Nippon Paint : FY2021 2Q Financial Results Conference Call Q&A Summary 208KB

FY2021 2Q Financial Results Conference Call Q&A Summary

(August 10, 2021)

• Questions by Atsushi Ikeda, Goldman Sachs Japan Co., Ltd.

Q1 NIPSEA China achieved significant revenue growth in the DIY and Project segments. However, competitors are estimated to have achieved larger market share gains because their revenue growth was higher. How much of a leading position you can regain with the overall paint market growth reaching a ceiling and the focus of market growth shifting to the Project segment? You explained earlier that NIPSEA China's operating profit margin declined considerably in the 2Q and your earnings environment will continue to be challenging through the 3Q, but your operating profit margin will recover from around the 4Q. Please explain what actions you will take for profitability to recover in the current competitive environment.

A1 Our DIY business is relatively larger than competitors' DIY businesses. Therefore, it is not necessarily appropriate to compare our growth rate with those of competitors given the difference in parameters. As shown in the heat map on page 15 of the presentation, we do not think that the paint market is reaching a ceiling. The DIY market was very strong in the 2Q. In this environment, we believe our market share has increased.

As we explained on page 18 of the presentation, the overall operating profit margin at NIPSEA China, which includes the decorative paints and industrial coatings businesses, decreased by around 9 percentage points YoY. This is roughly in line with the increase in the raw materials cost contribution (RMCC) ratio. We will aggressively pursue market share gains while taking actions such as increasing prices and reducing SG&A and other expenses. Our previous forecasts may have been rather conservative, but we have revised the forecasts. As shown on page 31 of the presentation, in our revised forecast estimates, we expect growth of around 30% in both DIY and Project revenues on a full-year basis. We are aware that we cannot readily achieve these forecasts in a fairly challenging market environment. In fact, we were able to achieve steady growth in the 2Q even though the market environment was very difficult. Considering this, we believe our operating profit margin will improve from the 4Q when raw material prices are expected to stop increasing and the benefits of price increases will emerge. Our basic strategy is to increase prices where appropriate and reduce costs as necessary based on our assessment of the

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competitive environment.

Q2 Your 2Q revenue at NIPSEA China increased by around 30 billion yen YoY, while operating profit declined by around 4 billion yen. I believe the business environment is far from easy. I think the situation is different from the past when you increased prices immediately mainly in the DIY business in response to raw material price increases. Please tell me what your understanding of the business environment is. The point is whether you can actually increase prices.

A2 The difference between the business environment between the 1Q and 2Q of FY2021 is that the raw materials price increases impacted the 2Q. While the raw material price inflation already had some impact on our earnings in May, our 2Q earnings were impacted more than expected. We are taking actions such as increasing prices to mitigate the impact of raw material price inflation. However, we cannot avoid the lagging of effects of these actions. We are considering price increases in the 2H. The right timing and the workability of price increases depend on factors including our market share in individual operating regions, moves of competitors, and contracts with suppliers. Therefore, we will make decisions based on businesses and regions.

Q3 Do you think the significant decrease in the operating profit margin in the 2Q of FY2021 is only a temporary trend and that the profit margin will start improving steadily in the 3Q?

A3 We anticipate a rather challenging environment for earnings in the 2Q and 3Q. Our revised forecasts include a higher operating profit for FY2021 than in our forecast announced this February. As shown on page 39 of the presentation, we expect that our operating profit margin in FY2021 will decline from FY2020.

• Questions by Takashi Enomoto, BofA Securities Japan Co., Ltd.

Q1 Revenue in Asia excepting NIPSEA China declined slightly from the 1Q to 2Q. The operating profit margin in the region fell significantly QoQ, just as at NIPSEA China. Is this largely due to the impact of COVID or raw materials price inflation? With the impact of COVID expected to increase in Asia excepting NIPSEA China, please explain your outlook for the 3Q or the 2H.

A1 The significant decrease in the operating profit margin in this region is

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attributable to the impact of COVID and raw material price increases, as well as the recognition of one-time expenses associated with PPA of around 1.5 billion yen. Higher revenue in Asia excepting NIPSEA China contributed to a higher operating profit margin YoY in the 1Q because we were able to mitigate the impact of raw material price increases by using the inventories of low-cost raw materials purchased last year. On the other hand, our operating profit margin is being affected by raw material price inflation to a certain degree in the 2Q and 3Q. There was a resurgence of COVID infections in June, which caused lockdowns across Southeast Asia. As a result, our operations in this region were affected to some extent in the 2Q.

There is no serious collapse in real demand, and we expect that lockdowns will be partially lifted. Based on these assumptions, we forecast that our full- year earnings will exceed the results in the previous year. However, COVID had a serious impact on our earnings in the previous year. Considering this, we need to be careful when making a year on year comparison of earnings.

We believe we can achieve a sufficient earnings recovery rather than having a pessimistic outlook about our earnings in the 2H due to the impact of COVID. Our outlook is reflected in the forecast on page 36 of the presentation.

Q2 We believe demand has declined significantly due to lockdowns in Asia excepting NIPSEA China. Do you think you can increase prices amid the falling demand?

A2 Price increases are possible in areas where we have a high market share, although we need to be careful about the timing in regions where our market shares are not that high.

• Questions by Tomotaro Sano, JP Morgan Securities Co., Ltd.

Q1 I have questions about the transfer of shares in consolidated subsidiaries to the Wuthelam Group. You explained that you have call options to buy back the companies subject to the share transfer within five years. In what situations would you request a buyback of the target companies? You also mentioned that you will be entrusted by the Wuthelam Group to continue managing those companies. Will you receive considerations for this?

A1 Regarding your first question about call options, we have call options effective for five years starting one year after August 2021. The share transfer

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agreement with the Wuthelam Group contains a provision for the automatic renewal of the call options. We are not necessarily required to exercise the rights within the five-year period ending in August 2027. Our plan is to have significant investments made in the target companies within one or two years and buy back the companies when they have good prospects for an earnings recovery, rather than leaving them in the hands of the Wuthelam Group for too long. When making a decision about the buyback, the important point is to ensure we can provide a reasonable explanation to minority shareholders with respect to the mission of pursuing Maximization of Shareholder Value (MSV). Therefore, we will make a judgment based on a comprehensive assessment.

The entrustment of management will be treated as a transaction with a third party. Therefore, we will receive a certain amount of consideration from the Wuthelam Group. But the amount will not have a significant financial impact on us.

Q2 If you are to buy back the target companies when you can expect them to start contributing to MSV, that means you will not wait until the target companies have good chance of generating maximum profits. Can we assume that you will carry out the buyback within a short period?

A2 The target companies are all in a very challenging market environment. For instance, our automotive coatings business in Europe, which is undergoing restructuring, is not yet a large player in the European market. We have established various assumptions for measuring the progress of business restructuring. But I don't think it is appropriate to tell you the expected timing of a buyback. Nevertheless, I can tell you that it is unlikely that we will execute the buyback a year later, immediately after the call options become effective. Nor is it likely that we will wait for five or six years. We assume the buyback will occur sometime in-between at the right timing and at fair prices.

• Questions by Tomomi Fujita, Morgan Stanley MUFG Securities Co., Ltd.

Q1 I have questions about the share transfer of consolidated subsidiaries. Frankly speaking, the context of the transaction is not clear to me. My understanding is that this is an ideal scheme for you, with the Wuthelam Group assuming risks without pursuing profits, playing the role of the "Group Private Equity (PE)", so to speak. My concern is that your capital ownership structure will

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become complex again. From what I remember from the presentation for the acquisition of the Asian JV stake and the Indonesia business, the establishment of a simple and easy to understand governance structure was an important element of the acquisition transaction. Are you going to take measures such as this one involving the "Group PE" over and over in the future?

Another point is that the paint industry has relatively low capital expenditure requirements. If so, doesn't it make more sense for you to make investments in those companies yourself? There is a risk that the purchase prices will be higher if you buy back the target companies at a later date. Please explain why you used this complex scheme. Is it based on your judgment that the several tens of billions yen of investments required for turning around the companies are too large to bear?

A1 I don't know if the "Group PE" is the right word to use in this case. As a publicly traded company, we constantly examine whether loss-making companies have a good chance of returning to profitability and how we should support the restructuring of these companies. You have just mentioned that the paint industry has low capital expenditure requirements. At the same time latecomers in this industry face some challenges to achieve decent earnings.

The transfer price of the consolidated subsidiaries is a little more than 18 billion yen. We believe the financial impact of this transaction is small compared to the acquisition prices involving the Asian JVs and the Indonesia business of around one trillion yen and 200 billion yen, respectively. As the major shareholder with 58.7% of our shares, the Wuthelam Group says it will do what is best for our Maximization of Shareholder Value. This demonstrates how the interests of a major shareholder with 58.7% of the shares of a company with a market capitalization of 3,200 billion yen can be aligned with the interests of minority shareholders whose total shareholding is 41.3%.

We looked into various possibilities including restructuring using our own funds and the sale to a third party. In the course of exploring various alternatives, the Wuthelam Group made a decision to bear various risks, leaving us a viable option. So, we decided to accept the offer. At the same time, there were also concerns about whether the proposal really has benefits for us. In order to eliminate those concerns, we established a special committee and held discussions on the proposal. As a result, we have confirmed that the proposal is reasonable enough to convince our minority shareholders to accept

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