Q&A from Small Meeting with President (Nov. 22.24, 2016)

My first concern is in the area of Environment, Social and Corporate Governance (ESG). While we are progressing with our efforts to protect the environment, I think we are falling a bit short of the mark in the area of contributions to society. The problem probably lies in our original policies and goals. My second concern is the weakness of our profit structure. The forex impact on our business is not entirely negative, but it has adversely affected our animal nutrition business, as indicated by the gap between results and our forecasts. This is a problem I hope we can solve during the three years of our FY2017–2019 medium-term management plan. My third concern is how to grow our Japan food products business, which we assume to be in a low growth phase. This is a challenge we will deal with over the medium term. The new medium-term plan will address the lack of growth pillars and clearly designate some areas other than the Five Stars that we will seek to develop as growth drivers. We expect healthcare to make a big contribution from 2020, and we will be investing in cell cultures used in regenerative medicine and in polymeric pharmaceuticals. These will likely be two of our next pillars for growth. 

Our revised FY2016 forecast assumes zero profit contribution from animal nutrition. The biggest differences with our original forecast are in the price of lysine, forex rates, and the delayed contribution from specialty products, in that order. Granted, the contribution from specialty products is not emerging as quickly as we expected, but we are seeing areas of steady growth and identify the issues. I think we are headed in the right direction. 

China’s domestic lysine market contracted for the first time in FY2015. Until then, double-digit growth in the Chinese market supported growth in the global lysine market but that has changed. The current Chinese government’s strengthening of environmental regulations has probably had an effect on the market. The Chinese government’s more aggressive action on environmental problems has hastened the decline in numbers of small-scale farmers engaged in poultry and pig farming. Demand remains strong, however, so if the contraction in the number of farmers leads to more large-scale livestock farms, the lysine market will probably return to a growth track. For now, excess supplies of lysine and other products caused by shrinkage of the China market are flowing into Europe and other Asian countries. 

Our revised forecast is for about 7% year-on-year growth for all of FY2016 on a local currency basis. Excluding the forex impact, sales will definitely be up, but not as much as initially expected. The shortfall is due mostly to increased competition in Thailand and weak sales in Myanmar Sales in Myanmar are being affected by forex movements and by increased competition from imitation products. In the first half, our Thai business experienced its first year-on-year decline in growth on a local currency basis, contributing to a low growth rate for the business as a whole. However, we are continuing to see double-digit growth in Five Stars other than Thailand and in other countries. The first-half results highlight the large size of our Thai business, as well as the existence of some challenges we are facing. I am confident that we can return the international seasonings and processed foods business to double-digit growth by strengthening our response to challenges we face in Thailand and nearby countries. 

The acceptance of product price increases depends on the inflation rate. Brazil’s inflation rate is 6%, and minimum wages are steadily being increased by about 3%. A certain level of price increases have become the norm in the Brazilian market. In the first half of FY2016, we saw sales increase 34% on a local-currency basis. However, much of that increase was due to changes in segmentation. In real terms, growth was a bit under 15%. Brazil was a difficult market in FY2015, but the main causes of that difficulty were a weak Brazilian real and political instability. The Brazilian economy remains in a recession but political conditions have stabilized. Meanwhile, our brands are well entrenched in the local market and I see no need for concern. 

Consumers in the US and Europe have a strong preference for natural foods as a whole, not just flavorings. Major global confectionary makers and beverage makers are increasingly abandoning artificial, synthetic flavorings. While I don’t think synthetic flavorings will disappear entirely, I expect the trend toward using natural flavorings, especially in foods, to get even stronger. We expect the vanilla flavorings market to be worth about ¥340.0 billion in 2020, accounting for about 20% of the overall flavoring market, making it the single largest product segment in that market. At present, more than 90% of vanilla flavorings are synthetically produced, with those extracted from natural vanilla beans accounting for just a few percent of the overall market. And these natural vanilla bean extracts are very expensive. Fermented vanillin is almost non-existent at the moment, but we think it will gather much interest from users. We also plan to use produce fermented vanillin in our own consumer products. Numerous flavorings are already being used in emerging countries, and we are procuring high quality flavorings from other companies. If we can produce those flavorings in-house, we can cut back on cash outflows. Moreover, our BtoB business is combining natural seasonings with enzyme preparations, which we expect will strengthen our products. The basic policy of our development program is to increase the number of materials that become tasty solutions. 

Beverages are one of the foundations of our Thai business. We are very sorry for the concern its recent weak results have caused the market, but we believe a turnaround is possible. Our Thai coffee business started with canned coffee and then expanded into powdered coffee. Our core Birdy® brand has established strong brand value and has taken the top share in the Thai market. Recently, however, we have come under severe competitive pressure from Nestle. Until now, we were not able to introduce AGF’s technologies and had to refine production technologies on our own. Coffee extraction technology and the milk ingredients used in 3-in-1 stick products are key points we plan to address. We plan to apply the powdered milk technology used in AGF’s Marim brand to enhance the taste of our 3-in-1 stick coffee. 

Seasonings are the core product of our Japan Food Products business. While it is difficult to raise the topline in a market with a declining population, seasonings business is highly profitable and therefore remains important to us. We will continue meet Japanese consumers’ needs for products like Nabe Cube®. Because our Japan Food Products’ sales mix is weighted toward seasonings, the growth rate looks smaller than that for other Japanese food makers. Frozen foods sales, however, are performing well. Our Japan Food Products business of course includes both, but the main reason for slow growth definitely is related to our sales mix's bias toward seasonings. Therefore, we will address the growth issue by strengthening our lineups of frozen and processed foods. However, sales of seasonings for use at restaurants and in prepared take-out foods continue to expand. We expect this market to continue growing and will therefore be putting greater emphasis on meeting its need for seasonings. We are not deliberately reconfiguring our product portfolio, but the sales mix will probably change.

(Follow-up question on same topic: Is slow growth of Japan Food Products business a structural problem in an otherwise solid market?) > Yes. Seasonings are our core product. The relatively low-growth nature of this business structure will not change. However, we plan to strengthen profitability by making changes across the entire value chain.

(Follow-up question on same topic: What are the problems in the value chain?) > Broadly speaking, we see issues in three areas: aging of our production facilities, inefficiencies in our logistics system, and decentralized back office functions. 

Basic M&A policy is set at our head office, but the approaches start from a local operation. Transferring certain authority to our local staff enables us to get a better look inside M&A candidates, which has led to the selection of higher quality partners for our local business. 

The ASV concept is based on the “Creating Shared Value” (CSV) business concept first advocated by Michael Porter. However, we are still in the initial stages of implementing this concept. To realize ASV on a broad scale, we must establish various targets that will enable us to realize the concept’s financial and non-financial goals and then conduct our business and other activities accordingly. We are currently engaged in the internal process of changing the way we set our goals. We will use the ASV as a tool for communicating with our external stakeholders during from the implementation of our FY2017-2019 medium-term plan. A more detailed announcement of the strategies we will pursue to realize our vision will also be presented in the FY2017–2019 medium-term plan, and we expect the promotion of ASV to generate new value during that three-year period. 

Our policy is to consider joint ventures and alliances as a response to changes in commodity prices. However, joint ventures and alliances are entered into only after we have thoroughly eliminated all risk of technology leaks. That basic policy has not changed. 

The AJI-NO-MOTO® brand has achieved a very high penetration rate in Myanmar, but more than half the umami seasonings on store shelves are AJI-NO-MOTO® rip-offs. Simply changing packaging will not be a fundamental solution to this problem. We plan to start up local production in September 2017. Once we begin shipping product from the local plant, we will be able to strengthen cooperation with local administrative and regulatory agencies. The current business model of relying on exports and local distributors puts us in a weak position. We think we can achieve significant changes by starting up local production. 

BtoB marketing is all about one’s ability to provide solutions. In hindsight, our past strategy of chasing after market share is not applicable today. Based on the lessons from that past experience, we will emphasize solutions capabilities rather than marketing power. For example, our amino acid BtoB business is getting involved with pharmaceutical companies at the drug discovery stage. The next big product likely to emerge from these efforts is polymeric pharmaceuticals. Another area is cell culture media. For example, we became involved in iPS cell culture mediums in the early laboratory stage of research at Kyoto University, essentially shutting out the entry of potential rivals. Our entry into the flavorings business has two goals. One is to expand our lineup of flavorings as specialty materials. The other is to acquire knowledge about the special solutions capabilities of flavoring makers. Strengthening of our solutions capabilities could open up huge new business opportunities with our existing MSG customers and the many global food companies with which we have established key accounts in the past. Reflecting on past experience that has taught us that the more you make of a particular material, the more quickly it becomes a commodity material, we are now focused on building a different type of business model. I would like to add one more point about the flavorings business. The ability to use flavorings as ingredients in our own products will enable us to increase the added-value of our products. We are not thinking at all about fragrances. Our flavorings business is completely focused on natural flavorings for use in foods. We thus are already practicing “selection and concentration” in our flavorings business. 

I believe ranking among the Top 10 global food manufacturers is easy-to-understand as a symbolic goal. But our FY2017–2019 medium-term plan will include quantitative targets similar to those of our current medium-term plan. For example, those quantitative targets will include absolute profits and profit margin, ROE, and growth rates. Unlike other global majors, we have not been able to establish quantitative ESG goals. Our only environmental goal thus far is to set high targets and then exceed those targets. We plan to establish financial and non-financial goals and then make every effort to achieve those goals. I agree we need to establish clearer criteria. From that perspective, I think you can consider Nestle to be the No. 1 global food manufacturer. Our Top 10 does not include alcoholic beverage or drink makers, grain majors or large companies doing business in a limited geographical area. We are aiming to be a global food maker similar to companies like Nestle or Unilever. On an IFRS basis, I think business profits of ¥150.0 billion would put us in the Top 10. 

Our current medium-term plan assumed annual free cash flow of ¥100.0 billion, of which ¥60.0 billion would be allocated to capital investments and the other ¥40.0 billion to shareholder returns. We plan to establish targets for those same financial indicators in the FY2017–2019 plan. Operating cash flow is presently around ¥110.0–120.0 billion a year, and future capital investment will come from those funds. We need to invest in the restructuring of Windsor’s production facilities, so capex in a single year could exceed ¥60.0 billion, but I think that figure will remain our base figure for individual year capex as we continue to make investments in line with strategic needs. 

I see some issues with the flexibility of action by the Board of Directors while conforming to the basic principles of the corporate governance code. Outside directors currently account for three of the 11 positions on our board, so I think there is some room for increasing that ratio. As we reported at the general meeting of shareholders, we had all our directors and corporate auditors, including external offices, fill out a survey that asked them to explain the challenges they were having in promoting and enforcing the corporate governance code. We are now in the process of reforming the Board of Directors based on an analysis and assessment of board members’ responses to the survey by an impartial third party. Although there may not be any changes to company with committees early in the new year, we are promoting an institutional design that targets changes in our governance system. Because such matters must be approved by a resolution at the general meeting of shareholders, the system will probably not be fixed in time for the announcement of our FY2017–2019 medium-term plan, but we are working on creating a better corporate governance system. 

We decided to include this data on our website because fluctuations in the price of feed-use amino acids have a major impact on our earnings and are of keen interest to investors and analysts. Our efforts in specialty areas are also important, and we are considering better methods of disclosure, such as inclusion of regular updates in our financial results presentation materials. 

The US FDA and European food safety authorities have all publicly stated that there are no health safety issues with MSG. However, various obstacles have been created to prohibit the spread of this information from the authorities. We plan to address this issue on two fronts. First is our international efforts to educate people about umami seasonings via NGOs. Representatives from umami seasoning makers are participating in a global organization (IGTC) comprising key opinion leaders from academia. One of our approaches will be through such third parties. At the same time, we are making our own efforts to aggressively disseminate information about Japanese food, Japanese soup stock “Dashi,” umami seasonings, and MSG at international gatherings, such as the Rio Olympics and the annual meetings of nutrition societies that gather nutrition experts and academics from around the world. In addition, our next medium-term plan will include measures to strength PR targeted at ordinary consumers in Japan, Europe and the US. 

We are assuming the international seasonings and processed food business will achieve sales growth of about 7% in FY2016 on a local-currency basis. Thai sales were down year on year in the first half of FY2016, but we expect a several percentage point rebound during the rest of this fiscal year. That will be the starting line for our next medium-term plan. Umami seasonings and flavor seasonings will be the core earnings drivers, with support from menu seasonings, sales of which have been expanding recently. Local core products, such as beverages, will be a mix of strengths and weaknesses. In markets enjoying steady growth supported by a growing middle class, our challenge is to determine how much we should expand our product portfolio. Beverage sales in Thailand are struggling and we have begun to experience some problems in neighboring Myanmar. Going forward, we will tackle these challenges one by one. That policy is the same as before. 

The handout materials simply provide a summary of data about the most important products. In our international seasonings and processed foods business, Thailand is the core market. Our Brazilian business is in the midst of a V-shaped recovery. Indonesia and Vietnam are both showing near 15% growth over FY2015 levels. Growth at our Philippines business is somewhat slower than in FY2015 but still in the mid-single digits. The main issue is therefore Thailand. The Thai business is larger than others because it has a fuller product lineup, including ramen and drinks that have yet to be introduced in other overseas markets. Therefore, our most immediate challenge is to rejuvenate the Thai business. Indonesia, Vietnam, and Brazil do not yet have full product lineups. Consequently, in these markets we plan to expand our product portfolios and make full use of the strength of current sales channels. As for Thailand’s neighbor Myanmar, first-half sales fell 13% year on year on a local-currency basis, but Myanmar Ajinomoto Foods, established earlier in 2016, will soon begin local production and sales. We think this will help reduce imitation products in Myanmar. During the next medium-term plan, we will strengthen and expand our business foundations in other countries, including subsidiaries AWI (Ajinomoto Windsor Inc.), Kukre Gida and Orgen in Turkey, Promasidor in Africa, our Peru business, which is approaching the ¥10.0 billion mark, and our Malaysian business. During the FY2014–2016 medium-term management plan, our discussions with you focused on the Five Stars but with the start-up of the new FY2017–2019 plan we will be providing more disclosures on our business in semi-core countries and look forward to explaining the emerging complementary relationships. 

Currently, more than 90% of all vanillin is synthetically produced, and sales prices are cheap. Natural flavorings, on the other hand, are expensive and can be produced only by certain companies. This has created intense competition among food and beverage makers wanting to use natural flavorings. We have yet to establish a business model in this area and are just now establishing a test production line. The focus in the immediate future will be to see if we can achieved larger-scale production yields similar to those achieved in the laboratory. The tie-up with T.Hasegawa targets the development of the fermentation-derived natural flavorings business, and we have already been able to produce two other flavors using the similar process we are using to make vanillin. We therefore hope to build the business around these three flavorings. The product development work undertaken together with T.Hasegawa has enabled us to proceed to the commercial production stage sooner than expected. Based on our achievements to date, we are now developing a strategy for how to expand this business. We have relied solely on large-scale M&A deals in the past, but I believe our strategy options have expanded. The announcement made at the time of our first-half results release, which was intended to endure fair dissemination of information about our progress, generated a reaction from the flavoring and fragrance industry.
(Follow-up question on same topic: One company said that it had a surplus of synthetically produced lignin-based vanillin that it was selling at a very low price. What’s your take on that? > Global majors like Nestle have announced in the US that they will no longer use synthetically produced flavorings so, yes, we expect some changes in the market. 

This is the thinking being used to draft our FY2017–2019 medium-term management plan. Of course, realization of these goals will be difficult unless we supplement organic growth with non-organic growth.
(Follow-up Q&A on same topic: The FY2010 operating income target of ¥150.0 billion looks aggressive to me. Can I assume that includes a rather large M&A deal?) > Yes. 

I believe that achieving that status is necessary for us to achieve our goals for profit structure and shareholder returns, in addition of course to achieving our operating income target of ¥150.0 billion. In addition, regarding reinvestments to secure the continuity of our food business and our healthcare segment in amino science business, which include our forward-looking investments in Althea and the cell culture–related business, we cannot rely solely on M&A but will also need to invest in organic growth. Reliance solely on our M&A deals might get us to our FY2020 profit goal but it will be difficult to secure stable growth thereafter. We also want to reach the ¥150.0 billion level in operating income to ensure our ability to cover investments to grow our food business and the expected need for additional investment in cell culture medium and the CDMO* business in 2019 or 2020. When asked this same question during internal discussions, I explained that this profit level would be needed to sustain growth while being engaged in the two distinct and unique business areas of foods and amino science.
* CDMO = Contract Development & Manufacturing Organization 

We have already begun technology exchanges related to Birdy® 3-in-1. This is helping us hold down material costs, which leaves more money for marketing activities. One specific example is our use of AGF’s creaming powder technology. Milk is an expensive raw material for foods, but using this technology reduces costs significantly. In addition, improving the flavoring enhances the taste, thereby strengthening the product appeal of powdered drinks. We think this will produce a synergistic effect that benefits both companies.

(Follow-up question on same topic: What about manufacturing synergies in Thailand?) > We are making Birdy® 3-in-1 in Thailand, but we are not using AGF’s technology.

(Follow-up question on same topic: So, can we understand that introducing AGF technologies has created a virtuous cycle that starts with improving taste and lowering production costs, which in turn makes available more funds for investing to raise product appeal?) > Yes. Meanwhile, we are developing flavoring technologies in cooperation with T.Hasegawa. However, flavor arrangements used overseas are different from those found in Japan. This requires compounding technologies that Ajinomoto has not possessed. We expect our cooperation with T.Hasegawa will enable us to introduce these different flavor arrangements. For now, we are procuring them from US and European flavor houses, but in the future we want to be able to use our own flavorings. Here in Japan we are strengthening what we call our “deliciousness library", which covers the five basic tastes, flavorings and aroma, and texture. We hope these efforts will lead to cost reductions and strengthen our products’ quality and appeal. 

AWI has reduced its SKU by about 17%, bringing total SKU at the end of the first half of FY2016 to about 1,100 items. While removing unprofitable items from its product lineup, AWI is also strengthening its lineup of frozen fried rice and ramen products. We expect these efforts will result in a 4% increase in sales on a local currency basis in FY2016 and double-digit growth in operating income. AWI's KAIZEN activities based on knowhow received from Ajinomoto Frozen Foods are having a positive effect. AWI is also planning improvements to its TAIPEI brand products, which are included in the Japan and Asian food categories. The introduction of technology received from Ajinomoto Frozen Foods is improving product quality, which is enabling AWI to raise prices on these products.

(Follow-up question on same topic: Would the growth figures you mentioned be higher if we excluded the impact of SKU cuts?) > Yes. However, reducing SKU by about 17% is not enough to achieve double-digit growth as quickly as you all are expecting. Some products are being still produced at former Windsor’s old factory, and structural reform is needed to speed the transfer of production to the new factory. These reforms are proceeding as planned, and we expect to see the results reflected in profit growth from FY2018.

(Follow-up question on same topic: So, will sales and operating income both expand from FY2018 onwards) > The KAIZEN activities, SKU elimination and improvements to the TAIPEI brand will be steadily implemented. Also, AWI began marketing frozen fried rice products in June and frozen ramen in October. These improvements will translate directly into higher sales in FY2017, which we think will enable the company to sustain double-digit growth in operating income. Once the structural reforms have been completed, annual sales growth should move up from the 4% level mentioned earlier.

(Follow-up question on same topic: Are the Japan and Asian food categories that you are emphasizing sustaining strong growth rates?) > Previously, Japanese food products were produced only at the Portland plant of the former Ajinomoto North America. That output was insufficient for nationwide distribution. However, the startup of AWI’s new production line in June has raised the production capacity for frozen rice products to a level that makes nationwide distribution possible.

(Follow-up question on same topic: Regarding the improvements at the TAIPEI brand, did you improve the seasoning and/or did you improve cooking methods? Also, are these improvements something that cannot be matched by competitors in the foreseeable future?) > The TAIPEI brand improvements are scheduled to be implemented in the near future. The US market has many processed rice products. However, none of our competitors is making products from rice that has actually been cooked and then stir-fried on a frying pan in the factory, which is the production process at AWI’s plant. All other US makers of processed rice products simply procure frozen rice from specialized rice producers and then mix the rice with other ingredients, without stir-frying the mixed product. There is a clear difference in taste between these products and ours. We cannot say that our competitors will never adopt similar techniques, but until they do we will take advantage of our position as the front-runner in precooked frozen rice products and establish a solid market position for our brands. These production methods are a key area of differentiation among frozen food companies in Japan. 

The bento (boxed lunch) market is contracting while the market for foods eaten at the dining table is expanding. This trend is supporting steady growth in sales of home-use products. One reason for the strength of the foods eaten at the dining table market is the increase in purchases of frozen foods by single people and two-person households. Distribution of frozen foods has also expanded, with convenience stores and drugstores now selling frozen foods. Ten years ago, when I was the head of home-use frozen food products, supermarkets were selling most frozen foods at 40–50% discounts. That was right about the time when Seven-Eleven started selling frozen food products. Frozen foods are now standard fare at all convenience stores. The occasions at which customers, such as single people shopping at convenience stores on their way home from work late at night, buy non-discounted frozen foods has increased. In addition, convenience stores and drugstores are serving catchment areas with many homes within 2km of their store. They have also opened stores in regional cities and towns. Consumers can now buy frozen foods even if they don’t have a car. The development of products targeted at single people is also driving market growth. 

Talks of consolidating Promasidor are not progressing. That was not part of the agreement we reached with the company. It is, however, something we want to consider. Promasidor's strengths are powdered milk, powdered juices and cube-type flavor seasonings. Promasidor will be able to take advantage of our technical expertise in these product areas. Our Nigerian business is also selling some flavor seasonings, but over half of its sales come from the umami seasoning AJI-NO-MOTO®. Consequently, the two companies’ businesses do not overlap. In Nigeria, we will be looking to integrate the two companies over the next year or so. Exactly what value that will generate is something we will be looking at in the months ahead. The Nigerian business currently faces a harsh external environment, and we therefore would like to make it more compact and generate synergies. 

Our domestic restructuring will start with the many old plants that we built to support mass production. By concentrating production in a fewer number of plants and switching to more efficient automated lines that eliminate manual processes we will raise our gross profit margin. In the logistics area, since April this year we have joined with five other food makers to operate a shared distribution and warehousing facility in Hokkaido. We will gradually strengthen this cooperation. Logistics can include some inefficiencies that result in long times for delivering products to customers. The six companies working together will correct these inefficiencies. We hope to reflect these improvements numerically in our next medium-term plan. Working style reforms will include reducing working hours, which should help reduce or eliminate overtime work. We are not intending to save money from it. Organization is the first step to achieving efficient working practices. We also have begun to create mechanism that will promote changes in the way our employees work. Requiring employees to use more of their allotted annual vacation days can improve their health condition, which in turn will be reflected in on-the-job performance. Currently, our employees work on average 2,050–2,100 hours a year. We aim to reduce that to about 1,800 hours by 2020.