KUBTF - Kubota Is A Hold

Summary

• Kubota posted strong sales growth, thanks in part to the pass-through of higher raw material costs due to higher inflation.
• Despite strong sales growth and favorable exchange rates, operating income declined.
• The company distributes a steadily growing dividend and the stock's valuation looks favorable.

Introduction

Kubota ( KUBTY ) is a Japanese company established since 1890 and headquartered in Osaka. The company mainly develops agricultural machinery and accessories, and generates revenue from the water & environment segment.

The stock's total return is down 17% over the past 5 years, compared with 56% growth in the S&P500. Japanese stocks have been in demand since Warren Buffett announced a significant position in five major trading houses.

The stock is a hold because I do not (yet) expect corporate profits to improve in the near term.

Company Overview

Kubota is a Japanese company that provides agricultural machinery and products for the food, water and environmental markets in Japan, North America, Europe and Asia.

The company consists of three business units:

1. Farm & Industrial Machinery (88% of total revenue)
   • Tractors, power tillers, combine harvesters, rice transplanters, turf equipment, utility vehicles, and others
2. Water & Environment (12% of total revenue)
   • Ductile iron and plastic pipes, valves, single stack drain fittings, design and construction services, and others.
3. Other (less than 1% of total revenue)
   • Logistics, roofing and siding materials, non-life insurance underwriting, finance leasing, factoring services, building maintenance, and others.

Results From The First Nine Months Were Mixed

Sales for the first 9 months increased sharply by 19% year-on-year, while operating income fell 13% year-on-year. Operating income decreased mainly due to increased material costs totaling 66 billion yen, higher logistics costs, R&D expenses and depreciation totaling 89 billion yen. This was partially offset by higher selling prices and favorable exchange rates.

The Farm & Industrial Machinery business segment achieved sales growth of more than 300B yen and grew strongly in North America by as much as 190B yen. In Japan, sales fell 9B yen due to the termination of subsidies for agricultural continuation and stagnant rice prices. Sales in North America increased due to government demand for infrastructure development.

The revenue of the Water & Environment business segment increased sharply by 15 billion yen compared with the first 9 months of 2021. Revenues from steel and plastic pipes increased due to price inflation, but construction work was delayed due to personnel shortages at construction sites. Water supply and sewerage revenues increased as operation and maintenance services and public-private partnership projects increased.

Kubota presents business unit sales figures in a monthly summary on their Investor Relations website . Figures for the Tractor, Mower & RTV division showed sharp declines in both the United States and Thailand. Mower & RTV did better than last month when sales were still down double digits year-on-year, this was also the case for tractor sales in Thailand. The CE division performed well with double-digit growth in the United States.

Kubota expects an 18% increase in sales and a 2.5% decline in operating income for the full fiscal year 2022 compared with the figures for fiscal 2021.

The sharp decline in operating income is worrisome for the upcoming quarterly figures. High inflation has a major impact on the operating result. Interest rate hikes by the Bank of Japan also do not directly lead to improved earnings with net debt of ¥1479B on net income of ¥175B in 2021 (net debt/net income = 8.5). Rising interest rates will lead to higher interest expenses when debt must be refinanced, this will directly lead to a decrease in earnings for the company.

Dividends And Share Repurchases

The dividend per share has been rising for years and is currently listed at 42 yen per share, representing a dividend yield of 2.3%. The average increase over the past four years is 7% per year. The company's shareholder return ratio is strong and will reach 40% by 2021.

Cash flows for dividends increased sharply each year; the company also repurchases shares, which gave an additional boost to dividends per share. Even though net income increased by 7% annually on average, free cash flow fluctuated greatly. Therefore, it is not possible to clearly outline future cash flows. This uncertainty poses a risk to both the company and its shareholders.

Valuation Looks Favorable

Looking at the valuation of the stock, the company is attractively valued with a P/E ratio of only 13. The 5-year average P/E ratio is 15, which means the company is currently listed at a discount of about 13% compared to its average.

Sales are growing steadily, the company can pass through higher raw material costs, and also the exchange rates were favorable for its earnings. Still, operating income decreased. The company has significant net debt of about 8.5x net income. The Bank of Japan raised interest rates, which will affect operating income in the near future when the debt must be refinanced. The company is cheaply valued on the market, but I do not see strong growth catalysts. Therefore, the stock is a hold.

Conclusion

The company posted strong sales growth, thanks in part to the pass-through of higher raw material costs due to higher inflation. Despite strong sales growth and favorable exchange rates, operating income declined. The company distributes a steadily growing dividend and the stock's valuation looks favorable. The stock is a hold because I do not see any growth catalysts that increase operating income in the near term.

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