Yaskawa Electric (OTCPK:YASKY) (OTCPK:YASKF) (6506.T) has been a surprisingly volatile stock over the last two years, although it has been one of the best-performing automation stocks over that time, but the 50% move since the start of the year is extreme even by that standard. While many automation stocks have done quite well on year-to-date basis (including Cognex (CGNX), Fanuc (OTCPK:FANUY), and Nidec (OTCPK:NJDCY)), Yaskawa has been the standout as investors apparently not only think that the worst is over, but that demand in markets like China is going to rebound sharply.
Much as I like Yaskawa as a company, I don’t share this view. China’s export-oriented sectors did better than expected in the first quarter, and I don’t see things getting substantially worse unless the trade friction with the U.S. gets worse, but I think a sharp V-shaped recovery is too optimistic given mounting challenges in North America and Europe. With today’s price already anticipating a major long-term acceleration in growth, it’s hard for me to see what can take these shares higher other than just raw momentum.
Miss-And-Lower Doesn’t Matter
What makes Yaskawa’s performance a little more surprising to me is that the shares have held up despite a fiscal fourth quarter that was weaker than expected, and guidance for the next fiscal year that was also weaker than prior sell-estimates (though almost spot-on with my prior estimate). The stock market is a forward-looking discounting mechanism, of course, but it seems like investors are choosing to believe in a pretty optimistic recovery scenario toward the back half of calendar 2019.
Revenue did rise 4% as reported in the quarter, which was about 4% weaker than expected (after some substantial revisions throughout 2018). Motion Control revenue fell about 6%, missing by about 4%, while 8% growth in Robotics was about 2% below expectations. Significant weakness in capex spending in the “3C” segment (consumer, computer, communications), including smartphone OEM capex as semiconductors drove much of the weakness in Motion Control (servos and controllers), though drives and inverters were helped some by the U.S. oil & gas sector. On the robotics side, auto demand remains quite healthy for Yaskawa, despite signs of weakness from various players, as the company continues to gain share, particularly with European automakers and apparently largely at the expense of KUKA (OTCPK:KUKAY) (OTCPK:KUKAF).
Operating income dropped 35% and came in well short of expectations, with Motion Control down more than 50% and Robotics down 13%. I’m not entirely shocked by the Motion Control weakness given that management has been working to adjust production and inventories (while continuing to invest in product development), but the weaker operating leverage in Robotics is a little more odd to me, and could perhaps be a byproduct of mix (as sales of high-end equipment used in semi fabs has declined).
Orders weakened even further in the fourth quarter, with a 17% yoy drop following the prior quarter’s 9% drop. Motion Control orders were down 17%, with servos down 32% and the higher-margin inverters down just 3%. Robotics orders were down 10%. By region/geography, orders from China dropped 39%, while Americas went into the red with a 10% drop and Europe declined 15%. Orders from Japan were down 6%.
I had previously expected JPY 465.6B in revenue for FY 2020 and management’s guidance came in at JPY 465B versus the prior IBES average estimate of JPY 472.4B (and JPY 485B back in late January). Guidance for operating income was likewise directed lower, with management targeting JPY 46.5B versus the prior sell-side expectation of JPY 48.7B.
Is The Recovery Starting?
While I can’t be all that bothered about guidance that came in close to what I was expecting, I am a little disturbed at what seems like some optimistic assumptions underpinning management’s targets. Yaskawa's management has a history/reputation of being too bullish, and I’m worried that could be setting investors up for a “double dip” later in 2019.
Management highlighted that March orders (the fiscal fourth quarter ended at end of February) for Motion Control were 25% higher than the FQ4 '19 average, with orders from China 50% higher. That’s fine, but it ignores the risks that Chinese customers had run down their inventories too far, not to mention the typical post-lunar new year momentum (in other words, I don’t think it’s a “new normal”). Along those lines, commentary from the recent China International Machine Tool show was still pretty guarded – while the auto business seems to be in better shape than expected, the “3C” and semiconductor categories are still weak and export-driven businesses are reluctant to commit to capex with so much uncertainty still hanging over U.S.-China trade relations.
I’d also note that Yaskawa is expecting strong demand for inverters in the North American oil & gas sector in 2019, and this is one of (if not the) highest-margin businesses for the company. Trouble is, there have been some accumulating signs that momentum is fading there; oil prices are still healthy, but capex spending seems more cautious, though we’ll all learn more as first-quarter earnings play out.
Yaskawa’s results are, perhaps, modestly encouraging for ABB’s (ABB) robotics business, but the read-throughs to companies like Fanuc, Emerson (EMR), Rockwell (ROK), and Siemens (OTCPK:SIEGY) are more nuanced. I’m very curious to hear what companies like ABB, Atlas Copco (OTCPK:ATLKY), Emerson, Ingersoll-Rand (IR), Rockwell, and Siemens will say about CY Q1 '19 demand in China and their guidance for the rest of the year. Fanuc badly needs a turnaround in 3C/smartphone spending, as well as proof that CNC tool demand in China has indeed bottomed.
I feel as though I’m still fairly bullish on Yaskawa’s business prospects. This new fiscal year will likely see a year-over-year decline in revenue, but I think a long-term growth rate around 6% is doable, and I likewise believe Yaskawa can leverage stronger positions in higher-margin businesses to drive FCF margins toward the high single-digits after years stuck in the low single-digits.
Unfortunately, even if that happens, the shares are already priced well above that level of performance. Likewise, the shares look expensive on margin/return-driven EV/EBITDA and P/BV.
The Bottom Line
I very rarely recommend short positions, and I’m not exactly doing that now, but if you think the market is too blasé about growth prospects for 2019 and 2020 (particularly a strengthening in the second half of the year), Yaskawa could be a way to play that. If this bottoming-out in China doesn’t turn into the hoped-for V-shaped recovery and conditions in North America and Europe weaken further, I don’t see how this multiple is sustainable. Maybe I’m too bearish on the global economy (and the U.S. economy in particular), but it looks like a pretty solid recovery is already priced into Yaskawa today.
Disclosure: I am/we are long ABB. 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.