2023-09-05 00:05:46 ET
Summary
- Shimano reported its results for the first half of 2023, which included a lowered guidance, leading to a decline in the share price.
- While the current year will probably be tougher than expected for Shimano's business, the company remains confident about its underlying prospects.
- Regarding the updated estimates, the latest sell-off seems reasonable, and yet it offers investors a long-term horizon to accumulate shares at lower prices.
Shimano Inc. ( SHMDF ) is a very unique company that was a perfect fit for my portfolio due to its strong balance sheet, capital efficiency, and favorable industry trends. In my last article , I looked at each of these aspects in more detail, but especially in light of the current guidance. The conclusion was: Shimano is a good long-term investment opportunity, even if the normalization of demand would burden the share price in the short term.
Since then, unfortunately, Shimano has surprised investors with two consecutive downgrades of this year's outlook, resulting in a -14% drop and a more pessimistic sentiment than six months ago.
Nevertheless, Shimano may now offer a more compelling investment opportunity than ever before, if one can be patient and wait for the company's secular growth to unfold.
Operating business Performance
In the first half of the year, Shimano experienced the expected slowdown in demand for bicycle components due to weak customers and continued high inventories. In contrast, the fishing equipment business held up well, mainly due to strong Japanese and European markets.
Overall, compared with the first half of the previous fiscal year, Shimano's sales decreased by 13% to ¥263 billion. Due to the weight of the bicycle components business, the solid +7% result in the fishing segment only partially offset the decline. And a similar, but more volatile, picture can be drawn for operating income and the corresponding margins by business segment. For the first 6 months of fiscal 2023, Shimano achieved an EBIT of ¥54 billion, down 33% YoY, which also represents a lower margin of 20% overall. Again, most of the decline came from the bicycle components segment, while the operating margin of the fishing tackle segment remained roughly the same.
Overall, Shimano's first-half results were in line with the underlying market conditions and exceptionally high comparables. Additionally, if we recall the originally issued guidance (year-end 2022), we can see that Shimano even exceeded these numbers on the top and bottom line. The biggest difference from the original guidance was on the EPS side, where Shimano reported ¥556.81 per share, 25% more than originally expected. The reason is simple: Shimano is finally getting a return on its huge cash pile. That is, Shimano earned ¥8.4 billion in interest income alone in the past 6 months. A bonus that is likely to continue as long as interest rates remain high.
Outlook
Now, we need to take a closer look at Shimano's perspective on the remainder of the year, as the originally issued outlook was cut back multiple times.
in ¥ million, excl. EPS | End of FY2022 | End of Q1/23 | End of Q2/23 | ||
Year | 2019 (Pre-Covid) | 2022 | 2023a | 2023b | 2023c |
Revenue | 363,229 | 628,908 | 500,000 | 460,000 | 450,000 |
Operating Income | 68,010 | 169,158 | 105,000 | 83,000 | 70,000 |
Net Income | 51,834 | 128,179 | 86,500 | 69,500 | 69,000 |
EPS | 559.15 | 1,405.70 | 954.44 | 768.79 | 763.24 |
As we can see from the summary table above, Shimano has significantly changed its guidance for FY2023 over the past two quarters. Instead of the originally expected sales of ¥500 billion, the company is now forecasting ¥450 billion, -10% lower than before. But more importantly, Shimano is reiterating its expected operating income and EPS of ¥70 billion and ¥763.24, respectively, indicating lower operating and net margin expectations. Shimano's management commented on its expectations as follows:
The consolidated business performance forecasts have been revised as follows in light of current trends in the first half of fiscal year 2023 where market inventories remain at a high level. Against this backdrop, retail sales got off to a slow start due to unfavorable weather conditions in the European market in early spring, which is expected to cause delay in recovery in demand for the Company's products in the second half of the year. Moreover, production cutbacks at factories are making it difficult for us to absorb the rise in manufacturing cost ratio.
In other words, Shimano's sales are suffering a little more than expected from the anticipated cool-down, mainly due to a slower recovery in demand and high inventory levels. In particular, high inventory levels are preventing a rapid return to baseline demand. In addition, Shimano can realize lower cost advantages due to reduced production capacity, which is probably going to result in lower margins in the future.
The Big Picture
After recalling all this "bad" news, I think it's important to take a step back and put these numbers into perspective.
The chart above shows the evolution of Shimano's total sales and operating margins from pre-pandemic levels to the current guidance for 2023. We can immediately see that the lowered sales level still represents a healthy and reasonable normalization given the accelerated consumption in 2021 and 2022. On the other hand, the operating margin is expected to be around 16%, which is lower than the pre-pandemic level, but still fine given the situation.
From my perspective, Shimano now seems to have a clearer view of the customer and market environment, so I would rate these numbers as very likely. Of course, a decline in sales and operating income of 28% and 59%, respectively, looks really bad at first glance, but still results in a healthy operating business with solid profitability.
Looking ahead, Shimano is likely to return to its historical growth trajectory as the underlying secular growth trends for the industry remain, with Shimano in a leading position.
Tour de France
The industry-leading position of Shimano was further underscored during this year's Tour de France.
Out of 22 participating teams, only four teams have chosen either SRAM or Campagnolo instead of Shimano for their drivetrain, showing a well-known dominant image. Moreover, the number has even decreased in the last year, with UAE Team Emirates switching to Shimano at the beginning of 2023.
However, it should be noted that this year's winner, Jonas Vingegaard, was one of the riders using SRAM drivetrains, which further reinforces SRAM's image as Shimano's closest competitor.
Tour de France: Unchained
Another exciting news for Shimano was the release of "Tour de France: Unchained" on Netflix, which follows eight teams at last year's Tour de France, seven of which used Shimano drivetrains.
If this series is anything like the F1 series "Drive to Survive", it could create additional hype around cycling and solidify Shimano's brand recognition as an industry leader. However, opinions vary on whether the concept can be successfully applied to cycling. 2018 Tour winner Geraint Thomas seems excited and optimistic, stating :
If it can bring in a new audience and make cycling more popular, that's great. I've watched Drive to Survive and it's certainly got me into F1. You know much more about what goes on. People may find the Tour more interesting when they understand the different aspects to it, and how teams work. It will be interesting for established cycling fans and new fans as well. Hopefully it brings in a bigger audience and ultimately more interest and money into the sport.
So the real impact of this series remains to be seen, although a second season has already been announced .
Cash Flows
Having put Shimano's current situation into perspective, we can now proceed with an updated analysis of its ability to generate cash flow.
To analyze a company's ability to generate cash flow, 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 the first half of FY23 looks like this:
in ¥ billion | |
Operating Cash Flow | 57.401 |
- Stock-based Compensation | 0 |
- Changes in Net Working Capital | 8.145 |
= Adjusted Operating Cash Flow | 49.256 |
- Net Capital Expenditures | 8.473 |
= Free Cash Flow | 40.783 |
In contrast to recent years, I achieved a lower adjusted OCF as Shimano's inventories and accounts receivable decreased, which I believe is a positive sign. Comparing free cash flow of ¥41 billion to total sales of ¥263 billion, the FCF margin is around 15.5%, which is still above the pre-pandemic level.
To get an idea of a possible free cash flow for FY23, I think the ratio of FCF to Shimano's ordinary income is a good proxy. Assuming that we are also likely to see pre-pandemic levels here, I took the 2019 FCF to ordinary income ratio of 70%. Multiplying this by Shimano's projected ordinary income of ¥93 billion, we get a possible free cash flow of around ¥65 billion.
In doing so, we're accounting for the entire 47% decline in Shimano's profitability, which is why I feel very comfortable with this.
Valuation
After taking a look at the potential impact on future cash flows, we are now finally ready to reevaluate Shimano's stock.
To arrive at a forward multiple for FY2023, I used the current enterprise value of ¥1,456 billion and the free cash flow calculated above. Therefore, at a current share price of ¥21,485 (~ $146.95), Shimano trades at a forward EV/FCF multiple of about 22x.
Of course, this valuation seems pessimistic as the current multiple would be much lower. However, the normalization of Shimano's operating results will continue, especially this year, and I think my assumptions are very reasonable going forward.
Compared to Shimano's average pre-pandemic multiple of around 28, the current valuation seems at least fair and slightly cheap. However, the recent decline in the share price is justified due to lowered expectations, especially with regard to the company's profitability.
Takeaway
Shimano's first-half results weren't very appealing to me, and especially the lower guidance caught me off guard. Considering that the current market environment won't get any easier in 2023, I think the stock will have a tough time this year.
However, I remain very optimistic about Shimano's long-term prospects and operational strengths, and therefore increased my rating slightly, even though the current valuation does not call for an urgent investment.
My underlying assumption remains that Shimano's share price is likely to rise after 2023, when the operational headwinds flatten out and product innovations start to pay off. Until then, I will continue to monitor the company's development and train my patience.
For further details see:
Shimano: Compelling Opportunity On Current Headwinds