LIXIL Group (5938) Favor shifting investment from TOTO to LIXIL

Transcription

1 Asia Pacific/Japan Equity Research Building Products (Housing (Japan)) Rating OUTPERFORM Price (20 Feb 17, ) 2,770 Target price ( ) 3,200 Change to TP (%) 16 Market cap ( bn) 795 (US$ 7.0) Enterprise value ( bn) 1,482 Number of shares (mn) Free float (%) week price range 2,854 1,640 Target price is for 12 months. Research Analysts Masahiro Mochizuki masahiro.mochizuki@credit-suisse.com Share price performance 3, , , , ,5 0 0 Price (LHS) Yasuko Fukuda yasuko.fukuda@credit-suisse.com Reb ased Rel (RHS) Ju l Ja n Ju l Ja n The price relative chart measures performance against the TOPIX which closed at 1, on 20-Feb-2017 On 20-Feb-2017 the spot exchange rate was /US$1 Performance 1M 3M 12M Absolute (%) Relative (%) LIXIL Group (5938) COMPANY UPDATE Favor shifting investment from TOTO to LIXIL Action: We revise our forecasts for LIXIL, but maintain our 3,200 target price (potential return 16%) and OUTPERFORM rating. Investment Overview: Looking ahead, we expect the market to price in: (1) profit growth in FY3/18, (2) expectations for the medium-term business plan slated to be announced during 2017, and (3) improved profitability at, or disposal of, Permasteelisa. We expect LIXIL to unveil its medium-term plan after 1Q In the meantime, we think the company could sell consolidated subsidiary Permasteelisa, a curtain wall maker. Such a move would likely create shareprice upside (LIXIL is considering it, according to a 15 September 2016 Nikkei article). Our analysis suggests LIXIL's shares are undervalued compared with TOTO (5332). From FY3/17, we expect LIXIL and TOTO to achieve the same rates of EBITDA growth. In comparative terms, however, LIXIL appears undervalued based on EV/EBITDA. If the market prices in EBITDA growth, we believe LIXIL s valuation could draw level with that of TOTO. LIXIL's shares are trading at a FY3/18E EV/EBITDA (core earnings + depreciation expense) multiple of 8.8x, versus 9.1x at TOTO. Catalystss/Risks: Catalysts: (1) above-guidance earnings in FY3/17, (2) confirming profit growth in FY3/18 guidance, (3) selling off Permasteelisa, and (4) announcement of the new medium-term plan. Risks: (1) earnings deterioration at Permasteelisa, (2) sluggish domestic renovation demand, (3) a capital increase, and (4) price competition Valuation: As before, we base our 3,200 target price on a fair-value EV/EBITDA of 9.5x applied to our FY3/18 estimates. Financial and valuation metrics Year 3/16A 3/17E 3/18E 3/19E Sales ( bn) 1, , , ,884.3 Operating profit ( bn) Pre-tax profit ( bn) (7.1) Net income ( bn) (25.6) EPS ( ) (89.2) IBES Consensus EPS ( ) n.a EPS growth (%) (216.1) P/E (x) (25.7) Dividend yield (%) EV/EBITDA (x) P/B (x) ROE (%) (4.5) Net debt/equity (%) Source: Company data, Thomson Reuters, Credit Suisse estimates DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 LIXIL Group (5938) Price (20 Feb 2017): 2,770 (upside: 16%); Rating: OUTPERFORM; Target Price: 3,200; Analyst: Masahiro Mochizuki Income statement ( bn) 3/16A 3/17E 3/18E 3/19E Sales 1, , , ,884.3 EBITDA Operating profit Recurring profit (7.1) Extraordinary gain & loss Profit before tax (7.1) Net income (25.6) Cash flow ( bn) 3/16A 3/17E 3/18E 3/19E Operating cash flow Depreciation & Amortization Financing cash flow (154.4) (30.9) (47.2) (48.7) Issuance (retirement) of stock Dividends paid (17.2) (17.2) (17.2) (18.7) Investing cash flow 19.1 (83.0) (83.0) (83.0) Capex (33.9) (83.0) (83.0) (83.0) Free cash flow Net change in cash (14.2) 3.2 (3.6) (1.5) Balance sheet ( bn) 3/16A 3/17E 3/18E 3/19E Cash & cash equivalents Current receivable Inventories Other current assets Current assets Property, plant & equipment Investments Intangibles Other non-current assets Total assets 2, , , ,177.1 Payables Short term debt Other current liabilities Current liabilities Long term debt Other non-current liabilities Total liabilities 1, , , ,515.5 Shareholders' equity Minority interests Source: Company data, Thomson Reuters, Credit Suisse estimates Key ratios 3/16A 3/17E 3/18E 3/19E Growth (%) Sales 13.0 (4.4) Operating profit (24.5) EPS (216.1) Margins (%) Gross margin EBITDA margin OP margin DuPont analysis ROE (%) (4.5) Net profit margin (%) (1.4) Sales/Assets Assets/Equity Credit ratios (%) Equity ratio Net D/E ratio Per share data ( ) Number of shares (mn) EPS (89.2) BPS DPS Dividend payout ratio (%) (67.3) Valuation (x) 3/16A 3/17E 3/18E 3/19E P/E (25.7) P/B EV/EBITDA Dividend yield (%) FCF yield (%) LIXIL Group (5938) 2

3 Reiterate OUTPERFORM rating Favor shifting investment from TOTO to LIXIL Maintain 3,200 target price and OUTPERFORM rating We revise our forecasts for LIXIL, but maintain our 3,200 target price (potential return 16%) and OUTPERFORM rating. Our analysis suggests LIXIL's shares are undervalued compared with TOTO. From FY3/17, we expect LIXIL and TOTO to achieve the same rates of EBITDA growth. In comparative terms, however, LIXIL appears undervalued based on EV/EBITDA. If the market prices in EBITDA growth, we believe LIXIL s valuation could draw level with that of TOTO. LIXIL's shares are trading at a FY3/18E EV/EBITDA (core earnings + depreciation expense) multiple of 8.8x, versus 9.1x at TOTO. If LIXIL manages to sell Permasteelisa and increase production output at LIXIL Water Technology (LWT), we could see LIXIL shares rise above TOTO's share price as the market prices in expectations for improved profitability. Investors looking to buy into Japanese residential construction manufacturers have mostly preferred TOTO or Rinnai (5947) thus far. Given the factors we now expect the market to price in, we believe more investors may start to prefer LIXIL over its rival TOTO. Figure 1: Consolidated earnings summary Sales Operating profit Recurring profit Net profit EPS mn YoY (%) mn YoY (%) mn YoY (%) mn YoY (%) YoY (%) Consolidated Mar-16 Actual 1,890, , , , Mar-17 1Q Actual 426, , ,237-11, Q Actual 443, , ,400-12, H Actual 870, , ,637-24, Q Actual 463, , , , Q CS E 474, ,700-5,700-1, Mar-17 CS E (new) 1,808, , ,500-44, CS E (prev) 1,834, , ,400-54, CoE 1,780,000-65,000-67,000-38, Shikiho E 1,780, , ,000-38, IBES E 1,811, , , Mar-18 CS E (new) 1,846, , , , CS E (prev) 1,877, , , , CoE 1,880, , , , Shikiho E 1,860, , , , IBES E 1,861, , , Mar-19 CS E (new) 1,884, , , , CS E (prev) 1,921, , , , IBES E 1,913, , , Source: Company data, Toyo Keizai "Shikiho"(Japan Company Handbook), I/B/E/S, Credit Suisse estimates Operating profit estimates We revise our forecasts as follows: (1) reduce our estimate for growth in domestic FY3/17 sales from a rise of 1.4% YoY to a decline of 1.2%, (2) raise our estimate for growth in overseas FY3/17 sales from a decline of 19.4% YoY to a 17.9% fall, and (3) push back into FY3/18 the 9bn in tax savings on deferred tax assets that we previously forecast in FY3/17. We now estimate OP of 72.5bn in FY3/17 (guidance 65.0bn; previously 73.4bn; I/B/E/S consensus 77.1bn), 86.9bn in FY3/18 (previously 91.6bn; I/B/E/S 92.1bn), and 104.0bn in FY3/19 (previously 110.5bn). LIXIL Group (5938) 3

4 Expect positive reaction to release of the new medium-term plan; LIXIL could sell Permasteelisa before the plan is released Factors to be priced in Looking ahead, we expect the market to price in: (1) profit growth in FY3/18, (2) expectations for the medium-term business plan to be announced during CY2017, and (3) improved profitability at, or disposal of, Permasteelisa. LIXIL is highly leveraged, with a capital-to-asset ratio of 25.7% as of end-december We therefore see risk of a capital increase. If LIXIL sells Permasteelisa, the capital-toasset ratio would improve by around 2%, lowering the risk of a capital increase. Sales growth possible, in Japan as well, from 4Q In FY3/18, we expect rising sales to drive profit growth. Sales on a local currency basis at Grohe and American Standard are rising and this trend seems solid. In Japan as well, we expect a return to YoY sales growth from 4Q at LHT, which mainly produces housing window sashes. Business strategy is the key issue in the medium-term plan Kinya Seto took over the role of President in FY3/17. Following this management transition, some changes have been made in the company s organization and business strategy, but there have been uncertainties over the longer-term business policy. We believe the release of the medium-term plan could bring clarity to the business strategy and stimulate investor scrutiny of this strategy. We anticipate share-price gains as more investors start to evaluate LIXIL s business strategy. The business strategy is the key issue in the medium-term plan. We expect the business strategy and a specific action plan to drive up market expectations for profit growth at LIXIL. At the results briefing, President Seto gave the first indications that the company plans to transfer technological expertise developed in Japan into other regions and improve productivity at its manufacturing sites. The President is in direct control of LWT and LHT and we expect the company to improve both productivity and marketing on a global basis. Permasteelisa sale would be good news We have previously highlighted Permasteelisa as a challenge that LIXIL needs to address, as this subsidiary generates low profit margins and lacks earnings stability. This issue would be resolved in a stroke if LIXIL sold Permasteelisa. We expect LIXIL to announce its medium-term plan after the 1Q FY3/18 results release. Disposing of Permasteelisa before the medium-term plan release could allow the LIXIL management team to announce reliable profit targets and a credible business strategy. LIXIL Group (5938) 4

5 Figure 2: Current status of seven key concerns mentioned previously Subject Progress Our view as of June 2016 Our view now Grohe's earnings Grohe's earnings reliability was low, owing to a lack of transparency in organizational management. With President Seto directly involved in LWT, there is an increased likelihood of continued growth in local currency-based sales. Permasteelisa's earnings We had doubts about the profitability of backlog. We still have doubts about the profitability of backlog. Risk of goodwill impairment Technical prowess, brand power There was a risk of impairment if acquired businesses didn't attain the level of profitability assumed at time of purchase. There was a problem in Japan with tankless toilets leaking. Impairment risk is low, as Permasteelisa booked a 10bn impairment charge when shifting to IFRS, while Grohe and ASB have prospects for profit growth. Although the tankless toilet problem in Japan is now resolved, LIXIL still needs to bolster technical prowess and brand power overseas Understandability of results presentation materials Likelihood of guidance being met Extremely hard to understand Extremely hard to understand Low Should improve Risk of capital increase There was a risk of capital increase if the company booked goodwill impairment and/or stepped up capital spending. There is a risk of capital increase if the company steps up capital spending. Source: Credit Suisse LIXIL Group (5938) 5

6 Share price LIXIL s absolute and relative share price performance has been improving since end-june Figure 3: Absolute share prices (Dec 2012=100) Figure 4: Relative share prices (Dec 2012=100) LIXIL Sekisui House TOPIX TOTO 12/31/2012 2/28/2013 4/30/2013 6/30/2013 8/31/ /31/ /31/2013 2/28/2014 4/30/2014 6/30/2014 8/31/ /31/ /31/2014 2/28/2015 4/30/2015 6/30/2015 8/31/ /31/ /31/2015 2/29/2016 4/30/2016 6/30/2016 8/31/ /31/ /31/ vs Sekisui House vs TOPIX vs TOTO 12/31/2012 2/28/2013 4/30/2013 6/30/2013 8/31/ /31/ /31/2013 2/28/2014 4/30/2014 6/30/2014 8/31/ /31/ /31/2014 2/28/2015 4/30/2015 6/30/2015 8/31/ /31/ /31/2015 2/29/2016 4/30/2016 6/30/2016 8/31/ /31/ /31/2016 Source: Thomson Reuters, Credit Suisse Source: Thomson Reuters, Credit Suisse Target price calculations Target price based on EV/EBITDA of 9.5x As before, we base our target price on a fair-value EV/EBITDA of 9.5x applied to our FY3/18 estimates. For EBITDA, we add back depreciation/amortization costs to core earnings. We expect LIXIL s valuations to remain on par with the average since 2003, given the company s improving prospects for profit growth and its steadily rising ROE. Figure 5: EV/EBITDA (EBITDA=core earnings + depreciation) (x) Apr-00 Oct-00 Apr-01 Oct-01 Apr-02 Oct-02 Apr-03 Oct-03 Apr-04 Oct-04 Apr-05 Oct-05 Apr-06 Oct-06 Apr-07 Oct-07 Apr-08 Oct-08 Apr-09 Oct-09 Apr-10 Oct-10 Apr-11 Oct-11 Apr-12 Oct-12 Apr-13 Oct-13 Apr-14 Oct-14 Apr-15 Oct-15 Apr-16 Oct-16 Source: Thomson Reuters, Credit Suisse LIXIL Group (5938) 6

7 Attractive valuations compared to TOTO s LIXIL s valuations versus TOTO s Figure 6 compares LIXIL s EV/EBITDA trend to TOTO s, while Figure 7 shows the ratio of LIXIL s multiple to TOTO s. Excluding FY3/12, when its earnings took a turn for the worse, LIXIL s EV/EBITDA was roughly x TOTO s during , but this ratio has fallen below 1x in FY3/17. In view of this, we consider LIXIL s relative valuation attractive. LIXIL s EV/EBITDA has often been 1.3x TOTO s since 2013 amid expectations for profit growth/cash flow expansion, but the drop in its valuations after the Grohe acquisition (due to accounting irregularities at Grohe subsidiary Joyou) still seems a fresh memory. Figure 6: EV/EBITDA Figure 7: EV/EBITDA (LIXIL vs. TOTO) (x) LIXIL TOTO (x) LIXIL/TOTO 4/30/2000 4/30/2001 4/30/2002 4/30/2003 4/30/2004 4/30/2005 4/30/2006 4/30/2007 4/30/2008 4/30/2009 4/30/2010 4/30/2011 4/30/2012 4/30/2013 4/30/2014 4/30/2015 4/30/2016 5/31/2000 5/31/2001 5/31/2002 5/31/2003 5/31/2004 5/31/2005 5/31/2006 5/31/2007 5/31/2008 5/31/2009 5/31/2010 5/31/2011 5/31/2012 5/31/2013 5/31/2014 5/31/2015 5/31/2016 Source: Company data, Credit Suisse Source: Company data, Credit Suisse Prospective EBITDA growth rates We expect similar EBITDA growth rates at LIXIL and TOTO in FY3/ If valuations only factor in EBITDA growth, we believe their EV/EBITDAs could converge again. Figure 8: EBITDA growth rates (YoY) 50.0% 40.0% 30.0% LIXIL TOTO 20.0% 10.0% 0.0% -10.0% 14/3 15/3 16/3 17/3 CSE 18/3 CSE 19/3 CSE -20.0% Note: LIXILGroup EBITDA=core earnings+depreciation, TOTO: EBITDA=OP+Depreciation LIXIL Group (5938) 7

8 Permasteelisa sale could lift valuations via better margins/profit upside Differing business structures Given the growth potential of each business based on their different structures, we believe LIXIL s offloading of Permasteelisa could raise business-profit margins and thereby lift valuations. At the 3Q results briefing, president Kinya Seto said LIXIL is now focusing on expanding production capacity at Grohe and American Standard. We think valuations would improve if LIXIL can increase capacity in LWT s overseas operations using proceeds from the Permasteelisa sale. Figure 9 compares the business structures of LIXIL and TOTO. The comparison shows (1) little disparity in domestic business-profit margins, (2) a lower business-profit margin for LIXIL overseas, and (3) a renovation sales weighting of 24% for LIXIL s domestic operations as of December 2016, which we estimate is lower than TOTO s. We put the lower business-profit margin in LIXIL s overseas business down to weak profitability at LIXIL Building Technology (LBT). The overseas business-profit margin is around 11% at LWT, but we estimate it at 1.3% at LBT over FY3/17. In Japan, TOTO s renovation sales weighting is currently higher than LIXIL s. However, we see upside for LIXIL s valuations if it can raise its renovation weighting via changes in marketing approach and product development. Figure 9: Comparison of business structures (using OP for TOTO) LIXIL Group TOTO 16/3 17/3 17/3 18/3 19/3 16/3 17/3 18/3 19/3 unit:1bn yen 3Q cumulative CSE CSE CSE CSE CSE CSE Sales 1, , , , , Domestic 1, , , , Reform Except reform Overseas Core earnings Domestic Reform Except reform Overseas Consolidated adjustment (29.7) (27.1) (47.9) (48.6) (48.5) (3.8) (5.0) (5.0) (5.0) Core earnings margin 3.7% 5.5% 4.6% 5.2% 6.0% 8.1% 8.2% 9.1% 9.8% Domestic 5.9% 7.4% 6.9% 7.5% 8.0% 6.5% 6.4% 7.5% 8.3% Reform 8.5% 8.3% 9.9% 11.0% Except reform 2.8% 2.9% 3.1% 3.4% Overseas 3.5% 7.4% 7.9% 8.9% 10.4% 16.8% 18.1% 18.1% 18.1% Domestic sales Reform ratio 24.0% 64.6% 64.2% 64.0% 64.4% Except reform ratio 76.0% 35.4% 35.8% 36.0% 35.6% EBIT Domestic ratio 79.2% 71.5% 70.0% 69.1% 66.7% 57.1% 53.9% 57.5% 59.7% Overseas ratio 20.8% 28.5% 30.0% 30.9% 33.3% 42.9% 46.1% 42.5% 40.3% Note: LIXIL Group=IFRS, TOTO=JGAAP, LIXIL Group's reform is Sales by reform in technology business. LIXIL Group (5938) 8

9 Domestic operations saw sales of housing window sashes slow in 3Q Domestic sales 3Q Japan sales fall due to housing window sashes Domestic 3Q sales were sluggish overall in the technology businesses or Lixil Water Technology (LWT), Lixil Housing Technology (LHT), Lixil Building Technology (LBT), and Lixil Kitchen Technology (LKT) (Figure 10). We attribute this to weaker sales at LHT, where housing window sash sales fell YoY. The domestic sales breakdown of 3Q results shows sales grew at LWT but fell at LHT. Sanitary ware sales in 3Q (Oct Dec) rose 7.2% YoY but housing window sashes fell 4.1%. Combined quarterly sales in the technology businesses declined 2.6% YoY in 1Q, 1.6% in 2Q, and 3.5% in 3Q. We attribute the 3Q slowdown in housing window sash sales to weak renovation demand and a high YoY hurdle set by sales boosted by the eco-points system. Owners that renovate their properties have been entitled to up to 300,000 in ecorenovation subsidies since November The tailwind from this factor is likely to peter out in June 2017, in our view. However, even now, we see the subsidies providing only a minor boost to renovation demand, owing to the strict terms on which they are offered. Figure 10: Domestic sales by products and reform Sales by major products Sales (1 bn yen) Sales( YoY %) FY3/16 FY3/16 FY3/17 FY3/16 FY3/17 FY3/17 Cumulative Cumulative 1Q 2Q 3Q 4Q 1Q 2Q 3Q Cumulative 3Q 3Q 3Q LWT Sanitary ware (2.1) Bathroom units (1.2) Washstand cabinet units Tiles (3.7) (2.5) (1.4) (1.0) 0.0 (0.5) LHT Housing sashes and related products (0.6) (3.9) (1.0) (4.1) (3.0) Exterior (12.6) (8.4) (2.8) (4.9) (2.5) Wooden interior furnishing materials Exterior wall materials for houses (6.0) (2.2) (11.8) (3.1) (4.6) Interior fabric (12.0) (2.1) 0.7 (4.7) (3.2) (2.8) LHT Other (10.8) (19.3) 5.6 (16.1) (8.5) (14.1) (49.2) (24.4) LBT Building sashes (7.2) (5.1) (27.4) 4.5 (7.5) (7.2) LKT Kitchens Sales by reform Sales (1 bn yen) Sales( YoY %) FY3/16 FY3/16 FY3/17 FY3/16 FY3/17 FY3/17 Cumulative Cumulative 1Q 2Q 3Q 4Q 1Q 2Q 3Q Cumulative 3Q 3Q 3Q Domestic Technology business Sales by reform Except by reform Source: Company data, Credit Suisse Aqua Ceramic contributing in LWT business In the sanitary ware category, the new product Aqua Ceramic, launched in April 2016, is contributing to sales growth. The main feature of this product is its ability to prevent stains. Aqua Ceramic s standard installation rate for sanitary ware through 3Q was around 30%. and we expect sales of the product to increase over the next year or so. LHT sales likely to grow from 4Q Housing window sash sales were sluggish in 3Q, reflecting a high YoY hurdle set by sales boosted by the eco-point system, but we expect them to turn upward (+4% YoY) in 4Q. LIXIL Group (5938) 9

10 Reduced risk of goodwill write-downs at Grohe Overseas subsidiaries Receding risk of goodwill write-downs The overseas subsidiaries causing concern thus far are Grohe and Permasteelisa. We saw a risk of goodwill write-downs at Grohe, but this looks unlikely now. However, Grohe still has a vast amount of intangible fixed assets on its books ( 2,827mn at end-3q). Permasteelisa is writing down 10.0bn of goodwill as part of its FY3/17 transition to IFRS. Its current challenges are to stabilize earnings and improve margins, in our view. Figure 11: Intangible assets in 3Q Permasteelisa ASB Grohe mil EUR mil USD mil EUR Goodwill ,215 Trademark 126 1,349 Other intangible assets Fixed asset/inventory valuation 73 Total ,827 1EUR=123Yen 1USD=115Yen Permasteelisa ASB Grohe bn yen bn yen bn yen Total intangible assets ,477 Source: Company data, Credit Suisse Ongoing sales growth at Grohe On a local currency basis, Grohe s 1 3Q sales grew 5% YoY. Figure 12: Performance of Grohe 15/3 16/3 17/3 17/3 18/3 19/3 CoE CSE CSE CSE Sales mil euro 1,315 1,409 1,352 1,381 1,450 1,522 (YoY) 7.1% 5.0% 5.0% Core ernings mil euro Core earnings margin 15.1% 14.3% 15.5% 15.5% 15.7% 15.9% Yen/EUR Sales bn yen EBIT bn yen Core earnings= Sales - COGS - SGA Permasteelisa likely to miss profit targets We expect Permasteelisa to miss its FY3/17 business-profit target. Figure 13: Performance of Permasteelisa 12/12 13/12 14/12 15/12 17/3 17/3 17/3 17/3 17/3 JGAAP JGAAP JGAAP JGAAP IFRS IFRS IFRS IFRS IFRS CoE(May) CoE(2Q) CSE CSE CSE Sales mil euro 1,645 1,372 Core earnings mil euro Euroyen Sales bn yen , , , , ,687.6 Core earnings bn yen Core earnings margin 5.0% 2.3% 3.0% 1.1% 3.4% 2.1% 0.7% 2.0% 5.0% LIXIL Group (5938) 10

11 Figure 14: Premise of sales by companies Forecasts and valuation IFRS 15/3 16/3 17/3 17/3 18/3 19/3 1H 2H 1H 2H 2H bn yen CoE CSE Co.E CSE CSE CSE Sales 1, , , , , ,884.3 Japan 1, , , , , ,363.6 (YoY) -0.8% -3.0% -0.7% 0.5% -1.8% -1.2% 1.9% 1.7% Overseas (YoY) 6.5% -1.8% -1.2% -0.5% -2.1% -1.8% 0.3% 0.3% By companies Grohe ASB Permasteelisa Others By regions Asia Greater China Thai 18.1 Vietnam 11.9 Korea 11.6 Other countries 24.1 North America Europe Other countries (0.7) (6.1) (Exchange assumption) JPY/Euro JPY/US$ Performance by companies LWT (YoY) 49.3% -4.5% -2.8% 2.7% -3.6% -0.8% 3.2% 3.0% Japan (YoY) 4.4% 0.3% 1.0% 2.5% 0.6% 1.4% 2.5% 2.0% Overseas (YoY) 137.3% -8.3% -6.3% 2.9% -7.3% -2.8% 3.8% 3.8% Asia North America Europe Other countries LHT (YoY) -1.3% -2.9% -3.8% -1.5% -3.4% -2.2% 2.0% 2.0% Japan (YoY) -1.6% -2.7% -3.5% -1.5% -3.1% -2.1% 2.0% 2.0% Overseas (YoY) 13.5% -13.8% -16.7% 0.0% -15.3% -6.8% 0.9% 0.0% LBT (YoY) -4.7% -25.3% -10.5% -8.9% -18.1% -17.3% 0.0% 0.0% Japan (YoY) -1.9% -9.4% -0.5% -0.5% -4.9% -4.9% 0.0% 0.0% Overseas (YoY) -6.1% -33.5% -16.0% -13.5% -25.1% -23.9% 0.0% 0.0% LKT (YoY) -2.5% 1.9% -0.2% 2.4% 0.8% 2.1% 2.2% 2.2% Japan (YoY) -0.5% 2.2% -0.2% 2.3% 1.0% 2.3% 2.0% 2.0% Overseas (YoY) -23.8% -2.2% 2.9% 11.8% 0.0% 3.8% 3.0% 5.1% D&R H&R Consolidated adjustment (41.9) (19.5) (21.7) (41.2) (18.4) (26.6) (26.6) (45.0) (45.0) (45.0) (45.0) LIXIL Group (5938) 11

12 Figure 15: Premise of business interests by companies (sales-cost of goods sold- sales and general administrative expenses) IFRS 15/3 16/3 17/3 17/3 18/3 19/3 1H 2H 1H 2H 2H bn yen CoE CSE Co.E CSE CSE CSE Core Earnings(Sales-COGS-SGA) (vs sales) 3.0% 4.3% 3.2% 3.7% 4.6% 4.4% 4.6% 4.5% 4.6% 5.2% 6.0% Japan ,005 1,084 (vs sales) 5.3% 6.6% 5.3% 5.9% 6.3% 7.5% 7.5% 6.9% 6.9% 7.5% 8.0% Overseas (vs sales) 1.2% 4.3% 3.2% 3.5% 7.2% 8.7% 8.6% 7.9% 7.9% 8.9% 10.4% By companies Grohe ASB Permasteelisa 2.8 (1.7) Others (4.9) 2.1 (0.3) (0.0) LWT (vs sales) 6.2% 7.7% 8.4% 8.1% 9.5% 10.1% 11.1% 9.8% 10.3% 11.1% 11.6% Japan (vs sales) 7.8% 9.0% 8.0% 8.5% 8.1% 9.8% 10.9% 9.0% 9.6% 10.6% 10.9% Overseas (vs sales) 3.1% 6.7% 8.8% 7.7% 10.7% 10.3% 11.2% 10.5% 11.0% 11.5% 12.1% LHT (vs sales) 5.7% 7.7% 5.8% 6.7% 7.3% 8.4% 7.9% 7.9% 7.6% 8.1% 8.9% Japan (vs sales) 6.1% 7.5% 5.4% 6.4% 6.9% 8.3% 7.6% 7.6% 7.3% 7.8% 8.6% Overseas (1.6) (vs sales) -15.4% 17.2% 21.7% 19.5% 28.0% 12.0% 20.0% 20.0% 23.6% 23.4% 23.4% LBT (6.0) (5.6) (0.8) (vs sales) 1.6% 0.2% -3.7% -1.7% -0.6% 4.7% 3.2% 2.2% 1.4% 2.2% 4.0% Japan (vs sales) 4.0% 2.4% 3.8% 3.1% 3.9% 6.9% 6.9% 5.5% 5.5% 5.5% 5.5% Overseas 1.1 (1.0) (8.3) (9.3) (2.8) (2.1) (vs sales) 0.5% -0.9% -8.0% -4.3% -3.8% 3.2% 0.8% 0.0% -1.3% 0.0% 3.1% LKT (1.5) (vs sales) -1.3% 0.9% 2.2% 1.6% 1.5% 2.9% 3.1% 2.2% 2.3% 3.2% 4.0% Japan (1.7) (vs sales) -1.6% 1.2% 2.6% 1.9% 1.4% 3.3% 3.8% 2.4% 2.7% 3.4% 4.1% Overseas 0.2 (0.1) (0.2) (0.3) 0.1 (0.1) (0.3) 0.0 (0.2) (vs sales) 1.9% -2.2% -5.9% -3.8% 2.2% -2.9% -6.6% 0.0% -1.8% 0.7% 3.1% D&R (vs sales) 3.3% 4.9% 2.8% 3.9% 5.6% 3.0% 3.0% 4.3% 4.3% 4.3% 4.2% H&S (vs sales) 7.2% 7.9% 4.9% 6.4% 7.1% 8.0% 8.2% 7.6% 7.7% 8.4% 8.4% Consolidated adjustment (24.3) (15.0) (14.9) (29.9) (17.2) (30.8) (30.8) (48.0) (48.0) (48.5) (48.5) LIXIL Group (5938) 12

13 Figure 16: Consolidated income statement 3/14 3/15 3/16 3/16 3/17 3/17 3/18 3/19 JGAAP JGAAP JGAAP IFRS IFRS IFRS IFRS IFRS ( mn) Co.E CS E CS E CS E Sales 1,628,658 1,673,405 1,845,117 1,890,450 1,780,000 1,808,200 1,846,500 1,884,300 COGS 1,180,823 1,226,085 1,321,656 1,348,849 1,780,000 1,215,700 1,239,600 1,250,300 (% of sales) 72.5% 73.3% 71.6% 71.4% 67.2% 67.1% 66.4% Gross profits 447, , , , , , ,000 (% of sales) 27.5% 26.7% 28.4% 28.6% 32.8% 32.9% 33.6% SG&A 378, , , , , , ,000 (% of sales) 23.3% 23.6% 25.3% 24.9% 28.8% 28.2% 27.6% Core earnings (Sales-COGS-SGA) 70,069 80,000 82,500 96, ,000 (% of sales) 3.7% 4.5% 4.6% 5.2% 6.0% Other expense (31,058) (15,000) (10,000) (10,000) (10,000) (% of sales) -1.6% -0.8% -0.6% -0.5% -0.5% Operating profits 69,079 51,674 56,259 39,011 65,000 72,500 86, ,000 (% of sales) 4.2% 3.1% 3.0% 2.1% 3.7% 4.0% 4.7% 5.5% Finance income(costs) (9,360) 2,000 4,000 (3,300) (3,300) Other (36,738) Non-operating income and expense 5,857 6,187-7,837 Recurring profit 74,937 57,862 48,421 (% of sales) 4.6% 3.5% 2.6% Extraordinary profit and expense -25,852-4,874-45,239 Extraordinary profit 2,953 13,446 10,687 Extraordinary loss 28,805 18,320 55,926 Income before income tax 49,085 52,988 3,182 (7,087) 67,000 76,500 83, ,700 Income tax 28,160 30,861 15,371 18,519 31,400 18,600 33,200 (Tax rate) 57.4% 58.2% 483.1% % 41.0% 22.2% 33.0% Non-controlling interests (27) 113 6,475 (1,066) Net income 20,951 22,012 (18,664) (25,606) 38,000 44,900 65,000 67,500 Figure 17: Consolidated balance sheet 3/14 3/15 3/16 3/17 3/17 3/18 3/19 JGAAP JGAAP JGAAP IFRS IFRS IFRS IFRS ( mn) CS E CS E CS E Current assets 942,532 1,005, , , , , ,300 Cash and deposits 162, , , , , , ,900 Notes and accounts receivable 487, , , , , , ,900 (% of sales) 29.9% 26.5% 22.4% 20.4% 20.0% 20.0% 20.0% Inventories 210, , , , , , ,100 (% of sales) 10.0% 13.6% 11.9% 11.2% 12.0% 12.0% 12.0% Others 81,471 77,211 91, , , , ,400 Non-Current assets 843, ,274 1,184,593 1,244,902 1,257,800 1,273,800 1,288,800 Total assets 1,786,293 1,875,249 2,060,873 2,130,120 2,126,800 2,151,500 2,177,100 Current liabilities 719, , , , , , ,900 Notes and accounts payable 235, , , , , , ,200 (% of sales) 14.5% 13.9% 12.7% 18.1% 18.0% 18.0% 18.0% Interst-bearing debt 222, , , , , , ,700 Others 261, , , , , , ,000 Non-current liabilities 465, , , , , , ,600 Interst-bearing debt 359, , , , , , ,700 Others 106, , , , , , ,900 Total liabilities 1,184,498 1,261,597 1,423,356 1,592,812 1,561,800 1,538,700 1,515,500 Total equity 601, , , , , , ,600 Total liabilities and equity 1,786,293 1,875,249 2,060,873 2,130,120 2,126,800 2,151,500 2,177,100 LIXIL Group (5938) 13

14 Figure 18: Consolidated cash flow statement 3/14 3/15 3/16 3/17 3/17 3/18 3/19 JGAAP JGAAP JGAAP IFRS IFRS IFRS IFRS ( mn) CS E CS E CS E Operating activities 83, , , , , , ,200 Net income 20,951 22,012 (18,664) (25,606) 44,900 65,000 67,500 Depreciation 49,167 50,724 60,451 62,205 65,000 67,000 68,000 Amortaization of goodwill 6,574 6,488 11, Impairment loss 1,615 3,910 5,662 19,701 5, Trade receivable -99,760 43,356 31,075 12,135 24,681-7,700-7,600 Inventories -62,093-16,766 7,510 18,086-5,145-4,600-4,500 Accounts payable 34,723 (2,828) 1,269 (10,401) (17,332) 6,900 6,800 Others 108,551 32,035 37,727 44, Investing activities -218, ,228 16,547 19,122-83,000-83,000-83,000 Fixed assets -61,304-59,354-51,183-33,901-83,000-83,000-83,000 Others (157,028) (69,874) 67,730 53, Financing activities 153,144 10, , ,403-30,900-47,200-48,700 Loan payable 223,237 62,602 (17,637) (134,092) (13,700) (30,000) (30,000) New share issuance Dividends -13,083-17,200-17,190-17,190-17,200-17,200-18,700 Share buyback 0 (19,999) Others (57,010) (15,394) (136,931) (3,121) Net increase (decrease) in cash 18,344 19,712 (18,199) (14,196) 3,200 (3,600) (1,500) Figure 19: Consolidated valuation sheet 3/14 3/15 3/16 3/17 3/17 3/18 3/19 JGAAP JGAAP JGAAP IFRS IFRS IFRS IFRS ( mn) CS E CS E CS E Net working capital 462, , , , , , ,800 Fixed assets 843, ,274 1,184,593 1,244,902 1,257,800 1,273,800 1,288,800 Estimated invested capital 1,306,027 1,307,778 1,583,243 1,500,206 1,510,900 1,532,300 1,552,600 Operating profit 69,079 51,674 56,259 39,011 72,500 86, ,000 Tax rate (%) 57.4% 58.2% % 22.2% 33.0% NOPAT 29,448 21,578 33,755 23,407 42,742 67,566 69,712 ROIC (%) 2.3% 1.6% 2.1% 1.6% 2.8% 4.4% 4.5% Common shares outstanding (mn) Current share price ( ) 2,846 2,847 2,295 2,295 2,770 2,770 2,770 Market capitalization 827, , , , , , ,010 Interest-bearing debt 581, , , , , , ,400 Cash and marketable securities 162, , , , , , ,900 Net debt 418, , , , , , ,500 Enterprise value 1,245,654 1,201,782 1,133,038 1,356,095 1,475,410 1,449,010 1,420,510 EBITDA 118, , , , , , ,000 EV/EBITDA (X,EBITDA=core earnings+depreciation) EV/Sales (X) EPS ( ) EPS growth (%) -1.8% 6.7% % 3.8% Dividend yield (%) 1.9% 2.1% 2.6% 2.6% 2.2% 2.2% 2.3% ROE (%) 3.5% 3.7% % 11.3% 10.8% ROA (%) 1.2% 1.2% -0.9% -1.2% 2.1% 3.0% 3.1% PER (X) PBR (X) BPS 2,041 2,104 1,895 1,829 1,925 2,092 2,262 Debt / equity DPS ( ) Dividend payout ratio (%) 76.3% 78.1% % 26.5% 27.6% LIXIL Group (5938) 14

15 Companies Mentioned (Price as of 20-Feb-2017) American Standard (Unlisted) GROHE Group (Unlisted) LIXIL Group (5938.T, 2,770, OUTPERFORM, TP 3,200) Permasteelisa (Unlisted) Rinnai (5947.T, 8,730) Sekisui House (1928.T, 1,798) TOTO (5332.T, 4,220) Joyou (JY8G.F^B17) Disclosure Appendix Analyst Certification Masahiro Mochizuki and Yasuko Fukuda each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. 3-Year Price and Rating History for LIXIL Group (5938.T) 5938.T Closing Price Target Price Date ( ) ( ) Rating 28-Jul-14 2,657 2,700 N 28-Aug-14 2,301 2,000 U 18-Dec-14 2,486 2, Jul-15 2,539 2, Sep-15 2,450 2, Jan-16 2,476 2,400 N 23-Jun-16 1,873 1, Jan-17 2,678 3,200 O * Asterisk signifies initiation or assumption of coverage. 3,500 3,000 2,500 2,000 1,500 N EU T RA L U N D ERPERFO RM O U T PERFO RM Target Price Closing Price 5938.T 01- Jan Jan Jan The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities As of December 10, 2012 Analysts stock rating are defined as follows: Outperform (O) : The stock s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-japan Asia stocks, ratings are based on a stock s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock s absolute total return potential to its current share price and (2) the relative attractiveness of a stock s total return potential within an analyst s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Prior to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts sector weightings are distinct from analysts stock ratings and are based on the analyst s expectations for the fundamentals and/or valuation of the sector* relative to the group s historic fundamentals and/or valuation: Overweight : The analyst s expectation for the sector s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst s expectation for the sector s fundamentals and/or valuation is neutral over the next 12 months. Underweight : The analyst s expectation for the sector s fundamentals and/or valuation is cautious over the next 12 months. *An analyst s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors. LIXIL Group (5938) 15

16 Credit Suisse's distribution of stock ratings (and banking clients) is: Global Ratings Distribution Rating Versus universe (%) Of which banking clients (%) Outperform/Buy* 45% (64% banking clients) Neutral/Hold* 38% (60% banking clients) Underperform/Sell* 15% (52% banking clients) Restricted 2% *For purposes of the NYSE and FINRA ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, and Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis. (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors. Important Global Disclosures Credit Suisse s research reports are made available to clients through our proprietary research portal on CS PLUS. Credit Suisse research products may also be made available through third-party vendors or alternate electronic means as a convenience. Certain research products are only made available through CS PLUS. The services provided by Credit Suisse s analysts to clients may depend on a specific client s preferences regarding the frequency and manner of receiving communications, the client s risk profile and investment, the size and scope of the overall client relationship with the Firm, as well as legal and regulatory constraints. To access all of Credit Suisse s research that you are entitled to receive in the most timely manner, please contact your sales representative or go to Credit Suisse s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Target Price and Rating Valuation Methodology and Risks: (12 months) for LIXIL Group (5938.T) Method: We base our 3,200 target price for LIXIL Group on EV/EBITDA of 9.5x applied to our FY3/18 estimates, with the 9.5x representing the average valuation since in view of the stock market s low expectations for LIXIL s earnings. Driven by mounting expectations for profit growth and a more stable ROE, we expect the shares to trade back up at the average post-2003 valuation. Until now, the company has been focused on asset expansion, but we believe it has now moved towards an emphasis on higher asset efficiency. LIXIL incorporated Grohe as a wholly owned subsidiary at end-september We look for greater ROE stability from FY3/18 and expect the company to enjoy higher visibility as a potential investment target We assign a OUTPERFORM rating based on total returns forecast over the next 12 months and a comparison with our coverage universe. Risk: Risks that could impact our 3,200 target price and OUTPERFORM rating for LIXIL Group include: Risks include (1) earnings deterioration at Permasteelisa, (2) sluggish domestic renovation demand, (3) a capital increase, and (4) price competition. Please refer to the firm's disclosure website at for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names The subject company (5938.T) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse. Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (1928.T, 5938.T) within the next 3 months. For date and time of production, dissemination and history of recommendation for the subject company(ies) featured in this report, disseminated within the past 12 months, please refer to the link: 6uamensuahpw6w0dwmbctgxtx. Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report may participate in events hosted by the subject company, including site visits. Credit Suisse does not accept or permit analysts to accept payment or reimbursement for travel expenses associated with these events. Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. This research report is authored by: LIXIL Group (5938) 16

17 Credit Suisse Securities (Japan) Limited...Masahiro Mochizuki ; Yasuko Fukuda To the extent this is a report authored in whole or in part by a non-u.s. analyst and is made available in the U.S., the following are important disclosures regarding any non-u.s. analyst contributors: The non-u.s. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-u.s. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the FINRA 2241 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (Japan) Limited...Masahiro Mochizuki ; Yasuko Fukuda For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at or call +1 (877) LIXIL Group (5938) 17

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