MHVYF - Mitsubishi Heavy Industries: Surging Numbers Soaring Stock Amidst Global Military Spending Rise

2023-08-22 06:36:28 ET

Summary

• Mitsubishi Heavy Industries is a major player in global industry, with a diverse portfolio spanning aerospace, power systems, ships, and more.
• MHI's expanding defense division is a key driver of its future success, with the Japanese government increasing defense budgets and strong collaboration opportunities.
• In Q1, MHI achieved significant growth in order intake and profit across all segments, surpassing estimates and leading to a surge in stock price.
• Significant upside potential highlighted by my Net Present Value analysis underscores undervaluation and makes MHVYF stock an attractive investment choice.

Introduction

My bullish investment thesis for Mitsubishi Heavy Industries, Ltd. ( OTCPK:MHVYF ) predominantly revolves around its expanding defense division in light of escalating geopolitical tensions and nations allocating larger budgets toward military expenditure. MHI's unique position becomes particularly intriguing due to the Japanese government's notable commitment to increasing defense budgets in the near future. With existing agreements already in place and the strong possibility of continued collaboration, this presents a promising business outlook for the company, which leads me to firmly recommend a BUY rating for MIH. To further underscore that, I will delve into the company's recently published numbers, highlighting key indicators that support my stance along with impressive figures across all other operational segments. Additionally, a thorough exploration of the company's financial health, coupled with a comprehensive Net Present Value analysis, will be undertaken to uncover the potential for significant upward movement in the stock price based on its present valuation. These analyses collectively reinforce my conviction in advocating for investment in this robust company.

Mitsubishi Heavy Industries, Ltd. stands as a major player in global industry, headquartered in Tokyo, Japan. As part of the Mitsubishi Group, MHI's influence reaches across diverse sectors, from engineering to electronics. With a legacy dating back to 1884, MHI's extensive portfolio includes aerospace components, power systems, ships, and more. The company's activities span Energy Systems, Plants & Infrastructure Systems, Logistics, Thermal & Drive Systems, and Aircraft, Defense & Space segments. MHI's broad spectrum of offerings reflects its adaptability and experience. With an employee base of around 80,000 across 260 subsidiaries, the company's presence is felt globally.

I consider MIH a portfolio diversification allowing you exposure to the defense sector, which was for many years rather neglected by many, but now, amidst geopolitical tensions, Russia's inversion of Ukraine, and concerns around Taiwan, the sector has not only regained attention by individuals but also governments who are increasing their military spending, as well as investors and other market participants who may want to participate in these business prospects for defense companies such as MIH. The special thing about MIH as mentioned, is that it doesn't exclusively give you exposure to the defense business, but it is still a company with a leading position in many other industrial segments, which already provides a certain degree of diversification and, hence, risk mitigation through the dependency of one single sector or segment.

Recent Results Q1

Mitsubishi Heavy Industries, Ltd. has demonstrated significant growth in its first quarter of FY23 , achieving remarkable year-over-year improvements in order intake and profit. Following the release of robust Q1 results, Mitsubishi Heavy Industries' stock price surged by approximately 10%. Their results surpassed estimates conducted by Seeking Alpha, with top-line revenue reaching $6.94 billion, exceeding expectations by an impressive $446 million.

Across all its segments, Mitsubishi Heavy Industries experienced remarkable year-over-year growth in order intake.

All reporting segments showcased elevated performance, with revenue, business profit, and net income surpassing 1Q FY2022 levels.

Furthermore, I want to add that from my personal review of the balance sheet and various other financial statements provided by the company, the enhancement in profitability can be attributed primarily to a combination of organic revenue growth, a reduction in year-over-year one-time items, and favorable foreign exchange effects, especially the last one.

The Aircraft, Defense & Space segment stands out significantly. Orders soared by approximately $5.227 billion YoY, driven by substantial missile defense system orders from Japan's Ministry of Defense, reinforcing the nation's strategic focus on defense capabilities.

This underscores my investment thesis, which argues for the defense sector to be a major driver of the company's success, continuing into the future. MHI's strong position in securing collaborations with its own government and potentially with other allies.

Guidance

Mitsubishi Heavy Industries, Ltd. looks ahead with a comprehensive fiscal year 2023 forecast that spells out its ambitious growth and financial improvement plans.

In terms of revenue, MHI anticipates an impressive surge, projecting a substantial increase of about $31.1 billion USD, which signifies a remarkable growth of approximately 97.2% Year-Over-Year (YOY).

Aligned with this robust growth, MHI envisions a significant enhancement in its profit margin. The target is to achieve a profit margin of 7%, reflecting a notable improvement of 2.4 percentage points YOY.

Shareholders are poised to benefit as well, as MHI projects an increase in dividends. The anticipated dividend of $1.23 USD per share surpasses the previous year's distribution of $1.00 USD per share in FY 2022.

Within the Aircraft, Defense & Space segment, MHI foresees substantial expansion. This growth is propelled by an anticipated additional $3.85 billion USD in order intake, culminating in a total projected revenue of about $5.38 billion USD for FY2023.

Across all operational segments, MHI projects a notable increase in total profits. The expected total profits of about $2.31 billion USD correspond to an approximate doubling of profits from business activities. This translates to approximately $1.46 billion USD in actual profits attributable to the owners of the parent company.

Leveraging Military Momentum

A pivotal aspect of Mitsubishi Heavy Industries' future success lies within the Aircraft, Defense & Space segment, which is poised to be a formidable driver of the company's growth trajectory. The anticipated influence of this segment extends to potential reverberations in the company's share price, underscoring its strategic significance.

While the Aircraft, Defense & Space segment currently reports revenue of approximately $1.05 billion USD, new Intakes reported last quarter surged remarkably. This shift substantiates the segment's escalating importance, positioning it to likely become an even more important cornerstone of the company's future prospects, in my view.

Notably, Japan has emerged as a significant player in the domain of increased military spending, revealing robust plans for fortification in response to global geopolitical tensions. As a testament to this commitment, Japan unveiled a comprehensive national security strategy, marking one of the nation's most extensive defense overhauls since World War II. This strategy aims to elevate security expenditure from 1% of GDP to NATO's established benchmark of 2% by 2027, amounting to a substantial $320 billion military expansion.

The momentum of this defense-focused approach is already tangible. Earlier this year, Japan solidified a $2.8 billion contract for missile systems, a precursor to a broader defense initiative. A suite of contracts encompasses land, sea, and air-launched missiles, as well as the deployment of a hypersonic ballistic warhead slated for 2026. As Japan's premier defense equipment manufacturer, Mitsubishi Heavy Industries stands poised to reap substantial benefits from this multi-billion dollar defense investment.

Expanding its international footprint, Mitsubishi Heavy Industries has secured a pivotal role in a collaborative endeavor with Britain's BAE Systems PLC and Italy's Leonardo. The tri-nation partnership aims to develop an advanced joint fighter, strategically slated for deployment by the mid-next decade.

Mitsubishi Heavy Industries' Aircraft, Defense & Space segment stands as a beacon of growth in response to burgeoning military spending initiatives. The company's integral role within these strategic developments positions it optimally for a future defined by growth, resilience, and global influence, building on the increased spending by governments on defense.

Valuation

As part of my comprehensive investment evaluation approach, I engage in a prudent Net Present Value analysis of Mitsubishi Heavy Industries ((MHI)), shedding light on its financial prospects and potential share price upside. Utilizing a conversion rate of 1 JPY = 0.0070 USD, I've delved into the company's financials and projected a conservative but enlightening picture.

My NPV model for MHI brings forth a fair share price of approximately $89, revealing significant upside potential in contrast to the current trading price of around $52. This analysis encompasses a careful examination of the company's profits, underpinned by a forward-looking projection.

A cornerstone of my valuation model rests on the revenue estimates from FY 2024 to FY 2026. I've incorporated the insights of Seeking Alpha , Market Screener as well as the company's own guidance materials to form my assumptions. In line with the company's management outlook, I've factored in an incremental expansion of both gross margin and profit margin over the forthcoming years.

Notably, the surge in MHI's potential future growth mirrors the unfolding momentum catalyzed by Japan's resolute efforts to bolster its military capabilities. This lens of optimism is complemented by my conservative approach to estimates - an approach that seeks to guard against overconfidence and foster calculated anticipation.

The model's assumptions extend beyond FY 2026, where I envisage modest annual revenue growth of 5%. This deliberate conservatism echoes the company's recent growth trajectory while balancing the need for prudence. My long-term projection envisions a gross margin of 25%, positioned below the sector's median of around 30%, as highlighted by Seeking Alpha.

In recognition of MHI's legacy and industry leadership connected to the bright prospects caused by the bulging military defense budget the government is committed to spending, I've encapsulated a pragmatic view of the company's future. Furthermore, the model assumes that growth will stabilize after 2036 and that both revenues and profits will cease by 2045, which is indeed very conservative to expect.

Financials

Cash & Equivalents, a pivotal indicator of a company's financial health, stand at approximately $2.43 billion USD . In parallel, the company carries an interest-bearing debt of around $5.19 billion USD. The noteworthy debt levels align with the industry's character, where companies of this nature - akin to prominent counterparts like Siemens ( OTCPK:SIEGY ) and ABB ( OTCPK:ABBNY ) - often navigate significant debt ratios as inherent facets of their operational frameworks.

Of particular significance is the marked debt reduction the company has accomplished. In a YoY analysis, Mitsubishi Heavy Industries Ltd. effectively trimmed approximately $1.07 billion USD of its debt burden, underscoring a concerted effort to enhance its fiscal standing.

Drawing from the company's robust cash position, the resultant net debt figure after such calculations - approximately $2.86 billion USD - emerges as a manageable benchmark. I think, when contextualized within the framework of the company's profitability and operational prowess, this net debt figure underscores the company's capacity to navigate its financial commitments effectively.

Risks

While Mitsubishi Heavy Industries Ltd. stands as an attractive investment prospect, it's important to understand that I also consider potential risks, especially related to my investment thesis for MIH.

Dependency on Military Development

One paramount risk I perceive in my investment thesis revolves around the company's reliance on military development as a pivotal driver of growth. While this strategic focus aligns with the prevailing geopolitical climate and national security priorities, an overemphasis on this domain carries inherent vulnerabilities. Overreliance on military contracts could potentially expose the company to shifts in government policies or a sudden shift in budget allocations.

Currency Risk

Investors engaged with Mitsubishi Heavy Industries unavoidably encounter exposure to the Japanese yen. This currency risk stems from the company's home base and international operations. Fluctuations in the yen can impact the translation of overseas earnings, potentially introducing an element of volatility to investment returns. While the yen's recent weakening against foreign currencies temporarily bolstered earnings, it's worth noting that this comes with a dual-edged consequence. Depreciation of the yen can simultaneously elevate energy and operational costs within Japan, effectively balancing the benefits. Therefore, investors need to be attuned to the dynamics of currency markets and their potential influence on the company's performance.

Conclusion/Opinion

MHI's global prominence, rooted in its extensive portfolio across aerospace, energy, infrastructure, and defense, highlights its adaptability and prowess. Dating back to 1884, the company's legacy is underscored by its commitment to innovative and integrated solutions that align with a sustainable and quality-driven world.

In the context of MHI's legacy, its recent robust Q1 performance magnifies the promising trajectory. Tangible year-over-year increases in order intake, revenue, and profit across segments.

Central to my bullish stance is MHI's burgeoning defense division, strategically positioned amidst geopolitical dynamics and amplified military budgets. With a commitment to strengthening defense capabilities, Japan augments Mitsubishi's prospects for collaboration and growth, evident through its involvement already, for instance, in missile defense contracts. It's very likely that we will read about additional deals in the near future.

My valuation analysis, rooted in a Net Present Value Excel model, accentuates this encouraging upside potential. I projected a fair share price of around $75 compared to the current $52, which is an upside of about 50%, and I used rather conservative assumptions.

While acknowledging inherent risks, I firmly believe that the potential of MHI far outweighs all of them at the moment.

With the sum of the company's already proven strengths, coupled with the dynamic military prospects and my valuation assessment, I firmly recommend a BUY rating for MHI.

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