Leading Independent Investment Research, Morningstar, Inc.

Morningstar

Leading Independent Investment Research

Morningstar, Inc.

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Equity Bottom-Up

We initiate coverage of power tool manufacturer <a href="https://www.smartkarma.com/entities/20187" target="_blank" data-smartkarma-citation="entities:20187:1">Makita Corp (6586 JP)</a> with a fair value estimate of JPY 4,200. The recovery of the European region (40% of the company’s revenue) and a stronger euro have benefited the stock’s outperformance over the Topix index in the year to date, but we see the stock as fairly valued at present. The market-implied 12-month forward enterprise value/EBITDA is traded at 2 standard deviations above its historical average. We assign a narrow moat rating to Makita because of its strong brand power, particularly in Japan and Europe, as well as the high switching costs derived from the incompatibility of batteries across brands and its wide range of tools.Makita has carved out a narrow economic moat supported by the company’s intangible assets around power tools and accessories (around 84% of its revenue in fiscal 2017), and the incompatibility of the batteries across different brands has elevated modest switching costs, especially for professional users. Makita has generated an average return on invested capital of 16% over the past 10 years, above our estimated weighted average cost of capital of 7%. We expect the company to maintain an 18% ROIC on average over the next five years.Our fair value estimate implies a forward 19 times price/earnings multiple, enterprise value/adjusted EBITDA of 10.4 times, and free cash flow yield of 3.3%, based on fiscal 2019 (ending in March 2019) estimates, which is largely in line with Makita’s historical five-year average. Higher price/book value of 2.1 times (versus 1.8 times over the past five years) reflects the improvement in return on equity to 11.5% from 9% on average.In our base-case scenario, we forecast that top-line growth on a local-currency basis will average 4.4% over the next five years, slightly lower than its 10-year historical average of 5.8%, mainly because of a higher base. Combined with our strengthening euro outlook, we forecast Makita’s top line will increase by 6%. We expect Japan, Europe, North America, Asia, and other regions to grow 4.5%, 8.6%, 2.3%, 5.1%, and 4.5%, respectively. Even though Makita must continue investing in product development and marketing to maintain its leading position, a stronger euro and higher operating leverage will elevate the operating margin to 17.7% in 2019 and around 17.5% at the midcycle, higher than 15.9% over the past 10 years.Analyst: Shanshan Wei, CFA

We initiate coverage of power tool manufacturer Makita Corp (6586 JP) with a fair value estimate of JPY 4,200. The recovery of the European region (40% of the company’s revenue) and a stronger euro have benefited the stock’s outperformance over the Topix index in the year to date, but we see the stock as fairly valued at present. The market-implied 12-month forward enterprise value/EBITDA is traded at 2 standard deviations above its historical average. We assign a narrow moat rating to Makita because of its strong brand power, particularly in Japan and Europe, as well as the high switching costs derived from the incompatibility of batteries across brands and its wide range of tools.Makita has carved out a narrow economic moat supported by the company’s intangible assets around power tools and accessories (around 84% of its revenue in fiscal 2017), and the incompatibility of the batteries across different brands has elevated modest switching costs, especially for professional users. Makita has generated an average return on invested capital of 16% over the past 10 years, above our estimated weighted average cost of capital of 7%. We expect the company to maintain an 18% ROIC on average over the next five years.Our fair value estimate implies a forward 19 times price/earnings multiple, enterprise value/adjusted EBITDA of 10.4 times, and free cash flow yield of 3.3%, based on fiscal 2019 (ending in March 2019) estimates, which is largely in line with Makita’s historical five-year average. Higher price/book value of 2.1 times (versus 1.8 times over the past five years) reflects the improvement in return on equity to 11.5% from 9% on average.In our base-case scenario, we forecast that top-line growth on a local-currency basis will average 4.4% over the next five years, slightly lower than its 10-year historical average of 5.8%, mainly because of a higher base. Combined with our strengthening euro outlook, we forecast Makita’s top line will increase by 6%. We expect Japan, Europe, North America, Asia, and other regions to grow 4.5%, 8.6%, 2.3%, 5.1%, and 4.5%, respectively. Even though Makita must continue investing in product development and marketing to maintain its leading position, a stronger euro and higher operating leverage will elevate the operating margin to 17.7% in 2019 and around 17.5% at the midcycle, higher than 15.9% over the past 10 years.Analyst: Shanshan Wei, CFA

Initiating Coverage of Makita With JPY 4,200 FVE and Narrow Moat Rating