Cameras and Copiers
Canon (CAJ) is a manufacturer of printers, copiers, cameras and semiconductor manufacturing equipment headquartered in Japan and is one of the largest companies on its home market. The company generates about 31% of its revenue in Europe, 27% in the Americas, 20% in Japan and the balance in Asia and Oceania. Canon operates in three segments, as shown in the following figure:
In terms of operating income, the company's largest segment is Office. This includes printers, copiers and multifunction devices which combine the features of printer, copier and scanner. Canon maintains the largest share for products in this segment globally and in most regional markets. The move to color copiers from monochrome has been the biggest product driver in the business in recent years, but while unit sales have generally grown, pricing has declined.
The Consumer business includes high-end digital SLR cameras, lower-end point and shoot digital cameras, camera accessories such as lenses and inkjet printers. The company maintains a dominant position in this segment with respect to cameras as it leads market share and has a strong awareness for its Power Shot, EOS and EF lens brands. Canon derives by far the most value from sales of higher-end products compared to the more popular low-end products. Internally, the company has increased its focus on high-end lenses to drive sales. The company is also a major manufacturer of ink jet printers, a technology they invented.
Industry and Other is the last of Canon's segments and also by far the smallest. Products include lithography and other equipment used in semiconductor manufacturing, medical imaging equipment and other miscellaneous products.
Muted Recovery From Recession
Revenue and profit have fallen steadily over the past years driven primarily by weakness in the Office segment, although Consumer has been a contributor to declines as well. As with all Japanese companies, the trend of yen appreciation has impacted sales growth negatively and profit to a certain degree as well.
On the positive side, operating and net income have remained consistent in relationship with each other with an average of about 63% falling to the bottom line. Analyst estimates for 2012 call for net income of JPY 284,700 compared to JPY 248,630 in the prior year. Canon itself projects an essentially flat profit result in 2012 compared to 2011. Average net income for the period is about 25% greater than where it currently stands.
Using a profit figure of JPY 248,630 yen, historical current returns on capital are somewhat below the cost of capital. At the average profit level mentioned above, returns approximately match capital costs. Given the strong position of the company's products, this is a somewhat surprising position. In my view, this shows the challenge of operating with an appreciating yen and a relatively inflexible labor force.
Returning Capital and Becoming More Efficient
Canon's current PE before adjusting for non-operating assets is 18.1x based on company estimates for 2012 profitability. Removing cash and associated investment income yields a PE of 15.5x on operating assets. Canon is rather aggressively returning capital to shareholders in the form of a relatively large dividend, representing some 60% of net income and share buybacks which so far this year total a little under 3% of the market capitalization. The willingness to return capital to shareholders should give some comfort toward the belief that non-operating assets (in this case, merely large cash balances) will be divested over time.
Given the low returns on capital, Canon's PE at 15.5x is rather high but using average profitability, the PE falls to 12.1x (and capital returns come up to cost). It could be that investors view the current level of low profitability as temporary. Given the strong market position of Canon, this view is likely reasonable; however, a turnaround is not imminent, at least according to the company. Another option is that investors expect capital employment to decrease over time. Given recent capital expenditures, this appears reasonable, but it is hard to tell if such low levels are sustainable. If Canon can increase returns on capital through a reduction in capital employed, then the valuation could be fair, if not attractive given the strong position the company has in its markets. Canon is one for the watchlist, at a minimum.