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Morningstar | Daikin’s Fiscal 2019 Results Within Expectations; FVE Increased Slightly to JPY 10,100. See Updated Analyst Note from 13 May 2019

No-moat Daikin’s net profit of JPY 189 billion for fiscal 2019 (year ending March 2019), flat year over year, was in line with our expectations. After rolling forward our valuation model, we raise our fair value estimate slightly to JPY 10,100 from JPY 9,900. While the company’s ability to control cost and achieve record high operating profit are impressive, this has been priced in and further outperformance is not sustainable, in our view. We think the company is overvalued at the current stock price given its slowing earnings momentum, as we forecast Daikin’s earnings per share to grow at a CAGR of 3.5% over the next five years (versus historical three-year CAGR of 11.3%) on the back of headwinds such as uncertain global economic growth due to geopolitical frictions, appreciation of the Japanese yen and slowdown in the China market.

Despite a surge in raw material prices and depreciation of emerging markets’ currencies, Daikin’s fiscal 2019 operating margin of 11.1% was better than guidance of 10.9% and was flat year over year. We think the firm has successfully mitigated the challenges through its three-pronged strategy of cost-cutting, raising selling prices and introducing new value-added products. In addition, overall margin was also aided by better performance of the chemicals and other segments. However, we believe all the low hanging fruits have been picked, and we expect Daikin’s operating margin to drop below 11% going forward, in line with management guidance.

The company’s core air conditioning business was robust with higher sales achieved in all major regions including Japan, the Americas and Europe. We expect the strength in these key markets to sustain but we think China will be a drag in fiscal 2020 due to slower economic growth, cooling property market and the China-U.S. trade war. In the longer term, despite being the firm’s firth largest market currently, sales in Asia should continue to grow given the rising middle class in the region.

Management guided that capital expenditure and research and development cost will increase by 20% and 7%, respectively, in fiscal 2020. We think this is not surprising given that investment in sales networks and new valued-added product will be crucial to maintain Daikin’s competitiveness. The firm’s balance sheet strength remains healthy, with stable net gearing ratio of 0.15 times. In addition, Daikin has proposed to keep fiscal 2020’s dividend per share at JPY 160, unchanged from fiscal 2019.