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Hitachi (HIT) is a Japanese based conglomerate operating through 11 segments. The company's business operations are diverse, ranging from construction machinery to consumer electronics and power plant machinery. One of the oddities of Hitachi's business is the large number of subsidiaries which are not wholly owned. These subsidiaries typically trade on the public markets and are run somewhat autonomously. From an accounting perspective, the majority are fully consolidated with a minority interest shown to account for the portion not owned by Hitachi.

Hitachi's largest cash flow generating segment is Information & Telecommunications Systems, representing 19% of EBITDA (all figures on a fully consolidated business). Products include servers, telecommunications equipment and storage platforms, among others. The company also provides system integration and outsourcing services through the segment.

The company's second largest segment is High Functional Materials & Components generating about 16% of EBITDA. The segment represents majority stakes in three companies trading on public markets: Hitachi Cable (5812), Hitachi Chemical (4217) and Hitachi Metals (5486). The products produced by the segment include specialty chemicals and metals, and cables for electronics as well as power transmission.

The Construction Machinery segment is the third largest and represents about 12% of EBITDA. The segment is not wholly owned by the Hitachi, with about 45% of the shares in Hitachi Construction (6305) held by outsiders through the public markets. Hitachi is a major manufacturer of hydraulic excavators, mining equipment and other construction machinery largely serving the Asian and Pacific markets.

Hitachi's final segment with cash flows over 10% of the total is Financial Services which represents the Company's share of Hitachi Capital (8586). The segment provides lease capital, automotive financing and loans for certain consumer goods.

The remaining seven segments of the company's business constitute between 1% and 9% of total company EBITDA. Products range from TVs to nuclear power plants with trains, automotive electric power trains and refrigerators in between. The company is currently in the process of divesting its rather considerable hard disk drive business to Western Digital (NASDAQ:WDC).

One fact of interest is that of Hitachi's 30 Executive Officers, the majority of which are heads of the various business segments or are senior group managers, 29 have been with the company for at least 30 years, with most in the range of 35 to 40 years. The single exception is the head of government affairs that recently joined after a career at MITI, the government agency responsible for industrial policy.

Financials

Performance over the past several years has been quite volatile especially in terms of income generation, both in operating and net terms. Revenue has stagnated over the period, in part driven by the strong yen, while operating profit has grown overall. Net income has been very weak o, showing significant divergence from operating income. In 2009, this was driven by a large deferred tax charge.

Cash from operations has been significantly more stable than operating or net income. This effect has largely been driven my working capital releases during downturns and non-cash charges included in profit. Investing cash flow shows that until recently, the company has reinvested nearly all the cash flow generated by the business; however over the last two years, Hitachi has pulled back quite a bit on its investments.

Since 2009, the increase in profit has been driven by Digital Media & Consumer Products and High Functional Materials & Components. Construction Machinery & Information and Telecommunications Systems showed some weakness in 2010-11, but in the TTM period has exceeded 2009s performance. For the last nine months, Power Systems, High Functional Materials & Components and Components and Devices have run into trouble with profits declining mainly due to delays in certain large projects and lower product sales.

Not unlike a number of large Japanese conglomerates, Hitachi's returns on capital are quite low; perhaps less than half the cost of capital. A company with operations as diverse as Hitachi makes it difficult to pinpoint the reason, but many years of historical over-investment and a slow response to changing macroeconomic conditions are likely go a long way toward explaining the condition.

Value Conclusion

Hitachi trades at a multiple of 9.6x analyst's fiscal year ending March 2012 earnings estimates, which includes one forward quarter. After adjusting for excess cash, the multiple is about 7x. The true multiple is somewhere in between as the company's cash balances could hardly be considered risk-free given the poor historical performance. Fiscal 2013 estimates call for about an 8% increase in earnings, but given the downturn in certain operating segments, there is risk to this forecast in my view.

Since 2006, average net income after adding back non-cash charges is likely barely positive based on average operating income and the differential between operating and net income in the more normal years. This would make the PE based on average earnings very high and not meaningful. Price to book, excluding goodwill is about 1.7x, another marker of quite high valuation given the poor historical profitability.

Given the current difficulties in Hitachi's business, lack of historical profitability, poor returns on capital and not especially cheap valuation, it is hard to get excited about the stock's prospects. Even though the company is currently restructuring, the magnitude of change needed is likely in excess of its ability to adapt. Every year a company must change just to keep up with competitors and the business environment -- doing that while fixing Hitachi's currently outstanding problems will be very challenging. For Japanese restructuring plays, businesses with simpler operating structures should be targeted, in my view.

Source: Hitachi: Optically Cheap, But Current Valuation Justified