DKILF - Daikin Industries: Riding The Global Trends In Heat Pumps And Air Conditioning

2023-04-24 18:29:52 ET

Summary

• Daikin Industries is one of the global leading manufacturers of heat pumps and air conditioning.
• I believe that the general conditions for further successful business development are enormously favorable.
• It's supported by global political decisions in Europe. There is also a growing need for air conditioning in developing countries due to urbanization and a growing middle class.

Investment Thesis

Daikin Industries ( DKILY ) ( DKILF ) is currently not cheaply valued, but the earnings per share have already tripled in the last ten years. The company is expanding its production facilities and benefiting from global trends in several areas. There is also a growing need for air conditioning in developing countries due to urbanization and a growing middle class. In addition, there are political decisions that promote the use of heat pumps and thus also electrified heating in colder countries.

Note: Some of the links in this article are in German because these topics make much more headlines in Germany than internationally right now.

The German heat pump policy

In Germany, a decision by the current governing coalition is making headlines and causing heated discussions among the population. A recent decision stipulates that from 2025 no new oil and gas-fired heating systems may be installed. Oil and gas heating systems that have already been installed and existing ones must be replaced by 2045. At the same time, the installation of renewable energies will be massively expanded so that a complete changeover to electricity will also occur here (just as with the move away from the combustion engine). Heating by electricity is to be provided by heat pumps. A heat pump works like a refrigerator but produces heat instead of cold. The principle is the same: ambient heat or geothermal heat is concentrated with the use of electricity.

We want 500,000 newly installed heat pumps per year from 2024.

Robert Habeck , German Minister of Economy

Market potential

Daikin Industries is currently the market leader for heat pumps in Europe, with about 500,000 units in total. These are the total units sold so far for all of Europe. As seen from the quote above, Germany's target is to install this per year in the future. Here is a graphical representation. The upper number, 929,000 at the last count, is the total sales of heating systems per year (heat pumps, gas, and so on). Below we see the market share for gas, oil, bioenergy, and heat pumps. We can see that under normal conditions, without pressure from the government, the market share is already increasing (dark green). However, gas is still by far the most popular new installation of heating systems. According to the German government, this will now be banned in one fell swoop and relatively suddenly.

Germany has a population of about 83M. In view of this, it can be assumed that the demand for heat pumps will remain high for decades. However, that is only the German market. Not yet included is the potential pan-European market, which is also growing dynamically.

There are, of course, also other manufacturers besides Daikin. One of the largest is not listed on stock exchanges (German company Bosch). However, manufacturers are already not keeping up with production, so waiting times are between 6 and 18 months. Given the demand, this shortage could intensify and thus increase costs.

German subsidies

These compulsory measures are a significant burden for homeowners, so the German government generously awards subsidies for replacing old oil and gas heating systems. Tens of thousands of Euros and up to a 40% subsidy are possible. So, Daikin benefits twice. First, the government forces citizens to switch to its products, and second, it partially pays for them.

Daikin overview

Daikin Industries manufactures and sells not only heat pumps but also air conditioning and refrigeration equipment, as well as chemical products around the world. Other products include air purifiers, freezers, systems for buildings and facilities, and chemicals for coatings, medicines, and electronic products. The company also provides after-sales services for these products. The company was founded in Japan in 1924 and is headquartered in Osaka. The company also provides after-sales services for these products.

With over 90 years of experience in developing and manufacturing heating and air conditioning solutions, Daikin is today the market leader for heat pump technology. For example, the Daikin VRV product series for commercial and Daikin Altherma for residential applications are the best-selling heat pump systems in Europe, with over 500,000 units sold. Over 85% of the units for the European market are also produced in Europe. Daikin is the only air conditioning manufacturer in the world that develops and produces all major components such as refrigerants, compressors and electronics in-house.

daikin-manufacturing.de

Daikin is expanding its heat pump production facilities (in Germany and Poland) with the aim of tripling production by 2025. They are currently investing about €1.2B for this purpose. Part of this amount is also spent on training qualified personnel for installation and maintenance, of which there is an immense shortage. Overall, the lifespan of a heat pump is only about 15 to 20 years, which is significantly less than oil and gas heating systems. This means increased installation and more maintenance, cleaning, and other services should positively impact future revenue streams. The company sees enormous potential, especially in Europe and the US, due to electrification and green policies.

The air conditioning business is also expected to boom. But regardless of whether climate change occurs, as some people believe: the fact is that a large part of humanity lives in a hot climate where growing prosperity will lead to more air-conditioned rooms. Few people in these countries currently have air-conditioning, at least in their private houses and apartments. This is the share of households that had air-conditioning in 2016.

The company, therefore, sees enormous potential in this area, as can be seen from this presentation from the Investor presentation.

Valuation

The company is currently valued at a market cap is $51B, with almost no debt. Unfortunately, the Seeking Alpha page is incomplete with data in this case, e.g., EPS information is missing. By the way, the trading volume is sufficiently given under the ticker DKILY.

2023 sales of about $29B are expected, so the P/S ratio is about 1.75. The P/E ratio for the past year is about 27, which is certainly not cheap. The average P/E has increased over the past few years, which may be due to the growing attention for the company's products.

Over the last ten years, net income has almost tripled. This corresponds to an annual increase of about 12%.

I have created a detailed analysis with three different scenarios to determine the current fair value with a DCF analysis. The normal scenario is indicated as the most probable variant. Of course, one must estimate the growth figures and the calculation can never be exact. Nevertheless, this approach is useful, as it allows us to approximate a fair value. In other words, it could be clearly seen if a stock was strongly overvalued or undervalued. The "normal case" numbers are based on past performance, which I think can be achieved again since the company´s products are now much more in line with global political agendas. The result is that the stock is trading close to its fair value right now ($17.7 fair value vs. $17.5 share price)

So, if all other factors and the future P/E ratio remain constant, the expected return for investors could be similar to the annual EPS growth rate of the company, which is likely to be higher than 10%.

Risks

Of course, several risks could cause the business not to develop as expected. On the one hand, the aforementioned political conditions could change, and fewer forced installations or subsidies could flow.

In addition, the company operates in China and is somewhat dependent on the construction industry. Furthermore, there is always the possibility that the valuation of the stock drops to a lower P/E ratio. If the P/E ratio were halved, the business could double, and we, as investors, would still make no money.

Share dilution and insider selling

Unfortunately, finding the appropriate information for foreign shares is often more difficult. According to this page , the number of outstanding shares has not changed since 2008 (based on the share trading in Tokyo). However, I could not find any information about SBCs and insider trades.

Conclusion

The positive prospects are already partly priced in here; therefore, given the valuation, nothing really unexpected should happen. Therefore, I would rather enter at a slightly lower price than currently. Nevertheless, I believe the general conditions for further successful share development are enormously favorable. On the one hand, supported by global political decisions; on the other hand, with the entire climate change and urbanization trend and thus the need for air conditioning as a tailwind. In addition, the company operates globally and is, therefore, less dependent on regionally limited events.

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