The company expects an operating profit of ¥363 billion (US$2.8 billion) on net sales of ¥3.76 trillion for fiscal 2022, which will end this coming March 31 – enough to reach its medium-term targets for both a year early.

But in a mid-December meeting, executives including President Masanori Togawa shared a road map expressing a strong desire to improve profitability.

“We’ll reverse the decline in profit margin,” a speaker said.

Daikin’s operating margin is on track to decline to 9.7% this fiscal year from the pre-coronavirus levels of 10% and 11%.

The driving force behind the record profits is Daikin’s decision to modify prices nine times over two years in the US alone. Daikin also raised prices elsewhere in response to rising raw materials and transportation costs.

At the same time, higher costs are to squeeze profit by ¥295 billion over two years through the end of fiscal 2022. The price hikes will cover only ¥246 billion of that hole.

Daikin has raised prices by 4% to 5% this fiscal year. It plans to continue with hikes next fiscal year – but “it won’t be the extent of the year ending March 2023,” said Koichi Takahashi, a senior executive officer.

Now that rising raw materials costs have settled down, price hikes are becoming a tougher sell. Daikin’s true ability to upsell its energy efficient air-conditioning products will be put to the test.

“The business challenges are obvious and demand a response to inflation,” said analyst Tsubasa Sasaki of Mitsubishi UFJ Morgan Stanley Securities. Air-conditioning equipment is exposed to higher prices for raw materials, since it uses large amounts of metals.

The big question hanging over Daikin going forward will be “how far will it be able to shift higher costs to customers and to reduce costs overall,” Sasaki said.

The Japanese company has a smaller profit margin than American and Chinese rivals. Trane Technologies, the Ireland-domiciled parent of US-based Thermo King, has an operating margin of around 15%.

Daikin has so far relied on Chinese operations, which enjoy a particularly high margin of around 25%, to lift the companywide figure. With sales growing fast in the US, Europe and India, it will need to improve margins outside China as well.

Inventory assets had roughly doubled in three years to ¥875.4 billion as of the end of September 2022, further weighing on the company’s results.

Daikin is believed to have built up inventories in response to the recent semiconductor shortage so that it has parts to build with and products to sell. But in accounting, inventory not sold by the end of a fiscal year is counted as unrealised profit.

This is a problem for Daikin, according to Sasaki. To resolve such issues and improve its performance, the company aims to reduce inventories by the end of March 2024.

The goal is to generate more cash in order to fund aggressive investment. Daikin is building factories in five locations by 2024, including in Mexico, India and Poland. It plans ¥210 billion in capital investment for fiscal 2022 – up 48% from its average for the past three fiscal years – and even more in coming years.

Daikin’s share price dropped more than 20% in 2022 over financial headwinds and economic uncertainty in China. Still, “I have no concerns about the stock as a medium- to long-term investment,” Sasaki said.