It’s not news that the stock market is a discounting mechanism, with investors frequently looking past dire near-term conditions and pricing in recoveries well ahead of the actual turns in businesses. We’ve seen that lately in a number of U.S. short-cycle manufacturing stocks (names like Parker-Hannifin (PH) and Rockwell (ROK)), where performance has been driven by evidence that the worst-case scenario is off the table and a late 2020/2021 V-shaped recovery is still in play.
In the case of Yaskawa Electric (OTCPK:YASKY) (6506.T), I think the nearly 30% move since my last update has been too much too soon, as investors seem eager (if not desperate) to buy into a China-centric recovery story. To be clear, I like Yaskawa’s leverage to markets like semiconductors, electronics assembly, and factory automation, but I believe the recovery in the share price is excessive relative to the sort of business recovery I expect to see.
Mixed Results In Fiscal Q1, With Strong Cost Controls
The fiscal first quarter was a strong one for Yaskawa in some respects, but decidedly more mixed in others. Management deserves a lot of credit for rightsizing capacity and aggressively cutting costs, but underlying demand is still weak and the margins in the robotics business are not at all impressive.
Revenue declined 15% in the quarter, missing expectations by a modest amount as there was significant ongoing weakness in most of the businesses. Motion Control revenue declined 8% on a 1% decline in servos and a 16% decline in inverters, while Robotics declined 25% and Systems Engineering declined 18%.
Gross margin held up better than expected, with a 100bp yoy decline by a nearly one-point sequential improvement. Operating income declined 13%, beating expectations by a whopping 56% as Yaskawa managed to adjust Motion Control manufacturing capacity (especially servos) more adroitly than expected, while also exceeding expectations on overall cost reductions. Motion Control profits improved 9%, with margin up 170bp, while Robotics profit declined 85% as the business only barely remained profitable. Systems Engineering squeaked by with a small profit, reversing a year-ago loss.
Orders News Is Mixed At Best
Yaskawa’s orders came in below expectations. Servo orders, which improved 3% yoy and 4% qoq, were a few percentage points shy of expectations, with some improvements in semiconductor demand offset by weakness in areas like machine tools and automation. Yaskawa noted some evidence of Chinese customers rebuilding inventories, and I’m concerned that there’s not enough underlying demand momentum to maintain positive order growth momentum in the near term.
Inverter orders declined 21% yoy and 6%, with weakness in both North America and the EU, and especially in the oil/gas vertical. I expect the oil/gas market to be weak for a while, and I’m a little concerned that Yaskawa didn’t see more offset from markets like HVAC.
Robotics demand remains quite weak, with orders down another 18% yoy and 4% qoq. Auto demand remains universally pretty weak, with most OEMs cutting capex to bare minimum levels, hurting demand for welding and painting robots. What makes these numbers a little more concerning is that they’re coming despite a pretty strong recovery in demand for chip-production equipment, including wafer-handling robots (a business that is meaningful for Yaskawa).
Demand Will Recover, But The Pace And Pitch Are Still Up For Debate
As I said in the open, I have no issue with the idea of buying ahead of the news when it comes to recoveries; if you wait for an actual return to growth in the reported financials, you’re going to miss out on most cyclicals. My issue here is simply with valuation and the level of recovery that seems to be factored into the stock. It’s not new for Yaskawa to trade as something of a proxy for Chinese demand, as the company sells a lot of servos and robots in China (about 25% of its sales) and has a good growth opportunity for inverters here as well. The problem is that a lot of indicators of Chinese demand are still struggling; there has been evidence of inventory restocking, but machine tool demand is still very weak, as is demand for robots and other automation equipment. With the JMTBA reporting a 34% decline in May machine tool orders in Asia (largely, but not solely China), it’s just hard for me to see the sort of strong near-term recovery that seems to be priced into these shares.
Demand will recover, though. The iPhone capex cycle seems to be running a little late (Yaskawa management suggested about two months relative to historical norms), but demand from Chinese assemblers should still support some tool growth in 2020 and Yaskawa has posted three straight quarters of sequential growth in servos (albeit at low levels). Likewise, the recovery in semi equipment demand is real and likely to last for some time. Inverter demand will continue to grow in markets like appliances and HVAC given the significant efficiency benefits, and auto OEMs will have to spend on robots as they shift capex toward new hybrid and EV lines.
I don’t think my expectations for Yaskawa are all that conservative. This is likely to be another down year (after a double-digit decline in FY’20), but I expect a new revenue peak in FY’23 and long-term growth of around 6% versus a long-term historical average on the lower end of the mid-single-digits, as more industries adopt automation in earnest. I likewise don’t think I’m being overly harsh on margins; I’m looking for various production and asset efficiencies to push FCF margins toward the double-digits over the long term versus a more recent trend that has topped out in the mid-single-digits.
The Bottom Line
Whatever metric I use, long-term discounted cash flow, margin/return-driven EV/EBITDA, or ROE-driven P/BV, Yaskawa looks expensive now. I believe that the market is pricing in a significant recovery from here, and while I do agree that Yaskawa is looking at improving business trends over the next 6-18 months, I think the valuation more than amply reflects that.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.