Equity Bottom-Up

In this briefing:

1. Sumco Reports Solid Growth in Revenue and Operating Profit; Stock Is Still Trading at a Discount
2. MODEC: 17% Price Jump as Results Beat, Guidance Is Lowballed
3. Pan Pacific International: UNY Acquisition the Bright Spot as SSS and Inbound Decelerate
4. Nintendo Downgrades Switch Unit Sales Forecast for FY03/19 Despite Strong 3Q Financial Performance
5. Kao Corporation, 4QFY2018 Results Falls Short of Guidance

1. Sumco Reports Solid Growth in Revenue and Operating Profit; Stock Is Still Trading at a Discount

Sumco (3436 JP) reported its 4QFY12/18 and Full-year FY12/18 results yesterday (5th February). The company reported double-digit growth in revenue and operating profit for 4QFY12/18 driven by strong demand for semiconductor silicon wafers across all sizes alongside a favourable trend in wafer prices. Revenue grew 17.7% YoY in the 4^th quarter, in spite of missing its own top-line estimate by 1.7% and falling a touch below consensus and our estimates. Operating profit increased 57.1% YoY to JPY20.9bn, yet again falling below guidance, consensus and our estimates. The strong growth in operating profit resulted in a 640-bps expansion in the operating profit margin to 25.3% compared to the 18.9% reported in 4QFY12/17.

2. MODEC: 17% Price Jump as Results Beat, Guidance Is Lowballed

Modec Inc (6269 JP) reported strong 2018 results as operations for the year went smoothly and gross margin recovered to double digits in the fourth quarter with the company also releasing its contingency reserves resulting in a large uptick in SPC related earnings below the operating line.

Like last year however, guidance disappointed as the company released what we consider to be lowball estimates. Nevertheless, the stock reacted positively as the strong results offset some of the recent negativity from the large fall in crude prices. We examine the degree of conservatism we see in guidance below.

3. Pan Pacific International: UNY Acquisition the Bright Spot as SSS and Inbound Decelerate

Newly and somewhat boringly renamed  Pan Pacific International Holdings (7532 JP; PPI) (formerly the much more evocative Don Quijote or Donki) announced results yesterday after the close, seeing 11% YoY sales growth for the first half and 14% YoY current profit growth. With the inclusion of the expected contribution from a consolidated Uny Holdings, the company also boosted its FY outlook by 46% at the revenue line and 32% at the NP line.

Results at the 6 converted Uny stores continue to trend well and the company announced its intention to convert a further 19 stores by the end of the calendar year. Familymart Uny Holdings (8028 JP) had been projecting about ¥25bn in OP for Uny and its subsidiary UCS, which combined with PPI’s previous forecast for FY06/19 of ¥53bn would sum to about ¥78bn in OP, in line with consensus for PPI’s FY06/20 OP. Given the store conversions, growth overseas and some modest growth domestically for the mainline Donki stores, the prospects for a significant beat of consensus next year seem good.

4. Nintendo Downgrades Switch Unit Sales Forecast for FY03/19 Despite Strong 3Q Financial Performance

• Nintendo recorded strong revenue and OP performance in 3QFY03/19. Revenue for the quarter amounted to JPY608.4bn (+25.9% YoY) and OP amounted to JPY158.6bn (+36.1% YoY).
• Albeit strong performance across topline and bottomline, the company downgraded the sales units forecast for the Switch from 20m to 17m for FY03/19. Switch unit sales continue to be heavily driven by software releases. The company has only two hit software releases planned for 4QFY03/19. As such, the company has not made any changes to guidance. 
• The company continues to broaden its reach in the mobile gaming market with two releases set for summer 2019. While this may help the company reduce its reliance on gaming consoles over the long run, currently, mobile games make up less than 10% of the company’s topline.
• Based on our estimates, Nintendo is currently trading at a FY1 EV/EBIT multiple of 11.4x, lower than its historical median of 13.4x.

5. Kao Corporation, 4QFY2018 Results Falls Short of Guidance

Picking up from where we left off Market Largely Untroubled by Kao’s Troubles, Kao Corp (4452 JP) announced its FY2018 results yesterday (4^th February). Kao’s Revenue grew 1.2% YoY in FY2018 to reach JPY1,508bn, while its EBIT margin improved by 10bps to reach 13.8%. Despite that, both revenue and EBIT fell short of company guidance for FY2018.

In this briefing:

1. Tesla (TSLA): SWOT Analysis Leads To…Rivian
2. Dali Foods (3799:HK): Short to HK$4.18 on Expected Cost Increases (Full Note)
3. TRACKING TRAFFIC/Chinese Tourism: HK & Macau Gained ‘Share’ in December, Continuing H218 Trend
4. Aeon Credit Service (Asia) – Giant Yield and ROA, but at Low Price
5. Dali Foods (3799:HK): Short on Expected Cost Increases (Summary Note)

1. Tesla (TSLA): SWOT Analysis Leads To…Rivian

What happens when innovation becomes commoditized?  We believe this is a core concern to every Tesla watcher, bulls and bears so we began our Lunar New Year week (or Pro Am 2019 week in Pebble Beach) with a quick and dirty SWOT analysis of Tesla to see where the next potential existential threat can come from…and we ended up looking at Rivian.  

Rivian is a private company that has not issued public debt so financial information on the company is unavailable in the U.S. public domain, so we poured through strategic investor Sumitomo Corp’s Yuho reports to see if we can find any tidbits in Japan but found nothing there either.  Hence, while we cannot make much financial observations about the company at this point, we do see a number of strategic signs from Rivian’s actions that may indicating that it is most likely improving upon the Tesla experience to avoid the hiccups and the bumps on the road to premium EV segment dominance.

From an APAC stock market perspective, we see LG Chem and Sumitomo Corp as two entities that could potentially see financial impact from Rivian in the next several years. Teslerati has made an educated guess on LG Chem as Rivian’s cell supplier which we believe to be reasonable, although Rivian and LG Chem have neither confirmed nor denied the relationship (https://insideevs.com/new-details-rivian-battery-pack-design/, https://www.teslarati.com/rivian-battery-lab-irvine-california-megapack-production/).  Current investment in Rivian by Sumitomo Corp is most likely an insignificant amount from the latter’s perspective but could perhaps grow into something bigger at some point in the future.  

The Rivian R1S

2. Dali Foods (3799:HK): Short to HK$4.18 on Expected Cost Increases (Full Note)

Chinese snack food and beverage maker Dali Foods Group (3799 HK) is well-loved by sell-side analysts, with 18 of 20 analysts rating the stock ‘Buy’ or ‘Overweight’.

In contrast to the consensus ‘bull’ view of the company, we believe revenue growth is slowing and that core margins will soon come under intense pressure due to rising raw materials costs. As a result, our earnings estimates for Dali Foods are substantially lower than consensus.

Based on 13.5 times our 2019 EPS estimate, our target price for Dali Foods’ shares is HK$4.18, about 23% below the closing price of HK$5.41 on February 1st. 

3. TRACKING TRAFFIC/Chinese Tourism: HK & Macau Gained ‘Share’ in December, Continuing H218 Trend

Tracking Traffic/Chinese Tourism is the hub for all of our research on China’s tourism sector. This monthly report features analysis of Chinese tourism data, notes from our conversations with industry participants, and links to recent company news and thematic pieces. Our aim is to highlight important trends in China’s tourism sector (and changes to those trends).

In this issue readers can find:

Although we remain positive on the long-term growth of Chinese tourism, it’s clear that near-term demand growth has slowed, and that Chinese tourists are generally staying closer to home and probably spending less than they were a year ago. 

Happy New Year (of the Pig)!

4. Aeon Credit Service (Asia) – Giant Yield and ROA, but at Low Price

As we expand over analysis of exceptionally high yield lenders, we continue to see interesting ideas outside of mainstream commercial banks. Aeon Credit Service Asia Co (900 HK) is another specialty lending that fits well with the several we have highlighted in our past research. There is one glaring difference though: value.

5. Dali Foods (3799:HK): Short on Expected Cost Increases (Summary Note)

Chinese snack food and non-alcoholic beverage maker Dali Foods Group (3799 HK) is well-loved by sell-side analysts. Fully 18 of twenty analysts (including all four of the ‘bulge bracket’ investment banks who cover it) rate the stock ‘Buy’ or ‘Overweight’, and only one analyst gives the shares an ‘Underweight’ rating.

The ‘bull’ case for Dali Foods includes continued strong revenue growth and further margin expansion over the next few years. In contrast, we believe revenue growth is already moderating and that core margins will soon come under pressure due to rising raw materials costs. As a result, our forward earnings estimates are substantially below consensus expectations.

Based on 13.5 times our 2019 EPS estimate, our target price for Dali Foods is HK$4.18, about 23% below its HK$5.41 closing price on February 1st. We suggest investors Short Dali Foods; current holders should consider exiting their positions, in our view.

A longer note that includes company and industry background, plus financial statements and forecasts for Dali Foods, can be found elsewhere here on Smartkarma using the company’s ticker.

In this briefing:

1. Yapi Ve Kredi Bankasi: Inexpensive but Consumer Exposures May Be the Next Shoe to Drop

1. Yapi Ve Kredi Bankasi: Inexpensive but Consumer Exposures May Be the Next Shoe to Drop

Key metrics/signals at Yapi Ve Kredi Bankasi As (YKBNK TI) underline positive fundamental momentum and quality-value, embodied in a high PH Score™ despite macro imbalances, asset quality stress, and structural challenges. The bank mostly exceeded its 2018 targets, especially on profitability, efficiency, and non-interest income, though loan growth was reined in as cost of risk and asset quality deteriorated. Improvement was helped by a TL4.1bn rights issue in June, 2018. For 2019, YKBNK targets continued cost-growth below CPI, mid-teen fee income expansion, an NPL ratio <7%, CoR at <300bps, stable liquidity (LDR at 105%), a somewhat surprising pick-up in lending (+15%), and a modestly higher CAR (>15%).

Banks have been bearing the brunt of government interventions to bolster the economy for awhile now. The sizeable expansion of state loan guarantees was the main driver behind the acceleration of bank credit growth (now sharply moderating given elevated lending rates and tighter standards), largely funded externally and with a partially dollarized deposit base, resulting in a deterioration of the gross FX position. In addition, the relaxation of macroprudential measures was a driver of rampant asset growth. Steps have been taken to enhance risk management, report quasi-fiscal operations, including CGF, and limit borrowing in foreign currency. (There is some USD360 bn of non-financial corporate debt, half of which is external). Banks have been active in equity and FI markets of late to plug the gaps caused by capital and asset quality erosion. In Q418, three state banks were subject to what looked like a back-door recapitalisation when the lenders sold TL11bn of subordinated debt, reportedly to a government unemployment fund. Akbank has since boosted its capital base too with a rights issue and a syndicated loan.

Renewed FX volatility arising from policy missteps, such as electoral-induced easing, and a subsequent pass-through to already high cost-push inflation, would deepen the slowdown and destabilize the fragile macro situation. Tight monetary policy (one-week repo rate at 24 per cent), lower global oil prices, weaker domestic demand and a stronger Lira can moderate Inflation towards <15% though high food prices are exerting an upward impact on prices. The current account is stabilizing.

The KOC Group and Unicredit are YKBNK’s main shareholders.  Energy, finance, and auto are the main contributors to KOC Group Profit, representing 87% of the bottom line in 2018.

In this briefing:

1. Hamamatsu Photonics (6965 JP): 1Q Sales Growth Led by Medical, Semiconductor & Factory Automation
2. Wilmar: China Listing at ~20x Might Prove Too Optimistic.
3. Zozo: Zo Far Zo Bad
4. BTPS – Sharia Lender Improves High Returns
5. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada

1. Hamamatsu Photonics (6965 JP): 1Q Sales Growth Led by Medical, Semiconductor & Factory Automation

Consolidated sales were up 4.1% year-on-year in the three months to December, supported by demand from the medical, semiconductor and factory automation sectors, to which sales were up 8.7%, 11.0% and 8.2%, respectively. Gross profit was up 4.5%, but higher S,G&A expenses resulted in a 1.8% decline in operating profit (the operating margin was, however, up from the previous quarter). Net profit was up 4.9% after a decline in extraordinary losses. It was a relatively good performance in view of the cyclical downturns in the semiconductor and factory automation markets, and medical sales growth of only 3.2% in FY Sep-18.

Management’s three-year plan calls for 4.2% growth in sales and 0.9% growth in operating profit this fiscal year, followed by acceleration in FY Sep-20 and FY Sep-21. This is predicated on investment in new production capacity, which should be largely completed over the coming year, sufficient demand to absorb that capacity, and depreciation leveling off in FY Sep-21. Sales growth was on target in 1Q while operating profit fell short, but management has a record of cutting R&D and other expenses in order to achieve profit guidance. 

At ¥3,985, the shares are selling at 29x management’s implied EPS estimate for this fiscal year (net profit guidance/ current shares outstanding), 26x next year’s estimate and 22x the estimate for FY Sep-21.

2. Wilmar: China Listing at ~20x Might Prove Too Optimistic.

INVESTMENT VIEW:  Management sounded confident that they could list its China operations at ~20x PER and unlock value in Wilmar International (WIL SP) shares by 1) paying a special dividend from the listing proceeds, and 2) investors using the SOTP valuation to see deep value in the ex-China portion of the business.  However, our review of Wilmar-China’s listed A-share peers highlights significant vulnerability in management’s key assumption on its potential listing multiple.  We recommend investors take profits from the recent rally in the shares and expect them to trade back towards the lower end of its recent trading range. 

3. Zozo: Zo Far Zo Bad

Just a day after the publication of a deep dive Smartkarma Originals report (Zozo: A Shooting Star Shooting Itself in the Foot) on  ZOZO Inc (3092 JP)  by Michael Causton and ourselves, the company announced moderate 3Q results, a 34% downgrade to its current year OP forecast and a cut to its year-end dividend from ¥22 to ¥10, bringing its full year payout down from ¥36 to ¥24.

At the results meeting questions focused on the fallout of Zozo’s new Zozo Arigatou initiative which prompted some brands to discontinue sales on the Zozotown Mall, the reason for such a large downgrade just after the announcement of a very bullish medium-term plan, and even management compensation given such a disappointment.

We feel that the results underscore the issues raised in our previous report and that the stock could remain under pressure in-spite of how far it has already fallen.

4. BTPS – Sharia Lender Improves High Returns

Bank Tabungan Pensiunan Nasional Syariah (BTPS IJ) is 70%-owned by Bank Tabungan Pensiunan Nasional (BTPN IJ), the specialized pension lender in Indonesia. The focus of BTPS is small-sized loans, under Sharia law and primarily to women and the under-banked. The business is fairly new, but credit metrics and returns have been exceptional for the past five years, and rising. The company has seen its ROA rise from 4.54% to 9.11%, from 2014 to 2018, which ranks it as one of the most profitable lenders in Asia, and likely anywhere.

5. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada

Huawei is one of the largest telecom equipment companies in the world and it is also one of the top customers of Taiwan Semiconductor Manufacturing Company (TSMC) (2330 TT). There has been a war waged on Huawei by the US government administration. Most recently in January 2019, the US Justice Department announced 23 counts of indictments on Huawei related to the intellectual property theft, obstruction of justice, and fraud related to its evasion of US sanctions against Iran. The following are the major reasons why the US government has become so aggressive in targeting Huawei to prevent this company from selling its telecom equipment products in the US and in other allied countries:

• Serious concerns about Huawei’s equipment which can be used to conduct espionage
• The quest for 5G 
• Beyond 5G & Global technology leadership

HiSilicon Technologies, which is a fully owned company of Huawei, is one of the top five customers of TSMC. Of TSMC’s top five customers, both Apple and Huawei face significant headwinds which could reduce their sales growth rates. Although we do not have an exact figure of what percentage of TSMC’s sales that Apple and Huawei represent, we believe that is closer to about 25-30%. 

The current US administration is trying to slow down this excessive outsourcing of manufacturing out of the US. The US government’s war on Huawei is a reflection of the US government’s desire to slow down the progress of Huawei and China’s dominance of 5G services combined with threats of potential espionage. In the midst of all these intricate battles and concerns involving Huawei, TSMC is becoming negatively impacted as one of the main companies that produce chips for Huawei’s Hisilicon. 

In this briefing:

1. BCP: More Stable Income with an Attractive Yield
2. Biosimilar Battlefield: The Remsima/Inflectra Warning
3. Aisin Takes a 50% Cut in OP This Quarter; A Downward Revision in FY03/19E Target
4. Denso Revises Earnings Guidance Downwards After a 22% YoY Decline in OP as of 3QFY03/19
5. Exxon and Qatar Proceed with US$10bn Golden Pass LNG Terminal: Positive for Chiyoda and MDR US

1. BCP: More Stable Income with an Attractive Yield

We initiate coverage of BCP with a BUY rating, based on a target price of Bt41, which is derived from a sum-of-the-parts (SOTP) methodology and imply to 10.2xPE’19E to bring it in line with the Thai energy sector.

 The story:

• Attractive dividend yield of 6-7% a year
• Refining business set to recover in 2019
• Hidden value from non-core business

Risks:

• Raw material price fluctuation
• Possibility of impairment losses from investment projects

Background: Established in 1940, Bangchak Corporation Public Company Limited and its subsidiaries ‘ operations include refinery, oil trading, petroleum product marketing and renewable energy businesses. With a capacity of 120,000 barrels per day, Bangchak produces and distributes its products through more than 1,000 service stations nationwide. It also plans to expand the scope of its business to cover food and convenience stores and novel product businesses and to seek investment opportunities in bio-based products and natural resource businesses.

2. Biosimilar Battlefield: The Remsima/Inflectra Warning

2019 marks an inflection point for Korean biosimilar companies Celltrion Healthcare (091990 KS), Celltrion Inc (068270 KS), and Samsung Biologics Co., (207940 KS). Several new product launches are on tap, but competition will be more intense from here. More to the point, our updated estimates of end market revenue in the EU for Celltrion’s Inflectra/Remsima show that revenue is declining: consistent with commentary regarding pricing pressure as new competitors enter the market. This development suggests that biosimilar launch curves won’t be as steep as in the past and that product maturity will come sooner.

Expectations for these companies remain high, so we remain wary of these stocks.

3. Aisin Takes a 50% Cut in OP This Quarter; A Downward Revision in FY03/19E Target

On Friday, Aisin Seiki (7259 JP) reported 3QFY03/19 results posting a slight decline in revenue by -0.5% YoY, below our estimates by -5.6%, although above consensus estimates by +1.4%. On profitability, Aisin failed to meet market expectations, posting OP significantly down by almost -51% YoY falling below market expectations by a significant -33%. However, the results for the nine-months ended FY03/19 reported revenue up by +4.7% YoY supported by the increase in AT and Brake and Body parts sales. OP, however, was still disappointing, declining by nearly -13% YoY for the period, on the back of increasing depreciation costs for advanced investments alongside the rising R&D costs.

Following the quite significant decline in OP this quarter, Aisin has revised its guidance for FY03/19E revenue and OP downwards. Aisin now expects FY03/19E revenue to increase by only +1.3% YoY (cf. previous guidance of +2.3% YoY) and OP to decline by -17.3% YoY (cf. previous guidance of -7.8% YoY), expecting an OPM pf 5.3%. This downward revision is despite the fact that the company has achieved almost 76% of its revised revenue target and 77% of the revised OP target as of 3Q FY03/19. Aisin could be expecting its depreciation on investments and R&D costs to increase further over the last quarter and may also the quarters in the next financial year, for the company to be on track to compete with leading players like Denso in the competitive automotive field. However, we feel that Aisin is being quite conservative by revising its revenue guidance downwards this quarter and we still believe that the company’s steady revenue growth could continue over the last quarter, alongside its business restructuring efforts driving margins to about at least 6% for FY03/19E cf. 6.1% for FY03/18. Following the release, Aisin closed 3.0% down on Friday from Thursday’s close, however, rallied up almost 6% on Monday’s open.

4. Denso Revises Earnings Guidance Downwards After a 22% YoY Decline in OP as of 3QFY03/19

Denso Corp (6902 JP) failed to deliver as strong growth in revenue during its 3QFY03/19, compared to the first two-quarters of FY03/19. Denso reported a growth of only +1% YoY during 3QFY19, -1% below both consensus and our own estimate. Profitability of the company seemed more disappointing witnessing a decline of -17% YoY, falling below market expectations by -24%. The nine months ended cumulative figures for the company also looked depressing on the OP front, with Denso experiencing a -22% YoY decline, delivering an OPM of 6.1% (down from 8.1% during the same period last year).

However, Denso’s nine-month revenue looked relatively steady at 7.6% YoY growth. Denso has managed to make steady growth in revenue during the period despite the market slowdown in its key business regions, especially Europe and China. Revenue across all regions increased over the nine-months, supported by the overall increase in global car production and sales expansion from its recently consolidated subsidiaries (DENSO TEN and TD mobile). However, Denso’s OP over the current financial year has been on a downtrend citing its investments for future growth as the key reason. As we have previously mentioned, we consider this to be consistent with the company’s recent moves, having witnessed the company’s investment in companies such as Renesas, Metawave, Tohoku Pioneer, JOLED, ThinCI (Denso Prepares for the Future; Investments in Tohoku Pioneer EG Following JOLED and ThinCI). The stock moved down 5% from pre-release to post-release low.

5. Exxon and Qatar Proceed with US$10bn Golden Pass LNG Terminal: Positive for Chiyoda and MDR US

Qatar Petroleum and Exxon Mobil (XOM US) have taken a positive final investment decision (FID) on the Golden Pass LNG export facility on the US Gulf Coast, one of 25 projects up for FID this year globally. Golden Pass awarded the engineering, procurement and construction (EPC) contracts for the project to a joint venture of Chiyoda Corp (6366 JP), Mcdermott Intl (MDR US) and Zachry Group, with the project expected to cost US$10bn and come on line in 2024. We discuss the company impacts, the project detail and market impacts

In this briefing:

1. Oil Majors Results: The Main Take-Aways. We Are Positive on Hess, Valero and Chevron
2. Mizuho Financial Group (8411 JP):  Under Pressure
3. SMFG (8316 JP): On Target But Drifting Off Radar

1. Oil Majors Results: The Main Take-Aways. We Are Positive on Hess, Valero and Chevron

A number of the largest oil companies in the U.S. and Europe reported results last week including Exxon Mobil (XOM US) , Chevron Corp (CVX US) and Royal Dutch Shell (RDSA LN), all showing strong share price performance on the back of their results and outlook statements.

We look at the main topics of interest that came out of the results so far and what this means for the oil and gas sector. The areas in focus were the strong cash flow generation and capex plans, reserve replacement, new LNG projects, IMO impact for the refining sector and digitalisation. The upstream areas that got the most focus were the US onshore (specifically the Permian), US Gulf of Mexico, Guyana, Brazil and Venezuela. This follows on from our note 2019 Energy Market Themes & Stocks with Exposure: Focus on Oil, Refining, LNG, M&A & Renewables.

2. Mizuho Financial Group (8411 JP):  Under Pressure

Results for the nine months to end-December 2018, reported on 31 January 2019 by Mizuho Financial Group (8411 JP), or MHFG for short, reveal the continuing pressure on management to stabilize revenues and profitability.  MHFG reported consolidated recurring profits for the nine months to end-December 2018 of ¥547.56 billion (down 15.0% YoY) and net profits of ¥409.92 billion (down 13.8% YoY) on higher revenues of ¥2.858 trillion (+6.9% YoY).  Core earnings dropped into the red as net interest and fee income is now insufficient to cover overhead expenses, while the group is running out of surplus loan-loss reserves to write back to profit to keep the megabank in the black.  On a quarterly basis, results were much worse: 3QFY3/2019 was the worst quarterly performance reported by the megabank group since 2Q FY3/2014, with recurring profits falling 62.2% YoY to ¥80.64 billion while net profits fell 68.2% to just ¥50.56 billion.  

Mizuho, which significantly outperformed both of its rival megabanks Mitsubishi Ufj Financial Group (8306 JP) and Sumitomo Mitsui Financial Group (8316 JP) in share price performance terms throughout CY2018 (largely through having lower foreign ownership than the other two), is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal.  We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates.  In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.

3. SMFG (8316 JP): On Target But Drifting Off Radar

Consolidated results for the nine months to end-December 2018, announced by SMFG (8306 JP) on 31 January 2019, represented 91% of management’s full-year target of ¥700 billion for consolidated net profits.  Nevertheless, 3Q results (October-December 2018) were well down year-on-year, with rising funding costs and higher credit costs offsetting much of the positives from the earlier deconsolidation of its two retail banking subsidiaries.  Full-year guidance remains unchanged.  SMFG is now poised to exceed its ¥700 billion FY3/2019 consolidated net profit target, although probably not by much.

The megabanks are always a ‘crowded trade’ for foreign investors when it comes to exposure to the Japanese banking sector: the choice usually coming down to either MUFG or SMFG.  Mizuho, which significantly outperformed both MUFG and SMFG throughout CY2018, is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal.  We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates.  In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.

In this briefing:

1. Zozo: Zo Far Zo Bad
2. BTPS – Sharia Lender Improves High Returns
3. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada
4. Yapi Ve Kredi Bankasi: Inexpensive but Consumer Exposures May Be the Next Shoe to Drop
5. Yellow Cake (YCA) – Great Idea, Wrong Time!

1. Zozo: Zo Far Zo Bad

Just a day after the publication of a deep dive Smartkarma Originals report (Zozo: A Shooting Star Shooting Itself in the Foot) on  ZOZO Inc (3092 JP)  by Michael Causton and ourselves, the company announced moderate 3Q results, a 34% downgrade to its current year OP forecast and a cut to its year-end dividend from ¥22 to ¥10, bringing its full year payout down from ¥36 to ¥24.

At the results meeting questions focused on the fallout of Zozo’s new Zozo Arigatou initiative which prompted some brands to discontinue sales on the Zozotown Mall, the reason for such a large downgrade just after the announcement of a very bullish medium-term plan, and even management compensation given such a disappointment.

We feel that the results underscore the issues raised in our previous report and that the stock could remain under pressure in-spite of how far it has already fallen.

2. BTPS – Sharia Lender Improves High Returns

Bank Tabungan Pensiunan Nasional Syariah (BTPS IJ) is 70%-owned by Bank Tabungan Pensiunan Nasional (BTPN IJ), the specialized pension lender in Indonesia. The focus of BTPS is small-sized loans, under Sharia law and primarily to women and the under-banked. The business is fairly new, but credit metrics and returns have been exceptional for the past five years, and rising. The company has seen its ROA rise from 4.54% to 9.11%, from 2014 to 2018, which ranks it as one of the most profitable lenders in Asia, and likely anywhere.

3. The War on Huawei, Its Impact on TSMC, and the Invincible Spanish Armada

Huawei is one of the largest telecom equipment companies in the world and it is also one of the top customers of Taiwan Semiconductor Manufacturing Company (TSMC) (2330 TT). There has been a war waged on Huawei by the US government administration. Most recently in January 2019, the US Justice Department announced 23 counts of indictments on Huawei related to the intellectual property theft, obstruction of justice, and fraud related to its evasion of US sanctions against Iran. The following are the major reasons why the US government has become so aggressive in targeting Huawei to prevent this company from selling its telecom equipment products in the US and in other allied countries:

• Serious concerns about Huawei’s equipment which can be used to conduct espionage
• The quest for 5G 
• Beyond 5G & Global technology leadership

HiSilicon Technologies, which is a fully owned company of Huawei, is one of the top five customers of TSMC. Of TSMC’s top five customers, both Apple and Huawei face significant headwinds which could reduce their sales growth rates. Although we do not have an exact figure of what percentage of TSMC’s sales that Apple and Huawei represent, we believe that is closer to about 25-30%. 

The current US administration is trying to slow down this excessive outsourcing of manufacturing out of the US. The US government’s war on Huawei is a reflection of the US government’s desire to slow down the progress of Huawei and China’s dominance of 5G services combined with threats of potential espionage. In the midst of all these intricate battles and concerns involving Huawei, TSMC is becoming negatively impacted as one of the main companies that produce chips for Huawei’s Hisilicon. 

4. Yapi Ve Kredi Bankasi: Inexpensive but Consumer Exposures May Be the Next Shoe to Drop

Key metrics/signals at Yapi Ve Kredi Bankasi As (YKBNK TI) underline positive fundamental momentum and quality-value, embodied in a high PH Score™ despite macro imbalances, asset quality stress, and structural challenges. The bank mostly exceeded its 2018 targets, especially on profitability, efficiency, and non-interest income, though loan growth was reined in as cost of risk and asset quality deteriorated. Improvement was helped by a TL4.1bn rights issue in June, 2018. For 2019, YKBNK targets continued cost-growth below CPI, mid-teen fee income expansion, an NPL ratio <7%, CoR at <300bps, stable liquidity (LDR at 105%), a somewhat surprising pick-up in lending (+15%), and a modestly higher CAR (>15%).

Banks have been bearing the brunt of government interventions to bolster the economy for awhile now. The sizeable expansion of state loan guarantees was the main driver behind the acceleration of bank credit growth (now sharply moderating given elevated lending rates and tighter standards), largely funded externally and with a partially dollarized deposit base, resulting in a deterioration of the gross FX position. In addition, the relaxation of macroprudential measures was a driver of rampant asset growth. Steps have been taken to enhance risk management, report quasi-fiscal operations, including CGF, and limit borrowing in foreign currency. (There is some USD360 bn of non-financial corporate debt, half of which is external). Banks have been active in equity and FI markets of late to plug the gaps caused by capital and asset quality erosion. In Q418, three state banks were subject to what looked like a back-door recapitalisation when the lenders sold TL11bn of subordinated debt, reportedly to a government unemployment fund. Akbank has since boosted its capital base too with a rights issue and a syndicated loan.

Renewed FX volatility arising from policy missteps, such as electoral-induced easing, and a subsequent pass-through to already high cost-push inflation, would deepen the slowdown and destabilize the fragile macro situation. Tight monetary policy (one-week repo rate at 24 per cent), lower global oil prices, weaker domestic demand and a stronger Lira can moderate Inflation towards <15% though high food prices are exerting an upward impact on prices. The current account is stabilizing.

The KOC Group and Unicredit are YKBNK’s main shareholders.  Energy, finance, and auto are the main contributors to KOC Group Profit, representing 87% of the bottom line in 2018.

5. Yellow Cake (YCA) – Great Idea, Wrong Time!

• Yellow Cake PLC (YCA LN) is a pure play on the uranium price
• Spot Price $28.90/lb U₃O₈ & L.T. Price remains $32/lb U₃O₈
• Share price trading at ~2% discount to NPV
• Despite recent production cuts, primary & secondary supplies cover world demand
• Est. surplus ~500ktU, representing six years of global primary production
• Global nuclear generation peaked in 2006
• Forecast world uranium demand to decline between 25% and 40% by 2050
• 1-year Target Price £1.98-2.02 ps NPV_4% assuming $24/lb U₃O₈
• 3-year Target Price £1.57-1.77 ps NPV_4% assuming $21/lb U₃O

In this briefing:

1. Yellow Cake (YCA) – Great Idea, Wrong Time!
2. Oil Majors Results: The Main Take-Aways. We Are Positive on Hess, Valero and Chevron
3. Mizuho Financial Group (8411 JP):  Under Pressure
4. SMFG (8316 JP): On Target But Drifting Off Radar
5. Keyence (6861 JP): Deceleration Continues in 3Q

1. Yellow Cake (YCA) – Great Idea, Wrong Time!

• Yellow Cake PLC (YCA LN) is a pure play on the uranium price
• Spot Price $28.90/lb U₃O₈ & L.T. Price remains $32/lb U₃O₈
• Share price trading at ~2% discount to NPV
• Despite recent production cuts, primary & secondary supplies cover world demand
• Est. surplus ~500ktU, representing six years of global primary production
• Global nuclear generation peaked in 2006
• Forecast world uranium demand to decline between 25% and 40% by 2050
• 1-year Target Price £1.98-2.02 ps NPV_4% assuming $24/lb U₃O₈
• 3-year Target Price £1.57-1.77 ps NPV_4% assuming $21/lb U₃O

2. Oil Majors Results: The Main Take-Aways. We Are Positive on Hess, Valero and Chevron

A number of the largest oil companies in the U.S. and Europe reported results last week including Exxon Mobil (XOM US) , Chevron Corp (CVX US) and Royal Dutch Shell (RDSA LN), all showing strong share price performance on the back of their results and outlook statements.

We look at the main topics of interest that came out of the results so far and what this means for the oil and gas sector. The areas in focus were the strong cash flow generation and capex plans, reserve replacement, new LNG projects, IMO impact for the refining sector and digitalisation. The upstream areas that got the most focus were the US onshore (specifically the Permian), US Gulf of Mexico, Guyana, Brazil and Venezuela. This follows on from our note 2019 Energy Market Themes & Stocks with Exposure: Focus on Oil, Refining, LNG, M&A & Renewables.

3. Mizuho Financial Group (8411 JP):  Under Pressure

Results for the nine months to end-December 2018, reported on 31 January 2019 by Mizuho Financial Group (8411 JP), or MHFG for short, reveal the continuing pressure on management to stabilize revenues and profitability.  MHFG reported consolidated recurring profits for the nine months to end-December 2018 of ¥547.56 billion (down 15.0% YoY) and net profits of ¥409.92 billion (down 13.8% YoY) on higher revenues of ¥2.858 trillion (+6.9% YoY).  Core earnings dropped into the red as net interest and fee income is now insufficient to cover overhead expenses, while the group is running out of surplus loan-loss reserves to write back to profit to keep the megabank in the black.  On a quarterly basis, results were much worse: 3QFY3/2019 was the worst quarterly performance reported by the megabank group since 2Q FY3/2014, with recurring profits falling 62.2% YoY to ¥80.64 billion while net profits fell 68.2% to just ¥50.56 billion.  

Mizuho, which significantly outperformed both of its rival megabanks Mitsubishi Ufj Financial Group (8306 JP) and Sumitomo Mitsui Financial Group (8316 JP) in share price performance terms throughout CY2018 (largely through having lower foreign ownership than the other two), is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal.  We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates.  In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.

4. SMFG (8316 JP): On Target But Drifting Off Radar

Consolidated results for the nine months to end-December 2018, announced by SMFG (8306 JP) on 31 January 2019, represented 91% of management’s full-year target of ¥700 billion for consolidated net profits.  Nevertheless, 3Q results (October-December 2018) were well down year-on-year, with rising funding costs and higher credit costs offsetting much of the positives from the earlier deconsolidation of its two retail banking subsidiaries.  Full-year guidance remains unchanged.  SMFG is now poised to exceed its ¥700 billion FY3/2019 consolidated net profit target, although probably not by much.

The megabanks are always a ‘crowded trade’ for foreign investors when it comes to exposure to the Japanese banking sector: the choice usually coming down to either MUFG or SMFG.  Mizuho, which significantly outperformed both MUFG and SMFG throughout CY2018, is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal.  We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates.  In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.

5. Keyence (6861 JP): Deceleration Continues in 3Q

Keyence reported higher sales and profits but lower rates of growth in the three month to December. Consolidated sales were up 11.8% year-on-year compared with 15.2% growth in 2Q and 19.7% growth in 1Q. Operating profit was up 9.1% compared with 12.7% growth in 2Q and 21.2% growth in 1Q. The operating margin declined to 53.8% compared with 55.2% in 2Q, 54.6% in 1Q and 56.6% in 4Q of FY Mar-18.

Once again, the results at Keyence were much better than those at other factory automation related companies – notably Fanuc (6954 JP) and Omron (6645 JP), where operating profits dropped at double-digit rates. But Keyence is geared to incremental improvements rather than large capital outlays, and to customers’ R&D spending, and it has a diversified base of user industries. On the other hand, it is not immune to weakening demand in China, Europe and elsewhere.

Since hitting a 52-week low of ¥50, 780 on October 26, Keyence has rebounded by 13%. At ¥57,270, the shares are now selling at 30x our EPS estimate for this fiscal year and 27x our estimate for FY Mar-20. Their 5-year historical P/E range is 18x – 42x. Other valuations are also well up in their historical ranges.

The sales and profit data suggest difficult year-on-year comparisons for the next few quarters.

In this briefing:

1. Hoya Reports Solid 3QFY03/19 Performance; Our Outlook on the Company Remains Unchanged
2. KDDI: 3Q18/19 Results Miss Slightly but Stock Is Poised to Benefit From Lower Handset Subsidies
3. DTAC: Survived 2019 but Pressured on All Sides. Maintain Reduce.

1. Hoya Reports Solid 3QFY03/19 Performance; Our Outlook on the Company Remains Unchanged

Hoya Corporation (7741 JP) reported its 3QFY03/19 earnings yesterday (01^st Feb). The revenues grew at 4.9% YoY while operating profit increased by a hefty 20.2% YoY during the quarter. On a constant currency basis, revenues grew 6.6% YoY while pre-tax profit increased 15.0% YoY during the period. In addition, Hoya’s margin too witnessed an expansion with operating profit margin reaching 27.8% from 24.3%, while it reported a pre-tax margin of 27.7% compared to 25.4% a year ago. Moreover, the company beat consensus estimates on revenue, operating profit and pre-tax profit.

Revenues grew thanks to strong performances by the Life Care and Electronics businesses although the Imaging business saw a decline.

2. KDDI: 3Q18/19 Results Miss Slightly but Stock Is Poised to Benefit From Lower Handset Subsidies

KDDI’s (9433 JP) 3Q results were a small miss (2% vs our forecasts), at both the revenue and profit lines, but not enough to change our positive stance. A key part of our view is derived from our negative view on Apple (AAPL US) from August 2018 where we see an “air-pocket” of demand loss coming through. This is particularly important to Japan where the iPhone accounts for around 75% of smartphones. Apple has downgraded guidance and we believe is in a secular downtrend as refresh cycles elongate and that has been accentuated by the pull forward of demadn for the iPhone X. 

This is playing out in Japan, with KDDI reporting handset revenues down 13% YoY, and the key cause of the revenue miss. KDDI increased discounting to offset falling sales in 3Q adding a ¥9.9bn increase in handset costs in the quarter. Without that, EBIT would have beaten expectations. KPIs were generally strong, and service revenue trends improved to -0.1% YoY from -0.8%. Given the nature of the miss, and the fact the company is reiterating guidance we do not expect material changes to forecasts. Our price target is ¥4,100, and our recommendation remains Buy.

3. DTAC: Survived 2019 but Pressured on All Sides. Maintain Reduce.

Total Access Communication (DTAC TB) has emerged from a torrid 2018 and has survived. That was not always a certainty as the year progressed and their access to much of their spectrum expired. In the end DTAC managed to buy some 2x5MHZ of 900MHZ and 2x5MHZ of 1800MHZ spectrum and retain access temporarily to expired spectrum (the remedy). See DTAC 3Q Result: No Recovery Yet. Spectrum Issue Now Solved, but Leverage Is Rising.

However, survival has come at a cost. DTAC is paying a high price to TOT to rent its 2300MHZ spectrum (and is paying to build out the network), it has paid large sums to secure small amounts of 1800MHZ and 900MHZ spectrum to partially replaced expired concession spectrum and has agreed to pay to use equipment sitting on CAT’s infrastructure.  Finally it has moved to settle a number of disputes with CAT (discussed in Thai Telcos: Outstanding Liabilities to CAT/TOT Loom Post DTAC’s Partial Settlement) and pay them a net THB9bn. That clears the decks partially but there are some very large outstanding cases not covered (these relate to all three operators).

Latest results do little to suggest that good times are just around the corner. They were disappointing and suggest the Thai market will continue to struggle in 2019 as discussed in Emerging Asean Telcos 2019: Indonesia Looks Best Placed. Malaysia Improving. DTAC’s survival has led to increased competition in the market as it moves to win back customers and that suggests more earnings disappointment to come. We remain cautious and somewhat surprised by the strong move in recent days. We have a Reduce recommendation and THB32 target price.

In this briefing:

1. Misumi Group (9962 JP): Another Downward Revision

1. Misumi Group (9962 JP): Another Downward Revision

Misumi Group sold off after announcing poor 3Q results and another downward revision to FY Mar-19 sales and profit guidance, but bounced right back to finish at ¥2,480 yesterday (January 31), which is 30x management’s new EPS estimate for this fiscal year. Price/book value (as of the end of December) is 3.6x. The indicated dividend was cut in line with guidance, maintaining management’s 25% payout ratio target but resulting in a dividend yield of 0.8%.

Operating and net profits are now expected to decline. Management is guiding for a 7.1% increase in sales in FY Mar-19 as a whole, but monthly data shows year-on-year growth dropping to 5.2%  in November and 3.1% in December. Factory Automation sales were unchanged in November and down 1.3% in December, 

In the three months to December, operating profit dropped 17.8% year-on-year on a 5.7% increase in sales, with Factory Automation profit down 16.9% and VONA profit down 35.4%. Inventory was up while receivables were down. Sales growth in China turned negative. 

The company continues to invest in production capacity, logistics and IT, aiming to expand its Factory Automation and VONA e-commerce businesses in Japan, Asia, America and Europe. The goal is to create a unified, cloud-based, rapid-response distribution system with the world’s largest components and production materials database. The anticipated success of this plan appears to explain both the rebound in the share price and relatively high current valuation, but with the China growth trajectory broken and the economic outlook uncertain, it may take longer and come with lower margins than originally expected.