EUR 850.00 For Business Accounts Only

Morningstar | MHI’s Fiscal 2018 Results Look Better Than They Actually Are, Our FVE is Unchanged

Mitsubishi Heavy Industries', or MHI’s, working capital and free cash flow improvement appears to be have exceeded expectations but we think this is mainly due to accounting changes and timing factors. The adoption of IFRS has halved inventory with, we suspect, the other half reflected as contract assets. We continue to include this into our inventory line for our cash flow forecast. Also, the company is accounting for assets related to its troubled South African power plant as indemnification assets. We think these have a similar impact on cash flow as receivables. Our fair value estimate of JPY 4,710 is unchanged, and we think the company is fairly valued presently.

The company’s fiscal 2018 (ending March 2019) core performance was largely within our expectation but operating profit of JPY 187 billion exceeding our estimate of JPY 148 billion and guidance of JPY 160 billion due to a lower loss on aircraft & defence activities, which is due to a timing factor, and higher other income. As a result, fiscal 2018 performance leads to minimal change in our assumptions.

We had already factored in a gradual improvement in profitability driven largely by cost-cutting and other efficiency efforts in its power systems segment, mid-single-digit growth in its industry & infrastructure segment, and reducing losses in its regional jet project. MHI management is guiding for operating profit of JPY 220 billion on revenue of JPY 4.3 trillion in fiscal year 2019. We are less optimistic given global growth headwinds especially with the ongoing trade war risks and see operating profit at JPY 192 million. Although we factor in better growth in its core power systems profits on an improved orderbook, a normalization in other income to JPY 5 billion from JPY 36 billion eats into the bottomline. We also expect delays in aircraft orders given Boeing’s Max problems, in which MHI provides parts on.

MHI’s power systems new orders was flat at JPY 1.43 trillion for the year but we think this is positive as the company was able to contract JPY 670 billion in new orders in the fourth quarter. The acquisition of wind turbine firm Vestas has helped while gas turbine sales has recovered. So we are more upbeat in our fiscal year 2019 assumptions but we still think sales growth will only average 2% in our midcycle forecast given global growth expectations for 1.2% annual growth in gigawatt consumption.

MHI is guiding for losses of JPY 80 billion at MRJ in fiscal year 2019. MRJ needs to be certified by year-end or else its 2020 deliveries could be at risk. We maintain our view that they will meet this timeline but we also don’t expect much sales success. The Scope Clause restrictions in the U.S. is unlikely to change which means that the MRJ 70 is unlikely to find buyers in the U.S. while the MRJ 90 is too heavy.

If six more seats are added to the MRJ 70, it may be possible to find some buyers in the U.S. However, the main buyer for these planes is United Airlines’s Express Jet service, which has started taking deliveries of Embraer’s E175 planes. We do not expect many other significant buyers for these sub-76 seat planes. In the meantime, the MRJ 90 has 213 firm orders. The best case for MHI is if Embraer’s E-series jets also fail to find enough buyers and Boeing pulls the lineup to focus investment on resolving the MAX series problems. But this is not in our base case assumptions and we think development of both the MRJ 70 and MRJ 90 models will still see losses through fiscal year 2022. We assume a breakeven in operating profit in our midcycle forecast.