FANUF - Fanuc Is Worth Buying If This Economic Slowdown Provides A Dip

2023-04-12 10:27:28 ET

Summary

• Fanuc is in an industry expected to witness sustained tailwinds.
• The company has a reputation for making products that are strong, rugged, and precise.
• They have low debt and appealing margins.
• I want to become a long-term investor, and hope the coming recession will provide me with an appealing buying opportunity.
• Fanuc is a Hold.

Thesis

I have been watching automation change manufacturing for decades and was trained as an integrator for industrial robots and cobots a few years ago. While all of the major manufacturers of robotic arms have good reputations, Fanuc ( OTCPK:FANUY )( OTCPK:FANUF ) is known for buildings arms that are strong, precise, and rugged. Up until a few short years ago, they were also known for having a clunky menu-driven user interface and so were slow to program. The eventual adoption of touch screens on their teaching pendants mitigated most of this drawback.

I am looking to gain exposure to several companies in this industry because I believe automated manufacturing is a disruptive industry and will do extremely well over the long run.

With the Fed still fighting inflation, and months of bond market inversion, we are facing the very real prospect of a recession. It is difficult to estimate by how much manufacturing will be affected , but Fanuc is very likely to experience a temporary drop in revenue. I am recommending a Hold for Fanuc because I believe if I wait, I will be able to buy it at a better price.

Company Background

Fanuc provides automation products and services such as robotics and computer numerical control wireless systems. The company has its roots in the 1950's , but was spun-off of Fujitsu Ltd. in 1972 . By 1982, Fanuc had captured most of the global Computer Numerical Control market.

During the mid-2000s, Fanuc launched what would become their most successful robot series, the R-2000 series. This line of robotic arms has earned them a reputation for producing the strongest and most reliable 6-axis robots on the market. In 2015, Fanuc launched its first collaborative robot, or cobot, the CR-35iA .

Long-Term Trends

The entire industrial automation and control systems market is expected to have a CAGR of 10.5% through 2030. The global market for industrial robotic arms is projected grow at a CAGR of 7.2% until 2030. The global market for collaborative robots is estimated to have a CAGR of 32% through 2030.

Financials

Because Fanuc produces automated manufacturing equipment, their revenue varies significantly with manufacturing demand. The cost of retraining integrators is not insignificant, so robotic arm customers tend to have high brand loyalty. The company is subject to fairly wild swings in revenue. They experienced a net income low in 2020, but it has been improving since then.

Fanuc has significantly more control over its margins than its revenue. Net margins were extremely stable up through 2019. The sudden dip in revenue that hit the company in 2020 also came with a margin contraction. The company has been experiencing improving margins since then. Net margins have mostly recovered and are back up above 20%.

I also like to look at the relationship between share count, cash, and revenue to see how these trends have been playing out. Since this is a mature company, instead of trying to get a measure of how effectively it converts dilution into revenue, we want to try to get a sense of their share buyback habits.

Share count has dropped 2.5% since 2013. Over that same time period, the company has lowered the amount of cash and short term investments it typically carries from around $750M to around $500M.

Total equity has been slowly rising over the last decade.

Looking over their quarterly financials, the revenue and net income growth that show up on the annual charts become more clear. Both revenue and net income have remained fairly stable since then.

The margin recovery that showed up in their annual margin chart can be seen here in more detail.

Valuation

As of April 11th 2023, Fanuc had a market capitalization of $31.77B. FANUY was trading for $16.82 per share, and FANUF was trading for $33.24 per share. Their forward EV/EBITDA is 15.35, and their trailing P/E ratio is 25.52.

This company pays a variable dividend instead of a fixed dividend. Although this is an excellent practice for maintaining the long term health of the company, it makes using discounted cash flow models difficult. Before trying to produce an estimate for if today's share price is fair based on recent dividends, I am going to produce an estimate for the fair value of a dividend based on today's share price. Assuming no dividend growth and using a discount rate of 9%, a company with a share price of $16.82 would have to pay an average annual dividend of $1.52 per share for me to want to buy it purely for its dividend value. The last 12 months of dividend payments came to $0.37. If we assumed the present annual dividend of $0.37 were a stable average, and apply the same 9% discount rate, then a discounted cash flow estimate produces a fair value of $4.11 per share. Using an expected annual growth rate of 8.5% produces a PEGY estimate of 4.232, which is well above a fair value of 1. These estimates would imply the company is presently overvalued, but they do not include factors such as the significant tailwinds the industry is expected to witness.

Risks

The soft landing the Fed keeps talking about may actually materialize. I could be wrong about a deep recession arriving. The expected drop in revenue for industrial automation companies might not occur, and I may find myself waiting for a pullback that never comes. Conversely, the economic slowdown we are experiencing could turn into a fairly deep recession. Macroeconomic conditions might become significantly worse, or stay poor for longer than expected.

Catalysts

As the cost of industrial robots declines and the cost of labor rises, we will eventually cross a threshold where it will be more cost effective to buy a large amount of robotic arms and hire a few programmers, than to try to staff a workforce entirely with humans. Some industries have already started automating. Each industry is unique and will cross that threshold at a different time, so the widespread adoption of automated manufacturing is likely to happen in waves.

Conclusions

Fanuc makes excellent products and is in an industry blessed with decades of expected tailwinds. They typically maintain net margins above 20% and do not carry high debt. They seem to prioritize the long term health of the company and pay a variable dividend instead of a fixed dividend. My only complaint about their financials, and this isn't much of a complaint, is that their share buyback rate over the last decade is at a lackluster 2.5%.

By choosing to wait, I run two risks. The share price might not experience the dip I am expecting and I am left behind as it rises over the coming decades. Or I might misjudge the bottom of the recession and buy too early, missing out on an even better cost basis. I will be looking at the unemployment rate and overall manufacturing demand to try and judge when we have turned the corner economically and are leaving the recession. I will also pay attention to the earnings calls for several industrial robotics companies to get a sense for how they are being affected. My goal is not to try and buy the absolute bottom, but to wait until we reach a perceived bottom and then start dollar cost averaging until overall manufacturing demand recovers. There are several good companies that make robotic arms and I am planning on establishing small positions in them. If Fanuc or any of its competitors eventually prove themselves to be more competitive than the others, I will grow that position from a small one, to a large one.

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