2023-09-02 05:25:15 ET
Summary
- Shimano, a Japanese firm specializing in bicycle components and fishing gear, has underperformed the S&P 500 but is potentially undervalued.
- Despite a decline in net sales and operating income, Shimano remains on a strong growth path and is financially stable.
- Shimano has a dominant market position in the competitive segment of bicycle components and has minimal competition, making it an attractive investment.
- The company has found a recent appetite for share buybacks, which paired with its strong cash position, might be a big catalyst for an increase in its stock price.
- The favorable exchange rate of the yen compared to the dollar provides an extra opportunity for further price gains.
Thesis
Shimano ( OTCPK:SMNNY , OTCPK:SHMDF ) is a Japanese firm which mainly fabricates bicycle components and fishing gear. It is the market leader in the competitive segment of bicycle components and one of the market leaders in fishing gear. Since the stock peaked in late September 2021 it has underperformed the S&P 500 by a wide margin. My analysis shows that the company is potentially undervalued and operates in a market segment that grows a lot faster than the general economy. Especially its strong cash position and its wide moat make it an attractive investment for investors who seek above average returns while sleeping well owning them.
Recent results
Shimano recently publicized its first half results for 2023. Net sales and operating income were down by respectively 13.3% and 33.4% (in yen). So why am I excited about this company? As a competitive cycling fanatic myself I have seen a huge influx of new cyclists buy new bikes during Covid, as its popularity surged. This has led to unsustainable peak sales for Shimano in 2021. In 2022 these sales normalized, which has led to a sell-off of the stock. The company, however, remains on a strong and sustainable growth path while being financially rock-solid. I therefore believe that the recent sell-off has created a favorable entry point for new investors in this iconic company. This is even more the case for non-Japanese investors, as the Japanese yen is currently the weakest it has been in decades when compared to the dollar.
What does Shimano do?
Shimano is the market leader in the competitive segment of bicycle components. Next to this, it is one of the market leaders in the business of fishing gear. It was founded in 1921 by Shozaburo Shimano in Sakai, Osaka, and has thus been around for a long time while thriving in recent decades.
In this article I will be focusing on the bicycle components business as this is my area of expertise. Shimano is a household name within cycling and especially has a deep integration in the competitive road cycling scene. The vast majority ( 70% ) of mid to high end components in cycling is made by Shimano and 50% of the general market is captured by it.
Its brand and reputation of creating quality components combined with a deep integration in the downstream network of vendors give it a huge moat and hence pricing power. The nature of the business (components) also means that there is a consistent stream of revenue, as parts need to be replaced often. This is especially true for competitive cycling in which the low weight of the components and the large forces on the components results in shorter life-spans of the components.
How do its financials look like?
Shimano also boasts strong financials and is priced attractively. Twelve month trailing TEV/EBIT is just below 10 and its P/E ratio is around 17. The large difference between TEV/EBIT and P/E is caused by Shimano having over $3.4 billion in cash on its balance sheet. This is typical for Japanese firms, as they commonly have large cash positions on their balance sheet. I see this as a very positive thing, as it makes Shimano very recession resilient. Even better, there is a growing appetite within the company for buying back shares with this huge pile of cash! Before 2021 Shimano actually very rarely bought back shares, but recent buybacks (2022 FY) have totaled over $260 million. It thus seems that Shimano’s strong cash position is being put to good use in the investors’ advantage.
Furthermore, next to being priced attractively and possessing a huge moat in the industry, Shimano is also very efficient. Its return on invested capital ((ROIC)) has consistently been in the high teens to low twenties, showing that the firm is productive in finding new and profitable investment opportunities. Gross profit margins are consistently above 40% and EBIT margins are north of 20%, which gives the financial backing of the claim of the company possessing a huge moat. Capital expenditure is also low, with only $100-$200 million being spent annually on capex.
The icing on the cake is Shimano’s debt position, which is effectively $0, thus making it one of the most recession resilient companies one can buy.
Competitors? Barely.
As I already stated above, Shimano has a huge moat in its main market, the cycling industry. As an avid cyclist myself I know how reliable Shimano’s components are and how widely they are used in the cycling world. The company has two main competitors, Campagnolo and SRAM. Both, however, are not listed and thus their financials are not openly available.
The former, Campagnolo, is a small boutique Italian brand. It is mostly used on Italian road bikes in a nostalgic fashion and poses no real threat to Shimano. Its components are widely known to be inferior and more expensive than Shimano’s.
SRAM, however, is a different story. SRAM is also widely adopted in the cycling world and especially has a strong foothold in mountain biking. Shimano and SRAM basically operate as duopoly in the market for performance bicycles. So far SRAM has not yet eaten into Shimano’s profits and margins, but it remains a strong and potentially dangerous competitor. Shimano’s financial position and great margins, though, make it very adequately equipped for any competition or market downturn. In fact, during tough market conditions the company is actually in a very favorable position due to it having zero debt and a huge financial war chest.
Global bike trends form a huge catalyst for further growth
Competitive cycling is a fast growing sport with high margins and cycling as a whole is getting more and more popular due to it being one of the most efficient, low-cost and eco-friendly modes of transport. According to Technavio the high-end bicycle market is expected to grow at a CAGR of 6.16% between 2022 and 2027. Grand view research estimates a CAGR of 9.7% for the bicycle market as a whole.
Shimano is the dominant player and has the best products on the market. As it operates in the premium-end of the market, it is especially associated with more expensive bikes. As global trends gravitate towards e-bikes, which are more expensive, it makes more sense to use premium material such as Shimano’s. Thus it is adequately equipped to profit from the general market growth rates as well. In my valuation I will be using the CAGR of the bicycle market as a whole since I think that Shimano is very well positioned to benefit from a trend of more expensive E-bikes.
A quick note on fishing
The market for fishing equipment is not my area of expertise. However, one cannot put a correct valuation on Shimano without taking this part of its business into consideration. Just under 20% of its sales come from selling fishing equipment. The market for fishing equipment is expected to grow at a CAGR of 4.3% over the period 2023-2028. This is also the growth rate I will be using in my valuation for this piece of Shimano's business.
Valuation ((DCF))
It is difficult to value Shimano in a relative setting, since there are no direct competitors listed on the stock exchange. Therefore I will solely resort to a DCF analysis for putting a valuation on the stock. I will be conducting this valuation in Japanese Yen. Over the last five completed fiscal years (2018 – 2022) Shimano has had free cash flow vary between ¥27.3 billion (in 2018) and ¥96.3 million (in 2021). 2018 was a particularly poor year for Shimano, while 2021 was a particularly good year. Free cash flow in 2022 has been ¥90.4 trillion. I will be using the 2022 free cash flow as a starting point, as this seems to be in line with the general growth path of the company.
Cash flow per share in 2022 was ¥913.7. Coupled with this, I will use a terminal growth rate of 3% (which is quite conservative), a discount rate of 10% (as we want to outperform the S&P 500), a combined growth rate of 8.6% (growth rate of the overall market for bicycles (80% at 9.7%) and fishing equipment (20% at 4.3%)) and a time horizon of 10 years. This gives us an intrinsic value just north of ¥20 thousand, which is slightly below the current price. However, it does not factor in the huge net cash position that Shimano has. This huge pile of cash is what makes it particularly interesting as the firm has found a recent appetite for buying back shares. As my DCF analysis just takes into account the value of the business itself, it makes Shimano a very interesting investment if the company is putting its cash to good use for its investors.
In the second figure I also ran the same calculation with different growth rates. It gives a bear case in which the free cash flow will grow 5% and a bull case in which free cash flow will grow 15%.
Conclusion
Shimano is a rock-solid quintessential stalwart. Its financial situation in impeccable and it operates a moated market leader in a faster than average growing industry. After a recent sell-off in its stock resulting from normalization of sales after its record 2021 year, it is poised to grow at an above average pace. With a TEV/EBIT below 10, DCF analysis showing it correctly valued and a huge cash position with a growing appetite for share buybacks, investors are bound to profit from investing in it. On top of this the favorable exchange rate of the yen compared to the dollar can provide extra future gains. I therefore give it a 'Strong Buy' rating.
For further details see:
Shimano: Wide Moat, Underfollowed, And Cash Rich