FANUY - Fanuc Corporation: Short-Term Pain Long-Term Gain

2023-06-26 16:32:51 ET

Summary

• Fanuc Corporation's short term prospects are unfavorable, as the company's earnings are expected to decline in fiscal 2023 as a result of the ROBOT division's potential underperformance.
• The improvement in profitability for the ROBOT business and geographic expansion for the FA business are expected to be the key long-term growth drivers for FANUY.
• A Hold rating for Fanuc Corporation is justified; the near-term outlook for FANUY isn't great, but the company has reasonably good growth prospects in the long run.

Elevator Pitch

I maintain my hold rating for Fanuc Corporation stock ( OTCPK:FANUY ) [6954:JP].

My prior January 16, 2023 update for Fanuc Corporation highlighted the stock's "balanced risk-reward profile." In this latest article, I come to the conclusion that Fanuc Corporation is a case of "short-term pain, long-term gain." The long-term outlook for FANUY is favorable, but the company's near-term prospects are poor. Therefore, Fanuc Corporation's shares are rated as a Hold.

Short-Term Outlook

The sell-side analysts covering Fanuc Corporation's shares have a negative view of the company's financial performance in the short term, and this is aligned with its recent disclosures at the FY 2022 earnings call . Fanuc Corporation's fiscal year ends in March, and the company refers to the period between April 1, 2022 and March 31, 2023 as fiscal year 2022.

The current consensus FY 2023 earnings per share or EPS forecast of JPY163.03 (source: S&P Capital IQ ) for Fanuc Corporation implies a -18.3% drop vis-a-vis the company's FY 2022 bottom line. While the analysts expect Fanuc Corporation's EPS to rebound by +20.4% to JPY196.33 for FY 2024, the consensus FY 2024 bottom line projection for the company was cut by -2.4% in the past two months. In other words, Fanuc Corporation's bottom line is expected to fall significantly in FY 2023, while its pace of earnings recovery for FY 2024 is now projected to be slower than what was anticipated earlier.

At its FY 2022 earnings briefing, Fanuc Corporation acknowledged that the company's ROBOT business is "experiencing the highest growth" among its various business divisions. In its FY 2022 annual report , Fanuc Corporation noted that its ROBOT division is engaged in the development of "industrial robots" which assist clients to "automate or robotize their factories." In the most recent Q4 FY 2022, the ROBOT business was the company's only division that achieved positive QoQ revenue growth (+5%). For full-year FY 2022, the +42% sales growth for the ROBOT division was the highest among Fanuc Corporation's various businesses.

As such, it is reasonable to assume that Fanuc Corporation's near-term outlook is very much dependent on the performance of its key ROBOT business division. The outlook for the ROBOT division in the short term is unfavorable, judging by Fanuc Corporation's management comments.

Fanuc Corporation's management cautioned at the company's FY 2022 results call that the ROBOT business' "production is unable to keep up (with customers' orders)" due to a shortfall in the supply of parts, and acknowledged that the "delivery time continues to be long." Therefore, revenue contribution from Fanuc Corporation's ROBOT division in FY 2023 is likely to be below expectations.

On the other hand, Fanuc Corporation noted that the "operating margin of ROBOT (business) is gradually improving", when responding to a question on whether the top line growth for the ROBOT division is "accompanied by the increase in profitability" at the FY 2022 results briefing. It is realistic to infer from FANUY's response that the ROBOT business' current profitability is still inferior to that of the other divisions. In that respect, the growing revenue for the ROBOT division is negative for Fanuc Corporation's overall profitability, due to a higher share of sales contributed by a relatively lower-margin business.

Investors in Fanuc Corporation will have to bear with some "short-term pain", as it will take some time for the ROBOT business to be a meaningful positive earnings contributor for the company. In the very near term, the ROBOT division doesn't have sufficient inventories to fully meet customer demand, and the ROBOT business' profit margins will be lower than that of the company's other businesses until meaningful economies of scale are achieved.

Long-Term Prospects

In the long run, Fanuc Corporation's ROBOT business has the potential to expand its profit margins via price hikes, while its FA or Factory Automation Division has growth opportunities in specific foreign markets. These two key drivers could be the source of "long-term gains" for Fanuc Corporation shareholders.

FANUY's ROBOT division is in the early innings of growth, and the company is pricing its industrial robots at a reasonably attractive level to incentivize adoption. However, it is likely that Fanuc Corporation has the intention to raise prices for the company's industrial robots in time to come. At the company's most recent fiscal year earnings call, Fanuc Corporation stressed that a growing number of its ROBOT business customers are beginning to appreciate that "the overall cost is low when using our ROBOTs over a long span (i.e. more than a decade)." This creates opportunities for Fanuc Corporation to initiate price hikes for its ROBOT business' industrial robots in the long term.

Separately, Fanuc Corporation's FA division is incorrectly perceived to be a slow-growth business for the company. While the FA business' revenue contracted by -6.8% QoQ in Q4 FY 2022, the division's long-term prospects are pretty decent. FANUY's FA business, which sells Computer Numerical Control or CNC machines, is in a good position to grow its sales derived from key international markets such as Europe and India. Fanuc Corporation revealed at its FY 2022 results call that its FA division's market share is "low in Europe" and emphasized that "there is much room for growth (for the FA business) in India." As highlighted in its FY 2022 earnings presentation , FANUY only generated 11% of its FA business segment revenue from Europe, while India's revenue contribution was not sufficiently significant to be separately disclosed.

Closing Thoughts

Fanuc Corporation doesn't deserve a Buy rating, as its FY 2023 outlook points to a contraction in earnings. But it wouldn't be right to assign a Sell rating to FANUY, as there are long-term growth opportunities for the company's key ROBOT and FA businesses. This explains why I have a Hold rating for Fanuc Corporation.

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