IHI (7013) Initiation – Engine Driven
Success in eliminating losses and expanding businesses such as Turbochargers and Boilers which have good profit potential should drive growth for FY17 and FY18. While the main earner, the Aero-Engine division (116% of FY16 OPe), only gains momentum from FY19, it will likely remain near current peak OP levels, well above management’s cautious FY18 medium-term target of ¥44bn vs our ¥55bn estimate (we use an exchange rate of ¥/$111).
For FY17, the earnings picture is one of recovery by the two loss-making divisions. Alongside the release of FY16 results due on May 9th, we expect IHI to announce a reboot of its businesses from FY17, with the aim of reducing risk in volatile areas such as F-LNG. Reducing operating losses is key, as these have equalled 60-75% of total operating profit in recent years.
Aero-Engines alone could justify a market capitalisation of ¥700bn (10x current annual Aero-Engine division cash flow of ¥71bn). This calculates to a ¥450 share value – over 30% above the current ¥341 share price. Moreover, we think Aero-Engine OP could easily be 50% higher, three years out. Throwing in the long-profitable and expanding turbocharger business adds a further 20-25% to fair value. The two profitable divisions, Aero-Engines and Industrial/Machinery, comprise 80% of OP in FY18 under our model which, if achieved, justifies a share price 40-45% higher.
At ¥550, 60% above the current share price, IHI would trade on a forward PER of 15.4x and EV/OP of 12.1x on our FY18 numbers.
Key Points
- Long-term Aero-Engine play looks promising
- Profit leap expected from FY19 as engines enter a high-margin maintenance phase
- Turbocharger business profits (15% of FY16 OP) to double by FY18
- Strong management to refocus businesses from FY17 to reduce losses
- Valuations cheap vs peer aero-engine plays Safran (SAF FP) and MTU Aero Engines AG (MTX GY)
IHI is engaged in the manufacture and sale of heavy machinery. Resources, Energy and Resources segment offers boilers, power systems, motors for land and marine use, large marine motors and gas storage facilities and process plants. Social Infrastructure and Offshore Facilities segment offers bridges, water gates, steel structures, floating LNG storage facilities and offshore structures. Industrial Systems and General-purpose Machinery segment offers marine machinery, logistics systems, parking systems, steel manufacturing equipment and heat/surface treatment machinery. Aero Engine, Space and Defense segment provides aero engines, rocket systems, and defense systems.
Founded in 2009, Pelham Smithers Associates (PSA) provides market intelligence on Asian technology, focusing in particular on Japan. The industries covered by our team of specialists are: consumer electronics, telecomms, pharmaceuticals, internet, electronic parts and materials, automotive technology, retail and capital goods.
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