2023-07-13 06:15:19 ET
Summary
- Hitachi has set a goal of improving its ROIC from 7%-8% in the past to 10% by fiscal 2025, which I think is achievable.
- Hitachi's holding company discount can be narrowed over time, as Hitachi proves to investors that it can exploit synergies with its business portfolio to deliver customized solutions for its clients.
- I am reiterating my Buy rating for Hitachi stock, in view of its multiple catalysts.
Elevator Pitch
I still have a Buy investment rating for Hitachi, Ltd. ( HTHIY ) [6501:JP] shares.
My attention turns to Hitachi's potential re-rating catalysts in this current article which justify a Buy rating for the stock. The key catalysts for Hitachi include ROIC (Return On Invested Capital) improvement, a narrowing of the conglomerate discount, and a growing revenue contribution from Hitachi's key growth business, Lumada.
Readers should note that Hitachi is listed on both the Tokyo Stock Exchange and the OTC market. According to S&P Capital IQ data, the three-month average daily trading values for Hitachi's Japan-listed and OTC-listed shares were around $200 million and $4 million, respectively. Investors have the choice of dealing in Hitachi's relatively more liquid Japan-listed shares by relying on US brokerages such as Interactive Brokers which offer trading services for international equity markets.
ROIC Expansion Goal
At the company's recent Investor Day on June 13, 2023, Hitachi has announced its goal of delivering a ROIC of 10.0% for fiscal 2024. Hitachi refers to fiscal 2024 as the period between April 1, 2024 and March 31, 2025.
As a basis for comparison, Hitachi reported ROICs of 7.7% and 7.6% for FY 2021 and FY 2022, respectively. The company has also guiding for a FY 2023 ROIC of 7.5%. As such, it will be a major achievement and a significant re-rating catalyst for Hitachi, assuming that the company manages to improve its ROIC from the high single digits percentage level to 10% as per its medium-term new financial targets.
Key Initiatives Put In Place By Hitachi To Meet Its 10% ROIC Target
Hitachi's CFO Presentation At Investor Day 2023
As per the chart presented above, Hitachi will be taking the necessary steps to increase the company's ROIC. With my prior May 1, 2023 update , I touched on how Hitachi was restructuring the company's portfolio of businesses and distributing more capital to its shareholders in a bid to unlock value. In my view, Hitachi's portfolio restructuring activities will boost the company's revenue growth and margin expansion by having faster-growing and higher-margin businesses contribute a larger percentage of its business mix. Separately, allocating more capital to buybacks and dividends is expected to shrink Hitachi's capital base and boost its ROIC. Therefore, I am optimistic that Hitachi's ROIC can improve to 10% in FY 2025.
A company's ROIC tends to be positively correlated with its total shareholder return (price appreciation plus dividends) over time, so it is realistic to expect Hitachi's valuation multiples to expand going forward in tandem with the increase in its ROIC.
Holding Company Discount
The market values Hitachi at a consensus forward next twelve months' price-to-sales of 0.90 times and a consensus forward next twelve months' levered free cash flow yield of 9.3% (source: S&P Capital IQ ). It is fair to label Hitachi's shares as undervalued, taking into account Hitachi's price-to-revenue multiple of below 1 times and its high single-digit percentage free cash flow yield.
Apart from the fact that the company's ROIC isn't that high, a holding company discount for Hitachi is one of the key reasons for the company's undervaluation. In my earlier November 12, 2020 initiation article for Hitachi, I have described the company as "a conglomerate with multiple business lines and operations located across the world." Therefore, it is natural that investors have awarded a hefty holding company discount or conglomerate discount to Hitachi based on the perception that it owns a bunch of unrelated businesses with limited synergies between each other.
Hitachi noted at its June 13 Investor Day that it is trying to "increase synergies" with its business portfolio by enhancing "collaboration between segments", so that the company can enjoy a "conglomerate premium" rather than a holding company discount. As an illustration of potential synergies, HTHIY disclosed at the company's Investor Day 2023 that it executed on 75 "customer co-creation cases" in FY 2022 by utilizing "products from each of Hitachi's business sectors."
Moving ahead, there is huge potential for Hitachi to provide customized solutions to tackle its customers' problems by capitalizing on the full range of products and services offered by its various businesses. If and when Hitachi convinces investors of the substantial portfolio synergies that it enjoys, it is very likely that the conglomerate discount assigned to Hitachi will become smaller in the future.
Lumada Is The Crown Jewel For Hitachi
Lumada is Hitachi's business focused on "corporate digital transformation" as highlighted in an article on the company's website. With growing demand for digital transformation solutions, it is reasonable to view Lumada as the "crown jewel" and key growth engine for Hitachi.
At the company's 2023 Investor Day in mid-June, Hitachi revealed that it aims to grow Lumada's top line contribution (as a proportion of total revenue) from 26% for FY 2022 to 29% and 33% in FY 2023 and FY 2024, respectively. The ultimate goal for Hitachi is to have Lumada account for half or more of the company's sales in the intermediate to long term.
I think it won't be tough for Lumada's revenue contribution to increase significantly in the years ahead.
One factor is that the size of worldwide digital transformation market is projected to expand at around +17% every year based on estimates provided by Hitachi. Hitachi has set a target for Lumada to grow its top line by +15%-20% annually, which is largely aligned with the broader digital transformation market's expected growth.
The other factor is that Hitachi will be continuously reviewing its portfolio of businesses with an eye on exiting businesses whose performances have been below par. This means that it is natural for weaker non-Lumada businesses to make up an increasingly smaller proportion of Hitachi's overall business mix.
In a nutshell, the market should be willingly to assign a higher valuation to Hitachi, when its crown jewel (Lumada) contributes a larger percentage of HTHIY's top line.
Concluding Thoughts
Hitachi's valuations are attractive, and I expect a positive re-rating of its valuations going forward with the realization of multiple catalysts. This explains why I have left my Buy rating for Hitachi unchanged.
For further details see:
Hitachi: 3 Catalysts To Watch