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Morningstar | Komatsu’s 1Q Fiscal 2019 Slightly Above Our Expectations; FVE Raised to JPY 3,750 ($34 per ADR). See Updated Analyst Note from 27 Jul 2018

Komatsu’s first-quarter fiscal 2019 (year ending March 2019) EBIT increased by 81% year over year to JPY 96 billion and came in slightly above our expectations. This represents around 28% of its full-year EBIT guidance of JPY 345 billion. The sharp year-over-year improvement is mainly driven by: (1) strong performance in its construction, mining, and utility equipment division, underpinned by strong sales recorded in North America, Europe, China, and Asia (excluding China and Japan), but partly offset by the decline in Japan and the Middle East; and (2) higher EBIT at its retail finance business, owing to the reversal of bad-debt allowance in China that was recorded in fiscal 2017. We have increased our fair value estimate for Komatsu to JPY 3,750 (from JPY 3,700) per share, while keeping our fair value estimate for the ADR unchanged at $34, owing to the depreciating Japanese yen. Our no-moat and stable moat trend ratings on the firm are intact. We think the shares are fairly valued at the current price.

Sales in construction, mining, and utility equipment increased by 15.4% year over year. Among the regions that saw the strongest year-over-year growth were Asia (excluding China and Japan) and China, which saw sales grow by 34.2% and 31.9%, respectively. This was driven by strong demand in mining equipment in Indonesia and growing demand for construction equipment in China as a result of the ongoing infrastructure projects. Strong demand for construction equipment, mainly for the energy and infrastructure sectors in North America, also drove sales growth of 21.2%. In Japan, sales decreased by 7.6%, as the firm was affected by an increase in prepurchase from its customers ahead of the new emission controls regulations, which were first enforced in September 2017.

Management is maintaining its guidance for fiscal 2019. EBIT is expected to increase to JPY 345 billion from JPY 303 billion in fiscal 2018, mainly driven by improving margins in both the construction, mining, and utility equipment segment and the industrial machinery and others segment. Net income is expected to grow to JPY 226 billion from JPY 196 billion in fiscal 2018. Management also plans to increase the dividend per share by JPY 12 to JPY 96 in fiscal 2019 on the back of the earnings improvement. For fiscal 2019, we expect demand for Komatsu’s equipment to remain strong, resulting in EBIT margin increasing to 13.2% from 12.1% in fiscal 2018.