Kao faces challenge as it comes to terms with Kanebo debts

By Simon Pitman

- Last updated on GMT

Following its acquisition of Kanebo's cosmetics division, Kao is
facing up to a new era of debt, as analysts down-grade the
company's squeaky clean credit rating.

Credit ratings agencies yesterday downgraded Kao's outlook as the company faces up to the heavy debts and continued efforts to ensure the operations maintain financial credibility following the deal.

Standard and Poor's said it would maintain Kao's 'AA' credit rating, but with negative implications.

"Although full details of the transaction have not yet been disclosed, we don't expect Kao will be able to maintain its financial profile at a level consistent with the current rating due to an increase in debt for the acquisition and refinancing of debt held at Kanebo Cosmetics totaling about ¥425 billion,"​ said Standard & Poor's credit analyst Machiko Amano.

Meanwhile London-based analysts Stanley Morgan chose to maintain their equal weight rating, but reduced the target price for the company's shares.

Morgan said that the downward grading for its target price reflected the deterioration in the company's balance sheet and an anticipated decline in profit margins.

Bearing in mind how much has been spent by the Japanese bail out agency, IRC, to get Kanebo back up in running order, Kao's investment seems like a good deal, but analysts believe there are still challenges ahead, which is why credit ratings have been cut.

The IRC has played a key role in digging out a number of leading Japanese business out of financial difficulties following the financial melt-down experienced in the country during the late 90s.

Many companies suffered big losses during this time, but to save face and maintain a good financial record, some made highly elaborate attempts to cover up poor performances.

Kanebo was no exception, and by the time its true debts came to light, it had run up heavy debts. Although the company is still has significant debt, thanks to the IRC investment it is now operating at a profit and is projecting increasing sales for the next two years.

However, Kanebo's debts now become Kao's debts, which in turn changes the company's financial position overnight. Although the deal gives Kao far greater exposure on the global cosmetics market, its increased financial vulnerability will mean greater challenges ahead.

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