I award a Hold rating to Japan Tobacco Inc.’s (OTCPK:JAPAY) (OTCPK:JAPAF) [2914:JP] shares. The weakening of the Japanese yen played a key role in JAPAY’s +4.6% revenue beat for Q2 2024. Given that there is a good chance of the yen strengthening going forward, I have decided to downgrade my rating for Japan Tobacco to a Hold in view of a potential FY 2024 results miss.
JAPAY’s first quarter financial performance was the focus of my prior write-up, published on May 12, 2024. The current update evaluates Japan Tobacco’s latest quarterly results and prospects for the full year.
Japan Tobacco’s shares can be bought or sold on the Japanese equity market and the Over-The-Counter market. The average daily trading values for the company’s OTC shares and its shares listed on the Tokyo Stock Exchange were $400,000 and $120 million (source: S&P Capital IQ), respectively, in the last 10 trading days. Investors can trade in Japan Tobacco’s Japan-listed shares with US brokerages like Interactive Brokers.
Second Quarter Revenue Was Boosted By Weak Japanese Yen
Japan Tobacco announced its Q2 2024 financial results on Friday, August 2, and the company’s meaningful top-line beat for the recent quarter was in the spotlight.
JAPAY’s headline revenue rose by +14.0% YoY to JPY829.6 billion in Q2 2024, which represented a +4.6% beat as compared to the sell side’s consensus forecast of JPY793.3 billion (source: S&P Capital IQ).
The company’s top line adjusted for foreign exchange effects increased by a much more modest +6.7% YoY in the second quarter. In its Q2 2024 results announcement, Japan Tobacco cited “favorable currency movements” as the main reason for the company’s significant headline revenue growth for the latest quarter.
The Japanese yen weakened from JPY151.4 per dollar at the end of March to JPY161.1 per dollar as of end-Q2 2024, and this was a tailwind for JAPAY which has significant exposure to foreign markets outside Japan. As a reference, Japan Tobacco earns around “70% of its consolidated revenue through overseas tobacco operations” according to Japanese credit ratings agency J&I’s April 26, 2024 report.
In a nutshell, Japan Tobacco’s Q2 2024 top line performance benefited from the weakening of the Japanese yen.
Separately, JAPAY delivered positive operating income growth for the second quarter of 2024 and that was slightly above expectations.
Operating income for Japan Tobacco expanded by +4.7% YoY to JPY216.8 billion for Q2 2024. JAPAY’s operating profit grew by a smaller extent as compared to its revenue (+14.0% YoY) in the recent quarter, which it attributed to “higher costs” associated with the “Ploom (Heated Tobacco Sticks or HTS product) geo-expansion” in its second quarter results announcement. In my May 12, 2024 article, I indicated that Ploom is “gaining traction in new international markets”, and it is natural that Japan Tobacco’s expenses have gone up with Ploom’s venture into new territories.
On the other hand, JAPAY’s actual Q2 2024 operating income still turned out to be +0.5% above the analysts’ consensus estimate of JPY215.7 billion (source: S&P Capital IQ). At the company’s second quarter earnings briefing, Japan Tobacco explained that “the robust pricing contributions outweighed the impact of increased investment towards Ploom” in Q2 2024. In other words, JAPAY’s price hikes have more than offset the increase in costs relating to Ploom for Q2, and this has driven an +0.5% operating profit beat for the company.
Second Half And Full-Year Performance Could Be Affected By Stronger Yen
JAPAY’s 2H 2024 and FY 2024 results might be impacted by a stronger yen.
The Japanese yen has strengthened from JPY161.1 per dollar as of June 30, 2024, to JPY145.3 per dollar at the end of last week. A recent July 31, 2024 Seeking Alpha News article mentioned that “the Bank of Japan raised its key short-term interest rate to 0.25%” which saw “the Japanese yen appreciate.”
Third-party research suggests that the Japanese yen is likely to strengthen further in the months ahead. ING (ING) (OTCPK:INGVF) is anticipating that the Bank of Japan will initiate another “rate hike” before December 31, 2024. On the other hand, Japan’s Mitsubishi UFJ Financial Group (MUFG) sees the Japanese yen getting to “the mid-to low 140.00’s” per dollar level near the end of 2024.
Notably, Japan Tobacco’s full-year FY 2024 top-line guidance of JPY3,109 billion, implying a +9.4% YoY growth, is based on the assumption of a relatively weaker JPY153.8 per dollar exchange rate (source: Q2 results announcement).
In summary, a stronger-than-expected yen increases the probability of Japan Tobacco’s actual 2H 2024 and FY 2024 revenue and earnings falling short of the market’s expectations. This explains why I have chosen to revise my rating for Japan Tobacco from a Buy to a Hold.
But Key Long-Term Investment Merits Are Still Intact
A Sell investment rating for JAPAY is unwarranted. Even though Japan Tobacco’s near-term prospects are affected by unfavorable foreign exchange effects, the stock’s key long-term investment merits are still intact. Specifically, Japan Tobacco remains an attractive dividend play, and the company is making good headway in expanding Ploom’s presence.
In its Q2 2024 results announcement, Japan Tobacco noted that it will be distributing “an interim (1H 2024) dividend per share of JPY 97 as initially planned.” The company also stuck to its earlier full-year FY 2024 dividend distribution guidance of JPY194 per share. JAPAY’s full-year guidance is based on an implied 72.5% dividend payout ratio, which is lower than its 75% dividend payout ratio policy. As such, the company has some leeway to raise its actual dividend payout ratio to meet the JPY194 guidance, even if its actual earnings turn out to be lower than what it anticipated. More importantly, Japan Tobacco’s forward FY 2024 dividend yield (as per guidance) is an appealing 5.6%.
On the other hand, JAPAY has done reasonably well in growing its HTS product Ploom’s reach. As indicated in the company’s Q2 earnings presentation slides, JAPAY’s HTS product Ploom was introduced to four new overseas markets in Q2 2024, which means that Ploom had a presence in 21 markets as of June 30 this year. In its home market of Japan, Ploom’s market share in the HTS product segment increased from 11.0% in Q1 2024 to 11.4% for Q2 2024. Therefore, it is no surprise that Japan Tobacco emphasized at its Q2 2024 earnings call that Ploom is “pretty much expanding in line with our expectation.”
Japan Tobacco’s status as a dividend stock and a play on diversification into HTS offerings are the stock’s key investment merits for the long run, which have stayed unchanged.
Conclusion
I take the view that a Hold rating for Japan Tobacco is fair.
On the negative side of things, a strengthening yen will likely be negative for JAPAY’s short-term financial results. On the positive side of things, Japan Tobacco is still an attractive dividend play, and it has done well in expanding in the HTS segment.
In terms of valuations, Japan Tobacco’s consensus next twelve months’ EV/EBIT of 9x (source: S&P Capital) is aligned with the company’s operating profitability target. JAPAY’s goal is to grow its operating income by a “mid to high single digit” percentage CAGR for the “mid to long term” outlined in its business plan presentation slides. A stock is usually judged to be fairly valued if its earnings multiple and earnings growth rate are at a similar level. In JAPAY’s case, both its EV/EBIT multiple and EBIT growth outlook are in the high single digit percentage range.
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