Nippon Kayaku Group Integrated Report 2024 Online

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Message from Chief Financial Officer

Through initiatives for strengthening earning power and improving capital efficiency, striving to enhance economic value and environmental and social value

Member of the Board, Representative Executive Vice President,
In charge of Corporate Planning Division, Corporate Communications Division,
Finance & Accounting Division, Information Systems Division, and Purchasing Division

Yoshitsugu Ishida

The Nippon Kayaku Group leverages its strong financial capital, characterized by a well-balanced mix of three business units that support sustainable growth, a robust financial standing that maintains an “A” corporate rating from the Rating and Investment Information, Inc. (R&I), and a cash allocation strategy that prioritizes growth investments to drive transformation.
Through KAYAKU Vision 2025 (KV25), the four-year Medium-term Business Plan that began in FY2022, we at the Nippon Kayaku Group will maintain our solid financial structure at a certain level, appropriately manage our resources, and flexibly respond to changes in market conditions and business risks. At time same time, we will contribute to the realization of a sustainable society by providing economic value and environmental and social value through mitigation of climate change and other measures.

Action to Implement Management That is Conscious of Cost of Capital and Stock Price

Looking over the Nippon Kayaku Group’s company-wide performance over the past 11 years, it can be observed that while net sales have grown driven by increased demand, operating income margins have stagnated. We recognize that the main cause of this is a chronic decline in marginal profit rate due to a lack of new businesses and new products.

　As part of our efforts to address this issue, in June 2023, we defined promising market units and reorganized our segments into three business units: -Mobility & Imaging^*1, Fine Chemicals^*2, and Life Science^*3. We will aim to achieve the continuous creation of new businesses and new products by leveraging synergies within each business unit and actively investing in growth fields.

　In addition, to earn the trust of our shareholders and investors and further increase corporate value, we have established target levels for management indicators such as ROE and ROIC, focusing on efficient business operations with an awareness of capital efficiency and on the swift creation of new businesses and new products. Furthermore, to contribute to a sustainable society, we are committed to necessary investments to address mitigation of climate change and make effective use of human capital.

　Unfortunately, as of the end of June 2024, our group has been evaluated as undervalued, with a price-to-book ratio of approximately 0.8. In response to the Tokyo Stock Exchange’s request for “Action to Implement Management That is Conscious of Cost of Capital and Stock Price,” we have identified “strengthening earning power” and “improving capital efficiency” as priority issues. We intend to advance asset-efficient management by presenting our approach to portfolio transformation and other efforts focused on enhancing efficiency.

*1Safety Systems Group (Automotive Safety Components), Polatechno Group (Optical films for automotive, etc.)
*2Functional Materials Group, Color Materials Group, Catalysts Group
*3Pharmaceuticals Group, Agrochemicals Group

Stable PBR of 1x or more

Scroll sideways for an overview of the table below.

Strengthen earning power	Transformation of business portfolioLeverage strengths in main fields and businesses, address business issues
Improve capital efficiency	Treasury stock Decided to acquire 3 billion yen this fiscal year, with plans to cancel some treasury stock Dividends Aim for a dividend payout ratio of 40% or more in the medium to long term Maintain annual dividends of 45 yen/share or more during the KV25 period while actively investing for the future Cross-shareholdings Less than 10% of net assets (achieved during the KV25 period) Invested capital Reduce inventory and accounts receivable, and reduce cash equivalents to 45.0 billion yen or less (achieved during the KV25 period)
Promotion of sustainable management	Addressing company-wide material issues to realize our mission Reducing greenhouse gas emissions (FY2030 target: 46% or more reduction compared to FY2019) Promotion of active participation of diverse human resources (promotion of human capital management)

The desired management indicators are ROE of 8% or more and company-wide ROIC of 10% or more in the medium to long term.

Portfolio Transformation to Strengthen Earning Power

In FY2023, we reviewed our business portfolio policy to strengthen earning power and classified each product group into “earning power amelioration business,” “foundation business,” “novel and future prospects businesses,” and “important business.”

　Based on this result, we will determine the fields to concentrate management resources from FY2024 onward, which is the second half of KV25.

　In order to prevent “Earning power amelioration businesses” from occupying a large part of our portfolio, we will make it a foundation business by leveraging profit improvement and deciding whether to continue the business, and adjust it so that it accounts for 2% or less of net sales.

　“Foundation businesses” are business that support our current performance, such as squibs and micro gas generators in the Mobility & Imaging Business Unit. We will be even more conscious of this and operate our business more efficiently, aiming to maintain or slightly increase sales while maximizing cash generation.

　“Novel and future prospect businesses” are a product group that will be useful for a sustainable society in the future, such as safety devices for drones in the Mobility & Imaging Business Unit. We will consciously invest management resources such as R&D expenses and human resources to create new businesses and new products, and aim to increase it to 20% of sales by FY2030. (Approximately three times the amount in FY2023)

　“Important businesses” are a product group that is just starting to grow, such as inflators in the Mobility & Imaging Business Unit, semiconductor manufacturing products in the Fine Chemicals Business Unit, and unmet needs anti-cancer drug in the Life Science Business Unit. We will concentrate the greatest portion of management resources, such as capital investment, human resources, and licensing, on these units to achieve further growth and improve profitability. We have set a goal of increasing the proportion of sales to 35% by 2030. (Approximately double the amount in FY2023)

Business portfolio transformation Arrows indicate FY2030 targets compared to FY2023

Important	MIInflators FCSemiconductor manufacturing products group FCDigital printing inks LSUnmet needs oncology drugs LSBiosimilars
Novel and future prospects	MIX-ray analyzer components MIPolarized film for new automotive applications MISafety devices for drones FCNew functional dyes FCCarbon neutral catalysts
Foundation	MISquibs, micro gas generators FCAcrylic and methacrylic acid production catalysts FCConsumer inkjet colorants LSGeneric anti-cancer drugs LSInsecticides

Cash Allocation to Promote Transformation for Growth

The period of KV25, from FY2022 to FY2025, has set a larger growth investment budget than in the previous Medium-term Business Plan, to allocate management resources toward “important businesses” and “novel and future prospect businesses” in our portfolio. Specifically, we have planned a total R&D expenses of 65.0 billion yen and a total capital expenditures of 91.0 billion yen over the four years, with a cash allocation framework with a maximum of approximately 200 billion yen, including flexible allocations for M&A and product introductions. In addition to cash and deposits and accumulated net profit, we will also utilize borrowing with a target equity ratio of around 70%.

　Major uses of funds through FY2023 include expenses for a licensing agreement for Taletrectinib, a new drug candidate for lung cancer in the Life Science Business Unit (R&D expenses); capital investment to increase production capacity for epoxy resins for semiconductors and industrial inkjet inks in the Fine Chemicals Business Unit, and an investment in SkyDrive Inc., a company developing flying cars, within the Mobility & Imaging Business Unit (flexible allocation).

　For FY2024 and beyond, we will continue to concentrate management resources on growth, with anticipated investments for the introduction of new unmet needs anti-cancer drug in the Life Science Business Unit, and for production capacity expansion in the Mobility & Imaging and Fine Chemicals Business Units.

A cash allocation of approximately 200 billion yen has been set to drive transformation toward growth during the KV25 period.

R&D investment limit: 65.0billion yen Total amount used by FY2023:
33.1billion yen: 51%

Capital investment limit: 91.0billion yen Total amount used by FY2023:
41.2billion yen: 45%

Flexible allocation: Approx. 45.0billion yen

Major usage results up to FY2023

License agreement cost for Taletrectinib, new drug candidate for lung cancer (LS approx. 6 billion yen)

Expansion of facilities to increase epoxy resin production at the Asa Plant (FC 6.6 billion yen)
Expansion of facilities to increase industrial inkjet production at the Fukuyama Plant (FC 4.3 billion yen)
Construction of an integrated pharmaceutical quality assurance building at the Takasaki Plant (LS 3.5 billion yen)

Underwriting cost for third-party allocation of new shares to Adrais, a company developing buparlisib, a new drug candidate for head and neck cancer (LS approx. 6 billion yen)
Investment cost in SkyDrive Inc., a company known for flying cars (MI)

Main candidates from FY2024 onward

Costs to introduce unmet needs anti-cancer drug candidates (LS)

Costs to meet increased demand for semiconductor-related products such as epoxy resins (FC)
Costs to meet increased demand for inflators and other Automotive Safety Components (MI)

M&A and introduction costs related to the four target units of R&D: “Mobility,” “Environment and Energy,” “Electronics,” and “Life Science”

MI Mobility & Imaging Business Unit
FC Fine Chemicals Business Unit
LS Life Science Business Unit

Promote ROIC Management to Improve Capital Efficiency

Manage each department using ROIC to improve asset efficiency

The Nippon Kayaku Group has adopted ROIC as a management indicator starting with the Medium-term Business Plan KV25 and is monitoring it by business unit to improve asset efficiency. While ROIC may temporarily decline during periods of aggressive growth investment, we consider it a useful indicator that reflects the business and our ability to generate profits efficiently. Over the long term, we are aiming for an ROIC target of 10% or higher.

　In FY2023, two major investments for the introduction of new drug development projects were made within the Life Science (pharmaceuticals) Business Unit. Of these was a one-time payment of approximately 6 billion yen recorded as R&D expenses for the license from Anheart (US, currently NuvationBio)*, and the divisional ROIC declined due to the decline in profits in the Life Science Business Unit. In addition, the decline in profits in the Fine Chemicals Business Unit also had an impact, leading to a decline in the company-wide ROIC. However, no significant, unexpected R&D expenses are anticipated in FY2024, and we expect to see a recovery in company-wide ROIC driven by overall profit growth.

　Although we are still not fully in line with our long-term targets, we will aim to improve our company-wide ROIC over the medium to long term by implementing measures such as strategically reducing inventory while determining the quantity of customer requests, improving our cash conversion cycle by considering reducing accounts receivable, reducing cross-shareholdings that are not highly relevant to our business, and selling unused facilities and equipment and other unnecessary assets.

*Additionally, we acquired approximately 6 billion in shares through a third-party allotment for a licensing agreement with Adlai (Cayman Islands).

Implementing ROIC improvement activities across the company

In order to increase corporate value as a company, we need to deepen ROIC management one step further. The key to this is to spread awareness within the company that specifically leads to each person’s work improving ROIC in all subdivided tasks, such as company organization, individuals, and projects.

　The group determines the performance-linked bonuses for executive officers based on the achievement of ROE, etc., while using a calculation method for employee bonuses that takes ROIC into account. In addition, the group encourages all employees to practice business improvement using the ROIC tree through e-learning and other education.

　Furthermore, under the catchphrase “always be conscious of 3% cost reduction,” the group is working on “A3 activities (KAIZEN)”, aiming to eliminate difficulty, waste, and inconsistency (referred to as the 3Ms (Muri, Muda, Mura) in Japanese) to reduce cost by improving business efficiency and productivity, and by sharing good examples of activities throughout the group, thereby striving to foster everyday cost awareness.

Award themes for the 2023 A3 activities Presentation Conference

*1Pre-tax operating income is used to calculate company-wide ROIC.
*2There is no arrow for the R&D expense ratio because it is not necessarily better to lower it.

Shareholder Returns

The Nippon Kayaku Group regards returns to our shareholders as important and target a medium- to long-term dividend payout ratio of 40% or higher. Under the Medium-term Business Plan KV25, which spans from FY2022 to FY2025, we have maintained a dividend payout ratio of 40% or more, with plans to sustain a minimum annual dividend of 45 yen per share through FY2025 (an increase of 5 yen in FY2022).

　Furthermore, we will use retained earnings to strategic investments in R&D, capital investment, product introductions, M&A, and other areas necessary for future growth, but will also flexibly acquire treasury shares as part of our profit return measures, while carefully monitoring the situation.

　In FY2024, we declared interim dividends of 22.5 yen per share, with a record date of September 30, and year-end dividends of 22.5 yen per share, for total annual dividends of 45 yen per share. Additionally, from May to September 2024, we repurchased 2.4 million shares (approximately 3 billion yen) of treasury shares.

Recent acquisition of treasury shares:

November 2019 to March of the following year.	Acquisition of treasury shares	2.4 million shares (approx. 3 billion yen)
May to September 2021	Acquisition of treasury shares	2.6 million shares (approx. 3 billion yen)
February 2022	Cancellation of treasury shares	7.0 million shares (Book value basis, 8.1 billion yen)
November 2022 to March of the following year	Acquisition of treasury shares	3.0 million shares (approx. 3 billion yen)
May to September 2024	Acquisition of treasury shares	2.4 million shares (approx. 3 billion yen)

Target dividend payout ratio of 40% or more Maintain a minimum of 45 yen/share until FY2025

The paper version of the Nippon Kayaku Group Integrated Report 2024 is produced using environmentally friendly digital inkjet printing.
For details, please refer to “Focusing on growth areas - Expansion of industrial inkjet inks and dyes” under Topics in the Fine Chemicals Business Unit on page 60 of this report.

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