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Japan’s Keyence (OTCPK:KYCCF) (6861.T) is a exceptional firm in lots of respects. This chief in automation and automation-enabling applied sciences has generated low double-digit income progress and mid-teens free money stream progress over the previous decade, producing unimaginable margins whereas additionally reinvesting in the enterprise and persevering with to innovate. It is usually probably the most opaque, difficult-to-follow firms on the market, and in case you don’t learn Japanese, I feel it will likely be a battle to maintain up with quarterly outcomes.
Keyence has additionally been valued because the uncommonly distinctive firm that it’s, and that has lengthy been one among my main points (I communicate/learn Japanese, so the shortage of English language info is much less limiting). Even so, the shares have risen one other 45% or so in native forex since my final replace (down 10% in U.S. {dollars} for the ADRs, although), outperforming Omron (OTCPK:OMRNY) (6645.T) (down 28%) and Hexagon (OTCPK:HXGBY) (up 18%), whereas lagging ABB (OTCPK:ABBNY) (up 138%) and Siemens (OTCPK:SIEGY) (up 75%).
At this level I regard Keyence as an “is what it’s” kind of funding. Finish-markets like autos and machine instruments aren’t doing nice proper now, and markets like chemical compounds are slowing, however electronics and semiconductors are trying higher and I’m nonetheless very a lot bullish on the long-term prospects for automation as nations like Japan take care of persistent labor shortages. Valuation merely doesn’t work by the approaches I take advantage of, however I’ve little motive to imagine that Keyence received’t stay a progress chief throughout companies like machine imaginative and prescient, metrology, security, sensing, and management.
Sluggish Gross sales And Softer Margins
Like different firms within the automation and precision equipment business (ABB, Emerson (EMR), a part of Honeywell (HON), Rockwell (ROK), Siemens, et al), Keyence has seen a slowdown in its enterprise as firms in a spread of end-markets pull again on capex within the face of higher macroeconomic uncertainty.
The final quarter (the fiscal fourth quarter) noticed over 7% progress in reported income, however underlying progress was nearer to flat, with gross sales in Japan down 1%, gross sales in Asia up 2% in native forex, gross sales in Europe up 2% in native forex, and gross sales within the Americas up 6% in native forex. This was truly higher than the instantly prior quarter, although, with all areas besides Europe accelerating on a sequential foundation, helped by stronger demand within the semiconductor/electronics area.
Gross margins stay fairly sturdy, up one other 200bp to 83.7% within the final quarter. No, that isn’t a misprint. Keyence makes use of an outsourced manufacturing system like Atlas Copco (OTCPK:ATLKY), however goes even additional, and that drives distinctive gross margins.
Working revenue rose 4% as reported (however declined 3% in fixed forex), with working margin down 160bp to 52.1%. An working margin above 50% is fantasy for many industrial firms (even when Keyence is extra of a design and engineering firm in some respects), besides, Keyence has now seen eight straight quarters of declines, due largely to vital hiring exercise, as the corporate elevated its worker rely by 16% in FY 2024 after an 18% improve in FY’23.
It is also price noting that that the corporate continues to build up money on the steadiness sheet. The corporate raised its dividend by 50% in FY’23 (to 300 JPY/share), however payout stays at round 20% of free money stream and there may be now about JPY 4,671/share in short-term money and securities on the steadiness sheet (in opposition to a latest value of round JPY 75,580).
Ample Alternatives Throughout The Enterprise
Whereas many industries have pulled again on capex just lately, the general outlook for automation and precision tools stays fairly wholesome for Keyence and the corporate’s huge breadth of merchandise give them a probably vital share of pockets with vital automation tasks.
Whereas American traders have a tendency to consider Keyence when it comes to its machine imaginative and prescient enterprise (the place it competes with Cognex (CGNX)), that is solely round 10% to fifteen% of the enterprise. Extra vital are companies like sensing and measurement, the place it competes with firms like Omron, Honeywell, and SICK, and certain generates round 25% to 30% of income, automation (PLCs, HMIs, security, et al), the place it competes with the likes of ABB, Emerson, Honeywell, and Siemens and certain generates round 30% of income, in addition to different companies like marking/printing (the place it competes with firms like Dover (DOV) and Danaher (DHR)) and metrology.
As firms look to extend their automation and implement industrial IoT with smarter edge units, sensing/measurement merchandise and management programs will solely change into extra vital. Likewise, machine imaginative and prescient remains to be a progress market, not solely as standalone programs for purposes like warehouse automation, but additionally as imaginative and prescient programs for robotic programs.
It’s additionally price noting that Keyence performs an unusual emphasis on product growth and customer support. Whereas the corporate usually produces standardized merchandise, I don’t know of different firms of this dimension that ship high-end merchandise with such quick lead-times, and the corporate continuously appears to be like to keep up a excessive proportion of gross sales from merchandise launched throughout the final two or three years – I want I had the numbers to again that up, however it’s a level administration has reiterated many instances over time of their earnings displays.
All in all, Keyence is a modern picks-and-shovels vendor to automation, and I feel that’s going to be a terrific place to be for the subsequent decade. Provided that I imagine precision – be that in measurement or motion – goes to be a key enabling expertise, Keyence’s capabilities in sensing, management, and measurement look like an ideal match for the place lots of its markets are going.
The Outlook
I do nonetheless see dangers to the near-term outlook from weak spot in key markets like autos and machine instruments, in addition to weak demand in logistics and iffy demand in meals and pharma markets. Semiconductors and electronics are perking up, although, and I do suppose course of markets exterior of chemical compounds are nonetheless wholesome (and I do suppose chemical compounds is simply going by a pause, as Western firms reinvest in sustainability and Chinese language firms spend money on capability).
I do suppose Keyence can generate round 6% to 7% income progress this yr, and I don’t dismiss 10% progress if shorter-cycle industrial markets choose up across the finish of this calendar yr. Long run, I feel 9% income progress is attainable and given Keyence’s historical past, which may be conservative.
On the margin aspect, I feel the corporate is probably going near the top of its hiring growth part and weaker operational leverage from the gross sales slowdown. I do suppose FY’25 EBITDA margin might nonetheless be down round two or three factors from the prior yr (to round 50%), however I anticipate growth within the subsequent few years. On free money stream margins, I see no motive why the corporate can’t proceed to generate mid-30%’s FCF margins over the long run; I’m unsure that high-30%’s or 40%’s are sustainable given how optimized the enterprise already is. With that, I’m anticipating excessive single-digit FCF progress.
Valuation is a dialogue that nearly feels pointless, as Keyence virtually by no means appears to be like low cost. Discounted money stream? You both have to anticipate mid-teens FCF progress throughout the subsequent decade or use a mid-single-digit low cost charge, or some mixture in between. Likewise, with margin/return-based approaches, Keyence trades properly past any kind of regular valuation parameters and the inventory trades at round 45x FY’25 earnings.
The Backside Line
I’m not going to say that Keyence can’t head increased from right here, significantly as Keyence’s enterprise mannequin is so very completely different than different comparables. Nonetheless, it’s a must to make your peace with the valuation and the lack of knowledge (even in case you can learn Japanese, the extent of disclosure isn’t that good) and belief that progress in world automation demand will proceed to gasoline alternatives for Keyence to proceed to outgrow its friends. That mixture doesn’t actually work for me, however I do acknowledge the excellence I see right here.
Editor’s Word: This text discusses a number of securities that don’t commerce on a serious U.S. trade. Please concentrate on the dangers related to these shares.
