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Morningstar | Komatsu’s Fiscal 2019 in Line; Fiscal 2020 Guidance Weaker than Expected; FVE Cut to JPY 2,680. See Updated Analyst Note from 29 Apr 2019

After rolling forward our model and lowered our sales forecast for its construction, mining and utility equipment division on the back of weakness mainly in China, Indonesia and Latin America, we cut our fair value estimate for Komatsu to JPY 2,680 per share ($24 per ADR) from JPY 2,840 per share ($26 per ADR). Our narrow moat and stable moat trend ratings on the firm remain intact. We think the shares are slightly overvalued at the current price as we expect the company to be affected by near-term weakness from the machinery sales in China, Indonesia and Latin America.

Komatsu’s fiscal 2019 (ending March 2019) EBIT increased by 33% year over year to JPY 399 billion on the back of an 9% year over year increase in revenue to JPY 2.73 trillion. Although these were largely in line with our expectations, the results beat the firm’s fiscal 2019 guidance of JPY 384 billion of EBIT and JPY 2.66 trillion of revenue. For fourth-quarter fiscal 2019, EBIT was largely flat year over year at JPY 103 billion on the back of a 2% increase on revenue to JPY 707 billion. For its full-year results, the 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, CIS, Asia (excluding China and Japan) and Oceania, but partly offset by the decline in Middle East; and (2) strong performance in its industrial machinery and others division supported by increased sales of machine tools to the autos industry and excimer laser to the semiconductor industry. Dividend per share of JPY 59 has been proposed, leading to a full-year dividend per share of JPY 110, which was above the guidance of JPY 102 and represents a 31% year-over-year increase from JPY 84 in fiscal 2018.

For fiscal 2019, sales in its construction, mining and utility equipment increased by 9% year over year. Among the regions that saw the strongest year-over-year growth were CIS and Oceania, which experienced sales growth of 24% and 19%, respectively, mainly driven by strong demand for construction and mining equipment. In Europe, strong demand for construction equipment, especially in Germany, the United Kingdom and France resulted in sales growth of 15% year over year. In North America, sales grew by 14% supported by demand from infrastructure and energy related sectors. In Asia (excluding China and Japan), sales grew by 14% although demand growth in Indonesia, which is the largest market for Komatsu there is slowing down. In Latin America, sales increased by 3% supported by increased demand from Brazil, mitigated by a decline in demand from Argentina. In Japan, sales declined by 1% year over year due to a high base in fiscal 2018 driven by prepurchase ahead of new emission control regulations in September 2017, partly mitigated by growth from the rental industry underpinned by recovery work from natural disasters.

In China, sales decreased by 9% year over year in fourth-quarter fiscal 2019, leading to a flat year-over-year growth. This is despite strong growth of excavator shipments of 24% and 41% year over year in fourth-quarter fiscal 2019 (calendar year first quarter 2019) and calendar year 2018, respectively, according to data from the China Construction Machinery Association. This shows that Komatsu is losing market share as the environment remains competitive in China.

For fiscal 2020, management is guiding for EBIT to decrease by 14% year over year to JPY 342 billion from JPY 399 billion on the back of a 4% year over year decrease in revenue to JPY 2.62 trillion from JPY 2.73 trillion. The decline in revenue is mainly due to a decrease in revenue from its construction, mining and utility equipment driven by the strengthening of the Japanese Yen (forecast of JPY 105 per USD) and a slight fall in volume, offset by a slight increase in selling price. Among the regions where the management is expecting to see a decline in sales include North America, Latin America, China, Asia (excluding Japan and China), Oceania and Africa. Management is also expecting for an increase in fixed cost, leading to a decline in EBIT. However, as we expect the Japanese Yen to strengthen only to JPY 110 per USD, we are forecasting an EBIT of JPY 371 billion on the back of JPY 2.76 trillion of revenue for fiscal 2020. Management is also guiding for net income of JPY 215 billion and dividend per share of JPY 110 in fiscal 2020, translating to a decent yield of 3.9%.

In terms of Komatsu’s mid-term plan which spans from fiscal 2020 to fiscal 2022, management will continue to focus on research and development, or R&D, and innovation by leveraging on Internet of things and autonomous equipment to drive future growth for the company. Management’s commitment to this could be seen from its guidance of an increase in R&D expenses in fiscal 2020 to JPY 82 billion from JPY 73 billion in fiscal 2019. This is in line with our view for Komatsu where long-term growth will be driven by its focus on advancement in technology.