Nippon Paint : FY2021 3Q Financial Results Conference Call Q&A SummaryPDF195KB

FY2021 3Q Financial Results Conference Call Q&A Summary

(November 12, 2021)

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

Q1 The prices of raw materials are expected to continue to increase, in particular in China, through 1H of 2022. In the meantime, the market climate has been changing significantly in China, and I assume the prices of some product lines have fallen sharply. Please tell us whether or not there are obstacles to and the possibility of a change to the policy of passing on the higher raw material prices in the Chinese business.

A1 Regarding the procurement of raw materials in China, we have faced the issues involving the higher cost of raw materials and the significant availability issues of some raw materials due to the power supply shortages. Our policy is to continue measures to pass on the higher raw material prices to the extent possible based on the assumption that the raw material availability challenges will not be resolved anytime soon.

If we increase selling prices in the competitive Chinese market while nobody is following suit, that would undermine our competitiveness. Therefore, we will choose the right time to increase selling prices appropriately in China. In the meantime, we need to improve our operating profit margin from the 3Q level. So there is no change to our basic policy of raising selling prices.

Q2 Do you assume that the operating profit margin in the Chinese business reached a bottom in 3Q? Or do you expect downward pressure on the operating profit margin to continue in 4Q?

A2 We are taking actions to improve the operating profit margin from the 3Q level. But we are not optimistic enough to assure you that the operating profit margin stopped falling in 3Q. We are raising selling prices in China. As a result of this, our operating profit margin may improve if the prices of some raw materials decline. But this is not our assumption at this time.

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

Q1 NIPSEA China's 3Q revenue increased 21.4% YoY on a Non-GAAP basis due to the continuing market strength and the acceptance of selling price increases. On the other hand, operating profit on a Tanshin basis declined 6.3 billion yen

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from the 3Q of 2020. Considering the marginal profit from revenue growth, I think you could have reduced the operating profit decline despite the impact of the higher cost of raw materials. What is your view of the market climate in China? Wasn't your Chinese business impacted by the financial difficulties of some real estate developers? Didn't you compete based on prices against the Chinese paint manufacturers? Please tell us about the business climate for your Chinese business including market conditions.

A1 The operating profit decrease of 6.3 billion yen from the 3Q of 2020 on a Tanshin basis includes a provision. Meanwhile, operating profit declined by 4.4 billion yen on a Non-GAAP basis. The major reason for this was the significant increase in the cost of raw materials in the 3Q this year compared to the 3Q last year.

Our decorative paints revenue increased both in the Project and the DIY businesses. In particular, the DIY revenue increased 32% YoY, which was largely attributable to the increase in the sales volume. The 26% revenue growth in the Project business was mainly due to the selling price increases. In the Project business, we need to determine the right time to increase selling prices, such as when contracts are terminated or renewed and by taking into account market conditions such as the Chinese government's policy measures involving the real estate sector. As a result, the business climate is different in the DIY business and the Project business.

If the selling price increases are more widely accepted based on the premise that our competitiveness will not be undermined, I believe we can secure a sufficient operating profit. In the meantime, the competitive environment in the Chinese market is far from rosy. However, we are not in a less advantageous position than our competitors. Our scale gives us a considerable advantage over our competitors in terms of the procurement of raw materials as well. Now we are firmly positioned to survive the competition.

Q2 You have just mentioned that you increased selling prices in the Project business. Did you raise prices, say, by double-digit percentages? If so, I assume you could have reduced the operating profit downturn from the 3Q of 2020 even after taking into consideration the lower prices of raw materials in 2020.

A2 We did not increase prices by double-digit percentages. Our selling price increases include effective price increases such as by reducing discounts. Our perception is that the acceptance of selling prices increases is steadily

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progressing.

Q3 Have you been able to raise selling prices in the DIY business by the same degree as in the Project business?

A3 In the DIY business, we are increasing selling prices frequently rather than increasing prices by a large amount each time. These price increases taken together will contribute considerably to our revenue growth. For your information, the DIY revenue growth was attributable more to the increase in sales volume than to the selling price increases.

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

Q1 NIPSEA China recorded a provision of 2.7 billion yen in the 3Q of 2021. You explained in the conference call for the consolidated earnings forecast revision in October that around 20% of the operating profit decline of 16.5 billion yen was attributable to one-off expenses. Based on this information, I have estimated the amount of this provision to be around 3-4 billion yen. Do you plan to record an additional provision in 4Q or thereafter? Or, will there be no provision in addition to the 2.7 billion yen recorded in 3Q? Your 26% revenue growth in the Project business without selling price increases of around double- digit percentages leads me to assume that demand has continued to grow. In the meantime, there are concerns about the slowdown in the Chinese real estate market. Please tell us your outlook for paint demand in China in 4Q and the next year onward.

A1 In the consolidated earnings revision released in October, I explained that the one-off provision would account for around 20% of the 16.5 billion yen downward revision of the operating profit forecast for NIPSEA China. That comes to 3.3 billion yen by a simple calculation, but we recorded a provision of

2.7 billion yen in 3Q. To answer your question regarding whether or not we will record an additional provision, the provision of 2.7 billion yen is our best estimate at this time. So I cannot tell you that there will be no additional provision. This is the appropriate provision for 3Q based on an agreement with our auditors.

To give you the outlook for paint demand in China, I believe the DIY market has a more room for market share gains than the Project market does based on the YoY comparison. Our assumption is that new construction demand in the

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Project segment will slow down more or less, rather than remaining on the growth momentum that has been continuing since 2020. The important thing is to capture repainting demand such as large-scale renovation projects as much as possible.

We expect that the overall decorative paints demand in China has room to continue growing moderately in the next year and beyond. We believe we can achieve growth that outpaces the market by capturing a greater share of the growing pie.

Q2 You expect that the new construction market in China will slow down in the near future, but the overall Project market will not shrink because the repainting market will grow. And you will increase selling prices by determining the right time by monitoring the moves of competitors and aim at expanding market share. Is my understanding correct?

A2 We may be impacted by the slowdown in the new construction market with a time lag. However, our decorative paints revenue grew in 3Q despite the severe market conditions. So our strategy will be different depending on how we see the market climate. The new construction market has room for growth in the future. But we will adopt the assumption within the Nippon Paint Group is that this market's growth will be slower than in the past. We will aim at gaining market share in the repainting market by taking actions to target the demand created by repainting properties that were constructed in the late 1990s.

• Questions by Atsushi Yoshida, Mizuho Securities Co., Ltd.

Q1 The operating profit margin in the Japan segment has been consistently falling since the 1Q of 2021. Operating profit in 3Q 2021 was 1.4 billion yen, which was significantly lower than in 2020. In particular, the 3Q operating profit declined considerably compared to 2Q 2021. What are the main reasons for the sharp decrease in operating profit? I expect that lower automotive coatings revenue and the higher cost of raw materials are two reasons. Please share with us the background and other reasons for the profitability decrease. Please also give us the outlook for the Japan segment including the possibility of incurring an operating loss in 4Q.

A1 As you pointed out, we see the decrease in the profitability of the Japan

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segment as an urgent matter to deal with. Under the new organizational structure that will start in January 2022 including the establishment of Nippon Paint Corporate Solutions, we will accelerate the improvement of the profitability and efficiency of the Japan segment as a whole, including partner companies and functional departments in Japan. The main reason for the decrease in the operating profit margin in 3Q both YoY and QoQ was the impact of higher raw material prices. In addition, both variable and fixed costs increased due to an increase in personnel expenses and logistics costs. We are taking various actions to mitigate the impact of higher raw material prices to improve our operating profit margin. Unfortunately, we face higher hurdles for raising selling prices in Japan than in overseas markets including China. This holds true not only for the B2B business but also for the architectural paints business due to business practices unique to Japan. This has created downward pressure on our operating profit margin. However, we are not accepting the situation as it is. We will continue to take actions such as eliminating unnecessary fixed costs and negotiating with customers for selling price increases.

Regarding the increase in fixed costs, we are taking actions to prevent supply instabilities and disruptions, even if it requires additional costs, in order to fulfill our responsibility as a manufacturer to supply products. These measures are in all our operating regions, but these costs were somewhat higher than normal in the Japan segment in the 3Q of 2021.

We will aim at improving our operating profit margin in 4Q and thereafter because the current profit level is far from satisfactory. The management teams of the partner companies, Co-President Wee and I have discussions on a daily basis about how we can improve profitability, and we have incorporated practical ideas into our measures.

Q2 Are you going to proceed with the investment project for updating production facilities in Japan according to the plan announced in the New Medium-Term Plan? Or, are you going to revise the plan to some degree in view of the present business climate?

A2 Today we released "Notice of a Change in the Redevelopment Project for the Tokyo Office". We are also reviewing our plan for renovating production facilities in Japan. Our initial plan was to build a new head office building, but the pandemic has changed the required functions of the head office. The

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