2023-09-05 10:14:48 ET
Summary
- Backed by a growing earnings base, Panasonic stock has deservedly been on a tear this year.
- The EV batteries business remains the crown jewel, though smaller growth engines within the portfolio also present long-term optionality.
- Yet, Panasonic’s high-quality business portfolio still trades at parity with book value, leaving ample upside on the table for investors.
Panasonic Holdings ( PCRFF ) has de-rated since its below-par fiscal Q1 2024 result – while overall adj. operating profits were up strongly on a robust automotive and energy performance, weakness in the lifestyle and industry segments has weighed on investor sentiment. Yet, management was confident enough to raise its net profit guidance, partly due to deferred tax asset benefits but also due to seasonal tailwinds for its air conditioning business. Perhaps even more importantly, automotive battery sales, an increasingly important contributor to operating profits, continue to gain traction, with higher US production and sales volumes set to unlock more ‘Inflation Reduction Act’ (IRA) subsidies ahead. Also impressive has been the auto pipeline – building on its cylindrical lithium-ion battery partnerships with pure-play EVs, Panasonic has now broken through with larger-scale automaker tie-ups with the likes of Subaru ( FUJHY ) and Mazda (MZDAY).
While the stock has rallied strongly since my coverage last year, the rise has been more than justified by a growing earnings base (P/E currently at ~10x). Similarly, Panasonic trades at parity with its book value, well below other EV battery names (Asian peer CATL, for instance, trades at 5x book) and the underlying growth of the business portfolio. Net, I continue to see good value in Panasonic shares here.
EV Batteries Emerging as the Key Growth Driver
Panasonic’s headline fiscal Q1 revenue and adj. operating profit may have fallen short of consensus estimates, but after adjusting for the adverse sales impact from the accounting treatment of US IRA subsidies (JPY24bn headwind), top-line growth would have been far stronger in real terms. Unsurprisingly, automotive batteries (housed within the energy segment) was the key highlight, with another quarter of sequential revenue acceleration testament to the company’s leadership in cylindrical batteries. The only blemish here was increased fixed expenses, though this was largely related to the development costs of its 4680 cell (provides cooling advantages during charging) rather than a reflection of the underlying pricing power. Plus, management’s disclosure of US volumes exceeding expectations at 9.4GWh (up from 8.6GWh in fiscal Q4 2023) bodes well for future IRA subsidy tailwinds.
The encouraging development pipeline has yielded new deals – this time, with large-scale auto manufacturers like Subaru and Mazda for the supply of cylindrical lithium-ion batteries at its Japan and North America plants. This follows similar supply contracts with EV pure-plays like Lucid and Hexagon Purus, though the breakthrough tie-ups with major established automakers present larger-scale supply opportunities. And given Tesla ( TSLA ) is currently the largest Panasonic battery customer, the diversification of its customer base is welcome news. Expect more supply agreements down the line, particularly with news flow this year also linking the company with the likes of European automakers Stellantis ( STLA ) and BMW (BMWYY).
Not All Doom and Gloom for the Lifestyle Segment
Offsetting the strength in the automotive and avionics businesses was weakness in the lifestyle segment, which houses the key heating & ventilation (i.e., air conditioning equipment) business. In contrast with the accelerated sales growth in Europe, domestic demand, a result of seasonally low temperatures in Japan through the April-June quarter, weighed on sales. The lack of pricing power here also led to lower operating profit for the segment as input cost inflation continues to bite.
Yet, the seasonal headwinds in fiscal Q1 will likely reverse for the lifestyle segment from the next quarter. In contrast with the cooler June temperatures, Japan has since experienced a heat wave that should boost the domestic air conditioning earnings outlook. So even with management retaining its adj. operating profit guidance of JPY430bn and raising its bottom-line guidance to JPY460bn (up from JPY350bn due to deferred tax asset benefits), Panasonic should still be well on track to achieve its updated full-year targets.
On Track to Deliver on its Mid-Term Promises
Having initially committed to a holding company structure in 2020 under President Kazuhiro Tsuga (subsequently replaced by President Kusumi) to increase capital allocation independence for its business subsidiaries, progress has been slow. The lack of time devoted to governance reforms at this year’s mid-term plan means I wouldn’t get my hopes up on any value unlocking from spinoffs or non-core disposals either. But the silver lining is the improved disclosures by each subsidiary, from standalone cash flow projections to return on investment capital ((ROIC)) targets each unit will be held accountable for.
Also positive is management’s renewed investment focus on key growth areas like European heating & ventilation, where sustainable hydronic systems are gaining traction, as well as hydrogen, a >JPY100bn longer-term market opportunity. Backed by ample cash generation to fund its investment plans, the company should have sufficient headroom to simultaneously maintain its capital return as well (target dividend payout ratio of ~30%).
A Cheaply Priced Basket of Growth Opportunities
Along with the rest of the Japanese stock market, Panasonic has rallied strongly this year. A disappointing fiscal Q1 result may have triggered a small blip, but the stock has begun to recover and now looks on track to break its YTD highs. Yet, I don’t think Panasonic’s valuation screens richly here – at a ~10x earnings multiple and ~1x book, the shares trade far below comparable Asian EV battery names. And if the Q1 strength in its EV battery business, led by US production and sales volumes, is anything to go by, there remains ample room for the stock to re-rate higher. Alongside a seasonal rebound in air conditioning amid the ongoing heat wave in Japan, as well as management’s mid-term plan to unlock new growth opportunities elsewhere in the portfolio, expect more upward earnings revisions to re-rate the stock going forward.
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Panasonic: A Cheaply Priced Basket Of Growth Opportunities