FINANCIAL STRATEGY AS EXPLAINED BY THE CFO

We have completed the first three years of our medium-to-long-term strategy VISION 2020, which focused on rebuilding our business foundation, and have commenced a new three-year plan aimed at further accelerating our growth. Thus far, we have implemented a range of initiatives targeting sustained growth, including measures to increase investment and bolster productivity. As a result, our sales increased at a CAGR of 9% during the three-year period, and in 2017 we achieved record-high operating income as well as increased dividends for the first time in nine periods.

Strengthening investment in key areas, funded by stable cash flow

To ensure sustainable growth beyond 2020, Shiseido will invest over ¥300 billion during the three years from 2018 in key areas, including human resources, supply chain management, research and development, and IT. While substantial cash flow generation will be required to support that level of investment, our cash generation capability has steadily increased, and in 2017 EBITDA was over ¥100 billion. During the four years from 2017 to 2020, we will generate a total of over ¥350 billion in operating cash flow.

Increasing capital efficiency by improving the cost structure and balance sheet

To increase capital efficiency, we will aim to realize operating margin of 10% or more through top-line growth and further cost structure reforms. Meanwhile, we will implement balance sheet management through appropriate inventory control, leading to a cash conversion cycle (CCC) of 100 days or less. In this way, we will aim to realize ROE of 14% or higher, against cost of shareholders' equity of 5%, and ROIC of over 12%, which exceeds our 4% weighted average cost of capital (WACC).

Bolstering returns to shareholders in the medium-to-long term

In terms of returns to shareholders, we emphasize total returns, comprising direct returns through dividends and increases in share price over the medium-to-long term. In determining dividends, we will focus more on our consolidated results and free cash flow, and from 2018 we will adopt the dividend on equity (DOE) ratio as a measure of our capital policy. Through these efforts, we will strive for long-term stability and continuously enhance returns to shareholders by improving our business results.

Initiatives to Increase Corporate Value

*1 ROIC (Return On Invested Capital) = Operating Income x (1 – Effective Tax Rate) / (Interest-bearing Debt + Equity)
*2 CCC: Cash Conversion Cycle (days) = Receivables Turnover Period (days) + Inventory Turnover (days) – Payables Turnover Period (days)(average of each indicator during the period is used)
*3 The figures for cost of shareholders' equity and WACC (Weighted Average Cost of Capital) are Shiseido's estimates.

Toward Further Sales Growth and Increased Profitability

1.Enhance ROE

Shiseido will aim to increase ROE to 14% or more in 2020 through organic growth. To that end, our value driver will be return on sales (ROS). We plan to increase ROS to 6–7%, principally by increasing operating margin through the promotion of self-sustaining management in each region. We expect to maintain total asset turnover at about 1.0–1.1, the same level as in 2017, through reducing working capital, disposal of idle assets, and other measures.

2020 Target

2.Further Cost Structure Improvement

Our top priority is to maximize profits through sustainable sales growth. By achieving sales growth and lowering our fixed-cost ratio, as well as enhancing our brand equity, we will increase marketing return on investment (ROI) and drive growth in profits. In addition, by strengthening prestige brands and skincare products, which have high profitability and repeat rates, we will improve the cost of sales ratio and swiftly realize a cost structure that can generate an operating margin of more than 10%.

% of Net Sales

3.Further Cost Structural Reforms for Aggressive Marketing Investment

To further accelerate our growth momentum, we will bolster our marketing investment toward a total of ¥120 billion over the next three years to 2020. We plan to invest ¥25 billion mainly in digital-related areas; ¥15 billion in store counter areas, which are important contact points with consumers; and ¥15 billion in PR/event-related areas. Moreover, to secure resources for these investments, we will aim for ¥40 billion in total cost reductions over three years. In addition to increasing efficiency in COGs, marketing, and other costs, including in the supply chain network, we will also integrate all internal operation processes to enhance productivity.

Aggressive Investment in Marketing

Improving Productivity:
Cost Structural Reforms

4.2020 Operating Margin Target and Initiatives by Region

* Operating margin for the Americas and EMEA before amortization of goodwill, etc.

Cash Flow Management to Increase Capital Efficiency

5.Improve CCC through Appropriate Inventory Management

To stand on par with other global companies financially, we must not only increase profitability but also maximize cash flow by improving capital efficiency. Accordingly, we have set the cash conversion cycle (CCC) as an important financial indicator. Currently, inventory levels are rising due to higher product inventory for brands acquired through M&A and other initiatives as well as to certain raw materials acquired to offset the risk of out-of-stock situations. In response, we will work to achieve a more appropriate inventory level and aim for a CCC of 100 days or less in 2020. Specifically, we will increase productivity through such measures as improving efficiency by substantially reducing SKUs, strengthening per-SKU efficiency management, and shortening lead times over the entire supply chain, including procurement, production, and supply.

6.Aggressive Investment for Sustainable Growth

Shiseido has steadily increased its ability to stably generate cash from its business activities. To achieve sustainable growth, we will use these cash inflows as a resource to invest over ¥300 billion in total over three years in priority areas. In response to growing demand, we will take steps to build a system that can supply appropriate quantities in a timely manner. To that end, we will further bolster our investment in new factories and in overall supply chain management. Furthermore, to generate the innovation necessary for future growth, we will strive to strengthen research and development. Accordingly, we will invest in the Global Innovation Center (GIC) and expand points of contact with consumers through investment in store counters.

Aggressive Investment in Key Areas

Capital Expenditure Plan

7.Our Vision for the Balance Sheet

For 2020, we are planning capital expenditures of over ¥300 billion, and accordingly our balance sheet will expand overall. Meanwhile, looking at cash and time deposits, we will maintain a sound level of liquidity on hand at 1.5 months of sales, while giving priority to growth investment. We will also reduce inventories to an appropriate level.

Regarding the balance between liabilities and equity, we will maintain a sound balance sheet while securing a single-A credit rating for fund-raising on advantageous terms. Moreover, given the nature of funds invested and market conditions, we will aim for a debt-to-equity ratio of 0.3 and an interest-bearing debt to EBITDA ratio of 1.0. Through balance sheet and cash flow management, we will target ROIC of over 12%, which exceeds the cost of capital.

8.Shareholder Return Policy

Based on our approach of emphasizing total returns, comprising direct returns of profits to shareholders and medium-to-long-term share price gains, we will emphasize strategic investment toward sustained growth and aim to maximize corporate value. In addition, to increase our dividend and share price, we will enhance invested capital efficiency while considering the cost of capital. In determining dividends, we will focus on our consolidated business results and free cash flow, and target 2.5% or higher for the DOE ratio, a measure of our capital policy. Through these changes, we will target both the growth of Shiseido and the stable, sustained expansion of returns in line with improving ROE. Also, our policy calls for a flexible approach to buying back shares, with consideration for the market environment.