Brief Equities Bottom-Up: Shimadzu (7701 JP): 3Q Results Suggest a Trading Range and more

In this briefing:

1. Shimadzu (7701 JP): 3Q Results Suggest a Trading Range
2. Olympus: 3QFY03/19 Profits Decline on the Back of Litigation Related Costs
3. Cypress Semiconductor. The Perfect Acquisition Target.
4. Concordia Financial Group (7186 JP): Out of Focus
5. Shiseido Company Limited: 4QFY2018 Results – Setting Expectations Too High

1. Shimadzu (7701 JP): 3Q Results Suggest a Trading Range

Shimadzu’s 3Q results were good enough to reassure long-term investors, but not good enough to be called a buy signal. Sales and operating profit were up 4.5% and 4.6% year-on-year, respectively, in the three months to December, an improvement over 2Q but well below the double-digit increases recorded in 1Q and last fiscal year.  Forex losses and other factors led to a 2.2% decline in net profit. 

Sales were up in Japan, Europe and Asia ex-Japan and ex-China, but down in America,  China and Other Regions. Sales of core Analytical & Measuring Instruments were up 2.4%, operating profit on those sales was up 4.1% and the operating margin rose to +15.4% from +15.1% the previous year.

Sales of Industrial Machinery were down 5.7%, but operating profit on those sales was up 2.7% and the division generated a +9.7% operating margin vs. +9.0% the previous year. Sales of turbo-molecular pumps, primarily to semiconductor equipment makers, were down 14.3%.

Medical System sales were up 10.6% and the division generated a +1.5% operating margin vs. + 0.1% the previous year. Aircraft Equipment sales were up 12.1% but the division made a -0.5% operating loss vs. +1.2% profit the previous year. 

At ¥2,659 (Friday, February 8 closing price), the shares are selling at 24x our EPS estimate for FY Mar-19 and 12x EV/EBITDA. The five-year historical P/E range is 13x – 30x, the EV/EBITDA range is 6x – 16x. Over the next several quarters, we expect continued weakness in Industrial Machinery to offset single-digit growth in Instruments, keeping overall growth low. 

2. Olympus: 3QFY03/19 Profits Decline on the Back of Litigation Related Costs

Olympus Corporation (7733 JP) reported its 3QFY03/19 results on Friday (08^th February) after markets closed. The third quarter revenue dropped 1.7% YoY while operating profit declined by a significant 21.5% YoY, which was 12% below consensus estimates. The operating profit margin for the quarter was 8.8% compared to 11.1% for the same period last year.

The cumulative nine-month results were not impressive either. Although revenue saw a marginal improvement of 1.6% YoY, operating profit declined by 66%, resulting in a 700 basis point decline in operating margin, which fell to just 3.5%. Revenue and operating profit missed consensus estimates by 0.4% and 10.4%, respectively.

The company shares are currently trading at JPY4,645 per share which we believe is overvalued based on our EV/EBIT valuation. The premium is not justified given the governance related issues and the scandals currently faced by the company. Further, Olympus’ financial performance has been disappointing recently, and the company’s largest segment is growing only at single-digits and the Imaging business continues to drag on company revenue and margins. The share price gained nearly 38% since the beginning of the year following the company’s announcement to transform its business and improve governance. In our view the potential for a transformation in governance and business practices is already fully-discounted in the share price.

3. Cypress Semiconductor. The Perfect Acquisition Target.

There’s a lot to like about Cypress Semiconductor. Since taking the helm back in August 2016, CEO Hassane El-Khoury has led the company through a series of strategic realignments as part of his Cypress 3.0 initiative. While some of those moves were initially counterintuitive, they are now proving prescient as the company demonstrates far more resilience in the face of the current downturn compared to any period in its history.

Cypress offers exposure to the high growth automotive and IoT markets, industrial and consumer to a slightly lesser degree. Their product portfolio is the #1 market leader in new fewer than seven key segments, up from #3 just two years ago. On the latest earnings call, the company reported annual revenues of $2.48 billion for 2018, a 7% YoY increase. The company’s financial model targets a growth CAGR of 7-9% through 2021 and is well on track to achieve that goal. 

Like many of its peers, last year’s downturn saw Cypress share price fall more than 30% from its 52-week high at the trough. Currently, after a 6.63% rise on the back of solid earnings and reasonable outlook, its stock currently trades at $14.79, a 21.6% discount to the 52-week high. It also comes with an impressive dividend yield of 3.5% annualized as of December 31’st 2018.

We believe that the company would be an excellent acquisition target for the likes of Qualcomm whose failed bid for NXP last year thwarted its attempt to expand into the market for automotive semiconductors. We expect any such takeover offer would instantly add ~30% to the company’s share price. 

4. Concordia Financial Group (7186 JP): Out of Focus

CY2018 was not a good year for Concordia Financial Group, Ltd (7186 JP)  (CFG), the holding company for one of Japan’s largest regional banks, the Bank of Yokohama (BoY), and a small secondary regional bank, Higashi-Nippon Bank (HNPB).  Beset by a lending scandal at HNPB, which forced the bank’s president to step down, CFG’s share price remains some 30% below February 2018 levels, and has essentially traded sideways so far this year. 

CFG management’s attempts to placate disgruntled shareholders with stock buybacks and dividend payout increases have largely failed to impress.  3Q FY3/2019 profits declined by 8% year-on-year but relied heavily on non-core profit items: true core earnings collapsed 35.9%.  The Japanese banking sector remains unloved at present.  That said, currently trading on similar valuations to our much-preferred Chiba Bank (8331 JP) , CFG remains a liquid alternative to the ‘crowded trade’ of simply buying megabanks for exposure to the Japanese financial sector.  Patience, however, is the key word for investors here.  No harm in waiting to buy at a better entry price.

5. Shiseido Company Limited: 4QFY2018 Results – Setting Expectations Too High

Shiseido Co Ltd (4911 JP) reported its FY2018 results on 8^th Feb 2019. Shiseido’s revenue grew 8.9% YoY in FY 2018, marginally above our estimated growth rate of 8.7%. Shiseido’s EBIT increased by 34.7% in FY2018 primarily due to the gains made in the first 9 months of the year. However, in 4Q2018 the EBIT margin dropped to 2.4% from 3.6% in the same period last year. On a QoQ basis, margin drop was far more substantial as it declined more than 8.5% in 4QFY2018. Even though we were forecasting a decline in margins, we expected it to be a bit more gradual. Thus, Shiseido’s FY2018 EBIT fell short of our expectation. On the positive side, Shiseido also guided that they are increasing their semi-annual dividend by another JPY5.0 to JPY30.0 from 1HFY2019.