KYCCF - Keyence Corporation: Taking The Long-Term View

Summary

• Keyence Corporation is expected to witness faster top-line growth going forward, and this is achievable considering projections for the worldwide industrial automation market and global capital expenditures.
• Keyence is in a good position to sustain high profit margins for the future, thanks to customer diversification and its research & development efforts.
• I am bullish on Keyence's prospects in the long term, so I make no changes to my Buy rating for the name.

Elevator Pitch

I continue to rate Keyence Corporation's ( KYCCF ) [6861:JP] stock as a Buy.

I highlighted positive takeaways from KYCCF's Q2 FY 2023 (YE March 31) financial results in my previous November 2, 2022 write-up for Keyence. With my latest update for Keyence, I focus on the company's long-term prospects.

My research indicates that Keyence is a worthy investment for investors with a longer investment time horizon. I see KYCCF's top line expanding faster in the years ahead after considering the outlook for corporates' capital spending and the industrial automation market. I also expect Keyence to be as profitable as it was in the past, as factors like a diversified customer base and a strong focus on new products are supportive of high profit margins. My Buy rating for Keyence remains unchanged, even after I assess its growth and profitability outlook.

Long Term Revenue Growth Outlook

In my opinion, the global industrial automation market's outlook and worldwide capital expenditure forecasts offer the best indication of how fast Keyence Corporation can grow in the long run.

Keyence refers to itself as "a global leader in the industrial automation industry" on the company's website. As such, it is reasonable to assume that KYCCF's future financial performance in the years ahead is strongly correlated with the growth of the worldwide industrial automation market.

A number of market research firms have a favorable view of the worldwide industrial automation market, considering their respective long term CAGR projections for the sector at the high single digit percentage level.

Allied Market Research is forecasting a +8.7% CAGR for the industrial automation sector for the 2022-2031 period; while Precedence Research's estimates point to a 2021-2030 CAGR of +8.6% for this industry. The most bullish of the lot is Fortune Business Insights with its +9.8% CAGR prediction for the worldwide industrial automation market during the 2022-2029 time frame. All three research firms think that the size of the global industrial automation industry can expand to around $400 billion in the next decade.

Separately, KYCCF's future growth is also closely linked to the pace of increase in capital expenditures. As an example, Keyence managed to deliver a strong +25% YoY top expansion for 1H FY 2023 because "manufacturers worldwide maintained capital expenditures" as indicated in an October 30, 2022 MarketWatch news article .

It is worthy of note that McKinsey outlined in an April 7, 2022 research report that there will be a "once-in-a-lifetime wave of capital spending on physical assets between now and 2027."

Specifically, McKinsey projected that approximately $130 trillion of capital expenditures will be committed to renewable energy investments, and the upgrading and replacement of critical fixed assets in the next five years.

These positive growth trends are reflected in expectations regarding Keyence's revenue expansion for the intermediate to long term. According to the sell-side analysts' consensus financial estimates obtained from S&P Capital IQ, KYCCF's top line is forecasted to grow by +12.2%, +11.9%, and +10.8%, for fiscal 2025, 2026 and 2027, respectively in local currency ((JPY)) terms. In comparison, Keyence recorded low-to-high single digit top line expansion rates on an annual basis during the FY 2017-2019 period prior to COVID-19. In other words, Keyence is expected to grow its revenue at a much faster pace in the coming years.

High Operating Profit Margins Are Sustainable For The Long Run

Keyence's EBIT margin has exceeded 45% in every year for the past decade between FY 2013 and FY 2022 as per S&P Capital IQ's financial data. The sell-side analysts see KYCCF achieving an annual operating profit margin of at least 50% in the subsequent five years. I am of the opinion that the market's consensus profitability forecasts are reasonable.

I have already noted in my previous article for Keyence published in early-November 2022 that KYCCF "had the ability to pass on cost increases to its clients by disclosing plans for price increases."

In my view, Keyence's pricing power is attributable to broad diversification and commitment towards research & development.

KYCCF disclosed in its fiscal 2022 annual report that the company has a 300,000-strong client base with customers coming from more than a hundred markets globally. Keyence also emphasized in its FY 2022 annual report that no single client contributed over 10% of its annual revenue in the most recent fiscal year. Given that Keyence doesn't suffer from customer concentration risks, the company should have decent bargaining power with individual clients.

Keyence is also able to raise its selling prices, as it keeps on introducing new and better products which is made possible by its investments in research & development. In the past two decades, the company has allocated roughly 4% of its top line to research & development spending every year according to data taken from S&P Capital IQ . It is also notable that KYCCF mentioned on its corporate website that "70% of our new products are 'industry’s first' or 'world’s first.'"

After reviewing KYCCF's customer base and its research & development spending, I am confident that Keyence can continue to maintain its high operating profit margins going forward.

Closing Thoughts

My rating for Keyence Corporation stays as a Buy. I think that Keyence Corporation can deliver reasonably robust revenue growth and high profit margins in the long run, and this supports my favorable view of KYCCF as a potential investment candidate.

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