Revision of FY2021 Forecast Conference Call QA SummaryPDF180KB

FY2021 Consolidated Earnings Revision Conference Call Q&A Summary

(October 12, 2021)

• Questions by Tomomi Fujita, Morgan Stanley MUFG Securities Co., Ltd.

Q1 I have questions about NIPSEA China. You mentioned earlier that the decrease in the operating profit forecast of 16.5 billion yen includes a potential provision for bad debt. A simple calculation using the operating profit margin indicates that the impact of provision is large. How much would this one-off expense be? Please give us a qualitative or quantitative explanation.

A1 The reasons for the decrease of 16.5 billion yen include increased cost due to higher raw material prices and a provision for bad debt. We have provided a reasonable provision for bad debt based on our internal estimation. Please note that we have not agreed with our auditors about this provision, and it is a rough estimate; we have not decided whether or not we will actually post this provision in the 3Q.

To provide a rough estimate, we think that the one-off provision would account for around 20% of the 16.5 billion yen downward revision of the forecast. The remaining 80% would be the impact of higher raw material prices.

Q2 If the raw material price increase is the major reason for the downward revision of operating profit at NIPSEA China, I think the impact of higher raw material prices would be significant. Does the revised earnings forecast assume lower earnings in the automotive coatings business in China while the outlook for real estate market conditions and the Chinese decorative paints business remain unchanged from three months ago? Can we assume that the earnings figures are approximate numbers and actual sales are somewhat lower than the revised forecast, which is reflected in the operating profit forecast? Or, can we assume that the downward forecast revision is largely attributable to the higher cost of raw materials considering that the ongoing weakness in the new construction market will impact the decorative paints business with a time lag?

A2 I will answer your questions regarding revenue and operating profit separately. Revenue in the Chinese decorative paints business is slightly higher than the forecast announced in August. Our customers in the decorative paints segment in the so-calledreal-estate sector do not anticipate that the market will decline significantly until at least the end of this year. Revenue in the industrial segment centered on the automotive coatings business is slightly

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lower than the August forecast. The decorative paints segment accounts for a significantly larger percentage of total revenue than the industrial segment. As a result, overall revenue is expected to be slightly higher than the August forecast. This is how we see the market.

The supply of raw materials became extremely tight in September and October, and we can now make a more accurate assessment of the inventory available for use in 4Q. As a result, our revision of the August forecast is based on firm estimates. In addition, we are considering selling price increases almost on a daily basis. In the next month or so, we will know how much of the impact of higher raw materials we can absorb. Therefore, we have estimated the raw material cost slightly conservatively. My explanation is based on our assumption that we can keep the impact of higher raw material prices to a certain level based on firm estimates of the cost of raw materials. It is true that higher raw material prices have had a significant impact.

• Questions by Takashi Enomoto, BofA Securities Japan Co., Ltd.

Q1 Please give us your outlook for automobile production. You mentioned earlier that automotive coatings revenue was significantly impacted by the decrease in automobile production in September and October. What is your outlook for November and December? Please tell how much of the decrease in the operating profit forecast is attributable to the automotive coatings business?

A1 We do not disclose the operating profit in the automotive coatings business. The downward forecast revision of automotive coatings revenue is considerably below 10 billion yen, and you can assume that the impact is roughly half that amount.

Our forecast assumes that automotive coatings revenue will rebound to the prior-year level in November and December. However, we do not assume that our revenue will grow by 20-30% YoY from November onwards and offset the revenue decline in September and October. On the other hand, there may be a recovery in automotive coatings revenue next year driven as people rush to buy new vehicles. However, we assume that the automotive coatings business will remain sluggish throughout this year. These are our assumptions although there is a risk that parts and semiconductor shortages will continue in November and December.

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Q2 Can we assume that you cannot expect a recovery in December as the shortages of parts and other key components continue?

A2 We expect that the parts shortage will end to some extent in November and December and automotive production will recover almost to the initially planned level. But automobile manufacturers will decide whether their output will rebound beyond that level. When that happens, we will focus on supplying products as required by our customers. The earnings forecast revision does not factor in an automotive production recovery beyond the initially planned level.

• Questions by Atsushi Ikeda, Goldman Sachs Japan Co., Ltd.

Q1 I would like you to give us more details on the impact of raw material price increases. Are the increases largely attributable to higher crude oil prices or to factors specific to China such as power supply restrictions? Do you expect that raw material price inflation will subside once crude oil prices settle down? Or do you think that the price increases could become structural in nature due to environmental factors? How is the NIPSEA China procurement team dealing with the higher prices of raw materials? Please give us an answer separately for crude oil-based raw materials and titanium oxide. Also, please tell us your strategies such as selling price increases in the DIY and Project businesses if raw material prices remain elevated.

A1 As I mentioned at the beginning of my presentation, our raw materials include crude oil, as well as monomers, solvents, resin, and titanium dioxide, and their prices are surging across the board. The cost of crude oil has increased significantly, but all raw material prices are climbing. The shortage of electricity is adding to this inflationary pressure. Therefore, I cannot explain the impact crude oil price increases and the power supply shortages separately. What I can say is that we are not optimistic about the situation. We are reviewing various actions assuming that raw material prices will remain high at least until the first half of 2022.

Our management teams worldwide, including at NIPSEA China, are developing strategies for the next year right now because a relatively accurate assessment of our business performance for FY2021 has become available. Possible actions include selling price increases, cost reductions, and substituting raw materials. Of these, we will focus on increasing selling prices and reducing SG&A and other expenses.

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Our Project and DIY sales are not decreasing. So, we are developing strategies that will allow us to deliver operating leverage to secure a solid bottom line (net profit) by further driving sales growth. This goal is based on the assumption that sales in these businesses will continue to increase or that we can there will be opportunities to increase our market share.

If raw material prices increase further, the cat and mouse game begins. What is critical when the raw material prices are rising is that we can only increase our selling prices with a time lag. What we can do is to work out our strategies assuming that the upward pressure on raw material prices will continue throughout the first half of next year due to issues involving power supply restrictions, total supply and demand, and high crude oil prices.

Q2 My understanding is that the downward revision of the operating profit forecast includes a one-off provision for bad debt. The operating profit margin at NIPSEA China will decrease from a little over 11% to, say 3-4% in the second half of FY2021. In addition, you will be forced to accept a low operating profit margin in the short run in the first half of next year. When you have overcome these challenges and increased your market share, you will take actions to use operating leverage to recover profitability. Is my understanding correct?

A2 I will not go into numbers. But if you ask me if we will be satisfied with the same level of operating profit margin in the first half of next year as in the second half of this year, my answer is no. We will take actions such as selling price increases and cost reductions wherever we can in order to improve our operating profit margin. Our KPI are earnings growth as well as increasing sales and market shares. The management team in China is well aware of this, and is not settling for an operating profit margin in the first half of FY2022 that is on a par with the second half of FY2021. How much of an improvement we can achieve will depend on our capabilities. This is our thinking behind how we can improve the operating profit margin.

• Questions by Tomotaro Sano, JP Morgan Securities Co., Ltd.

Q1 I have questions about the timing and the degree of acceptance of selling price increases. Is the acceptance of price hikes, in particular in China, slower than anticipated in August, or progressing as planned? Do you think you can continue to increase selling prices? I guess increasing these prices too much

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will have an adverse impact on your market share to a certain degree. Please share your thoughts on this subject.

A1 Regarding the selling price increases, we have already raised prices in areas where we can do so. In reality, we are unable to fully absorb the impact of higher raw material prices by raising selling prices because raw material prices are increasing faster than we expected. As a result, we are forced to use higher priced raw materials at NIPSEA China due to factors including tightening supplies of raw materials.

On the other hand, we have been able to increase selling prices steadily in other Asian countries and Australia, where we have a high market share. Given the low unit price of paint products, price increases are unlikely to lower demand that much. In addition, paint products, in a sense, are essential and have no substitute. Therefore, we believe we can make additional price increases by single-digit percentages, say by 5% or 8%.

We are closely monitoring the raw material prices, in particular in China, to determine how we can pass on price increases. However, if we increase selling prices too quickly, for instance, in the Project segment, that would create a big gap with the prices of competitors. On the other hand, the DIY segment is brand-centric and therefore easier to raise prices. Our management team in China is working to ensure that we raise selling prices within an appropriate range while keeping a close eye on our competitors.

In a nutshell, we are increasing prices in our operating regions and businesses where possible. However, we have to carefully choose where we can increase prices. We raise prices based on careful decisions at divisions that directly deal with customers so that we do not lose market share to our competitors as a result of increasing selling prices too much. I believe our resilience will pay off in the long run.

Questions by Atsushi Yoshida, Mizuho Securities Co., Ltd.

Q1 I have questions about revenue at Betek Boya. What are the reasons that you upwardly revised its revenue growth forecast from around 40% YoY to around 45% YoY? You explained that the downward revision of the operating profit margin is attributable to the weakening of the Turkish lira and increase in raw material prices. However, you did not change your exchange rate assumption for Turkish lira at 1 TRY = 13.2 JPY. Are there any other factors that would

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