2023-04-23 07:03:23 ET
Summary
- Shimano is the market leading company for bicycle components and one of the leading players in fishing equipment.
- After benefitting remarkably from increasing demand during the pandemic, Shimano's sales are cooling down again.
- As growth prospects remain solid for the future, Shimano shares currently offer an attractive investment opportunity.
Shimano ( SHMDF , SMNNY ) reached new heights during the pandemic as bicycle sales soared and bicycle components were needed more than ever before. Since then, the lockdowns have ended and bike manufacturers suffer from full inventories and overcapacities. As a result, Shimano issued a very pessimistic looking guidance, forecasting a 20% drop in sales for FY23, which led to the end of the hype and a -45% selloff. In this article, I want to classify the downturn and discuss why the stock currently offers an attractive investment opportunity.
Shimano's business Model
Shimano is the world's leading manufacturer of bicycle components as well as one of the largest players in the fishing tackle market.
The company was founded by Sh?zabur? Shimano in 1921, when he was just 26-years old and only had a single lathe to begin with the production of freewheels - the most technical components of a bicycle at the time.
Over the years, the portfolio expanded to include other industrial products and the company was constantly involved in the development of innovative bicycle components, starting with the first 3-speed-hub in 1957. In 1970, the fishing tackle division was introduced as a second business pillar for the company, contributing to the same mission of improving public health by encouraging outdoor activities. Another milestone was set in 1973 with the release of the "Dura-Ace"-series, which is still one of the leading group sets for racing bikes today.
In the following years, Shimano expanded into many more countries, creating a deep distribution network, e.g. through Paul Lange (& Co. OHG) in Europe, and introduced several new products.
Today, Shimano's offerings can be divided into the following three categories:
- Bicycle Components (82.3% of total revenue in FY22), including derailleurs, brakes & other bicycle components and related goods
- Fishing Tackle (17.6% of total revenue in FY22), containing of reels, rods and other recreational fishing gear
- Other (0.1% of total revenue in FY22), consisting mainly of rowing-related equipment
Accounting for around 82% of total revenues, the bicycle components business is by far the most important segment for Shimano and in my opinion the most promising as well.
In addition to this, it's interesting to know that most of these revenues aren't even made in Japan. In fact, the most important region is Europe with 47.7% of total revenues, followed by Asia (30.4%), North America (9.2%), Japan (8.6%) and Other (4%). It's worth knowing that an investment in Shimano really is an investment in the European and Asian bicycle market.
Keeping that in mind, we can now continue with an overview about Shimano's historical sales .
Since 2013, Shimano was able to achieve a CAGR of 9.80% for its revenues, showing constant growth and a significant boost in FY21 (+44.6% YoY) and FY22 (+15.1% YoY).
Current Situation
During the pandemic and lockdowns in most of Shimano's targeted regions, people were unable to pursue their hobbies and fitness activities normally.
Therefore, the demand for bicycles and its components increased significantly as it was an outdoor activity that anybody could do on their own and at any time. Or as the management of Shimano stated in their 2020 report :
[...] cycling gained attention as an easy form of recreation and exercise, as well as a mode of transportation with a lower risk of infection, leading to an increase in demand for bicycles on a global scale.
And the increase was tremendous, as total sales went up 45% in the following year, resulting in a record year for Shimano. On this basis, Shimano presented its results for the fiscal year 2022 in the annual report on March 30.
As mentioned above, Shimano achieved a moderate sales growth of 15% YoY, driven by continued high demand for bicycle components. In addition to that, the operating income increased by 14.1%, showing that Shimano was almost able to defend its higher margin level.
Especially interesting is the comparison with Shimano's own forecasts for the FY22. As stated in the 2021 annual report , management only expected a sales growth of 6.1% and operating income of +8.6% compared to FY21. This shows how conservative Shimano's management is and provides an example of the difference between Japanese and American business culture. Keeping this in mind, I want to continue with Shimano's inventory development, as some manufacturers have had problems with loaded storages due to the normalization of demand.
Inventories
In order to meet the increased demand during the pandemic, Shimano maxed out existing production capacities without overly expanding production. This more conservative approach was based on the assumption that the increased level of demand would only exist for a short period of time before returning to normal.
Although the strong interest in bicycles during the COVID-19 pandemic showed signs of cooling down, demand for bicycles remained above the pre-COVID-19 levels.
In retrospect, this was exactly the right approach, as demand is now cooling down without leaving behind excess capacity. However, also Shimano saw its inventories rise, especially for mid- and low-class bikes.
In FY22, overall inventories increased to about ¥130 billion (~ $983.7 million) or +75.71% compared to 2020. Although this development should be monitored over the next few years, it's remarkable how well Shimano managed their inventories during the "boom". In contrast, SRAM's CEO admitted in an interview that they have more finished goods than ever, due to an increase in production capacity of at least 50%.
Guidance
Now that we've classified Shimano's recent results, I want to discuss what the management is holding out to investors for FY2023.
As we can see from the table above, Shimano is expecting a 20.5% drop in sales (YoY) and declining operating margins, which would lead to a 37.9% lower operating income of ¥105 billion (~ $794.5 million). Here, it becomes apparent why the stock fell after the announcement and still hasn't come close to the 2021 highs.
Analysts probably expected a less impactful downturn as the average sales estimate for FY23 ($4.09 billion ~ ¥547 billion) is still above Shimano's guidance of around ¥500 billion. And indeed, the forecasted sales look a bit lousy at first, but still represent an increase and CAGR since the pre-pandemic FY20 of 32.27% and 9.77%, respectively.
Compared to the 5.2% CAGR from FY13 to FY20, the sales guidance looks pretty solid after all. That's why I've spent so much time talking about historical growth, the recent numbers and developments, so we can put the forecasts into perspective.
That being said, I would argue that Shimano's growth momentum is still present, although it will continue from a more normalized level. To provide a basis for this expectation, I will now continue with an analysis of Shimano's underlying market situation and prospects.
Shimano's Competitive Position
As already mentioned, Shimano generates its revenues primarily from the distribution of bicycle components and fishing tackle.
Bicycle Components
The global market for bicycle components is expected to grow at a CAGR of about 6.5% until 2029, resulting in a total volume of $22.34 billion.
Mainly driven by the increasing popularity of bicycles as a vehicle for fitness- and outdoor-activities, the bicycle components market also benefits from public bike-sharing programs - a good measure for governments to advance the mobility transition and reduce CO2 emissions.
This current trend is also an opportunity for future growth, since road traffic is still responsible for 29% of all EU emissions. The EU aims to reduce these significantly by 2030, which could also boost the demand for bikes and bike components.
On the opposite, the current market environment is also challenging for producers, as the costs of materials are rising, especially for light-weighted bikes, and concerns about renewed supply chain disruptions due to the situation in Ukraine.
Finally, I want to add that it's very pleasant for us as investors to be in a market where positive regulatory surprises are more likely than negative ones.
And Shimano could be one of the biggest profiters, since their market share in major components is around 70%, according to Reuters . This is also confirmed by a look at the teams in the most important races: more than 3/4 and about 2/3 of all participating teams in the Tour de France and Giro d'Italia , respectively, used Shimano.
Their biggest competitor is the US component manufacturer SRAM , followed by the smaller and more traditional manufacturer Campagnolo from Italy. Unfortunately, both of these companies aren't listed, which makes a comprehensive comparison difficult. However, I did my best to find meaningful data, which is summarized in the table below.
Company | Sales (in $ million) | # of Employees |
Shimano ("Bicycle Components") | 3,922 (in 2022) | 12,984 (in T otal) |
SRAM | 974 (in 2020) | 3,500 |
Campagnolo | 198 ( in 2022 ) | >1,000 |
SRAM is probably the closest competitor, having a wide portfolio of components as well as a good reputation for its quality and price. In case of circuits, both companies seem to be on the same level, just differentiating in niches. One article even described the current market situation as a quasi-duopoly.
In conclusion, I would say that the competition around Shimano definitely enhanced in the last years. But as the market continues to grow, there will be enough space for Shimano and its competitors.
Fishing Tackle
Now, writing a lot about Shimano's business in terms of bicycle components, I want to add a brief overview of the fishing tackle market.
According to Research and Markets , the global market for fishing equipment is going to grow at a CAGR of around 4.2% until 2028, resulting in a total market value of $31.84 billion. Unlike bicycle components, this market is fragmented rather than consolidated. Still, Shimano is one of the biggest players, but there are a few others with similar market share.
And also in this case, it is very tough to find comparable and recent data from competitors, since the fewest of them are solely selling fishing equipment. Therefore, I can just provide a list, representing Shimano's biggest competitors as follows: Pure Fishing Inc., Newell Brands, Globeride and Eagle Claw.
Knowing that this is truly insufficient, I would love to hear from you if you have more provable knowledge. But since this segment only accounts for about 18%, I will leave it at that and move on to Shimano's cash flows.
Cash Flows
To analyze a company's ability to generate cash from operations, I focus primarily on its free cash flow. Despite the usual calculation (OCF - CapEx = FCF), I adjust the operating cash flow for changes in net working capital and the expenses for stock-based compensation.
Using this approach, I try to get closer to the actual cash generation of the business, as inventory selloffs, for example, won't have an impact.
In case of Shimano, the calculation for FY22 looks like this:
in ¥ billion | |
Operating Cash Flow | 110.68 |
- Stock-Based Compensation | 0 |
- Change in Net Working Capital | -30.36 |
= Adjusted Operating Cash Flow | 141.04 |
- Net Capital Expenditures | 20.09 |
= Free Cash Flow | 120.95 |
A closer look at the calculation reveals that the adjusted OCF is higher, due to increased inventories. The inventory situation was already discussed and has to be monitored, but for analyzing the pure operating business, we can assume that these short-term effects will offset each other in the future.
In terms of Free Cash Flow, Shimano was able to achieve a CAGR of 19.79% since 2013, which is more than twice their annual revenue growth rate. And also excluding the last two years, the CAGR of 16.88% until 2020 demonstrates that the business became more profitable and cash-generating over time - currently achieving a FCF margin of 19.23%.
Estimating Free Cash Flow
Although this reflects a strong market position and pricing power, the recent level of FCF is unlikely to be maintained under the given guidance.
Unfortunately, Shimano doesn't provide any cash flow forecast, therefore, I use the expected net income as an approximation. In its annual filings, Shimano forecasted the net income to decline by 33%.
Subtracting this of the current free cash flow, I obtain approximately ¥81.04 billion, which is still above pre-pandemic levels. The free cash flow estimate will be important to calculate an appropriate multiple. Before that, however, I want to discuss Shimano's cash appropriation.
Dividends, Share Buybacks and a loaded Checking Account
Since their IPO in 1972, Shimano was able to constantly pay a dividend to its shareholders that even increased at a CAGR of 12.94% in the past 10 years. At a share price of around ¥20,880, shareholders receive a dividend yield of 1.25% and 1.37%, based on the FY22 and FY23 dividends, respectively.
Hopefully, Shimano will continue to increase their dividends, as there is enough room in the current payout ratio of around 20%. And while waiting for this to happen, we move on to the next vehicle used to return shareholder value.
As you can see in the chart above, share buybacks weren't really a thing for Shimano, as the number of shares outstanding has only decreased by 1.82% since 2013, mainly due to a buyback program in the recent years. At this point, I have no knowledge about further share buybacks, but I wouldn't be too optimistic given the historical data.
In summary, Shimano does a good job at generating cash, yet not allocating it most efficiently for shareholders. And in my opinion, investors shouldn't be too hopeful that this will change soon. The Japanese business culture just isn't focused on optimising capital allocation, but rather on ensuring the company's success to last sustainably. This might contradict our experiences with businesses over here, but can be very rewarding in such a volatile market environment. Furthermore, this conservative capital allocation is reflected in the fact that most Japanese companies use little or no leverage - so let's take a look at Shimano's balance sheet.
Balance Sheet
Shimano's balance sheet is probably one of the cleanest I've ever seen and I'll tell you why. In 2022, Shimano reported cash and short-term investments of ¥430.4 billion and total debt of just ¥6.6 billion, resulting in a net cash position of currently ¥423.8 billion (~ $3.21 billion) or about ¥4,656 per share (share price: ¥20,880).
So instead of reinvesting the cash or returning it to shareholders, Shimano stacked all of it, leading to the fact that investors are currently receiving 22.3% cash, when buying shares of Shimano. This circumstance can be frustrating for investors, but is typical for Japanese companies and their accounting policy, as already mentioned.
Similar to share buybacks, this could change some day in favor of shareholder returns, although I wouldn't invest for this reason.
Valuation
Valuing Shimano can be misleading at first sight as it seems rather expensive due to the large cash position. In order to offset this effect, I would recommend using the enterprise value instead of the market capitalization.
And because we already calculated and discussed Shimano's net cash position, I just list the computation as follows:
Share Price (TYO: 7309, in ¥) | 20,880 |
x Number of outstanding Shares (diluted, in million) | 91.02 |
= Market Cap (in ¥ billion) | 1,900.52 |
- Net Cash (in ¥ billion) | 423.84 |
= Enterprise Value (in ¥ billion) | 1,476.68 |
~ EV (in $ billion) | 11.05 |
The table above highlights the significant difference between market capitalization and enterprise value in this case. As we're now taking the total company value into account, I consider the earnings to be inapplicable, as they already include payments to the creditors. Therefore, I use the free cash flow of Shimano as the most appropriate measure for future shareholder returns.
EV/FCF ratio
So using the current EV and the free cash flow of ¥121 billion, we obtain an EV/FCF ratio of 12.21, which suggests that Shimano is currently very cheap compared to the 10-year average of around 23.
Still, we have to keep in mind that Shimano's cash flows are likely to decline next year without having a specific guidance - as already analyzed under "Cash Flows". I think it would be more meaningful to use probably the lower FCF of around ¥81 billion that is derived from the current guidance, which results in a ratio of 18x EV/FCF.
* The outlier in FY16 the results from a weak operative performance and, therefore, a significant lower free cash flow. As this is a "casual" outlier, I decided to leave it in the calculation.
Based on the last 10 years, even the forward FCF multiple would be below average, indicating a reasonable pricing at the moment.
EV/Sales ratio
To verify this thesis with another metric, I reviewed the developments of EV in relation to Shimano's total revenues.
The chart above is showing a very similar progression, although being less volatile than free cash flow. However, even in this case, the current ratio of 2.38 indicates that Shimano is undervalued compared to the 10-year average of 3.28x EV/Sales.
The advantage of using this metric is that we're able to include analyst estimates to get an idea of the valuation considering future operations.
The inclusion of future revenue estimates confirms my thesis of Shimano being currently underpriced, as forward EV/Sales multiples for FY23, FY24 and FY25 would be 2.70, 2.58 and 2.44, respectively.
Risks
Now that we've found several factors that support my investment thesis, I want to add a discussion on possible risks.
Stronger-than-expected demand pressure from economic downturns
In its guidance for FY23, Shimano stated that the current economic and political environment could negatively impact Shimano's customer sentiment, as global supply chains remain unstable and monetary policies tighten. This could lead to a decline in demand for bicycles and their components. As Shimano's management is known for its conservative guidance, I would argue that the current guidance should prevent a sufficient margin of safety in terms of the expected demand. In addition to that, I want to point out that bicycles are relatively cheap compared to cars, which could make bicycles an alternative, if the current inflationary environment continues. Therefore, I would rate this risk as rather low.
Competition
In the review of Shimano's main competitors, I already mentioned that SRAM in particularly is narrowing the gap, leading to a de facto duopoly. Since Shimano is still in a leading position and doesn't have any margin problems at the moment, investors shouldn't be too worried. Nevertheless, the development of the main competitors should be monitored.
Conclusion
As an investor, I want to be involved in high-quality companies and follow them over a long period of time as they grow and create value.
Shimano fits my investment approach perfectly because it's a leader in a sustainable growth market that has already demonstrated its ability to grow cash flow over a long period of time while maintaining an excellent balance sheet.
Although the forecasted normalization of demand surprised the market, I have confidence in Shimano's management and its ability to maintain its growth record when demand returns. In addition to that, Shimano maintains a sufficiently large cash balance for any possible downturn scenario.
While I will certainly continue to provide updates on future results, I expect investors to be positively rather than negatively surprised by political action due to the increasing need to reduce CO2 emissions.
Shimano is, therefore, a clear "buy" for me at the current valuation, given the very limited downside and moderate upside potential. I have started with a position of around 5% of my single stock portfolio and will probably raise it if we see further weakness in the share price.
For further details see:
Shimano: A Unique Long-Term Compounder