Our analysis - TAP Japan - Cross-border financial services in Japan
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Our analysis

Another Look at Nidec

Nidec is near the top end of its valuation ranges, but to us it appears to be more speculative than inappropriately valued as some “activist” investors have implied.  The company has been criticized for its active self-promotion and supposedly low-quality earnings, but we think the risks have more to do with uneven growth rates, unpredictable contributions from M&A and a possible decline in demand for HDD motors.

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We see 40% downside risk to a ¥6,413 “no-growth valuation” calculated by Japan Analytics based on company’s trailing twelve month operating earnings.  But sales should rise by nearly 20%, operating profit by 15% and net profit by 14% over the next two years. On this forecast, our model indicates 30% downside risk to ¥7,460. That is 18x our EPS estimate for FY Mar-19, compared with a 10-year P/E range of 11x – 38x.

Growth continues, largely due to M&A, while efficiency gains lift margins.  The Company has a sound balance sheet and generally positive free cash flow.  Over the past two years Nidec has made 10 acquisitions.  Can they be efficiently assimilated?   The share price is up 50% since last July and is approaching overbought levels.  As quarterly profit comparisons improve with a weaker JPY, this looks like an opportunity to sell into strength ahead of the next acquisition.

 

Nidec has been criticized by “activist” investors who believe its valuations are unreasonable. The gist of their argument is that analysts and fund managers have become infatuated with the company’s charismatic CEO, Mr. Shigenori Nagamori, and its enthusiastic approach to investor relations, consequently ignoring the low quality of its earnings, highly optimistic sales and earnings guidance, aggressive accounting and questionable strategy of growth through acquisitions.

 

We think their complaints are well known (and most probably being constantly reviewed and discounted) and that the risks involved in owning or not owning the stock are, rather, uneven sales and profit growth, the possible collapse of demand for HDD spindle motors (17% of sales), unpredictable future contributions from M&A and the constant need to rationalize acquired companies in order to bring their operating profit margins up to Nidec standard (10% or more).

 

These risks are easily visible in the company’s financial statements: annual sales growth ranging from 1% to 23% in the past five fiscal years, an operating margin that peaked in FY Mar-11, ROE that is still below the level reached in FY Mar-10. In addition, there is Key Man Risk: the irreplaceable Mr. Nagamori is 72 years old.

NEC renews its focus on growth and efficiency gains

For several years now, management of NEC has taken steps to reduce its exposure to unprofitable businesses and reorient the company toward new markets. Reported sales have declined while, until this fiscal year, the sales of the current business and overall operating profit have increased. Year-on-year declines in sales and operating profit in the six months to Sep-16 were due a combination of project timing and weak demand in Japan and overseas, which overwhelmed efforts to cut costs. In order to get the company back on a growth track, management has launched a new medium-term plan that focuses on future-oriented businesses – cyber security, the Internet of Things (IoT), IT services for retailers, advanced telecom technology – and more efficient use of resources.

As a result of these efforts, plus the consolidation of Japan Aviation Electronics (JAE) and a more favorable operating environment, we expect sales to rise from ¥2,900 billion this fiscal year to ¥3,100 billion in FY Mar-19, operating profit to rise from ¥92 billion to ¥140 billion and net profit from ¥45 billion to ¥78 billion over the same period. The operating margin should rise from 3.2% to 4.5% and ROE from 5.8% to 9.2%.

At ¥318 (January xx closing price), NEC shares are selling at 18.4x our EPS estimate for this fiscal year, 13.3x for next year and 10.6x for the year to Mar-19. Projected EV/EBITDA multiples for the same three years are 8.3x, 6.9x and 6.0x. Projected price/book value multiples are 1.1x, 1.0x and 1.0x. These valuations are in the middle of their historical ranges. Since the company turned profitable in FY Mar-13, the P/E multiple has ranged from 8.3x to 26.9x. For reference, 15x our EPS estimate for FY Mar-19 is ¥450, indicating upside potential of 41.5%.

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keyence

A fresh look at Keyence

Our research specialists explain the complex financial statements of Keyence, a successful Japanese provider of industrial automation and services.

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Keyence has established its highly profitable business model worldwide, becoming a significant supplier of factory automation and inspection products and services to manufacturing and R&D customers in all major markets. But after six years of expansion, the appreciation of the yen combined with a weak global economy has brought sales and profit growth nearly to a halt. In the three months to September, sales were up 2.6% year-on-year and operating profit down 0.1%.

In the year to September, the yen appreciated by about 15% against both the U.S. dollar and the euro. If that hadn’t happened, management estimates that sales and operating profit would have increased by about 13% year-on-year in the six months to September. With the yen now weakening again, we expect growth to resume and, barring recession, continue at moderate rates for at least the next 2-3 years. Underlying demand for the company’s industrial automation and inspection products should also continue to grow, in our estimation, supported by technological advance and manufacturing upgrades worldwide. The issue for investors is, how much do you want to pay for this?

At ¥77,010 (November 22nd close), the share price is near the all-time record high of ¥77,890 reached in October this year. The shares are now selling at 32x our EPS estimate for the year to Mar-17, 18x EV/EBITDA, 4.0x book value and 12x sales. These valuations are near the top of their 10-year historical ranges and are likely to drop only to 27x, 15x, 3.2x and 10x by March 2019, in our estimation.

Keyence has a very strong balance sheet, with total cash & securities (including long-term investment securities) amounting to ¥981.6 billion, or 89.5% of equity, at the end of September 2016, and zero debt. Despite this – and despite an annual return on financial assets of less than 1% – ROE is 12%. The annual dividend was raised from ¥60 to ¥200 in the year to March 2015, but the dividend payout ratio remains below 10% and management talks about maintaining a stable dividend, not another large increase. Cash might also be used to make acquisitions, but no M&A strategy has been made public. In the meantime, cash & securities are increasing at an annual rate of more than ¥100 billion, raising another question for investors: what does management plan to do with all this money?