenue growth rate is presented, but we are focused more on securing profit. That will be our focus in the second half. So rather than chasing the revenue, I hope you can understand how we are improving the margins. So that was a long answer, but I think I covered your questions.

So in terms of credit management, it's not something that you have been mentioning. So it's becoming more apparent. Can you please tell us what has changed? And regarding the inventory level, has that been reduced to a certain extent? Is the sell-through expected to improve through the second half?

Yes. So TUC distributor receivables management is a very safe initiative. It's not that we are exposed to such risk. Normally, at the end of the year, we collect all the receivables in the TUC business. So it's not that we have individual customers with higher risk, but towards the second half of the year when we think about eventually collecting those receivables, we decided that in some regions with a longer sight of collection, there are specific regions. In such regions, we decided to perform a tighter control. So creditworthiness -- credit risk has not been -- has not increased. But given the struggling external environment, we decided to take a step ahead for the sake of sound operation. That's how I would like you to understand. And in terms of the inventory level, it's not that we are facing an abnormal inventory level all of a sudden. But distributors' inventory is not something that we want to see increased above a certain level. So we decided to take a careful -- pay careful attention. In certain regions, as I said, this is something that we've been observing in only limited regions. This must have affected the performance.

Next, from SMBC Nikko Securities, Shintani-san, please.

This is Shintani from SMBC Nikko Securities. I have a question on AOC. This time, sales forecast was slightly lowered. Market condition, as you have been describing, is such that rates remain high, housing market is struggling, but it seems to be quite persistent. But it was negative 9%. Demand is weakening. The background of the weaker demand. Any specific applications? Could you discuss where the demand is stronger and weaker in the market? With such volume decline, usually margin would also decline, but a high level of margin is maintained. And I feel that you're confident, but how are you able to maintain such a large -- high margin?

Thank you for your question. As for AOC, 70% of the sales is in the U.S. and the remainder is Europe. Asia is a small portion. In both regions, demand is rather weak. As for how we feel, on an anecdotal basis, it seems that in the U.S. as rates are expected to decline, there may be recovery. But at the moment, rates are maintained. When we look at the market, not just the housing market but construction market overall, in construction area in the United States, companies are all struggling. This is simply because of volume. It's not that we are losing market share. The market itself is declining, and therefore, our sales is also performing in a similar manner. As you know, our customers are quite diverse. And we also have a large number of customers who are not exposed to any one particular sector. So this is generally the condition of the market as a whole. As for margin, as you rightly pointed out and in a nutshell, looking at overall cost, SG&A ratio is smaller. Mainly speaking, most of the cost is raw material cost. So between RMCC and sales, the cost management is the key. And since October, I have discussed this several times, but very thoroughly, this company has a disciplined view on selling price and cost, and these two factors are controlled in a very granular fashion. As a result, as you mentioned, usually due to volume decline, because of our fixed cost, margin would decline. But since management is very lean, fixed cost burden is not impacting the margin so much. I believe that is the strength of AOC. If I were to add one other point, it should be that the strength of this company is, in terms of RMCC, when there are larger fluctuations, there should be certain opportunities. But the current situation is that there is a gradual increase or gradual decrease in RMCC and it is -- it makes it complex to negotiate with customers as a result. In the short term, some raw materials are increasing in cost and that is posing as a pressure. But looking at the revenue structure, RMCC level in relative terms is contained vis-a-vis volume. Of course, operating cost, productivity improvement, we are making enormous efforts on a daily basis. And at the same time, I'm also serving on the Board together with Goh Hup Jin, and safety level we have seen significant improvement and this is possible because of operational excellency. I think that is the testament of operational excellency, which we find encouraging. But volume is an issue and we had discussion internally, if there a pent-up demand in the U.S., is the pent-up demand significant? That is without doubt. As we discussed in October, the U.S. infrastructure requires investment in large amount in many respects. So in the medium term, our prospect for the U.S. is that -- of course, certain conditions have to be met such as lowering of the rates and we are almost certain that, that will be the case. But in the short term, it is somewhat tough. But the good news is that AOC was not included in the consolidated account, and this year AOC is contributing more fully. And in addition to cash, this is a huge positive for us. And as I have noted repeatedly, when there is volume recovery in the future, we expect to capture greater market share. And also, we look forward to increasing our market share in Europe as well. So there is much to look forward to in the future. That remains unchanged.

So regarding pent-up demand, I agree, it may be after next year. It is difficult to ascertain timing, but there may be large pent-up demand. And since your margin is very high, as top line increases, should we expect that there will be profit contribution?

Yes, I think that is correct. Operating leverage is also not in place even when revenue is increasing, which means the contribution margin is large. And of course, we will be aiming to expand further contribution margin. But once volume recovers, actual revenue and profit should also increase. So in the medium term, over the next 5 to 6 years, we believe it is well within our sight to achieve growth on the higher end of single digit, although the situation may be difficult over the short term.

Next question is from BofA Securities, Enomoto-san.

So I have a question about how I should look at the second half plan. On Page 7, when I look at the heat map, no market will grow. They're basically declining. So market recovery is not assumed in the second half plan. Is that the correct understanding? And there's one thing I would like to know about AOC. Minus 9% revenue decline year-on-year is projected and that's, on a full year basis, minus 5%. So when I only think about the second half, apparently the revenue is expected to grow. So how did you develop the second half plan?

Okay. First of all, starting from the heat map, as you just said, we are not thinking that overall market situation is favorable. Based on such assumptions, we are thinking about how we can increase market share and how we can increase profitability. Even if the market situation is bad, if we can reduce the RMCC and if we can control SG&A and if we can -- maybe not wasteful, but maybe if we can control ineffective promotional costs, we'll be able to generate profit. I don't want you to misunderstand that we will be continuing making significant investments, meaningful investments. But we will be careful not to make investments that won't contribute to the overall growth. So we are in a difficult situation. But including new consolidation, we are aiming to achieve positive growth together with sufficient profit growth. Probably from the guidance, if you do the math, you might imagine that margin is expected to decline. Of course, there will be fluctuations. In the first half it's 4 months, but AOC is contributing and PPA is excluded. In the second half, it's a 10 months' worth of PPA and one-off cost that needs to be taken into account. So first half margin post-PPA should decline slightly. Out of JPY 9 billion, JPY 2 billion is one-off, so JPY 7 billion. That means JPY 700 million per month. That's JPY 2.1 billion in 3 months. So AOC, JPY 48 billion versus JPY 2 billion or something, that means a 3-point decline or something is expected. But that is not equal to the impact on the overall performance. So that's a slight decline in the first half, and we are expecting an improvement in the second half. In terms of volume, if you look at Page 4 and 5, revenue is expected to decline. So maybe you were worried about the full year performance. But it is difficult in terms of revenue, to be honest. But we are not expecting significant decline, so it's only within the tolerable buffer. Foreign exchange, while we are facing stronger yen and it's not impacting the full year guidance, but in terms of volume, we need to rely on the market to a certain extent. But as you can see on Page 4 and 5, profit in every region is expected to achieve the initial plan or slightly above that. So we are confident that we can secure profit. Finally, about AOC, year-on-year, minus 5% is projected. This is just a referential value. This is a comparison against the previous year. So minus 5% starting from 0 of previous year. So everything is positive. But if you look at the year-on-year trend, in the second half, volume is expected to bottom out. So we are not assuming a decline in trend. As a result, the remaining 6 months' performance, if that is flat, we will be able to achieve the projected figure. That's it. Thank you.

Next, Yoshida-san from Mizuho Securities, please.

This is Yoshida from Mizuho Securities. About NIPSEA China, I have a question. In Q2, revenue increase is expected and RMCC rate improvement and cost reduction being effective, these were commented. NIPSEA China cost control, specifically what measures are you implementing or do you plan to implement?

This is not limited to NIPSEA China. Overall, when things are difficult, we have to tighten our belt. We have to make sure that we tighten our belt. For example, including CapEx, we are scrutinizing whether it is truly necessary. In controlling CapEx, we are very disciplined. In addition, let's say, for example, in China, another area that we can look at is promotion. In a way, it is similar to variable cost. And discount and promotion for both, as I mentioned earlier, in markets where these measures are not effective, we should not spend money unnecessarily. And in local market, they want to invest more. So there are differences of views. But based on our understanding of the market, and ultimately, the KPI is profitable growth for both sides, we should not lose competitiveness. We should not take measures that will lead to weaker competitiveness on the ground. But we have to be more disciplined. And operational efficiency, there are various improvements for operational efficiency. And reduction of fixed cost, efforts will be continued. And this is not only in China, but we will be revisiting all of the regions. And this is already embedded in our DNA. In such a market as China, I think we can do this even more. We have a history, and that is also the reason why we are confident about achieving profit. For example, in NIPSEA China, head count reduction is a situation not so dire as to require head count reduction. Constantly, we are reviewing our head count size and we are also taking measures to ensure that we do not have excess head count. But early retirement package that was taken in Japan, it is not that such a measure is required. But there is a quite variability in terms of head count. And this is true for all countries in the world. Even if there is vacancy, rather than replacing immediately, regarding hiring from outside, this is being scrutinized and not simply because of instructions from myself or Wee Siew Kim, but it is being tightly controlled and we are constantly reviewing the appropriate head count size. So in some regions, adjustments are made and that is always ongoing in various parts of the world. So in that sense, Mr. Yoshida, so one-off cost of several billions of yen, and then there will be a recovery of JPY 10 billion. That type of measure, it's not that we are taking a measure of that nature. Please take it that we are implementing routine measures.

The next question is from Citigroup Securities, Nishiyama-san.

This is Nishiyama from Citigroup Securities. On Page 4 and 5, I have been reading the assumptions for the projection. So roughly speaking, you are lowering the top line projection and you are willing to do cost control to secure profits. I think that's the overall policy. And regarding AOC, given the weak market, you are focused on securing margins more than other partner companies. I think that is the strength of AOC. So I would like to ask if there's anything you can learn from AOC. And it's been a couple of months since it joined the group, so have you discovered any new strength of the AOC or are there any challenges?

Thank you for the question. Well, I would say that we've seen no surprise. In this acquisition, we decided to step out of the comfort zone and we were convinced after doing a research on the strength of the company. And then we made a decision on the acquisition. So there is a good news that this assumption has not collapsed. But when you ask if we've discovered anything new, I and Wee Siew Kim made a decision for the acquisition. So we don't have any new discoveries. But in the group, we learned the granularity that they are working with and we have had a lot to learn. As we've been saying, and as I said earlier, procurement of raw materials account for a large proportion, which means that there is room for improvement. That is not only AOC's procurement, but it's also about procurement in North America or procurement of the group. When we think about the ability for procurement or channel for procurement, if we can make 1-point improvement, it will make a significant impact in terms of amount. So we have been deepening our dialogue. And the raw material market situation is favorable to us. So a potential impact is not quantified, but that is what we have been seeing. And in September, they will be visiting Japan for the first time after acquisition, and Wee Siew Kim and Japan team will join their discussion with the Board. Their stand-alone earnings power shouldn't be hindered. They are aggressive in looking for ways to improve, and we will also be collaborating with each other. This may sound vague, but we are confident that we will surely have a positive impact.

Next, Omura-san from UBS Securities, please.

This is Omura from UBS Securities. Can you hear me?

Yes, we can hear you.

Sorry, I also have a question on AOC. Looking back at the presentation material, at the time of the acquisition, the U.S. market is 70%, EMEA is 21%, Asia is 9%. And noncustomized product type of business is 30%, customized business is 70%. Right now, mainly in the U.S. market, customized and noncustomized products, between these two products, are there any developments that are different? If so, could you elaborate?

Thank you for the question. To be honest, there's not much difference. On our part, customized product ratio to be raised, of course, that is our strategy because stickiness will improve. But customized products and some commodity type of products will also have to be sold in order to achieve volume, and that will remain unchanged. Between Americas and Europe in terms of difference, customization is more advanced in Americas, and in Europe business system inversion included, there is a room for improvement. And we consider that to be an upside that will -- market be ready to accept more customized products. The U.S. is much more ready. It is a market that pays for value. And in Europe, there is a slightly more cost consciousness. And regarding added value or value, the premium payment, there may be more resistance. But at the time of the acquisition, between what we have explained at the time and now, there has not been much change. But -- and at the same time, we also would like to increase customization product. But since volume overall is not growing, it is difficult to increase customized product ratio.