Q&A at Interim Results Briefing Q&A (Nov. 9, 2015)

We are halfway through our structural reinforcement, and accomplishing our targets for fiscal 2016 will make clear at last how far we still have to go to become one of the global top ten companies. In addition, by 2020 the Ajinomoto Group (“Ajinomoto”) will be expected to display not only the growth potential of a world-class company, but also sustainability. Accordingly, where possible, I want to provide numerical targets for ESG (environmental, social and governance) as well as financial targets.

As you point out, speed is an issue, and we are considering measures for inorganic growth. We will be sure to provide shareholder returns in line with our announced policy, but at the same time we will make well-considered investments to accelerate growth.

Looking at the top 10 global food companies, some companies’ business is polarized regionally. Over and above our goal of becoming a global company, we want to achieve a certain balance among the regions where we do business. Formerly, Ajinomoto operated primarily in Asia, including Japan, but with the acquisition of Windsor Quality Holdings, LP (“Windsor”) at the end of last year, we have been able to change our business portfolio. Europe will be very much on my mind in the future.

In order to realize sustainability, we need to make clear the relationship between financial indicators and ESG indicators. However, we have not been able to do that yet, so it remains an issue for me. I want to create ways to measure the contributions to society that only Ajinomoto can offer. Then, I intend to announce them as indicators in our next Medium-Term Management Plan.

We will offset it by expanding sales of AjiPro®-L and other specialty products, using multiple raw materials, implementing flexible production and reducing costs with resource-saving fermentation technologies, among other measures. We also intend to increase production of Tryptophan, for which we have a relative cost advantage.

One topic for generating synergy with Ajinomoto General Foods, Inc. (“AGF”) will be creating a global center for R&D in the field of beverages. Until now, AGF has only been able to use its technologies for delicious coffee and powdered coffee in Japan. Being able to use them in the beverages and powdered drinks businesses in ASEAN and Brazil will be a major plus. Canned coffee and powdered drinks are facing tough conditions in Thailand, and we plan to use AGF’s technologies to raise the level of sales.

Concentrating on expanding our library of the components of deliciousness to launch major initiatives has been a topic of both our current medium-term management plan and the previous one. We have set specific themes in the area of flavor. As a result, we have made a start in the domain of natural flavors with T.HASEGAWA CO., LTD. and created the new field of “food preparation materials” with Okome Fukkura Choriryo, which is made with an enzyme preparation. As this library expands, the number of viable applications will increase. The challenging conditions in Japan are not going to change, but we are aiming for income growth of a few percentage points each year until 2020. As our initiatives progress, we can enhance them with marketing.

We actually have a framework for steady income generation based on organic growth overseas, although there are effects from exchange rates and costs. Even excluding the impact of Windsor, we are growing steadily. The question is how to expand. Ajinomoto’s strong point is its thorough adaptation to local conditions. For example, we are planning the launch in Indonesia of the frozen bread business we have built up in Japan. As for instant noodles, although we have ended our joint venture in Brazil, we have laid the foundations of the business in India and Nigeria. The fields where we deploy Ajinomoto’s technologies clearly vary depending on the markets in each region. Based on my own experience, before I was posted to Latin America, I thought that M&As conducted by top U.S. and European companies never led to a good outcome. Once I was there, I realized that many opportunities exist. We have created an organization that is currently investigating M&As in ASEAN, Brazil and Europe.

Raw material prices are a factor in costs, but measures such as using multiple raw materials and flexible production contribute to results. We will steadily maintain such measures. As for exchange rates, the largest impact comes mainly from the exchange rate for trade. For businesses where the impact is great, it will be important to increase the number of bases to enlarge the natural hedge.

The payout ratio of 30% is our target for each year, and we always strive to meet it. As we announced on August 27, 2015, we will allocate the extraordinary gain from the equity transfer of NISSIN-AJINOMOTO ALIMENTOS LTDA. to invest in growth areas. If you exclude that amount from net income, the payout ratio for fiscal 2015 will not reach 30%, but it will be very close.

Market conditions for electronic materials were weak in the first half of this fiscal year and are recovering in the second half, which is the opposite of the usual trend. I think this recovery track will continue through the second half due to inventory adjustments for personal computers. On the other hand, personal care ingredients grew in the first half with the help of the rapidly growing popularity of natural ingredients. Overseas operations are increasingly a source of earnings, with growth of over 10% in some countries. Even for electronic materials, although the personal computer market is shrinking, server applications and the field of smartphones are expanding. New applications are being adopted for organic electroluminescent encapsulants, which are a new product, and we will begin commercial production soon. This is likely to contribute to income in the future.

Commodities consist of three products: Lysine, Threonine and Tryptophan. The rest of our products are specialty products. Our objective is to increase the absolute amount of operating income from specialty products. When the ratio of operating income from commodity products decreases, the ratio from specialty products increases. During the interim period, we changed our forecast for the ratio of bulk products, including umami seasonings for processed food manufacturers and sweeteners, from 11% at the start of the year to 15%. The reason for the change is because earnings from commodity products are increasing due to the effects of exchange rates and raw material prices.

The price adjustments that had an impact on results for the interim period were for frozen foods and for household-use and restaurant and institutional-use AJI-NO-MOTO®. Price adjustments for both were around 8-10%, but I don’t believe they affected sales volume. Particularly for AJI-NO-MOTO®, sales volume rose in the first half, due in part to so-called “last-minute demand” before the price adjustments. Sales prices are on the rise throughout the industry, which makes it easier to gain acceptance for price increases. Sales conditions were very challenging in the first quarter for frozen foods, mainly for household use. However, sales made a comeback in the second quarter with aggressive promotional activities, and the cumulative result for the interim period was a recovery to basically the same level as the previous year. In that sense, there was virtually no impact on sales volume for Ajinomoto, but consumers are very sensitive to price adjustments. Outside major metropolitan areas, the tendency to economize is more pronounced. The impact on sales of the price adjustments we conducted this year will be a matter to watch in the second half.

(Q: Why do you expect operating income from frozen foods in Japan in the second half of fiscal 2015 to be flat year on year despite a forecast increase in sales?)

That is mainly the result of a revision in our exchange rate assumptions for the full year. Because of the revision from JPY 115 to JPY 120 per USD 1, we expect an increase in costs for imported raw materials compared with our initial budget.

The depreciation of the BRL has a negative impact on the currency exchange rate and a positive impact on the exchange rate for trade. I suppose the main thrust of your question is about the exchange rate for trade. If so, then calculated based on the sensitivity we disclosed in the presentation materials, the positive impact on operating income will be somewhere around JPY 1.5 billion. The depreciation of the BRL has been ongoing since last year, so we expect an impact on a similar level in the second half. However, exchange rates are shifting substantially, mainly for the BRL, so we will have to look carefully at their impact.

We will continue to conduct structural reforms. There are still businesses with issues. However, in strategic terms, if a business generates synergy with another business or it is necessary for future growth, we are not going to make it the target of sweeping reforms, even if its profitability is low. We will conduct management that is attentive to revising and strengthening our portfolio while regularly assessing the situation. If there are acquisitions that would allow us to secure a clear market position, like Windsor, we will manage them carefully to lead to further growth.

(Q: In strengthening specialty in the bulk business, which commodities are indispensable?)

Commodities are more important points of connection with customers than branded products. Because we have a commodity business, we can offer our customers affordable specialty products. This is also clear in our umami seasonings for processed food manufacturers business. Currently, nearly 70% of the MSG Ajinomoto produces is used by Ajinomoto, making the Group our biggest user. The feed-use amino acids business is by nature different from the MSG business, but from the perspective of key accounts, commodities are important.

Without a doubt, the economies of Thailand and Brazil are weak at present. Thailand will have a military government for the next two years, but stability has been returning. The weakening of the Chinese economy is affecting exchange rates throughout ASEAN, and our exports to surrounding countries are suffering. These effects are showing up to a great extent in the sales volume of powdered drinks. We are responding by working to reinforce the business, including through pricing measures. Sales volume will gradually recover, but operating income will face a growing challenge. The scale of our operations in Thailand is already large, so double-digit growth will be difficult, but we plan to come close to our target with core products such as AJI-NO-MOTO® and Ros Dee® as well as new products. In the second half of the fiscal year, we plan to launch highly delicious new products, which should contribute to net sales in the next fiscal year. We will also actively conduct promotional activities in the second half, so I think we will be able to achieve growth on a local currency basis exceeding first-half results. In Brazil, the economy dropped below the previous year’s level in the first quarter, so conditions were particularly severe. However, we achieved nearly double-digit growth in the second quarter, mainly in seasonings. Together with planned launches of new products, mainly seasonings, in the second half, I think we will be able to make a recovery toward double-digit growth. (Q: Is my understanding correct that Thailand’s internal demand, excluding exports, is firm?) Yes. 

I will answer regarding the commodities Lysine, Threonine and Tryptophan. Lysine prices remain soft against a backdrop of weak demand in China. However, some Chinese manufacturers appear to be making production adjustments. Although the drop in prices seems to be halting, there are no concrete signs of a turnaround. The spread in China has grown from around USD 50/ST to the most recent price of nearly USD 150/ST, which signals market recovery, but this has yet to be seen in the numbers. Based on these conditions, our market price forecast for the second half is USD 1.25/kg. Threonine is showing the same trend as Lysine, but markets other than China are growing substantially, so the drop in prices is more moderate than for Lysine. The market price has fallen below USD 2.0/kg in China and elsewhere in Asia, but remains above USD 2.0 in the Americas. Accordingly, we have assumed a market price of above USD 2.0/kg for the second half. For Tryptophan, a competitor has increased production and is making aggressive offers backed by a favorable exchange rate. We are estimating a market price in the second half of around USD 9.0/kg, based on our assumption that Chinese manufacturers cannot make a profit at the USD 8.0/kg level. Since we can still make a profit at that price, we intend to expand our share.

We are currently considering methods for linking ESG and financial data. Unfortunately, we don’t have a particular approach yet. We have been studying the global top three companies, and we would like to take an approach similar to theirs. These companies have been conducting such initiatives for 15-20 years, so we probably won’t be able to catch up quickly, but at least I would like to have an index. These evaluations are ultimately linked to assessments of our brand value, so I am thinking of making them one aspect of assessing brand value. In preparing the Ajinomoto Group’s sustainability report, we currently have a board to obtain the input of opinion leaders from outside the company. I want to expand their scope to build a monitoring framework for ESG. I want to incorporate the three aspects of an index, a monitoring framework and brand assessments.

Formerly, there was no great difference between net and gross debt, so it wasn’t necessary to take note of it. Now, interest-bearing debt exceeds JPY 200 billion, and cash on hand and in banks comes mainly from overseas, where our performance is strong. In light of this situation, we chose to use net debt because we thought it would be best to make clear our approach to the use of debt in raising funds for investments. The reason for using 75% of cash is to set aside 25% as the equivalent of working capital with numerous overseas subsidiaries. It is a special calculation, but the same approach has been adopted by some rating agencies, so it is not that unusual a figure.

I do not think it has become a full-fledged trend. The MSG market is growing by around 2-3% annually and supply holds the upper hand, so competitive conditions are not changing. Under these circumstances, the profitability of each supplier has been worsening, and all of them, including Ajinomoto, have been making moderate price adjustments to suit. As a result, there has been a slight overall adjustment in prices. For nucleotides, market growth is firm at 7-8%. There is more of an oversupply than for MSG, and the price situation is particularly severe in the Chinese market. Ajinomoto has been working to reduce supply in China, and intentionally prioritized unit price over sales volume in China in the first half. As a result, sales volume decreased compared with the previous year. Even though the market is steadily expanding, prices are falling.