Hengan Earnings: Elevated Input Costs Dragged Margin Despite Decent Sales Growth

We lower our fair value estimate on no-moat Hengan International 01044 to HKD 37.00 from HKD 40.00 after disappointing first-half 2023 results. Net profit missed the Refinitiv consensus estimate primarily due to continued weakness in sanitary napkin sales. Gross margin also fell short of our estimates. The tissue segment delivered strong top-line growth thanks to competitive pricing. Management expects margins to improve in second-half 2023 with lower pulp costs. But we continue to see pressure to long-term profitability of the sanitary napkin business, which made up close to 80% of Hengan’s EBIT over the last five years. We lower our long-term margin projection, but the company should see alleviating cost pressure in the near term, which could limit possible negative reaction to the weak results.

We reduce our 2023 net income estimates by 17.6% on lower gross margin and higher channel expenses expectations. We also cut our medium-term gross margin estimates to account for heightened competition. Volume growth for sanitary napkins remains limited, and we are cautious toward Hengan’s ability to gain share over international brands. However, we think Hengan’s current share price already reflects the weaker outlook. Our revised fair value estimate implies 15 times 2023 and 13 times 2024 price/earnings.

Top-line growth was driven by a 23% increase in the tissue category, as Hengan remained competitive versus peers and expanded into emerging channels. Diaper segment revenue also appears to have stabilized following two years of transition and clearance of low-end product inventory. We view the progress in channel diversification constructively and think it could strengthen the company’s market position in the medium term. But we note channel expenses would also increase accordingly.