NJDCY - Nidec Hammered Again On Weak End-Markets Adds A Restructuring To The Mix

Summary

• Nidec posted ugly third quarter results, with a revenue miss driven by weak end-markets and a larger operating income miss driven by ongoing cost/margin issues.
• Management is launching an aggressively cost restructuring effort meant to prioritize operational streamlining, production automation, and the development of technologically-differentiated products.
• Nidec's management has bold targets - not just for a quick turnaround in profitability with the restructuring efforts, but for aggressive long-term revenue growth.
• Nidec is leveraged to multiple attractive growth opportunities, including electric vehicles, e-mobility, and energy-efficiency HVAC and appliances.
• The growth rates that Nidec needs certainly aren't modest, but success in these end-markets can drive a higher share price in the years to come and expectations may be washed out now.

It's gone from bad to worse with my bullish call on Nidec (NJDCY) (6594.T), as fiscal third quarter results were exceptionally weak, even when adding back restructuring costs. While I do believe Nidec is a premier manufacturer of electric motors from a technology and product performance standpoint, management is clearly struggling to translate that into acceptable financial performance as it balances multiple weak core end-markets and ongoing investment in its large EV opportunity.

I may be a glutton for punishment and deserving of mockery here, but I'm still a believer in the long-term story at Nidec. I've hacked and slashed my estimates to reflect weaker near-term end-markets and weaker profitability, but given long-term trends like automation, energy efficiency, and vehicle electrification, I still think Nidec has a chance to be a worthwhile investment.

From Bad To Worse

I wasn't expecting a strong third quarter from Nidec. A weak global PC market and slowing data center spending didn't bode well for hard drive motor demand, appliance demand is softening around the world, and auto production continues to be impacted by COVID-19 infections in China and component shortages elsewhere.

Even with lower expectations, though, Nidec still missed.

Revenue rose 15% year over year, but fell about 4% sequentially, missing expectations by 5%. There wasn't a big driver of the underperfomance beyond the Machinery segment (which accounted for a third of the miss on around 12% of overall revenue), but the underperformance was present across the business.

Small precision motor revenue declined 7% yoy and 7% qoq, driven by a 13% qoq decline in hard disk drive motors, with a more significant inventory correction in nearline HDDs seen in the quarter. With the PC cycle likely to trough this quarter (March of 2023), this business should start to improve.

Auto sales were up 35% yoy but down slightly on a sequential basis, with the business coming up short on the aforementioned issues in China and global production rates. Appliance sales fell 1% qoq, Machinery sales fell 13%, hurt by weaker demand at flat panel and semiconductor customers, and Electro-optical sales rose about 2%.

Gross margin declined 230bp sequentially. Operating income fell 37% yoy and 46% qoq as reported, missing by 45%. Adjusted for restructuring charges, operating profit was still down 8% (and closer to 20% sequentially) and still missed by a large amount (20%), with margin down 170bp yoy and 160bp qoq to 7.2%.

The inventory correction in HDD spindle motors crushed profitability, driving operating income down 65% yoy and 56% qoq, with margins down 760bp yoy and 510bp qoq to 4.5%. Auto profits fell to a loss on the restructuring charges, but would have still been down about 64% qoq on an adjusted basis. Appliance profits rose 1% sequentially, with margin up 30bp to 9.1%, Machinery profits fell 28% qoq with margin down three points to 15.2%, and Electro-optical profits rose 8% sequentially, with margin up 130bp to 20.3%.

Aggressively Targeting Costs To Drive Higher Sustained Profits

To be fair to management, inadequate profitability has been on the board's radar for some time, and an inability to simultaneously drive new innovation and new market growth (like the e-axle project) with satisfactory profits is a big part of the reason why former CEO Jun Seki was forced out earlier this year.

Now the company is implementing WPR-X, which it describes as a "radical reform" on profitability that is targeting a significant reduction in fixed costs and a V-shaped profit recovery next year (and beyond).

The idea of streamlining operations and incorporating more automation into manufacturing makes sense, but I do question what can be accomplished in such a short time without compromising the business over the longer term, particularly with strong volume growth in the auto business. Then again, the HDD motor and appliance businesses are operating well below capacity now, so shuttering excess capacity and quickly incorporating more automation there may not be as challenging.

While cost-cutting is the current focus, Nidec isn't taking its eye off the ball with respect to growth, looking to expedite the development of product that can, in the chairman's words "overwhelm competitors" with their technological superiority.

There Are Still Real Opportunities Here

While not a lot is going right for Nidec now, I think that obscures some fundamental strengths and long-term drivers in the business.

The HDD motor business is never going to be a growth driver again, but management has been repurposing a lot of their knowhow into other small precision motor types, and the company is positioning itself to take advantage of upcoming growth markets like e-mobility (electric bikes and scooters). Given how much of the world still uses motorcycles, scooters, and the like, and where electric cars aren't going to be mass-market affordable for a long time, I believe this is a real opportunity (it's also something I've written about in relation to Gates Industrial ( GTES ) in the past).

I've written at length about Nidec's opportunities in EVs with its strong technology platform in e-axles. The joint venture to produce e-axles for European OEMs with Stellantis ( STLA ) is underway, and the company continues to see strong growth from its Chinese customers (including Geely ( OTCPK:GELYY )), with Nidec-powered EV sales up 175% in CY'22.

I also want to point to a recent partnership as a way of underlining some of Nidec's technological capabilities. Airbus ( OTCPK:EADSY ) recently selected Nidec (its Leroy-Somer unit) to develop electric motors for a hydrogen fuel cell-powered aircraft prototype. I don't necessarily think this is going to amount to much (certainly not for at least a decade), but it does highlight the capabilities that Nidec can bring to bear.

I also continue to believe in the long-term potential of the appliance business. Nidec has a leading presence in markets like HVAC motors, refrigerator compressors, elevator motors, and appliance inverters. With inverters significantly reducing the energy demands of appliances, I believe Nidec is leveraged to global initiatives to reduce emissions and power consumption by replacing HVAC systems with more efficient models (especially commercial/industrial units), and I likewise believe the company is well-leveraged to growing adoption of HVAC in new markets.

The Outlook

Even after cutting back my expectations, I'm still looking for long-term revenue growth of around 12%. Much of that will be driven by the company's e-axle business, where I believe it will be a leading supplier to Chinese OEMs and new market entrants, as well as some established auto OEMs. I also see above-market growth opportunities in appliances, and particularly in HVAC. I should note as well that as bold as my projections may sound, management's target for 2030 revenue is double what I have in my model.

I've revised margins as well. I do think this new restructuring effort will produce noticeable benefits, but I'm still only looking for near-term operating margins to reach 10%. Long term, I expect free cash flow margins to climb toward the high single-digits, but most of the next decade will likely be in the mid-single-digits. Key to all of this is the extent to which the business can scale up in e-axles and HVAC motors/inverters, as there are significant operating leverage possibilities here.

Discounting that all back, I get a fair value of around $16.50 for the ADRs today. I get a similar fair value using a 15x multiple on my FY'24 EBITDA estimate. While 15x is high relative to the company's near-term margin and ROIC potential, the market has shown in the past that it will reward growth as well as margins.

The Bottom Line

I've joked in the past that the difference between patience and stubbornness is the end result. If Nidec fixes its cost issues and executes on opportunities in electric vehicles and energy-efficient appliances, I believe the share price performance will be strong. If management is overestimating end-market growth and their ability to gain share in those markets, this is just doubling down on a bad call. I still believe this story will work out, but it's definitely one where investors are going to need patience to see the rewards.

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