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Morningstar | Slowdowns in Europe and China Weighed on Denso’s December Quarter Results; Cut FVE to JPY 6,500. See Updated Analyst Note from 08 Feb 2019

We’re lowering narrow-moat Denso’s fair value estimate to JPY 6,500 from JPY 6,800 per share to reflect the slowdowns in European and Chinese automobile markets. The company’s December quarter operating profit came in short of our and consensus forecasts at JPY 91.2 billion, down 17% year on year, mainly owing to higher investment costs for future growth. Meanwhile, management seemed be concerned with weak business outlook and rising raw materials costs and revised down its full-year operating profit guidance to JPY 380 billion from JPY 393 billion.

We cut our full-year fiscal 2019 operating profit forecast to JPY 382 billion from JPY 404 billion previously, as we lessen our revenue and operating profit margin estimates, reflecting the weak quarterly results and pessimistic operating outlook for the remaining quarter. Our five-year revenue and operating profit growth projections are now changed to 4.1% and 2.7%, respectively, from the previous 5% and 4% forecasts. We believe the company’s continuous spending on research and development will sustain its technological lead as one of the tier-one global suppliers and view the shares as undervalued at current levels, trading at 30% discount to our new fair value estimate.

Despite management’s efforts on reducing its operating expenses from last quarter (selling, general, and administrative expense ratio down to 9.4% from 10% in the second quarter), third-quarter’s organic revenue was down 1.7% from last year, decelerating from 4% increase in the first half. This worse-than-expected performance was due to slowing car production growth in overseas, particularly Europe and China, with reported sales slowed at low-teens percentage points compared to the first half. On the product front, the mobility systems remained the primary growth driver, with sales up 21%, while other businesses posted low single digits declines in revenue.

Operating profit and net income dropped 17.3% and 19.7% year on year, respectively. Profitability improved significantly from the second quarter but still below our expectation, with operating profit margin declining 150 basis points year on year to 6.7%, which was attributable to 1.7 percentage points gross margin deterioration.