Earth Corp
TSE:4985
Earnings Call Analysis
Q2-2023 Analysis
Earth Corp
The Earth Corporation's top line exhibited year-on-year growth as of the second quarter of FY2023. Unfortunately, gross profit and operating income fell below initial forecasts, largely impacted by the insecticides and repellents segment's performance that typically peaks between May and July. While June-end figures did not meet expectations, results as of the end of July showed improvement, surpassing previous estimates.
With operating income traditionally peaking in Q2, Earth Corporation has recently aimed to balance results across all quarters. This year, Q2 underperformed against forecasts, hinting at a stronger Q3. Soaring raw material and energy prices alongside distribution costs were less concerning due to successfully executed cost pass-throughs, though a suboptimal sales mix in insecticides affected income by JPY 1.24 billion.
While the insecticides and repellents segment experienced a sales composition shift leading to a JPY 1.24 billion negative impact on operating income, this is expected to normalize on a yearly basis. Notably, new household product launches are anticipated to compensate for other underperforming categories, such as bath salts impacted by changing consumer habits and masks affected by the end of the COVID-19 pandemic. Additionally, pet supplies and total health care products are outperforming expectations.
The company's domestic insecticide and repellent market share grew to 57.3%, a sign of robust consumer support, despite new product sales falling JPY 900 million short of plans. However, the brand remains confident in meeting full-year targets driven by recent shipment data and upcoming marketing initiatives.
The impact on the cost of goods sold, which stood at JPY 1.75 billion at June-end, was in line with half-year expectations. Similarly, SG&A expenses are within forecasted ranges, not posing significant concern.
The overseas business was a highlight, showing robust performance despite global challenges, except in China, where the company faces difficulties requiring organizational restructuring and recovery plans. The other regions have seen sturdy results, supporting the overall positive growth.
Despite being nearly JPY 1 billion behind as of June-end, management remains optimistic about achieving year-on-year profit increases, considering upcoming initiatives. These initiatives include further cost pass-throughs, new product launches, and expense control. The company upholds a full-year sales forecast of JPY 160 billion and an operating income goal of JPY 8 billion, amounting to a 5% operating income margin.
The company aims to maintain at least JPY 118 per share in dividends, aligned with previous year payouts. Furthermore, engagement in ESG activities is evident through certifications such as the White 500 and inclusion in the SOMPO Sustainability Index, underscoring a commitment to long-term growth.
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Greetings, everyone. My name is Katsunori Kawabata, Representative Director, President and CEO of the Earth Corporation. Thank you for taking the time to view today's earnings briefing, covering the results for the second quarter of the fiscal year ending December 2023. Additionally, the Earth Corporation welcomes stakeholder questions.
First are the financial results highlights. The table on Page 3 lists each sales and income metric for the first half of the fiscal year, from sales and to net income attributable to owners of parent. As you can see, while the top line grew on a year-on-year basis. Unfortunately, gross profit and operating income fell short of the forecast. I will be going over the details later on in today's presentation.
Ideally, we expected results as of the end of the second quarter at the end of June to match the forecasts. But to the insecticides and repellents segment has an outsized impact on results during this part of the fiscal year. Some years, results for insecticides and repellents peak around May, sometimes they peak around June. And sometimes, even as late as July, although never in August. There has, therefore, been a mismatch between the cutoff period at the end of June, corresponding to the end of the second quarter and peak results for the segment, and this has tilted realized results this year.
However, as of the date of recording this video on July 31, 2023, results for the month of July have exceeded expectations. The benefits of cost pass-throughs, which we started implementing this fiscal year, have materialized according to the forecast. And additionally, we made progress in keeping SG&A expenses under control. Naturally, net income ultimately comes down to a function of subtracting expenses from gross profit, and we have made progress in keeping these under control, as outlined in the forecasts, including through the use of cost pass-throughs.
There appears to be a slight gap between progress made and to the state of things and the actual realized results in this, among other topics, is something I will be addressing in today's presentation. In reality, things are progressing according to plan.
Next is a discussion of progress towards the operating income target on a quarterly basis. Up until recently, the trend for the Earth Corporation was for operating income to peak in the second quarter and then for it to drop in the third and fourth quarters. Against this backdrop, last year, we started working on equalizing these results across all 4 quarters through adequate timing in the recording of sales promotion expenses. Realized results for the second quarter fell short of the forecast, so we believe we will be able to tack on extra performance to the results in the third quarter. Additionally, we are working toward our ability to deliver results according to the full fiscal year forecast.
Page 5 discusses operating income change factors on a year-on-year basis, while Page 6 contains a comparison with the forecast. Our competitors in the sector of household products refer to soaring raw material and energy prices and the distribution costs as operating income decrease factors into the Earth Corporation, too, initially expected an impact of JPY 1.75 billion in the first half. With that being said, the execution of cost pass-throughs has allowed us to more than offset this, so we don't view this factor as being problematic.
On the other hand, a change in the sales composition that is the sales mix had a negative impact of JPY 1.24 billion. This happened on account of a gap between planned expected product sales for some subcategories within insecticides and repellants, and actual realized results for this particular period. We view the segment of insecticides and repellents as a time span running from around February to October every year. Within this dynamic, there is some variance in terms of which subcategories sell faster each year. As such, some years, it's insecticides for flies and mosquitoes. Some other years, it's insecticides for cockroaches. In some years, it's miticides. This leads to some variance in terms of profits.
Going by last fiscal year's results, as of the end of June, we had expected slightly better sales of insecticides for flies and mosquitoes, compared to actual realized results. This variance disappears on a full year basis, but the snapshot as of the end of June shows a slight year-on-year change in sales composition, and this weighed down on operating income by JPY 1.24 billion, compared to the initial forecast.
It should be noted that this change in composition could have taken place in the opposite direction, allowing us to record sales earlier in the fiscal year. Still had this happened, ultimately, this would have been followed by a reactionary decrease in the third quarter. So this is an area we don't put too much emphasis on information. Some stakeholders might view this snapshot as of the end of June as indicating a lackluster performance on our part, but this perception does not match reality.
Next are the operating income change factors versus the forecast, which for the most part, match the factors I mentioned on the previous page. In terms of change factors on both a year-on-year basis and versus the forecast, one area that requires our attention is the company's cost pass-through measures. Had we not been able to execute to these cost pass-throughs according to plan, then there would have been a need to change direction and make adjustments, including in terms of distribution. However, we have been able to secure the cooperation of the relevant parties involved and have been able to make progress according to plan. As such, as of the end of June, we don't feel there is cause for concern on this front.
Next, our sales by segment. The results shown here are on account of the cutoff period being the end of June. However, as I mentioned earlier, in insecticides and repellants, we have been able to regain ground and starting in July. So while the third quarter started just under JPY 1 billion behind on a profit basis, we don't view this as a cause for concern. Conversely, product categories, we do view as a cause for concern are bath salts in Household Products and masks in the category of other household products.
Higher temperatures in the end of the COVID-19 pandemic have translated into a steeper-than-expected decrease in mask sales. To offset this, we will be launching new household products in the second half. These are releases outside the scope of the initial forecast and a way allowing us to absorb the impact of sales decreases in the categories I mentioned just now. Lastly, pet supplies and total health care system products have been posting a strong performance, exceeding the forecast.
Next is the status of the insecticides and repellents segments in the domestic market. As of the end of June, this market had posted a slight year-on-year growth, staying close to last fiscal year's levels. With that being said, as I mentioned earlier, this has not been without changes to the sales composition. The Earth Corporation pays close attention to our market share, which shows consumer support for our products. We grew our market share by 0.9 percentage points to 57.3%. This increase of close to 1 percentage point underscores the fact that we haven't lost consumer support.
Sales contribution from new products fell short of the plan by approximately JPY 900 million and sales volume following cost pass-throughs was JPY 450 million lower than the forecast. As I mentioned earlier, the cutoff period is the end of the first half, but on a full fiscal year basis, we expect to be able to achieve our targets. There is a degree of variance as some items sell better than others. But in light of recent shipment data, we are confident in the results for the full fiscal year. In terms of new products, there is a degree of variance in terms of which products perform well and which don't. This is the case every year, and we will continue reviewing these within the scope of our marketing initiatives.
Additionally, in terms of the profit mix, Earth No-mat is a high-margin product within the insecticides and repellents segment. As of the end of June, this product had underperformed year-on-year and versus the forecast. And this, among other factors, contributed to this profit variance. However, we believe there is plenty of room for us to catch up in the third quarter between July and September. Recent results, too, indicate a sufficient recovery, so I believe we will see robust results in the third quarter.
Next is the status of bath salts in the domestic market. This segment faced a more challenging environment than expected. However, while the overall market was down on a year-on-year basis, it nevertheless remained above pre-COVID levels. In light of this and despite this year-on-year decrease, we don't view the overall market for bath salts as being on a shrinking trend. We do, however, see a shift from products for family use to products for personal use. And consequently, we will work to capture this trend, including through initiatives to be carried out in the fall and beyond in the form of large-scale product renewals.
Much like the peak season for insecticides and repellents is in the first half, the main season for bath salts is in the second half, and we are carrying out initiatives around this. We positioned this as an important area for us to expand our own efforts on within the initiatives for the second half of the fiscal year.
Next is the status overview of the cost of goods sold. As stated in the initial forecast, the cost of goods sold impact was more heavily weighted toward the first half as expected, of the full year forecast of JPY 2.5 billion, the cost of goods sold stood at JPY 1.75 billion as of the end of the first half. These results, therefore, do not represent soaring cost of goods sold, surpassing the forecast for the current fiscal year. Rather, while this is the main area of concern on the part of stakeholders, the results are within the forecast range.
In terms of SG&A expenses, well, there is a degree of variance here as well. We don't view these results as being problematic. We are working to control the factors we can in terms of SG&A expenses and keep these within the initial forecast range in the second half of the fiscal year. As of the end of the first half, we don't view SG&A expenses as an area for concern.
Next is the overseas business, which we consider to be the most crucial focus of the current medium-term business plan. Overall, the overseas business has posted a strong performance. As in Japan, we also faced a number of adverse factors overseas, such as soaring raw material prices, but our operations in each country have been able to complement one another, allowing the overall business to deliver growth.
The other concerns here is our business in China, which has worsened considerably, we have been able to offset this decrease coming from the business in China through the overseas business overall, allowing it to grow. With that being said, the business in China is performing worse than expected. In light of this, we want to make a genuine effort to learn from our shortcomings while at the same time, carrying out a review of our organizational structure and executing recovery plans. Through these, we seek to drive results in the second half and into next fiscal year.
We have been delivering a strong performance in the regions other than China, with only China being a reason for concern. As such, we will continue executing a two-pronged approach of carrying out investment, while reaping returns and in doing so, grow profits. Please refer to the appendix for detailed information on our business in each country.
I would now like to discuss the initiatives going forward. First is the execution of additional cost pass-throughs. In the first half of the fiscal year, we carried out cost pass-throughs with an emphasis on insecticides and repellants. In the second half, we will be carrying out additional cost pass-throughs, targeting some of our core products, such as bath salts and Mondahmin mouthwash. We are targeting a price revision of between 5% and 7% for 45 SKUs, and these increases will have a positive effect on results.
Next, our new product launches and renewals. We are launching products to realize significant improvements in the category of bath salts and staple products in insecticides and repellents, which demand all year round, which is now influenced by advances in global warming, meaning a lengthening of the sales period for these products, something retailers are aware of. In the past, we released Goki Jet Pro as a new product for the fall and winter season, and this initiative will be the successor to that consisting of the release this winter of a product in the category of insecticides and repellents.
MAMOROOM for cockroaches and our ZEROnoKNIGHT miticide are high value-added products, leveraging the Earth Corporation's technical capabilities. Our clients, too, have great hopes for these, and we are carrying out negotiations towards the release of these products. The majority of these products for a release in the fall do not feature in the initial forecast. So these are expected to have an extra positive effect on results.
Next is the outlook for the full fiscal year forecast. As of the end of June, profits were just under JPY 1 billion behind schedule. The forecast for the second half needs to take into account product returns, and we have taken a rather conservative approach in our product returns target in the current fiscal year for insecticides and repellents. Our data clearly indicates that a strong performance in insecticides and repellents in the second half, can translate into a decrease in product returns.
As such, we believe there is a low probability of product returns exceeding the forecast, quite the contrary, the potential to keep these low constitutes upside potential as the decrease in product returns translates directly into profits. Information, in addition to a decrease in product returns in insecticides and repellants, if cost pass-throughs, the release of new products and product renewals and the control of expenses go according to plan in the second half, we believe there is plenty of opportunity to meet the forecasts, which call for a year-on-year increase of approximately JPY 500 million in operating income. At the very least, we intend to achieve this target, and we believe there is the possibility of going beyond this.
Shown here are the targets for fiscal year 2023. We are forecasting JPY 160 billion in sales and JPY 8 billion in operating income, which corresponds to a year-on-year increase of JPY 560 million. We have a steadfast commitment to delivering an operating income margin of at least 5%. And overall, we are seeing results indicating a positive outlook in terms of our ability to meet our targets.
Next is the topic of shareholder returns. Starting a few years ago, we positioned DOE as a KPI. And while keeping a close eye on DOE results, we expect to distribute at least JPY 118 per share in dividends to shareholders, matching last fiscal year's performance.
Last is a discussion of ESG-related activities. Next year marks the start of the medium-term business plan and as a company listed on the prime market of the Tokyo Stock Exchange, we are making steady progress in the execution of ESG-related activities. The Earth Corporation was certified as the health and productivity management outstanding organization, White 500 company for the third consecutive year, and we intend to continue this trend next fiscal year and beyond as we value and price our employees.
There were also positive developments in terms of ESG investment as well as the company was selected for the first time as a component of the SOMPO Sustainability Index. With that being said, receiving these certifications in being selected for inclusion in the SOMPO Sustainability Index in and of itself is not the purpose behind our activities. Rather, we carry these out with the objective of achieving sustained growth for our company.
The main thrust of today's financial results presentation is that in light of recent results, we do not believe there is reason for concern in terms of achieving the full fiscal year forecast. This is an opinion held by Earth Corporation management and one which I wanted to share with stakeholders through today's presentation.
For topics not covered in today's presentation video and for more detailed questions, we welcome you to Director and Grace to the company's Investor Relations department. This concludes today's presentation. Thank you for your time.