Tsumura : Business Results for Fiscal Year 2022 Q&A

Business Results for Fiscal 2022 Q&A (for Investors) 【date】13:00-14:00, May 10, 2023

【presenter】 2 persons
President and Representative Director, CEO	Terukazu Kato
Director, and CFO	Muneki Handa
【questioner】 4 persons
Credit Suisse Securities	Fumiyoshi Sakai
SBI Securities	Ryuta Kawamura
Tokai Tokyo Research Institute	Takashi Akahane
Mitsubishi UFJ Trust and Banking	Shinichiro Hyogo

Sakai [Q]:

It appears that the forecast for FY 2023 includes a fairly sizeable forex impact. It would be great if you could explain the mechanism of the impact from forex in a little more detail. Generally speaking, a depreciation in the value of the yen is naturally a positive factor for sales. However, in the case of Tsumura, given the large volume of imported raw materials, I believe the portion of negative impact from a depreciation in the value of the yen is invariably notable. That being said, Tsumura holds on to its inventory for around two years. In light of this, the spot rate today will not necessarily readily apply to the cost of sales a year from now. What factors stacked up to equal the ¥2.4 billion you have come up? Going forward, it is unclear whether the yen will or will not continue to depreciate in value. At this point, I believe this an uncertain factor. Can you explain the manifestation mechanism? This is my first question.

Handa [A]:

The forex rate mechanism is a positive factor for sales, even if the yen depreciates in value. A rise in import expense as a part of the expense of crude drugs, which

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makes up a large portion of raw materials, is a negative factor. Then there is processing expense. This is slightly negative as there are impacting factors on the China side. As for SG&A expense, the impact is not that sizeable. The difference with FY 2022, when looking back, the average rate for the annual JPY/RMB rate, which is disclosed, for example for FY 2021, was ¥17.02/RMB. In FY 2022, the rate was ¥19.49/RMB. There isn't a big change from that point, but the crude drugs make up a large portion of raw material expenses. You mentioned the current inventory and the possible outcome a year later, and we are using forex forward contracts as a hedge against the rise in the cost of crude drugs to the best of our ability in the situation that the yen keeps weakening. Our scheme aims for a maximum coverage of around 70% of forex translations for a period of up to 1 year and up to 80%-90% in the near term, and a maximum coverage of up to but not over 50% after 2 years but less than 3 years. There was a sharp devaluation of the yen in the market from 2021 to 2022. 2022 is relatively recent, therefore, we booked many forex forward contracts. However, these contracts cover forex translations 2 and 3 years ahead from 2023. As I said, the forex forward contract coverage ratio is around 30% or even as low as 20%. We were not able to book forward contracts at a very good rate. In light of this, the impact from the spot rate will be sizeable.

I might have discussed this before. Theoretically, for every 1 yen decline in the value of the yen against the RMB, assuming the absence of forward contracts, the full impact to cost of sales will be a negative impact of around ¥1.4 billion. As I just said, this reflects the speed at which the yen depreciates in value in the market and the range of forex translations. In comparison with FY 2022, the impact from forex is likely to be considerable in FY 2023 due to this mechanism.

Sakai [Q]:

So what is your estimated forex rate, I mean your forward contract rate for 2023?

Handa [A]:

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Our estimated forex rate is ¥19 per RMB. However, this is merely our estimate. It is a spot rate and the forward rate is still slightly better than the spot rate. Conversion will not all be carried out at this rate.

Sakai [Q]:

I understand. Thank you. Also, I may have missed this but in the sales portion, but regarding the total for drug-fostering program formulations this time around, the growth in sales in this category is slightly slowing down. The growth in total sales for 119 formulations other than the drug-fostering program and growing formulations is 4.5%. Sales of growing formulations increased 10.3%. This may have been within the scope of expectations, but Tsumura is constantly claiming that the benefit from e-promotions and the expansion of the range of face-to-face sales activities by MRs is an issue. From a sales perspective, was the outcome for FY 2022 and the sales results for drug-fostering program formulations, and growing formulations, and in other areas within the scope of expectations? Or do you believe that you needed to grow drug-fostering program formulation sales a little more? Can you explain this?

Sorada [A]:

First, regarding drug-fostering program formulations, as you pointed out, we did anticipate slightly more growth. A major factor was the response to the "restricted shipments" implemented in and after the end of August, particularly as MRs scrambled to respond to inquiries from dispensing pharmacies. This was a huge point. Another factor was the substantial impact reflecting our slight ease up on e- promotions due to the implementation of restricted shipments. Sales for formulations other than for the drug-fostering program and growing formulations rose 4.5%. This likely reflects the development of the number of physicians writing 10 or more prescriptions, owing to the establishment of Kampo medicine. We believe this is serving as a foundation.

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Kawamura [Q]:

Can you give us more details of the "comings and goings" in the FY 2023 operating profit forecast for the domestic business? In your plan this time around you forecast sales growth but you released a forecast for a profit decline in the domestic business. Tsumura is one of the few companies where the NHI drug price revisions are positive factors. Even with deterrents including energy procurement costs, I have not yet convinced that profit will decline of this extent. Can you provide a further explanation of these " comings and goings? " I believe the growth investments are sizeable. It is correct to assume these are one-off items? Can you explain this?

Handa [A]:

First, we gave a simple explanation today of the content on slide 15. The negative impact from external factors in this slide totals ¥2.4 billion. This is exactly how it looks. We touched upon the uptick in cost for some wild crude drugs and the issue with Japanese peppers. The rise in the procurement cost for crude drugs is primarily attributable to an increase in cost for several crude drugs. Soaring energy and raw material costs is not just an issue with Tsumura alone. The rise in electricity and power costs is substantial. And then there was forex. As I mentioned just now, this had a negative impact of ¥2.4 billion. Our estimated forex rate is ¥19/RMB and we have few forward contracts at good rates in comparison with FY 2022. This is likely to have a considerable monetary impact.

Then there is our growth investment of ¥3.5 billion to realize our vision. This includes one-off items and also growth investments to ensure the next phase of growth. Specifically speaking, for instance, this includes research and development expense of ¥800 million. Or in relation to DX promotion I mentioned earlier, an investment of ¥900 million in a DX system. Or as for one-off items, at present we are strengthening our production and plan to proactively or limitedly acquire production personnel. This will entail an investment of ¥300 million. This includes various investments of this nature. Either way, we are planning investments that

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will support recent growth. We are therefore carefully selecting these investments.

Kawamura [Q]:

I understand. Thank you. I would additionally like to ask about wild crude drugs. I believe Tsumura has been raising the ratio of cultivated land under proprietary management by a fair degree for some time in an effort to lower the cost of the wild crude drugs it procures and stabilize costs. Wouldn't it be better to think that the procurement cost of wild crude drugs are not controllable and that in the future the cost is likely to waver around ¥1.0 billion?

Handa [A]:

Thank you for your question. Grasping these figures is slightly difficult in the market. As you pointed out, we are growing 80% or more of domesticated products are grown on cultivated land under proprietary management. The price and quality of these crude drugs are relatively stable. Naturally, the rise in prices, which will correspond to inflation in China, will surface, although somewhat lagging. As I mentioned in my presentation, we are pushing forward with the domestication of wild crude drugs. We will not domesticate all wild crude drugs but we plan to domesticate those wild crude drugs whose prices are skyrocketing and which are easily affected by the weather. It is our plan to prioritize the domestication of these wild crude drugs. Also, as I touched upon this in the topic of Japanese peppers, we plan to increase the amount of Japanese peppers we are planting to achieve a balance between supply and demand. We are implementing measures such as this in the medium term.

Kawamura [Q]:

I may be getting ahead of myself but my second question is about the next fiscal year. I want to talk about price. Precisely, NHI drug price revisions. The NHI drug price revision this time around had a positive impact. Tsumura is one of the few companies for which this was positive. However, performance in Japan appears to

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