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Morningstar | Fanuc Hit by China Slowdown, and We Downgrade Our FVE to JPY 23,700. See Updated Analyst Note from 04 Feb 2019

Wide-moat Fanuc posted weaker third-quarter fiscal 2018 (quarter-ending December 2018) results featuring a 20% year-over-year decrease in revenue and a 42% decrease in operating income. Management made mild reductions to its full-year guidance with operating profit guidance reduced by 2% to JPY 147.9 billion. Highlighting the potential impact of the trade war, Fanuc’s sales in China were down 56%, and the Americas were down 19%. We downgrade our earnings forecast by midteens levels and increase our capital expenditure forecasts, reducing our fair value estimate to JPY 23,700 (and USD 22 per ADR) from JPY 28,100 (and USD 25 per ADR) previously, and we retain our wide moat rating. Our fair value estimate implies an adjusted price/earnings ratio of 34 times. Fanuc remains decent value in 4-star territory at current prices although the uncertainty surrounding the trade friction and smartphone market could trigger some short-term volatility.

The FA division, which accounted for 31% of total sales, saw 23% decline in revenue year on year this quarter after growing during the first half of the year. Sales remained at a high level in Japan, Europe, India, and the Americas, however, demand in China and Taiwan declined sharply due to the U.S.-China trade friction. The robot division, which made up 37% of total sales, was down 3% year on year. Within this division, Robodrills (compact machining centers) decreased significantly due to the IT and smartphone markets, while other products such as Roboshots and Robocuts remained robust.

Our base-case forecasts now incorporate 1.6% per year decline in both Fanuc’s revenue and operating profit over the next five years. Most of this is in this financial year with revenue growth averaging 2% and operating profit growth averaging 9% over the following four years. Given the International Federation of Robotics forecasts 14% average annual growth in worldwide industrial robots for the four years out to 2021, our forecasts could be accused of being conservative, but we are conscious that the base years in our forecasts are seemingly at a cyclical high and the IFR forecasts were made before the Trade War Impact became apparent.

Fanuc continues to invest strongly in artificial intelligence, or AI, and the Internet of Things, which it believes are fundamental technologies to be adopted in all of its product lines in the longer term. It has introduced Fanuc Intelligent Edge Link and Drive, or “Field.” The system, introduced in 2016, is an open, cloud-based platform that allows Fanuc to collect global manufacturing data in real time and funnel it to self-teaching robots. Given its high existing market share, we believe the application of Big Data and AI technologies to self-teaching robots and machines could add further strength to Fanuc’s wide moat.