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Morningstar | Kubota’s FY18 Results and FY19 Guidance Below Expectations on Higher Costs; FVE Cut to JPY 1,670. See Updated Analyst Note from 15 Feb 2019

After rolling forward our model and factoring in the higher-than-expected costs, we lower our fair value estimate for Kubota to JPY 1,670 from JPY 1,750. Our narrow moat and stable moat trend ratings remain intact. We think the shares are fairly valued at the current price as prospect of higher demand for the company’s products has been factored in. Kubota’s fullyear 2018 EBIT was below our expectations and company guidance of JPY 204 billion, where EBIT decreased by 5.3% year over year to JPY 189 billion on the back of a 5.7% year-over-year increase in revenue to JPY 1.85 trillion, based on the restated accounts on the newly adopted IFRS standards. For fourth-quarter 2018, EBIT decreased by 19.4% year over year to JPY 40.9 billion on the back of a 1.1% year-over-year increase in revenue to JPY 486 billion. A dividend per share of JPY 18 has been declared, bringing the fullyear dividend per share to JPY 34, in line with guidance.

The lower 2018 EBIT was mainly caused by the lower EBIT in its Water and Environment division, which was impacted by higher raw material costs and the decline in domestic sales of ductile iron pipes. As for its main EBIT contributor, the Farm and Industrial Machinery division, despite a 6.3% year-over-year increase in revenue, EBIT remains largely flat year over year mainly due to an increase in raw material and other costs, which includes sales promotion expenses and fixed costs, resulting in a lower EBIT margin. The increase in raw material prices could be due to the higher steel prices that were caused by a tighter steel market driven by the ongoing steel supply side reform in China and the higher tariffs imposed on imported steel into the U.S., boosting steel prices in the U.S. The rising interest rates in the U.S. in 2018 also increased the financing cost for Kubota, resulting in an increase in sales promotion expenses as Kubota offers attractive financing packages with interest rates as low as 0% to customers.

In 2018, higher revenue in the Farm and Industrial Machinery division is driven by an increase in sales for its farm equipment, agricultural-related products, and construction machinery in Japan and North America. Sales of utility vehicles in North America was also helped by the introduction of a new model. In Europe, sales for construction machinery increased significantly partly helped by the depreciation of Japanese yen. Sales of farm equipment in Thailand increased due to improvement in demand on the back of rising agricultural products prices, while sales of farm equipment in China decreased significantly due to a decline in demand and increase in competition. For its Water and Environment division, strong overseas sales were supported by increasing demand for its ductile iron pipes and wastewater treatment plants.

For full-year 2019, management is guiding for EBIT to increase by 5.6% year over year to JPY 200 billion on the back of a 6.5% year-over-year increase in revenue to JPY 1.97 trillion. Net profit is expected to increase by 4.6% year over year to JPY 145 billion. The increase in revenue is mainly driven by: (1) an increase in revenue in the farm and industry machinery in North America and Asia excluding Japan; and (2) an increase in sales of its environmental-related products in Japan. Our EBIT forecast of JPY 210 billion and net profit forecast of JPY 151 billion for 2019 are slightly above guidance as we expect steel prices to decline, resulting in lower raw material costs and a reduction in sales incentives on the back of improving demand for its machinery, resulting in higher profitability. The more dovish tone on future interest rate hikes by the Fed would also help to keep Kubota’s financing costs and sales promotion expenses stable. In the long term, we continue to expect growth in its sales of agricultural and construction equipment along with improvements in its cost control, resulting in an improvement in its profitability.