2024-01-15 06:44:12 ET
Summary
- Panasonic's earnings outlook remains muted due to weak underlying growth and macro conditions.
- The potential sale of its automotive segment could be a positive catalyst but may result in major asset writedowns.
- Consensus expectations for sales growth are low, and profitability improvement is uncertain in our view. Valuations do not indicate a major undervaluation.
Investment thesis
We reiterate our neutral rating on Panasonic ( OTCPK:PCRFF ) stock. Recent trading was mixed with weak underlying growth, and the outlook for earnings remains muted given macro conditions. A potential sale of its automotive segment could be a positive catalyst but could involve major asset writedowns negatively impacting book value.
Quick primer
Panasonic Holdings Corporation is a Japanese electronics manufacturer. Its product lines span home appliances, lighting, auto parts, industrial systems, and automotive batteries. In April 2021, the company bought the remaining 80% interest in Blue Yonder Group (a leader in supply chain management software and SaaS) from Blackstone Group and New Mountain Capital for USD7.1 billion which was debt-funded.
Key financials with consensus estimates
Reviewing our rating
We are updating our hold rating from April 2022 , where we felt that a valuation multiple of 1.0x was sufficient, with consensus forecasts that were too bullish for FY3/2023 and FY3/2024. Currently trading below book value, we are reviewing our rating to see if there is an opportunity to buy the shares.
Recent trading was a mixed picture
With a boost in global automobile demand YoY, a weak Japanese yen, and beneficial IRA tax credits, expectations for Q1-2 FY3/2024 results were quite upbeat. Actual results also looked passable on paper with flat sales YoY and operating profit growth of 19% YoY. The automobile business (semiconductor auto parts) saw 15% sales growth YoY and a major recovery in margins, but the overall picture was marred on two fronts. Firstly, underlying growth was poor with sales under constant currencies falling 3% YoY, with operating profit down 6% without the impact of IRA tax credits. Secondly, despite the forex and tax credit tailwinds, the company downwardly revised FY3/2024 operating profit guidance from JPY430 billion to 400 billion, citing weakness in the following segments: Lifestyle (consumer electronics and HVAC), Industry (capital spending in industrials) and Energy (in-vehicle EV batteries, as well as consumer and industrial solutions).
We do not view Panasonic as a quality cyclical and the current economic environment is not conducive to its growth. Real estate remains under pressure with high financing costs, limiting opportunities for HVAC. Industrials are experiencing some pockets of growth in certain market verticals (primarily auto from a low base), but capital spending remains limited in technology hardware, and China demand remains low-key and unlikely to return in the short to medium term. With demand for high-end EVs such as Tesla ( TSLA ) slowing, Panasonic has lowered expectations for a theme that has been viewed as a major positive driver for the company.
Sales growth outlook less than exciting
With consensus expectations penciling in low single-digit sales growth for the next two years, we find it difficult to get too excited. There appears to be scope for profitability improvement with operating margins expected to rise to 5.6% in FY3/2025E - although we expect to see sustained IRA tax credits coming through which may help, we currently cannot envisage a major turnaround in business conditions or sales mix that would drive this uplift YoY.
There is some market expectation over Panasonic conducting a potential stake sale in its automotive business, following news in November 2023 . Whilst this may be seen as a positive restructuring story, a major disposal of a core business segment will harm both sales and earnings. A private equity fund would be discerning over asset valuations and seek writedowns. However, an asset sale could generate capital that can be allocated to new growth initiatives, as well as shareholder returns.
Valuation
On current consensus forecasts, the shares are trading on PER FY3/2025 8.8x, PBR 0.8x, and a dividend yield of 2.8%. Valuations are not stretched for a business with a decent brand and a relatively healthy balance sheet. However, we view consensus as being too optimistic in terms of margin expectations, and the prospective dividend yield is not exactly high. For what looks on paper to be an ex-growth business, free cash flow generation remains weak on low single-digit FCF margins. We believe valuations do not indicate a major undervaluation.
Thesis catalysts
Macro conditions remain tepid for the short to medium term, capping growth prospects for sales. The weak Japanese yen stabilizes offering no tailwind, and although inflation is coming off highs operating costs remain elevated.
Risks to thesis
Restructuring via a sale of the automobile division is received as a positive for the shares. The economic environment steadily improves, driving a recovery profile in sectors such as real estate and industrials that boost demand for Panasonic.
Conclusion
With limited growth opportunities for what is inherently a low-margin and asset-heavy business, we do not see an opportunity to invest despite valuations being in value territory. The shares have some upside risk through a one-time event from the potential disposal of the automotive business, but this could involve hefty asset writedowns which could negatively hit book value. We prefer to remain on the sidelines and reiterate our neutral rating.
For further details see:
Panasonic: Still Staying Away From This Value Trap