Nifco: Quality Tier 1 Supplier Looks Fairly Priced

Summary

• Nifco is a well-run auto parts business with relatively high margins and disciplined capital management.
• It is experiencing an upturn in business which should carry through into FY3/2022. Its product diversification efforts into EV and ADAS should prove to be a success.
• Valuations are not steep for a quality Tier 1 supplier, but we do not think the shares are undervalued on PER FY3/2022 16.6x. We are neutral.

Photo by humonia/iStock via Getty Images

Investment thesis

Nifco (OTCPK:NIFCY) (OTCPK:NIFCF) is a well-run Japanese auto parts company. It has relatively high margins, good capital management, has globally diversified clients and is demonstrating some success expanding into EV and ADAS markets. The shares are trading on PER FY3/2022 16.6x which we feel is a fair valuation - we are neutral on the shares.

Quick primer

Nifco is a Japanese manufacturer of industrial plastic components ranging from cup holders to turbo ducts primarily for the automotive industry. It also operates a bedding and furniture business under the 'Simmons' brand. Its sales is diversified globally to all regions, with the domestic market making up the largest contribution with 33% of total FY3/2020 sales.

FY3/2020 sales by segment

Source: Company, created by author

FY3/2020 OP margin by segment

Source: Company, created by author

FY3/2020 sales by geography

Source: Company, created by author

Our objectives

In this piece we want to assess the following:

• As an auto component supplier Nifco is economically sensitive. Assess its performance for FY3/2021 to date, and look for forward indications for the company post-pandemic.
• Outlook for Nifco and find any secular trends that would be a tailwind for its business.

We will take each one in turn.

Sensitive to an upturn in demand

FY3/2020 ended with a mixed picture for the company, as some regions such as Indonesia and China saw robust demand whilst Thailand and India experienced downturns. Europe began to signs of demand recovery, but overall Nifco did not have enough visibility to issue FY3/2021 guidance. It managed to flag its first FY guidance in July 2020 and since then business conditions began to improve consistently, leading to the company issuing its second upward revision in February 2021.

Company guidance FY3/2021 - sales

Source: Company, created by author

Company guidance FY3/2021 - OP

Source: Company, created by author

The company instigated cost restructuring during the period which has proved to be effective. We saw high Q3 FY3/2021 operating income as volumes began to recover to normalized levels.

Quarterly sales and OP trend

Source: Company, created by author

The recovery is being led by all regions, with China and North America looking strong whilst Europe brings up the rear. Nifco's business sees spikes in demand from new model introductions from auto OEMs, and one driver appears to be efforts to release more hybrid and EV models into the market.

Global auto production is currently experiencing parts shortage from semiconductors, but it appears that the current recovery is being driven by pent-up demand. As demand normalizes, auto parts suppliers such as Nifco will see its business stabilize with the added benefit of operating a leaner cost structure. We believe Nifco should see its medium term earnings outlook stabilize to mid-single digit revenue growth YoY with some margin enhancement.

Next we look at any secular drivers for the business.

New product opportunities

Targeting growth from EV auto parts is not a new theme in the sector, and Nifco is not alone in grabbing this opportunity. As a supplier of plastic components for both the interior and exterior of cars (for parts such as fender seals and air vents), parts of its business are relatively unaffected by the industry shift away from internal combustion engine models. However, Nifco has exposure to fuel systems as well as engine parts and consequently even if hybrid vehicles remain in high demand, the company's overall addressable market will shrink in the long term.

The company has been expanding its product base to new areas such as EV and ADAS (advanced driver assistance systems). We see that Nifco is seeing improvements in creating value with a rising trend in return in invested capital (ROIC) - not all of this will come from new product developments, but it shows that progress is being made at product diversification.

ROIC trend

Source: Company, created by author

Currently EV components are supplied primarily for battery parts, and the company is developing new products for both motor and inverter to boost exposure to the EV powertrain. ADAS products supplied are peripheral parts for car-mounted cameras, and brackets used for corner radars and front millimeter-wave radars.

Although Nifco's product line do not look particularly cutting edge, it has a track record of providing high quality certified parts. Consequently, as a Tier 1 supplier it does enjoy relatively high operating margins at around 10% for the last 5 years.

Operating margin trend

Source: Company, created by author

In terms of sales mix, the most profitable region is Japan but Asia is a close second with 32% of total FY3/2020 sales. With escalating demand for EV in China who are leading the world in its adoption, we believe Nifco has the potential to improve its sales mix to improve overall profitability.

We would not go as far to say that Nifco is a direct beneficiary of EV and ADAS adoption. However, it is positioned to supply products to these nascent markets and appears better hedged than other peers whose core business remains focused on internal combustion engine vehicles.

Balance sheet

Nifco ended FY3/2020 with a slim net cash position of JPY4.5 billion and remains well capitalized. In preparation for uncertain times, the company lined up a JPY40 billion unsecured commitment line from its banks valid for a year but remained liquid with a current ratio of 3.0x - excluding inventory the quick ratio was a high 2.5x. The business is relatively capital intensive but not excessively so, with average capex being 9% of sales over the last 10 years.

Capital allocation

Nifco is well capitalized but it does not hold excessive unneeded capital. When looking at how capital has been allocated over the last 10 years, the company has been quite disciplined in balancing out free cash flow generation with shareholder returns. Some M&A activity although small has been internally funded. It looks like Nifco is on top of capital management.

Capital allocation over the last 10 years

Source: Company, created by author

Valuation

On consensus estimates the shares are trading on PER FY3/2022 16.6x with a prospective dividend yield of 1.8%. Consensus free cash flow yield stands at 2.3%, indicating a significant drop YoY in free cash flow generation which looks on the conservative side.

For an auto parts supplier these valuations do not look particularly cheap, although there may be a positive market reception as the company looks to book record high sales and earnings into FY3/2022.

Risks

Upside risk to Nifco stems from a pipeline of new hybrid and EV model releases from its key Japanese OEM customers such as Honda (HMC), Subaru (OTCPK:FUJHY) and Toyota (TM). These players have been relatively slow in the release of pure EV cars, but have been highlighting their intention to scale up releases from 2025.

Chinese demand for EVs are currently scaling new heights post-pandemic. Exposure to new Chinese model releases could provide a major boost to demand into FY3/2022.

The company has successfully acquired assets (two German firms in FY3/2013 and FY3/2014) which were temporarily margin dilutive but ultimately high return businesses once integrated. More such cases could be viewed positively by the market.

Downside risk could stem from the company requiring significant investment to develop new products. This could involve increase in R&D spend, as well as building new production facilities. Both profitability and free cash flow generation may be impacted negatively as a result.

Conclusion

Nifco is a well-run auto parts business with relatively high margins and disciplined capital management. It has navigated the pandemic well, seeing an upturn in business which should carry through into FY3/2022. Its product diversification efforts into EV and ADAS should prove to be a growing success, as well as its focus on the lucrative Asian market.

Valuations are not steep for a quality Tier 1 supplier, but we do not think the shares are undervalued on PER FY3/2022 16.6x. We believe a lot of positive news is already priced in, although if Nifco makes more tangible progress to conduct business in EV this would be a positive catalyst. We are neutral on the shares.

Analyst’s Disclosure: I/we 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.