2023-05-26 11:52:22 ET
Summary
- One-off restructuring expenses weighed on TDK’s headline results, but normalized profitability remained strong.
- The conservative FY24 guidance leaves ample room for more beat-and-raise quarters ahead.
- With the new mid-sized battery JV also freeing up cash for more growth investments, the long-term optionality is compelling as well.
- At a modest premium to book, the stock is priced inexpensively.
Japanese power electronics manufacturer TDK Corporation ( OTCPK:TTDKY ) ended FY23 strongly , with its underlying fundamentals staying resilient despite a challenging tech backdrop globally. Headline profitability wasn’t great at first blush, though this was largely due to higher-than-expected restructuring expenses related to loss-making business units and outdated assets (e.g., the disposal of its lithium-ion battery facilities). Post-restructuring, TDK is now better equipped to deliver margin improvements in lagging businesses like HDD, previously a drag on overall profits, with positive contributions guided in FY24 and beyond. TDK’s guidance for a step up in growth investments (helped by lower investment needs post-JV setup for battery production) also bodes well for the long-term growth optionality. Success here should, in turn, drive the stock to re-rate from the current ~1.2x P/B valuation (vs. low to mid-teens ROE).
Restructuring One-Offs Cloud Resilient Fundamentals
On the back of a solid FQ4, TDK saw its sales rise 14.7% YoY to JPY2,181bn for the fiscal year, with operating profits also up 1.2% YoY to JPY169bn. Key drivers included positive sales contributions from the energy application products segment (i.e., rechargeable batteries) due to higher renewable energy and energy-saving equipment demand. Also positive was the step up in component demand in autos – as electric and autonomous vehicles require higher component density, this tailwind is only likely to accelerate from here. With TDK’s growth segments already offsetting the flattish growth in smartphones and PCs, as well as the secular decline in HDDs, sales growth looks poised to accelerate from here.
Headline profitability growth failed to match the top-line, but to a large extent, this was due to higher-than-expected restructuring expenses in Q4. For the fiscal year, TDK has incurred restructuring costs of ~JPY47bn (up from the prior ~JPY20bn estimate), though a ~JPY12bn one-off gain related to retirement benefits cushioned the impact. Yet, these restructuring costs will yield P&L benefits down the line, as most of the spending was allocated to rightsizing the HDD business in anticipation of further declines in the broader industry. Additionally, TDK also incurred one-off losses post-disposal of outdated rechargeable battery facilities, though this should be more than offset by production at the new Xiamen site (on track to triple capacity to 32GWh through FY27). On a normalized basis, overall operating profits would have been closer to JPY200bn, up ~20% YoY.
Lots of Conservatism in the FY24 Guidance
For the next fiscal year, TDK sees sales coming in at JPY2,020bn (slight deceleration in Q1, followed by a recovery post-Q2) based on the following FX assumptions - USD/JPY of 130 (down from 135.46 in FY23) and EUR/JPY of 142 (down from 140.89 in FY23). The passive components segment will be a key source of upside, with management guiding to 9-12% YoY growth on higher auto-related shipments. The biggest surprise was perhaps the energy application products sales guidance at -19-22% YoY. While a large portion of the decline is due to the pending transfer of the mid-sized batteries business to a joint venture with Chinese battery producer CATL , management has also embedded a cautious outlook for lithium-ion battery and Android smartphone shipments. The end-market outlook reflects a similarly conservative stance outside of autos (+5% YoY in autos; +27% in xEVs), with smartphones and HDDs projected to decline by -5% and -2%, respectively.
At first glance, the operating profit guidance might seem optimistic at JPY190bn. But the delta between TDK’s yen assumption at 130 USD/JPY and spot (~140 currently), as well as the company's cautious rechargeable batteries volume growth outlook, leaves ample room for outperformance. Margin assumptions for rechargeable batteries also seem conservative, particularly for the smaller categories (volume decline, flat margins). Mid-sized batteries are on track for 10% segment margins, though scale benefits following the planned ramp-up at Xiamen (scheduled to kick off in FY24 and contribute JPY500bn sales by 2030) should drive improved unit economics going forward. That said, any boost to profits will need to be balanced by higher R&D and reinvestment needs, potentially at the expense of shareholder returns.
Leveraging the JV Approach to Inorganic Growth
One of the biggest changes in the pipeline for TDK’s business is the transfer of its mid-sized secondary battery production to a separate JV with CATL; the JV is scheduled to take on full control of production by FY25. The new Xiamen City-based manufacturing site is scheduled to kick off in FY24 at <10GWh, after which production will ramp up to 32GWh in FY27. So even with segment sales set to decline ~20% in the initial year post-transfer, the targeted production capacity expansion (3x by FY27) should more than compensate, driving consolidated net sales growth to JPY500bn by 2030. Given the high-growth addressable market opportunities such as energy storage systems and compact electric vehicles (via its proprietary pouch and cylindrical cell tech), prioritizing scale makes sense. Hence, sharing the capex burden via a JV approach seems like the right way to go.
TDK will also deploy any excess cash from the disposal of its battery facilities post-restructuring into reinvestments to accelerate growth in high-growth areas in passive components and sensors. Management will leverage a JV approach as well here via a $150m corporate venture capital fund (67%/33% split between TDK Ventures and Amperex Technology). Given the company’s prior success in leveraging its VC fund to gain access to leading-edge materials and tech innovations ahead of rivals, the latest fund will likely adopt a similar approach for batteries. There should still be ample headroom for capital returns, though – management has guided to JPY80bn of free cash generation in FY24 (vs. JPY28bn in FY23), helped by a lower capex burden post-formation of the mid-sized battery JV.
Conclusion
Amid a challenging tech backdrop in the January-March quarter, TDK’s underlying FY23 profitability was impressively resilient (excluding one-off charges). With the overall business also in much better shape post-restructuring and the FY24 guidance screening conservatively, the path is clear for more positive earnings surprises in the coming quarters. TDK’s JV approach should also help with the investment burden, raising optionality with regard to growth and shareholder returns. In the meantime, the stock trades at an undemanding ~1.2x book (vs. low to mid-teens ROE); with the market still largely skeptical of TDK’s growth prospects, the risk/reward seems favorable here.
For further details see:
TDK: Fundamentals Resilient As The Growth Transition Continues