Brief Japan: SMC (6273 JP): Profit Decline Accelerates and more

In this briefing:

1. SMC (6273 JP): Profit Decline Accelerates
2. Japan – Chinese Flu
3. Japan Stock Weekly
4. UUUM (3990) Phenomenal Growth but at a Price.
5. Renesas: Factory Stoppage Announcement Should Correct Premature Rebound Expectations

1. SMC (6273 JP): Profit Decline Accelerates

Downturns in the semiconductor, auto and other user industries have caught up with SMC. Sales were down 4.0% year-on-year in the three months to December (the first decline in more than two years) and the decline in profits accelerated, with gross profit down 5.4%, operating profit down 10.6% and net profit down 18.8%. Year-on-year comparisons are likely to remain difficult for at least another two quarters.

In December, we wrote: “Management reports that semiconductor-related demand is down in all markets and that auto-related demand is down in the U.S. Auto sales are also declining in China.” (SMC (6273 JP): Profits Start to Decline ) Last week, WSTS reported the first decline in semiconductor sales in 30 months and the Nikkei newspaper reported that “Japanese chipmaker Renesas Electronics will temporarily halt work at 13 of the company’s 14 production facilities, including all nine domestic plants, due to high inventory levels and possible impact as Chinese demand for automotive and machinery tools plummets.” On Friday, March 8, SMC’s share price dropped by 3%. 

SMC has left FY Mar-19 guidance unchanged, implying a 4.1% decline in sales and a 2.9% decline in operating profit in 4Q. In view of current trends, this looks over-optimistic. The shares are now selling at 17.8x our EPS estimate for FY Mar-19 and 18.6x our estimate for FY Mar-20. These multiples compare with a 5-year historical P/E range of 13.8x – 28.5x. 

2. Japan – Chinese Flu

By Konstantinos Venetis, Senior Economist

• Japan skirts recession but near-term prospects remain weak
• Deflationary headwinds to persist in H1, threatening business spending
• Recovery likely in late 2019 as world trade finds a firmer footing

3. Japan Stock Weekly

NSK (6471) – operating environment poor, analysts revising down but are we close to the bottom for the share price?

UUUM (3990) – great performer, and business will continue to grow fast. A buy for those who have believe in the growth of internet advertising, and do not mind a lofty valuation. 

Rakuten (4755) – announced IPO of Lyft has helped share price rally. Sum of parts makes this look cheap to us, and we believe they have a sporting chance as a mobile operator. Market is overly negative in our view. 

4. UUUM (3990) Phenomenal Growth but at a Price.

This has been a fantastic performer. Since our buy note one year ago, the shares are up just over 3 times. Earnings growth has been very strong, and much better than we had anticipated. The story is even better now than it was then. Unfortunately, the valuations are not! The company is very focussed on growing revenue for the time being. If one is happy to buy a very fast growing new business, then this is still worth looking at.

5. Renesas: Factory Stoppage Announcement Should Correct Premature Rebound Expectations

We commented previously on 13 Dec 2018 that:

We visited Renesas Electronics (6723 JP) this week to discuss progress on inventory reduction and its likely ramp of utilisation rates/wafer throughput, as well as to gather further details on the IDT acquisition and its long -term strategy. On the whole, we continue to like the long-term picture, consider the stock to be undervalued and believe investors with long time horizons should be looking at the stock on the long side. However, our discussions suggested to us that while production cuts to reduce inventory should be completed this month or at worst in 1Q2019, a ramp in utilisation rates could take longer than is implied by consensus.

Following this comment Renesas Electronics (6723 JP) traded directionally with the market though in very volatile fashion, first dropping 17% before rebounding 69%. Now, with Nikkei reporting that the company would halt production at most facilities during the year and for as much as two months in some cases, the stock is once again giving up its gains and is limit down -14%.  This leaves it just 10% above where we previously commented on the stock and as it approaches the ¥500 level again we feel it is becoming interesting again. We examine the potential financial impact from the production halts below.