EUR 850.00 For Business Accounts Only

Morningstar | Nabtesco’s Guidance Shows Sluggish Expectations, but not as Weak as We Assume

Nabtesco’s fourth-quarter performance was in line with expectations so the focus is likely to be on the company’s 2019 guidance that shows revenue growth staying sluggish at 6% and net profit at 9%. The company’s margin guidance is better than we assume and we’ll look to lift our JPY 3,350 fair value estimate slightly following details from the company’s analyst briefing. We’d be interested to hear management’s outlook for its precision components sales. This segment has been propped up by hydraulic equipment sales to China and the company guidance does hint that both the reduction gear and hydraulic equipment sales will be slow. We note that Nabtesco’s share price fell 5% ahead of its results release on Feb. 8, but we think that there is little in the numbers to warrant the sharp sell down. The shares are presently undervalued for investors with a three-year horizon. We think earnings may dip in 2020 as its added capacity comes on stream and this could cap performance.

Without the JPY 5.3 billion one-time asset impairment charge reflected in the second quarter, Nabtesco’s bottom line is in line with top-line growth at 4.3%. The slowdown from 2017’s 35% earnings growth pace is largely cyclical, in our view, with reduction gear sales growth weaker as China demand cooled. We think this should see some recovery in 2019 but the main risk to Nabtesco’s earnings will be in 2020 as its new components capacity comes on stream. We think this could lead to capacity utilization rates declining to around 95%, which may eat into operating efficiency.

On a positive note, sales to China picked up in the fourth quarter to 14% year-over-year after slowing to 8% in the third quarter. Should the U.S. and China avoid a second round of tariff hikes, we think sentiment may improve and demand for Nabtesco’s products could get a slight boost. However, we maintain our view for auto segment demand to lag.

On a positive note, sales to China picked up in the fourth quarter to 14% year over year after slowing to 8% in the third quarter. Should the U.S. and China avoid a second round of tariff hikes, we think sentiment may improve and demand for Nabtesco’s products could get a slight boost. However, we maintain our view for auto segment demand to lag.

Nabtesco’s components plant capacity utilization rate likely fell in the second half of 2018. While we think it still exceeded 100% for the year, we suspect that operating leverage may have dropped with lower usage of a third shift at its plants. In addition, the company’s Gifu plant expansion completed in October 2018. We think that this impact coupled with higher input costs during the year led to a fall in gross profit margins to 27% in 2018 from 28.5% in 2017. We expect gross profit margins to improve in 2019 by 40 basis points as input costs are easing. The company remains bullish in its outlook for industrial robot needs and has purchased more land in Japan for a future precision gear production facility, that will probably be required in five years’ time.

Somewhat surprising to us was a more than doubling in short term debt to JPY 34.1 billion and along with this was a 14-fold jump in interest expense to JPY 1.5 billion. Financing cost alone in the fourth quarter made up half that of the full year. We think that this debt will be refinanced into longer term borrowings and bonds and interest expense should fall back from the relatively high short term costs. Nabtesco was free cash flow positive in 2018 and working capital needs were little changed so we do not expect a sustained rise in the company’s debt. Dividends were relatively unchanged with the company paying out 43% of earnings or JPY 73 per share. This has been guided to remain stable in 2019.