EUR 850.00 For Business Accounts Only

Morningstar | Mitsubishi Heavy Industries' 1Q Profit Rebounds but New Orders Slow, Aircraft Loss May Widen. See Updated Analyst Note from 05 Aug 2018

Following Mitsubishi Heavy Industries', or MHI's, first-quarter (for fiscal year ending March 2019) results, there is little change to our expectations for the company over our five-year projected period. The challenge remains a relatively sluggish outlook in demand for power systems while the aircraft segment should see a wider loss. The 21% year-over-year rebound in first-quarter bottom line is mainly due to timing factors that dampened year-ago performance and does not really reflect an improving outlook. However, we think the slow growth outlook is already reflected in MHI's share price. We made only minor tweaks to our profit forecast for this year, which is around 15% below guidance and consensus, and our fair value estimate adjusts lower to JPY 4,800 from JPY 4,900 as we factor in slower inventory turn. We think there is little in near-term catalysts to lift investor sentiment on the stock.

First-quarter net profit of JPY 15.1 billion is a rebound from year-ago net loss of JPY 3.1 billion (revised on adoption on IFRS) mainly because of the absence of timing factors that dragged down power segment earnings a year ago. We continue to expect power segment revenue to grow only 1.5 % in fiscal 2018 and rise to a 2% pace from fiscal 2020. Much of the revenue consists of nuclear plant servicing in Japan as sales of gas turbines are likely to be remain highly competitive globally. Power segment orders were particularly weak at just JPY 194 billion in the first quarter supporting our view for prolonged slow growth. Management has kept its full-year new orders guidance at JPY 1,500 billion.

Of concern is the slow revenue growth of 1.7% year over year for the industry & infrastructure segment, which we are expecting to be the main driver of earnings growth. But since new orders growth for this segment remains decent at over 35% year over year, we maintain our assumption for over 3% growth and raise our operating margin slightly higher to 4%.

The company sells little turbine equipment in China so we see limited opportunity from it gaining orders under the U.S.-China trade war. But we do expect potential orders from other emerging markets although competition is likely to remain keen with not just industry leaders such as General Electric and ABB but also with Chinese turbine makers, who have gained industrial expertise from home-grown demand. To note, MHI did not receive any gas turbine orders in the first quarter. As a result, we see only minimal revenue growth of 2% for the power systems segment. So, cost cuts are likely to factor significantly for MHI to drive profit growth.

Although we see risk to MHI's official net profit guidance of JPY 80 billion for fiscal 2018, due to the potential negative impact of losses related to the Rolls Royce Trent 1000 engine blade issues that MHI is a partner manufacturer to, we believe we have already factored some degree of added costs into our current profit forecast.

We have as a whole assumed that MHI will be able to raise its operating margin from 3.1% in fiscal 2017 to 6.4% in fiscal 2022. Part of this will depend on the reduction of losses for 64%-owned Mitsubishi Aircraft Corporation, maker of the Mitsubishi Regional Jet, which are guided to be JPY 90 billion in fiscal 2018. This continues to impede earnings for MHI's aircraft, defense & space segment and our revenue forecast for this segment remains around 12% below company guidance of JPY 700 billion for fiscal 2018. This is mainly due to expectations of a slower ramp-up in Boeing's 777X that MHI manufactures parts for.

However, we believe losses related to MRJ should start to diminish once deliveries commence, which should finally take place in the next two years. Wiring on the MRJ has been redrawn earlier this year and the plane is trying to complete the requisite 3,000 hours for certification. MHI has indicated that it has 213 firm orders for the MRJ and an additional 174 on option. However, with Boeing and Embraer recently announcing plans to jointly develop a mid-size jet, we think the MRJ is unlikely to gain enough orders (we estimate at around 680) to render the project profitable given the reported USD 3.2 billion cost according to Reuters. Nonetheless, we suspect that the MRJ will remain a springboard to other aircraft launches.