Nippon Paint : Q&A Summary (with a Supplementary Explanation about the Credit Loss Provision at NIPSEA China)

A1In the 1Q of FY2023, NIPSEA China demonstrated a robust performance, buoyed by the rebound in economic activities subsequent to the relaxation of pandemic-related restrictions that continued throughout the latter half of FY2022. This resurgence led to substantial earnings driven by pent-up demand from the previous year and the moderation of raw material prices. Consequently, our 1Q operating profit margin surpassed projections, although the 2Q operating profit margin decreased from the 1Q. Notably, on the non-GAAP basis 2Q operating profit margin improved to 9.4% from the 7.6% recorded in the second quarter of FY2022.

In the 2Q, we observed robust performance in April. However, in our pursuit of expanding market share, we made the strategic decision to reduce prices on certain products, including economy items, in May and June, as a response to the prevailing economic slowdown. Particularly, the rebound in demand within Tier 0 cities had a favorable effect on margins, offsetting the downturn experienced in the 2Q of FY2022 due to lockdowns. Nonetheless, the deterioration in product/mix, stemming from elevated sales expansion in Tier 3-6 cities, exerted an adverse influence on the operating profit margin in the 2Q of FY2023. Furthermore, in the TUB business segment, there were cases where we had to resort to legal measures to recover trade receivables. Based on our internal policy, an almost 100% credit loss provision is recognized against trade receivables for which legal action is pursued for debt retrieval. Consequently, these delinquent debts have had an unfavorable effect on our operating profit margin.

We are committed to pursuing volume growth and expanding market share, perceiving the present business landscape as a chance, even if it means sacrificing some degree of our margins. Nonetheless, it's important to note that our operating profit margin has improved consistently compared to the same period of the previous year.

A2I will give you the following supplementary explanation about the credit loss provision in China.

Let me tell you first that the TUB business, which includes transactions with real estate developers, currently accounts for approximately 6%^* of our consolidated revenue. Accordingly, the performance fluctuations in this business do not significantly impact our consolidated performance.

*Compared to FY2022, the relative weight of the TUB business decreased with the growth of the TUC business. To illustrate, the revenue composition of the TUB business: NIPSEA China revenue (c. 35% of the consolidated revenue) x Decorative paints revenue in NIPSEA China (c. 80% of the overall revenue in NIPSEA China) x TUB revenue in the decorative business in NIPSEA China (c. 20%-25% of the overall decorative revenue)

The breakdown of sales in the TUB business between the real estate developers and others is approximately 40% to 60% and trade receivables from others generally have lesser collection issue.

We recorded a credit loss provision of approximately 15 bn yen for trade receivables from leading private developers last year. But that was related to a limited group of customers (10-plus developers). We have not recorded any additional provision for this specific group of customers this year. Furthermore, we have switched to cash-on-delivery transactions with customers who have a potential debt collection risk starting in the second half of FY2022 through FY2023.

We have focused on more than 100 developers, and the amount of trade receivables which were issued before we switched to cash-on-delivery and are in arrears have started to increase due to the economic conditions these days.

There have also been increasing cases in which we take legal actions to collect the trade receivables issued in the past (before we switch to cash-on-delivery) and are in arrears. Based on internal policy, 75%-100% of the amount of trade receivables which are undergoing legal actions will be recorded as a credit loss provision. The credit loss provision recorded in the 2Q as a result of us taking legal actions has impacted our operating profit margin. With historical recovery at 50-plus %, we believe our credit loss recognition is adequate.

To be specific, the impact of credit loss provision will be 1-plus % of the full-year revenue at NIPSEA China. The amount of credit loss provision is larger in the first half than in the second half, and the 2Q recorded the largest amount of credit loss provision (slightly below 2% of the 2Q revenue) on a quarterly basis. Since the trade receivables covered are basically those issued before we switched to cash-on-delivery, we expect that trade receivables that will be subject to credit loss provision will start decreasing gradually from the second half through FY2024.

The 2Q operating profit margin at NIPSEA China was 9.4% on a Non-GAAP basis but will be 11-plus % after excluding the credit loss provision accompanying legal actions even after taking into account the impact of higher sales composition of economy products (including higher sales growth in Tier 3-6 cities) in the product/mix and price reduction on some economy products.

We expect the percentage of trade receivables for which credit loss provision will be recorded following legal actions will start decreasing gradually in the 3Q. I have stated that we will prioritize market share gains, but we will not reduce selling prices in total disregard of profitability. I hope this supplementary explanation will clear up the misunderstanding that our operating profit margin in NIPSEA China will continue to decrease.