Nippon Paint : Q&A SummaryPDF216KB

Nippon Paint Group Medium-Term Plan (FY2021-2023)

Progress Report Presentation Q&A Summary

(March 16, 2022)

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

Q1	You stated that you will maintain the operating profit target of 140 billion yen for FY2023. However, the current business environment is significantly different from the one prevailing when the Medium-Term Plan was announced on March 5, 2021 due to raw material price inflation, deterioration of the Chinese real estate market and other factors. What are the reasons that allow you to maintain the operating profit target of 140 billion yen in this situation. Do you have strong pricing power? Or did you achieve greater-than-expected market share gains?
A1	Our revenue targets in the Medium-Term Plan announced last year were 890 billion yen in Year 1 (FY2021) and 1,100 billion yen in Year 3 (FY2023). Our Year 1 revenue was 998.3 billion yen and our Year 2 (FY2022) revenue forecast is 1,200 billion yen. We expect to achieve our Year 3 revenue target one year early. These are better results than we expected and are attributable to the strengths of our platform (business foundation), operating leverage, and pricing power due to market share gains. However, we were seriously impacted by the higher cost of raw materials in FY2021 and are already dealing with unexpected events in FY2022, such as the Ukraine crisis and lockdowns in China due to the resurgence of the pandemic. However, I believe we can turn challenges into opportunities and beat our competitors in the medium and long term by steadily raising selling prices and improving margins due to operating leverage on higher revenue and by leveraging the strengths of our platform all the more because of this challenging environment. In fact, our strengths stood out in FY2021. As shown on page 8 of the presentation, assuming the FY2022 operating profit guidance of 115 billion yen, we will need to improve our operating profit by 25 billion yen to achieve our FY2023 guidance of 140 billion yen. Raising our operating profit margin to 13% is not the only way to achieve the operating profit growth needed. For instance, we can achieve an operating profit increase of around 25 billion yen and achieve the guidance through the combination of 10% revenue growth, which we achieved in prior years, and a 1.0pt improvement in the operating profit margin. With solid underlying paint demand, we expect to achieve an operating profit of 140 billion yen, which is in line with our initial plan, by achieving steady growth despite the current challenging environment. Our plan is to offset the impact of higher prices of raw materials, the unstable global situation, and disruptions of international logistics by leveraging the strengths of our platform.
Q2	The paint market is in a challenging environment in all regions due to raw material price inflation. Can we assume that your competitiveness has increased despite the current tough environment?
A2	Based on the concept of "Asset Assembler", the headquarters does not overly interfere with the management of Group partner companies. For instance, DuluxGroup's excellent management team knows better than anyone else how to achieve steady growth in the Australian market. By respecting the autonomy of our partner companies to a certain degree, we can let them manage their operations in an unrestricted and autonomous manner. For example, Betek Boya in Turkey will miss many opportunities under the current hyperinflation if they are required to ask headquarters for approval every time they have an opportunity. Our extremely talented management teams of partner companies have high levels of risk sensitivity, which underlies the concept of "Asset Assembler" and makes our management structure unique in the world. In addition, all management team members of the partner companies have a strong commitment not only to achieving revenue growth and market share increases but also to achieving earnings growth. This also highlights our strengths.

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

Q1

Our estimate for the Chinese decorative paints market is around RMB 85 billion. Is this consistent with your assumption shown on page 13 of the presentation? We expect that decorative paint demand for new construction, which accounts for the 2/3 of the total decorative paints market, is likely to decline in FY2022. However, you forecast GDP+α growth for this market. Please give us a breakdown of growth between the DIY and Project segments.

A1

There are many views on the size of the decorative paints market, and our assumptions are different from yours on some points. Our assumptions are that around 2/3 of overall paint demand is in the new construction segment and the remaining demand of around 1/3 is in the renovation segment. As we stated at the Investor Briefing on the NIPSEA Business in September 2021, we estimate that the market composition of these two segments is roughly 50:50 in Tier 0 and 1 cities. Our sales composition of the DIY and Project businesses is roughly 6:4 and their market shares are 27% and 9%, respectively. You can estimate based on this information that the new construction market in the Project segment is larger than the new construction and renovation markets in the DIY segment and the renovation market in the Project segment. Our FY2022 market forecast is relatively strong for DIY and soft for Project. From FY2021 to FY2023, however, urbanization and the provision of high quality housing are unlikely to suddenly stop. We forecast positive growth with an increase in per-capita paint consumption. We have revenue from decorative paints for new construction as well as from renovation. In addition, there is still DIY paint demand for newly built move-in-ready units, although this

demand is declining. By targeting this demand, we achieved 35% DIY revenue growth and 29% Project revenue growth in FY2021. We have good prospects for achieving double-digit revenue growth in FY2022.

Q2

With Project market growth slowing, are you considering changing your sales model from the perspective of risk management to distribution via distributors as your competitors do, rather than selling products directly to real estate developers? Your consolidated price/mix in FY2021 was around 5% according to page 6 of the presentation. Is this figure for NIPSEA China also close to 5%? Is your FY2022 price/mix forecast better than the FY2021 price/mix?

A2

Considering that blue-chip developers will continue to grow their businesses, we don't think we need to lower the sales ratio of developers in the Project business. We achieved strong revenue growth by increasing our market share with the top 100 developers. However, some developers have become financially constrained, which has caused our Project revenue growth to moderate temporarily. In light of the recent developments in the Project segment, we cannot avoid a slowdown of growth. On the other hand, we expect that some developers will continue to grow. We have strengthened cooperation and established strong relationships with those developers. We will prioritize improving margins in FY2022, and take a selection and concentration approach based on profitability for transactions with real estate developers and paint stores. Looking at the volumes and price/mix, most of the 29% revenue growth in FY2021 was attributable to higher volumes and the contribution of price increases was minor. We expect that more than half the revenue growth in FY2022 will be from volume growth. We will continue to raise selling prices wherever and whenever possible in order to steadily increase earnings. Our strategy is to pursue volume increases due to market share gains and continuous selling price increases.

Q3

Is it possible to raise selling prices in DIY and Project in FY2022 by roughly the same percentages? Or is it easier to raise selling prices in DIY due to its market characteristics but rather difficult to raise selling prices in Project due to the tough competitive environment?

A3

Generally speaking, it is relatively easier to raise selling prices in DIY due to the competitive environment and market characteristics. Our Chinese team raises selling prices based on agreements with customers, although with much difficulty. The overall growth of NIPSEA China's decorative paints business is the total of growth in the DIY and Project businesses. We are not satisfied with the current operating profit margin levels, but we did achieve operating profit growth. While some competitors are recording losses in the Project segment, we will further step up actions to improve margins. However, if competitors seize the opportunity to take an offensive pricing strategy, our market share may decline. We assume that the current environment in the overall Project

market in FY2022 makes an offensive pricing strategy more difficult compared to the environment in FY2019 and FY2020. Therefore, we will raise selling prices wherever and whenever we can based on agreements with customers.

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

Q1

Regarding the Net Debt/EBITDA ratio on page 34 of the presentation, your forecast for FY2023-end was 1.6x based on the Medium-Term Plan announced on March 5, 2021 and your forecast for the end of FY2022 is 4x based on the presentation. Are you going to maintain your aggressive M&A strategy? Please tell us your medium-term M&A strategy including in terms of Net Debt/EBITDA.

A1

The paint industry is relatively capex-light and has a very stable capacity to generate cash flows. Due to these characteristics, I think the probability of bankruptcy among paint manufacturers is very low and Net Debt/EBITDA is not necessarily a consideration for M&A decisions. We have secured a certain understanding on these points from financial institutions and rating agencies. Therefore, having Net Debt/EBITDA of 4x is not a reason to preclude M&A. Net Debt/EBITDA numbers are forecasts at this time and will decline in the future if operating profit increases. There was a case with a competitor. Its Net Debt/EBITDA ratio rose when it acquired another company but its stock price increased after the Net Debt/EBITDA ratio declined due to a recovery of cash flows. By taking these factors into account and maintaining close communications with financial institutions and rating agencies, we will consider obtaining financing while paying attention to financial soundness. We are confident that we can maintain strong growth. At the same time, we need to obtain the understanding of financial institutions and rating agencies. Net Debt/EBITDA ratios that allow for M&A vary depending on the situation. As a result, we have no upper limit for the Net Debt/EBITDA ratio.

Q2

Is my understanding correct that you are at the growth stage in which you utilize leverage rather than at the stage of deleveraging?

A2

We are not pursuing M&A as an objective. Rather, we will constantly pursue M&A opportunities that have growth potential and save cash and repay debt when we have no M&A deals in the pipeline. We believe the paint market that gives us added value to us will expand to the adjacency arena. Based on this assumption, we will use capital for investments to pursue growth. Needless to say, our growth is predicated on achieving Maximization of Shareholder Value (MSV).

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

Q1

Is there a change in your outlook for your margins to start improving in the 2Q of FY2022? What are your assumption for crude oil or naphtha prices when you negotiate with customers for selling price increases? Don't additional price hikes reduce demand?

A1

Our current 2Q FY2022 forecast is as of its announcement in February 2022, and uncertainties have not declined since the announcement. As a result, the timing of the margin improvement may be slightly delayed. However, we have no plan to revise our FY2022 guidance because we expect to restore the operating profit margin on a full-year basis. Yet the business environment remains challenging. Taking the Chinese business, for example, January and February are off-season and March, when demand is usually highest, was impacted by lockdowns and other restrictions. Even after considering this, we are not changing our full-year forecast. Our assumptions for naphtha prices were in the high-60,000 yen range when we announced our FY2022 guidance in February 2022. We have increased our naphtha price assumptions to the mid-70,000 yen range. This significant change in price assumptions makes it difficult to form an outlook. While the prices of raw materials for water-based paint are less correlated with naphtha prices, the cost of raw materials for solvent paint is significantly correlated with naphtha prices. Therefore, our partner companies will determine the impact of naphtha price fluctuations on our earnings based on the understanding that the naphtha price assumption in the high-70,000 yen range may not be high enough. Regarding the possibility of lower demand due to selling price increases, we anticipate that demand will be impacted by increases in wages for professional painters and prices of materials other than paint if inflation increases across the economy. The cost of paint accounts for a small percentage of the cost of DIFM and DIY. We don't expect paint demand to decline much due to selling price increases, in particular for paint purchased by consumers, such as in the DIY market in Australia. The impact of selling price increases differs from region to region because of differences in business models. We believe overall paint demand is less sensitive to prices increases.

Q2

You have recently announced selling price increases for industrial coatings and decorative paints in Japan. Don't you expect any decrease in demand due to these price increases?

A2

It's not easy to raise selling prices because we must take into account our relationships with customers. Maintaining demand is our basic premise when raising selling prices. Just as with overseas customers, raising selling prices in Japan is not easy. However, we believe the current environment is not the same as in many industries in Japan many years ago when companies could not raise prices because they were afraid that competitors would adopt an offensive pricing strategy. Now, competitors raise selling prices when costs increase more than can be