Makita: Despite Strong Fundamentals, Not A Buy

| About: Makita Corp. (MKTAY)

Makita Corporation (NASDAQ:MKTAY) manufactures and markets an array of electric power tools globally. It also produces and sells woodworking machines, air tools, garden tools, and household tools. Makita was founded in 1915 and is headquartered in Anjo, Japan. Makita is also active in manufacturing outside Japan. Makita has expanded its global manufacturing base for power tools and other products to encompass China, the United States, United Kingdom, Germany, Brazil, Romania and Thailand. At present, Makita manufactures approximately 80% of its products outside of Japan.


The best way for an enterprise to improve profitability is by increasing its sales revenue. The best companies produce revenue year in and year out. In the case of Makita, annual revenues have increased steadily since 2010. Over the past five quarters, revenues have grown more than 25 percent. These figures indicate steady growth in revenues.
Investors need to be aware of the risk a business faces on account of unexpected higher cost of goods sold (COGS). At Makita, cost of goods sold has increased about two percent since 2010 as a percentage of revenue. This suggests only a modest increase in COGS. However, over the past five quarters, COGS has been flat as a percentage of revenue.
Investors also need to know if management is spending efficiently or wasting valuable cash flow. Makita's annual selling, general and administrative (SG&A) expenses have markedly declined since 2010 as a percentage of revenue. Over the past five quarters, SG&A expenses have remained in line with the most recent annual figures. SG&A data demonstrate a high degree of managerial efficiency.
Companies with high gross margins will have substantial money remaining to spend on other business operations, such as research and development or marketing. In the case of Makita, annual gross margins have lost two percent since 2010. Over the past five quarters, gross margins have decreased slightly. These figures signify a modest decreasing trend in gross margins.
Operating margins display the effectiveness of the enterprise's control of costs, or whether sales are increasing or decreasing faster than operating costs. At Makita, annual operating margins have increased about two percent since 2010. Over the past five quarters, operating margins have been relatively flat, except for the third quarter of 2013, which witnessed a four percent increase over the second quarter. Overall data represent a slow increase in operating margins.
An equity's profit margins usually determine whether or not it has advantages over its competition. Companies with high net profit margins have a larger buffer to protect themselves during lean times. Companies with profit margins reflecting a competitive advantage are able to improve their market share during downturns, an advantage that will improve their position in an upturn. Makita's annual net income margins have gained only one percent since 2010. Over the past five quarters, net income margins have been steady, except for the third quarter of 2013, which saw a three percent increase over the second quarter.


Cash offers protection during lean times, and it also gives enterprises more options for future growth. In the case of Makita, its cash position declined from 2010 to 2012, but has markedly increased this year. Over the past five quarters, cash has increased over 60 percent. This cash growth indicates strong company performance.
Investors need to know if a company has too much money tied up in its inventory. If inventory grows faster than sales, it is almost always a sign of deteriorating fundamentals. At Makita, inventories, as a percentage of revenue, have increased nine percent since 2010. Over the past five quarters however, inventories have maintained pace with growth in revenue. This suggests that Makita has stabilized the longer-term expansion of inventory.
If a company's collection period is expanding, it could signal problems ahead. The company may be allowing customers to extend their credit in order to recognize greater top-line sales. Makita's receivables as a percentage of revenue have been flat since 2010. Over the past five quarters, receivables have decreased slightly as a percentage of revenue. This shows that Makita's collection period is stable.
If a company's current liabilities are large relative to its current assets, that is an indicator that the company has a shortage of working capital and may have trouble paying its immediate bills. If the company's long term liabilities are large relative to its equities, the company is said to be highly leveraged, and may, in a difficult economy, have trouble servicing its debt load. Current liabilities as a percentage of current assets have been steady since 2010. Over the past five quarters, this figure has remained low. Non-current liabilities as a percentage of assets has been steadily low on an annual and quarterly basis. Makita's current and total liabilities are well under control.


Cash helps companies expand, develop new products, buy back stock, pay dividends, or reduce debt. Investors tend to prefer companies that produce a net positive cash flow from operating activities. In the case of Makita, cash flow from operating activities has been mixed since 2010. This year, operating cash flow has increased significantly over 2012, but the figure remains well short of its 2010 high. Over the past five quarters, this figure has been positive.
Investors want to see a company re-invest capital in its business by at least the rate of depreciation expenses each year. At Makita, cash flow from investing activities, with the exception of 2012, has been steady since 2010.
Cash flow from financing activities is of interest to investors because it illustrates how much cash flow is attributable to obtaining and repaying financing. Makita's cash flow from financing activities has been flat since 2010 and for the past five quarters. This is in line with its low liabilities.
Free cash flow signals a company's ability to pay debt, pay dividends, buy back stock and facilitate the growth of business. Free cash flow can be returned to shareholders or invested in new growth opportunities without hurting the existing operations. A company's ability to pay for its own operations and growth signals to investors that it has very strong fundamentals. At Makita, free cash flow has increased significantly this year over 2012. It is, however, well short of its 2010 highs.


The Makita ADR currently trades at $49.53, with a price-to-earnings ratio of 20.09. Volume tends to be low and bid-to-ask spreads are high. The ADR is not optionable, but it offers a dividend yield of 1.47. Makita's share price has outpaced all of its income metrics. A 51-percent increase in the price since the end of the 2009 fiscal year accompanied the 26-percent increase in revenue over the same period. The appreciation of the U.S. Dollar and Euro against the Japanese Yen has flattered Makita's top line. But the Yen does not live in a vaccum. The Federal Reserve, Bank of England and European Central Bank will continue to buy assets. A reversal of the Yen's performance would adversely affect Makita's income statement. Despite being a well-managed company, Makita is not recommended by this author on that account.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.