Generative AI Shift And Weak Polymer Additives Will Pressure Earnings Over The Long Term

Catalysts

About Adeka

Adeka is a diversified chemicals and food products company with businesses spanning polymer additives, semiconductor and environmental materials, and life science agrochemicals.

What are the underlying business or industry changes driving this perspective?

• Heavy reliance on agrochemicals for growth leaves Adeka exposed to normalizing crop prices and the unwinding of tariff driven front loaded demand, which could slow Life Science segment volume growth and stall consolidated revenue expansion beyond fiscal 2025.
• The shift to advanced semiconductor nodes and generative AI infrastructure is accelerating, but Adeka is seeing steep declines in legacy high k materials and rising fixed costs, raising the risk that product transitions lag technology cycles and compress margins and earnings for longer than expected.
• Structural weakness in key demand centers such as China and the U.S. for home appliances and automotive engineering plastics may persist, limiting recovery in polymer additives volumes and undermining the net pricing gains needed to restore operating profit in the Chemicals segment.
• Global energy efficiency and electrification trends are reshaping lubricant and environmental materials specifications, and failure to keep pace with higher performance formulations could erode pricing power, capping margin improvement in Environmental Materials despite only modest current profit growth.
• Management is pursuing global expansion of new clarifiers and semiconductor materials while simultaneously absorbing higher fixed costs and executing a large share buyback, which could strain capital allocation flexibility and constrain the investment needed to sustain ROE and ROIC targets beyond the Adeka 2026 plan period.

Assumptions

This narrative explores a more pessimistic perspective on Adeka compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming Adeka's revenue will grow by 4.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 6.4% today to 7.3% in 3 years time.
• The bearish analysts expect earnings to reach ¥33.6 billion (and earnings per share of ¥335.7) by about December 2028, up from ¥26.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 10.8x on those 2028 earnings, down from 14.6x today. This future PE is lower than the current PE for the JP Chemicals industry at 12.5x.
• The bearish analysts expect the number of shares outstanding to decline by 1.32% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.49%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Life Science is currently delivering strong global demand for agrochemicals, with higher sales volumes and successful net pricing across Japan, North America and Europe. This could structurally support consolidated revenue growth and sustain or expand group operating margins over the medium term.
• The ongoing shift to advanced semiconductor nodes and generative AI infrastructure is already driving robust sales of lithography materials for photoresists. If this secular trend accelerates faster than the decline in legacy high k products, Semiconductor Materials revenue and earnings could recover more quickly than expected.
• Management is explicitly targeting global expansion of new clarifiers and other higher value additives in the second half of fiscal 2025 and beyond. Successful execution of this strategy could lift Polymer Additives volumes and pricing power, improving Chemicals segment operating profit and group net margins.
• The company is maintaining ambitious Adeka 2026 goals for ROE, ROIC and operating profit while initiating an 18 billion yen share buyback. If these targets are met alongside reduced share count, earnings per share and shareholder returns could rise more than currently discounted.
• Overseas sales already account for just under 55 percent of total revenue. Continued geographic diversification combined with steady demand in areas like mobility lubricants, cosmetics ingredients and plant based foods may provide a more resilient long term revenue and earnings base than a purely domestic cyclical profile would suggest.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for Adeka is ¥3200.0, which represents up to two standard deviations below the consensus price target of ¥3981.67. This valuation is based on what can be assumed as the expectations of Adeka's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ¥4670.0, and the most bearish reporting a price target of just ¥3200.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be ¥460.9 billion, earnings will come to ¥33.6 billion, and it would be trading on a PE ratio of 10.8x, assuming you use a discount rate of 5.5%.
  
• Given the current share price of ¥3791.0, the analyst price target of ¥3200.0 is 18.5% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.