T. Hasegawa (4958 JP)

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T. Hasegawa (4958 JP) is one of the world leaders in the global flavours and fragrances market. It’s currently the second-largest flavours & fragrances company in Japan and has decent exposure to the fast-growing Chinese and Southeast Asian markets.

Roughly 85% of T. Hasegawa’s revenues come from ingredients used to improve the flavour or enhance the texture of food or beverages. The remaining 15% of revenues come from fragrances that create specific scents in household products or perfumes. A little over half of the revenues come from Japan and the rest from other Asian countries and the United States.

The flavours & fragrances industry is characterised by high switching costs and pricing power. The cost of a flavour is typically a tiny fraction of the total production cost yet contributes significantly to the success of a product. Customers are therefore willing to pay up for industry-leading R&D.

The companies in the sector tend to dominate specific local markets. To succeed, you need R&D personnel on the ground who understand what scents and flavours people enjoy. In Japan, the market is dominated by industry-leader Takasago, followed by T. Hasegawa. Globally, the major companies in the industry are Givaudan, IFF and Symrise.

For many years, T. Hasegawa has been a sleepy company, growing EPS in the mid-to-high single digits. The Japanese flavours & fragrances market is mature and slow-growing because of stagnant income growth and weak demographics. But the Chinese and Southeast Asian markets are significantly more attractive, with industry growth of around 7-8% per year.

What brought my attention to T. Hasegawa is UK shareholder activist AVI Japan Opportunities Trust's new campaign to reform the company. AVI sent a 13-page letter to Hasegawa last year, asking them to revamp the top leadership so that the company becomes more aggressive, more entrepreneurial.

It’s an opportune moment to get involved in T. Hasegawa. In 2017, professional CEO Takao Umino took over the business. He was previously running T. Hasegawa’s highly successful Chinese subsidiary. And just four months ago, the last of the original founding family retired from his position as Chairman. So right now, Hasegawa has become a 100% professionally managed business, and that’s why I think AVI will succeed in its activist campaign.

So far, CEO Takao Umino seems to be taking AVI’s suggestions to heart. He has recently implemented a new marketing division aimed at finding new solutions for customers by bringing together resources from across the company. On AVI’s suggestion, T. Hasegawa has also set up an English speaking global IR team. It has also started to monetise the company’s previous JPY 14 billion in cross-shareholdings and bought back shares.

Despite a similar growth profile, T. Hasegawa’s 2023e consensus multiple of 13x is roughly half of its global peer group’s. I’m sceptical of the 2023e consensus earnings estimate as some of the 2020-2021 earnings were boosted by one-off gains in the sales of cross-holdings. But a forward P/E multiple in the teens seems reasonable. It will still provide decent upside to the global peer group.

AVI thinks the stock is undervalued, having allocated 8% of the fund’s portfolio to the stock after acquiring shares just a bit below the current share price.

There are several ways that EPS growth could accelerate. In February 2022, T. Hasegawa finished a new US plant that increased the company’s US manufacturing capacity by about 50%. The company has been hit somewhat by COVID-19 due to weak foot traffic at restaurants and retail establishments selling beverages and weak duty-free sales of perfumes. It looks like the world is getting closer to recovery from COVID-19. In addition, AVI continues to push for more aggressive marketing and further share buybacks.

The key risk is that rising raw materials dent the company’s gross margins. Then again, given how vital food & beverage flavours are and how cheap they are compared to the total cost of a product, I suspect that they will be able to pass on those higher costs to the consumer. Higher raw materials prices and inflation might even accelerate T. Hasegawa’s overall growth.

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