NNDNF - Nidec: Executing On Innovation But Macro Concerns Loom Large

2023-08-28 20:53:35 ET

Summary

• Nidec's share price performance has been hurt not only by currency moves but growing concerns over the health of the key Chinese market.
• The company's fiscal first quarter showed better-than-expected results, with revenue rising 5% and operating income increasing by 35%, and Nidec booked its first profits from its e-axle business.
• Management substantially lowered FY 2024 e-axle sales expectations but boosted FY 2025 guidance and is pursuing new integrated systems developed with Renesas.
• Long-term opportunities in data centers, energy-efficient appliances, renewables storage, and vehicle electrification are significant and support a higher share price, but near-term macro risks are very real.

Japanese electric motor manufacturer Nidec (NJDCY)(NNDNF) has continued to test investor patience, even if many of the recent drivers of sentiment are outside of the company’s control. While Nidec local shares have risen about 5% since my last update , currency moves have worked against U.S. shareholders, driving a small loss, though the performance has been pretty close to that of the larger U.S. industrial sector.

I continue to believe that better days are ahead for Nidec, and that the shares are undervalued by 15% to 20%, but I don’t want to ignore the meaningful near-term challenges to the business and to sentiment. While recent trends in markets like appliances and autos have been positive for the company, and the hard disk drive market has probably bottomed, macroeconomic weakness in China, the U.S. and the EU remains a meaningful threat. Moreover, the company still has to show that it can fully execute on some rather ambitious volume and margin expansion goals across its diverse business units.

A Better Start To This Fiscal Year

Nidec’s fiscal first quarter (reported about a month ago), was a nice return to better-than-expected results, but I’d caution investors not to read too much into this, as Japanese sell-side analysts place less emphasis on quarter-to-quarter forecasting (relative to annual forecasts) and it has always been relatively common to see more quarter-to-quarter volatility in results versus expectations than for American companies.

Revenue rose 5% as reported, beating by about 7%, but currency-neutral growth was only slightly better than nil. The small precision motor business was weaker than expected (by about 14%), with the vast majority of the weakness coming from the hard disk drive motor business (down 49%), as customers continued to work through inventory as the market bottomed.

Appliance, Commercial, and Industrial (or AHCI) sales rose 7% as reported, beating by close to 9% on strong demand for battery storage products from utility customers (echoing the strong demand that YASKAWA (YASKY) reported from the Chinese solar market, as well as other positive reports from the renewables space), as well as healthy demand for appliances as more manufacturers (and customers) turn to more energy-efficient models. Auto sales rose 21%, coming in a little weaker than expected on Chinese demand. Machinery sales (down 3%) and electro-optical (up 14%) were closer to expectations.

Gross margin improved about two points from the year-ago period, as component availability and overhead leverage continue to improve. Operating income rose 35%, beating by almost 40%, as margin expanded 230bp (to 10.6%). Operating improvements were driven by mix shift (which also helped gross margin), but also by the company’s aggressive moves over the last few quarters to reduce costs and improve operating efficiency, as well as improved leverage in the e-axle business.

Autos - E-axles Are Now In The Black, But The Volume Outlook Is Shaky

Nidec’s auto business was decidedly mixed in the fiscal first quarter. On the positive side, the company has finally achieved profitability in its e-axle business (the core of its EV-related auto operations), with the segment generation JPY 0.5B in operating profits. On the negative side, management sharply reduced its FY’24 revenue guidance for e-axles (from JPY 152.4B to JPY 78.1B), as China’s EV market starts to slow and as EV launches in other regions get pushed out.

Importantly, I don’t see much evidence that Nidec is losing share in its e-axle business, and the company may well be sacrificing some 2024 sales by prioritizing its new 2 ^nd -generation offerings (which have more content and a higher ASP for the company). To that end, I’d note that management boosted its FY’25 e-axle revenue forecast by more than 10% (from over JPY 300B to over JPY 330B), and the company continues to move forward with new integrated products that combine a motor, inverter, and gears with a DC-DC converter, battery management system, and onboard charger. The company is also well underway with an integrated product jointly developed with Renesas (RNECY), a leading Japanese manufacturer of semiconductors for the auto industry, that it expects to launch commercially in 2025.

While the e-axle business will be the core of the auto growth opportunity in the near term, management has been taking a more comprehensive view of the opportunities in vehicle electrification and where it can apply its industry-leading motor technology (including superior power-to-weight ratios). Nidec has already made it clear that they want to participate in electrification opportunities for smaller form factors like scooters and e-bikes, and the company is expanding its portfolio of smaller products (sub-70kW) to address this opportunity in markets like India, Indonesia, and Vietnam.

New Opportunities In Older Units

One of the aspects of Nidec that I’ve long admired is the company’s ability to transfer its knowhow to new market opportunities. To that end, the company is harnessing its long-held expertise in small precision motors to develop new liquid cooling products for data centers. Given the ongoing growth in data center investment (including power-hungry AI data centers), I believe cooling demand will run well ahead of square footage growth and support a meaningful revenue opportunity.

Nidec is likewise using core competencies in areas like inverter and battery technology within its AHCI business to pursue new growth opportunities in renewable energy. Demand for renewable power generation is driving increased interest in onsite energy storage, and Nidec has continued to log significant wins for grid storage systems in the EU and expects to start signing and announcing more meaningful awards in the U.S. and China as well.

Looking further out, the company has also entered the aerospace electrification market. Earlier this year the company announced a project with Airbus (EADSY) to develop electric motors for hydrogen fuel cell-powered aircraft and more recently the company announced a joint venture with Embraer (ERJ) to develop electric propulsion systems for electric vertical take-off and landing (or eVTOL) vehicles.

The Outlook

I definitely risk to the near-term outlook for Nidec. China’s economy appears to be on very shaky footing right now, and although some Nidec customers (like Geely (GELYY)) appear to be holding up well, I’m concerned that EV production could be at risk in the near term, and reports from companies like Analog Devices (ADI) (a leading provider of chips for battery management systems) don’t lend a lot of confidence to the near-term outlook. Likewise, if China does weaken further, it will have a negative impact on demand for Nidec’s products in areas like consumer appliances and industrial motors (around 20% to 25% of quarterly revenue comes from China). So too with the European and U.S. markets, where weak PMI numbers and declining consumer confidence don’t paint a pretty near-term picture.

Beyond the near-term macro risks, there are also risks tied to competition and the company’s own aggressive targets. While I believe Nidec offers a strong value proposition for EV carmakers, there’s no shortage of competition in the e-axle space. Likewise in areas like data center cooling, appliances, and components for industrial automation, management continues to expect a significant ramp in its e-axle business over the next two to three years.

I haven’t changed my model all that significantly; I’ve revised my revenue numbers a little lower and my margin assumptions a little higher after the last couple of quarters, but they don’t materially change my outlook. I’m looking for high single-digit long-term revenue growth and significant improvement in free cash flow margins as projects/portfolios like e-axles and grid-scale battery storage transition from investment to profitability.

The biggest change to my valuation comes from the movements in the Japanese yen; netting out currency, my fair value is basically unchanged on both a discounted FCF and margin/return-driven EV/EBITDA basis. As is, though, my fair value estimate comes down about 10% due to currency.

The Bottom Line

At today’s price I think Nidec is still around 15% to 20% undervalued and priced for a good long-term annualized return. In the short term, though, there are very real challenges to important end-markets (the Chinese EV market in particular) and I don’t rule out the risk of downward revisions in earnings expectations over the next 6 to 12 months. For patient investors, though, I do think there are still sound reasons to own Nidec for the long term, as the company continues to pivot toward growth opportunities tied to electrification and green energy.

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