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Morningstar | Nabtesco's 1Q Not Great but We Are Already Cautious, FVE Unchanged at JPY 3,350. See Updated Analyst Note from 29 Apr 2019

Nabtesco's first quarter sales slipped 2.3% year on year on weaker demand for precision reduction gears, which is disappointing albeit not entirely unexpected. The industrial robots space is still sluggish given cyclically weaker auto sector capital investment, which is within our assumptions. However, there are pockets of stability in its other activities and the absence of impairment charges will help make 2019 income look decent versus 2018. We also think that the 57% drop in first quarter net profit is largely due to a higher effective tax rate that should normalize. Our fair value estimate is unchanged at JPY 3,350. We think there may be headwinds for Nabtesco shares at the current level with risks that the market could lower their expectations. We think there will need to be a clear signal for a pick-up in second-half demand for the share price to outperform.

Our earnings forecast is little changed and we continue to have earnings expectations for 2020 and 2021 that are well below market consensus as we factor in the risk of reduced operating leverage as new capacity comes on line. The company has deferred the setting up of some of its new production lines and will continue to have this flexibility this year. However, capital expenditure is unlikely to decline much as most of this year's planned spending is related to land acquisition for its new facilities. So even if depreciation is more subdued if new lines are delayed, this may not raise our discounted cash flow based fair value estimate by much.

Nabtesco maintains its view that earnings should improve in the second half, which remains our base case assumption. The company expects the second half to make up 60% of full-year income. We think this remains easily achievable for its operating income and a normalizing tax rate for the remaining quarters is consistent with past experience. We expect the bottom line to grow 2.3% in 2019.

The company's orderbook backlog growth is stable at the lower pace of 5% year over year, which we think is in line with cyclically weaker spending globally in the auto sector and declining China railway spending growth and marketshare. Nabtesco does have some exposure to delays in the production of Boeing's 737 Max plane but this is not expected to have a significant impact on the company due to its diversified portfolio. In fact, its transport segment orderbook is up 14% on higher overall aircraft activities.

There is risk to our assumed sales growth of 5.6% in 2019 in its precision components segment following an 8% year-over-year revenue slide in the first quarter. However, we think that this may partly reflect continued cautious sentiment which could be mitigated by greater certainty from the U.S.-China trade discussions in the second half. We estimate that two thirds of its reduction gears could see some recovery. The one third that is driven by the auto sector is likely to remain sluggish. Nabtesco doesn't provide the split between the reduction gears and hydraulic equipment sales on a quarterly basis but the growth in its China sales of 12.6% year over year in the first quarter would imply that the hydraulics equipment sales should be relatively stronger than for the reduction gears. This is in line with our full-year assumption for the company but we do expect both to slow.

A better trade outcome that lifts sentiment should also lift Nabtesco's manufacturing solutions (Others) segment sales, which slipped 15% year over year in the first quarter. This segment is still relatively small and has been more sensitive to short-term cycles but a reversal of the downtrend would help. Both the transport and accessibility solutions segments sales are relatively consistent with expectations.

Gross profit margin of 27.1% and operating margin of 8.8% are not far off from our full-year assumptions and that of 2018 and we do not expect input costs to be a challenge in 2019. Our current net profit forecast at JPY 21.8 billion is lower than company guidance of JPY 22.9 billion. The difference relates to our more subdued sales assumptions.