KMTUY - Komatsu: Cautious Guidance Increases Chances Of Earnings Beat (Rating Upgrade)

2023-09-05 05:49:35 ET

Summary

• Komatsu has chosen to keep its full-year guidance unchanged, even though its first quarter earnings were way above expectations.
• An increase in ASPs and a growing revenue contribution from higher-margin part sales are the key factors supporting sustained earnings growth for Komatsu in the full year.
• I raise my rating for Komatsu to a Buy, in consideration of a potential earnings beat for fiscal 2023.

Elevator Pitch

I rate Komatsu Ltd. ( OTCPK:KMTUY ) [6301:JP] shares as a Hold. With my earlier October 7, 2021 article , I touched on the impact of a change in the company's "revenue mix" and new "government policies" on Komatsu.

In this latest update, I determine that there is a high probability that Komatsu can register an earnings beat for fiscal 2023 (April 1, 2023 to March 31, 2024). Komatsu's Q1 FY 2023 results were way better than the market's expectations, and the company still has key bottom line expansion levers such as price increases and growing part sales. This is why I have chosen to change my rating for Komatsu from a Hold to a Buy.

Readers should take note that Komatsu's shares are listed on both the Tokyo Stock Exchange and the OTC market. The company's OTC shares and Japan-listed shares boast three month average daily trading values of $4 million and $100 million, respectively based on data sourced from S&P Capital IQ . US brokerages like Interactive Brokers allow investors to deal in Japan-listed shares such as those of Komatsu.

Komatsu Is Too Cautious With Its Full Year Outlook

Komatsu had previously guided for its revenue and net profit attributable to shareholders to contract by -5% and -8% to JPY3,382 billion and JPY299 billion, respectively in FY 2023 when it announced its FY 2022 results in late April this year. The company had made the decision to stick to its earlier FY 2023 guidance when it revealed its Q1 FY 2023 financial performance at the end of July in the current year.

The unchanged full-year financial outlook provided by Komatsu suggests that the company's management has taken a very cautious view about its short term prospects, especially when considering its recent quarterly results.

Revenue for Komatsu rose by +18% YoY from JPY764 billion in the first quarter of fiscal 2022 to JPY900 billion for the most recent quarter, while the company's bottom line grew by +31% from JPY81 billion to JPY105 billion over the same time period. It is worthy of note that Komatsu's Q1 FY 2023 top line and net income turned out to be +7% and +41% (source: S&P Capital IQ ) better than the sell-side analysts' financial projections, respectively.

I take the view that Komatsu's positive growth momentum for the first quarter of fiscal 2023 should be sustained for the remainder of the year, and the company's actual financial results for this fiscal year are likely to surpass its existing guidance by a wide margin. In the next section, I highlight the key earnings growth drivers for Komatsu that will enable the company to achieve a substantial earnings beat in FY 2023.

Price Increases And Parts Sales Growth Are Komatsu's Major Earnings Drivers

Price hikes and the growth in parts sales are what will drive Komatsu's bottom line expansion for fiscal 2023.

Komatsu highlighted in its Q1 FY 2023 results presentation slides that higher ASPs (Average Selling Prices) contributed to incremental revenue of JPY36.7 billion in the most recent quarter. In contrast, the company had earlier expected that ASP growth will translate into additional sales of JPY116.8 billion for full-year FY 2023. In other words, Komatsu's price increases were ahead of guidance in the first quarter of the current fiscal year, as Q1 FY 2023 incremental sales relating to price hikes represented 31% of the company's full-year guidance.

As such, Komatsu's full-year FY 2023 revenue and earnings might end up to be higher than what the company guided for, judging by the above-expectations pace of price increases in Q1. Looking beyond the short term, Komatsu's recent price hikes suggest that the company might have significant pricing power over its customers which might support margin expansion for the long run.

Separately, Komatsu's part sales have been increasing, and this has a positive effect on the company's overall profit margins.

Specifically, the company's revenue derived from the sales of parts increased by +16% YoY and +2% QoQ to JPY234 billion in the first quarter of FY 2023. At the company's Q1 FY 2023 earnings briefing , Komatsu shared that it has managed to get "customers buying more genuine parts" by "offering (longer) warrants up to 10,000 hours." A growing proportion of top line generated from part sales translates into greater profitability for Komatsu, as parts generally carry relatively higher profit margins than equipment.

My own prediction is that Komatsu is able to report a positive earnings growth rate in the high single-digit percentage range for full-year FY 2023, as compared to the company's guidance of a -8% bottom line decline this year.

Komatsu's Stock Is Still Trading At A Reasonable Valuation

KMTUY's shares have gone up by as much as +33.7% in 2023 year-to-date, which is unsurprising considering the company's massive Q1 FY 2023 bottom line beat mentioned earlier. But it is necessary to note that Komatsu's valuations are still at pretty reasonable levels.

Komatsu is currently valued by the market at 7.1 times consensus forward next twelve months' EV/EBITDA, which represents a 14% discount as compared to the stock's 10-year mean EV/EBITDA ratio of 8.3 times (source: S&P Capital IQ ).

Closing Thoughts

I see Komatsu achieving higher than expected earnings for the rest of fiscal 2023, and these earnings beats should drive a favorable re-rating of Komatsu's share price and valuations. This helps to explain my decision to upgrade Komatsu's rating to a Buy.

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