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Morningstar | Mitsubishi Heavy Industries Faces Sales Headwinds; We Lower Assumed Midcycle Margins, FVE Lowered

Mitsubishi Heavy Industries' second-quarter fiscal year 2018 (ending March 2019) performance wasn't bad, with revenue growth improving in its core power systems and aircraft segments, but the group's challenged regional jet project remains a negative overhang. Our lowered earnings estimate and fair value estimate to JPY 4,640 from JPY 4,800 reflects a more subdued midterm outlook. Our cash flow forecast assumes that the JPY 170 billion that the firm will pump into subsidiary Mitsubishi Aircraft will be used as working capital to complete the last mile of the regional jet, or MRJ, project. We think the firm's current share price already reflects a potential write off of the MRJ project, but we also think that it will see lower margins in its gas turbine sales.

Company profit guidance is unchanged with operating profit at JPY 160 billion, including an operating loss of JPY 90 billion at MRJ. Second-quarter operating profit of JPY 25 billion was down from first quarter's JPY 31 billion with the Power Systems segment operating margin declining to 6.1% from 7.9%. We think this reflects a competitive environment with Power Systems new orders continuing to slip year over year. Nonetheless, profit was still a marked rebound from year-ago levels. Mitsubishi Heavy Industries has been able to shift sales focus to small-to-medium sized gas turbines to offset the absence of large turbine sales, which is a positive development. However, the company admits that the mid- to long-term outlook remains challenging.

We have tweaked our aircraft segment profit assumptions lower mainly to reflect the firm's increased share of the MRJ project to 87% from 64% after fully funding the capital raising. We continue to expect MRJ to meet its 2020 delivery but with orders for the jet stagnating, we think losses may linger longer, albeit at a declining amount. The Industry & Infrastructure segment growth is slowing, but profit should rebound in the absence of provisions.

We are factoring greater risk into our assumptions for Mitsubishi Heavy Industries' longer-term profitability. We think it is positive that the company is evening out its gas turbine portfolio in order to mitigate weak demand and high risks in the large-scale projects. However, we think that we will see lower profit margins on sales of the smaller turbines and have notched down our projected profit margins accordingly to 9% from 10% in our midcycle assumption.