August 10, 2022

Kirin Holdings Looks Undervalued, But The Business Is In Transition (OTCMKTS:KNBWY)

Japan’s Kirin Holdings (OTCPK:KNBWY) is a challenging company to evaluate. On one hand, you have a management team that has done some very good things with its brewery operations over the past few years, including leveraging new product development to regain #1 share in Japan. Management has also been diligent about exiting (or at least trying to exit) business with weak margin and growth outlooks.

On the other hand, the company’s investment into Fancl, a Japanese manufacturer of cosmetics and supplements is a curious step, as was the acquisition of Kyowa Hakko Bio, and there have been persistent rumors about whether Kirin would acquire more of Kyowa Kirin (OTC:KYKOY).

I understand why Kirin management wants to look beyond the beer business for avenues of growth; Japan is a low-growth market (at best) and there aren’t many attractive “gettable” beer businesses elsewhere. On the other hand, not many companies manage to succeed in businesses well outside their core focus. Kirin shares don’t look particularly expensive, but investors attracted by the value should understand that it may take a while longer for the Street to buy into the story and bid the shares up to a higher level.

Brewing – Good Execution, But Limited Opportunities

Since selling its Brazilian operations to Heineken (OTCQX:HEINY) a few years back, Kirin has actually done a pretty good job with its beer business. Kirin has been relentless and consistently successful with new product development, shifting quickly to so-called “new genre” beer – a type of beer that is malt-free and meaningfully cheaper as a result – and building up a strong craft beer assortment. With this, Kirin has regained the top market share in position from Asahi (OTCPK:ASBRF) with mid-to-high 30%’s market share.

Kirin has also been fairly aggressive in improving its sourcing, manufacturing and distribution operations. As an example of one of the “little things” Kirin has done, the company has leveraged a new dispensing system that allows on-premise customers (bars, etc.) to offer more varieties with a single service unit – not a trivial detail if you’ve ever seen how limited space is in many Japanese bars and pubs. The net effect of all of this has been incrementally better margins.

Unfortunately, I don’t know that there are many rabbits left to pull out of management’s hat. Kirin has responded to Japanese beverage taxation with clever product innovation, but Japan is an aging country with an already-high standard of living and a shrinking population. There’s just not much growth potential in the domestic brewing business.

I also don’t see a lot of great ex-Japan growth options. Kirin’s acquisitions in the Philippines and Myanmar have worked out, but there just aren’t many markets left where similarly impactful deals could be done. There are certainly still many markets with low levels of beer consumption (India, much of Southeast Asia, and most of Africa), but those would be very difficult markets in which to establish profitable greenfield operations.

Looking Beyond Beer

Management seems to be realistic about its chances of finding good reinvestment opportunities within beer, and they’ve been actively looking elsewhere. Nutrition seems to be the area of greatest focus, and by “nutrition” I mean products like supplements and so-called functional foods that promote various supposed health benefits like “boosting your immune system”. These have long been relatively popular among Japanese consumers, and regulation in Japan is relatively benign.

Kirin has been active here for a while in its non-alcoholic beverage business, and over the last two to three years or so it stepped up its efforts by acquiring Kyowa Hakko Bio for $1.2 billion to accelerate wellness product development and then acquiring a one-third stake in Japanese cosmetics and supplement company Fancl for another $1.2 billion.

Kirin management has made the case that there are significant benefits to be gained from working closely with Fancl in product development and distribution, and Fancl does have both online and company-owned stories that offer some new go-to-market options for Kirin. On the product development side, the two companies are just now launching their first co-developed products – Hyo Rei Calolimit, a non-alcoholic chuhai drink (chuhai is kinda/sorta like hard seltzer), and Base, a flavored water product with HTC collagen and rose bud extract.

While I have my doubts about some of Kirin’s expansion activities outside of beer, I also acknowledge that management has very few options if they want to continue generating revenue growth. Although I personally don’t see a lot of utility in these supposed “wellness” products, the reality is that a lot of consumers do see value in them, and it is an opportunity for Kirin to leverage a responsive customer-driven product development process that has worked well in the brewing business.

One ongoing potential opportunity is further consolidation of Kyowa Kirin – a biopharmaceutical company in which Kirin owns more than 50%. Kyowa Kirin has a fairly strong foundation in areas like kidney disease and oncology, as well as a growing antibody/biosimilar business. Kyowa Kirin has made growth in the EU and U.S. a priority in the coming years; a worthwhile goal, but one that relatively few Japanese pharmaceuticals have managed to achieve. I would also note that Kyowa Kirin is only slightly smaller than Kirin itself in terms of market cap, so that may well limit what Kirin can do in terms of further consolidation.

The Outlook

I’m not expecting a lot of growth from Kirin’s brewing business, as the Japanese market just doesn’t have that much growth to give and the ex-Japan businesses are still too small to move the needle all that much. It’s a good business, just not a growth business. The wellness/nutritional category, though, does offer more growth potential, as does Kirin’s share of Kyowa Kirin. All told, I expect Kirin to generate around 2% to 3% long-term revenue growth, and there could be upside to that if the company can really leverage opportunities in wellness (both internally and with Fancl).

On the margin side, the pharma/bio operations offer strong margins, and I expect to see the domestic beverage business improve over time with more functional/wellness product offerings. All told, I believe FCF margins can move into the mid-to-high single-digits, driving high single-digit FCF growth.

The Bottom Line

Perhaps the biggest issue with Kirin today is that analysts and institutions don’t really buy into the transformation story. Kirin gets high marks for its move to improve its brewing operations, but there don’t seem to be many believers that the move into nutritional/wellness products will be all that successful. I certainly have my own doubts, but the valuation isn’t demanding a big leap of faith, and I do see value in the Kyowa Kirin stake. This could be the sort of investment idea that ends up being an “off the radar” success with steady, but not dramatic, re-rating as the company delivers, but investors should appreciate the risk that market skepticism will last a while longer, not to mention the risk that this pivot towards wellness just doesn’t work as hoped.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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