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Cosmetics a blemish for Kao despite bright earnings

Sluggish sales of high-end brands put company behind rivals

Kao has moved to rejuvenate its Sofina-brand skincare products.

TOKYO -- Kao's January-September group operating profit grew 5% on the year to 137.7 billion yen ($1.21 billion) on strong sales of disposable diapers and other mainstays, but cosmetics emerged as the consumer goods maker's weak link due to lagging luxury brands.

Building on Monday's earnings announcement, Kao has its sights on the "lofty goal" of 200 billion yen in full-year operating profit, as President and CEO Michitaka Sawada called it. Sales also edged up 2% to 1.08 trillion yen while net profit jumped 12% to 96.4 billion yen, both records for the nine-month period, and profitability of consumer goods rose. The company follows international accounting standards.

But cosmetics have become the company's Achilles' heel as the only unit whose sales declined, falling 7% to 168.6 billion yen. Even when taking into account changes to the sales system and other factors, revenue from cosmetics still fell slightly. Although the segment's operating profit for the nine months through September was not released, it probably bled more red ink after logging 4.1 billion yen in losses for the January-June half.

The trouble stems from the company's late start on luxury brands. Cosmetics operations are split between Kao's own brands and subsidiary Kanebo Cosmetics. In addition to launching global brand Kanebo last year, Kao also released its own line of upmarket skin care products under the Sofina brand this fall. Yet the company "has not captured inbound demand from visitors to Japan," said Kenichi Yamauchi, a director at Kao.

Meanwhile, sales of rival Shiseido's Cle de Peau Beaute, Kose's Decorte and other luxury brands with products priced over 10,000 yen are brisk, mainly through department stores. Kao will strengthen its sales of milk lotions going for over 10,000 yen a bottle and other high-priced products, but "the company has not jumped on the trend of raising unit prices," admitted Sawada.

"Even looking at France's L'Oreal and U.S.'s Estee Lauder, sales of high-end cosmetics are growing globally," said Wakako Sato of Mizuho Securities, thanks to rising incomes in emerging countries. Greater internet access also allows consumers to get information on well-regarded brands anywhere in the world.

"Kao lacks the spark to stir up interest in buying" their cosmetics, said an analyst at foreign securities firm. Kao has had difficulty generating synergies with Kanebo Cosmetics since acquiring the company in 2006. The brand's reputation took a big hit in 2013 when certain products caused unwanted white blotches on users' skin, for instance.

Shiseido expects consolidated operating profit for the year ending December to grow around 50%. Kao is looking to catch up by integrating sales of its own brands and Kanebo Cosmetics in January 2018, among other measures. Nevertheless, rival companies will only expand their lead should the company fail to get results.

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