All Shiseido’s Beauty Products Aren’t Enough to Put a Good Face on Its Earnings Prospects

Plagued by lackluster domestic demand and geopolitical wrangles, Shiseido’s sales slump is likely to take a toll on the company’s profits.

The attempts at stimulating Japan’s economy and the other concept enshrined in what has become known worldwide as “Abenomics” in honor of Japan’s newly-elected prime minister, Shinzo Abe, have yet to benefit Shiseido Co. Ltd. (4911.T). For starters, the cosmetics and beauty products company still generates about half of its sales within Japan itself (52% during the first nine months of the current fiscal year, ending March 31), meaning that it isn’t benefitting from the weaker Japanese yen as much as are the more export-dependent, companies. And even in its overseas markets, Shiseido hasn’t been able to take full advantage of any pricing opportunity, setting the stage for what now seems likely to be a disappointing operating profit when the company announces its annual results at the end of April.

Part of the problem is that Shiseido’s fortunes have been caught up in a geopolitical battle between Japan and China over a group of small islands in the South China Sea. (The two countries can’t even agree on the islands’ name: in Japan, they are known as Senkaku; in China, Diaoyu.) China argues that its claim dates back centuries; the Japanese government laid claim to them in the late 19th century after saying that it found no trace of Chinese ownership. Japan’s brutal invasion and occupation of China in the 1930s, which ended only with the former’s defeat at the end of World War II in 1945 exacerbates the tensions surrounding the question, which have spilled over into the commercial arena. Shiseido is only one company to feel the impact of a surge in anti-Japanese feeling, which has led to consumer boycotts of Japanese goods and to protests outside factories assembling products for Japanese companies.

Former U.S. Secretary of State Hillary Clinton had pledged to help resolve the dispute, and finding a solution is likely to be a priority during a forthcoming summit meeting between Abe and President Back Obama. Still, combined with a setback in European sales, this has been bad news for Shiseido’s revenues and profits. That is even more true in light of the fact that the company is still struggling with weak consumer spending at home in Japan, a trend it attributes to “deflationary trends and a continuing difficult employment environment.” What Shiseido described as modest growth in North American sales may not be enough to offset these headwinds.

Certainly, analysts are becoming more bearish about the company’s year-end earnings. Currently, the consensus estimate for Shiseido’s operating profit (the preferred measure of profitability in Japan) is ¥31.2 billion, down from ¥ 38.7 billion just 90 days ago. But the SmartEstimate is even lower, at ¥ 28.8 billion, giving the company a negative Predicted Surprise of -7.9% and hinting that analysts may well not have finished cutting their earnings estimates or that Shiseido is likely to report earnings that fall short of the already-lower consensus.

As of today, of the 14 analysts who follow the company, only two have a ‘buy’ recommendation on Shiseido’s stock, one fewer than was the case a month ago. Meanwhile, the number of ‘sell’ recommendations has climbed from five to six in the same period. All six of the analysts who have updated their estimates since the beginning of February have lowered their forecasts for Shiseido’s annual earnings.

Shiseido’s troubles seem to be specific to the company and not anything that is an industry-wide phenomenon. Indeed, while the median operating profit for the trailing four-quarter period for companies in the industry has risen to 9.5% from 8.2% over the course of the last four quarters. In the same period, however, Shiseido’s operating margin has fallen from 6.8% to 3.8%, displaying the company’s lack of pricing power (coupled, perhaps, with a high cost structure and sluggish growth in sales). While the weakness in the yen will help boost Shiseido’s profits outside Japan, there are few signs that this will be enough to reverse the broader trend of declining sales. China has been a significant market for Shiseido, and the strong anti-Japanese mood in the country shows no signs of abating, eating into the company’s sales there.

Shiseido scores only 5 out of a possible 100 on the StarMine Analysts Revisions Model, signaling that analysts are likely to remain bearish with respect to the company’s earnings outlook. Moreover, Shiseido scores only 10 on the StarMine SmartHoldings Model, in an indication that the company doesn’t offer the kinds of fundamental characteristics that institutional investors currently favor and thus that its name isn’t likely to pop up on a list of recommended “buys” generated by any of their models. With the odds of increased institutional buying low and the odds of an earnings disappointment high; not even Shiseido’s cosmetics can make these signals look more attractive.

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