Hitachi: A Mixed View

Summary

• Hitachi's automotive systems business, Astemo, was loss-making in the most recent quarter because of chip shortages and China lockdowns.
• On the flip side, I am more optimistic about GlobalLogic's growth prospects and the potential for value-accretive corporate actions.
• My rating for Hitachi is a Hold which is aligned with my mixed view of the stock.
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Elevator Pitch

I am revising my rating for Hitachi, Ltd.'s (OTCPK:HTHIY) [6501:JP] stock from a Buy to a Hold. I previously touched on Hitachi's "revenue growth outlook" and "portfolio restructuring activities" in my earlier update for the company written on December 10, 2021.

I see Hitachi's shares as deserving of a Hold rating, instead of a Buy or Sell. On the negative side of things, Astemo, Hitachi's automotive systems business, needs to reinvent itself to be more resilient and adapt to changes in the auto market. On the positive side of things, GlobalLogic, a new business bought by Hitachi in 2021, is well-positioned to meet growing demand for digital transformation services, and the planned sale of its interests in some listed businesses can fund new growth initiatives.

Readers can trade in Hitachi's shares on either the OTC market or the Tokyo Stock Exchange. The trading liquidity for Hitachi's OTC shares is pretty decent based on its three-month average daily trading value of around $3 million. The company's Japan-listed shares offer even better liquidity with an average daily trading value in excess of $100 million for the past three months. Investors can consider US brokers like Interactive Brokers (IBKR) and Fidelity which provide trading access for Japan-listed stocks, if they intend to trade in the relatively more liquid Tokyo-listed Hitachi stock.

Short-Term Outlook For Hitachi Is Unfavorable

The near-term prospects for Hitachi aren't encouraging.

Hitachi's most recent quarterly financial performance was poor. In the first quarter of fiscal 2022 (year ended March 31, 2023 as defined by the company), the company's net profit attributable to shareholders fell by -70% YoY to JPY37.1 billion. Revenue for Hitachi contracted by -12% QoQ to JPY2,570 billion in Q1 FY 2022.

Looking ahead, the sell-side analysts forecast (source: S&P Capital IQ) that Hitachi's YoY top line expansion will moderate from +8.5% in Q1 FY 2022 to +1.9% for Q2 FY 2022, and the company's revenue is projected to decrease by -11.4% YoY in Q3 FY 2022.

The company's automotive systems business, otherwise referred to as Astemo, was the main factor contributing to Hitachi's poor first-quarter financial performance and weak short-term outlook. Astemo was the only loss-making business segment for Hitachi in the recent quarter, with the automotive systems business generating a Q1 FY 2022 net loss attributable to shareholders amounting to -JPY20.9 billion. I will touch on the specific headwinds for Astemo in the subsequent section of the article.

Semiconductor Chip Shortage And China Lockdown

Many companies have been badly affected by the shortage of semiconductor chips , and Hitachi's Astemo was a victim as well.

Major automotive OEMs pulled back on their manufacturing plans and targets as they didn't have sufficient semiconductor chips, and this in turn led to lower sales volume for automotive systems company, Astemo.

But it is worthy of note that structural issues are at also at play here. Due to the business model that Astemo has chosen to adopt, it is at a bigger risk of being vulnerable to disruptions relating to the auto makers' production and new industry trends.

Hitachi acknowledged at the company's Q1 FY 2022 earnings call that Astemo is largely "a subcontractor" engaged in "providing parts or components to automotive manufacturers" which "occupies a very large portion" of its business. Hitachi also highlighted at the recent quarterly briefing that "if electrification continues, they (the future electric vehicles) are not heavy chassis that used to be in the past."

In other words, even if the semiconductor shortage issue is resolved in time to come, Hitachi's automotive systems business or Astemo could still underperform if it can't pivot successfully. Hitachi specifically mentioned at the first-quarter investor call that "we want to introduce our own model" rather than remain as a subcontractor, and it will also "allocate more resources" to meeting the demand for lightweight chassis catering to EVs.

Another key factor that resulted in lower-than-expected automotive OEM production and weaker-than-expected sales for Astemo was the COVID-19 lockdowns in China which is the key manufacturing location for many automakers.

China's decision to continue with its COVID-zero stance raises the risks of future lockdowns which will definitely affect auto manufacturing and be a big negative for the global automotive market. Notably, a recent September 15, 2022 South China Morning Post article quoted the "vice administrator of the National Administration of Disease Control and Prevention" in China saying that the country's "Covid-19 prevention and control measures are the most economical and the most efficient." As such, it won't be realistic to expect a major change in China's COVID-zero approach anytime soon, and it is necessary to keep an eye on the potential downside risks for Astemo in that regard.

Medium-Term Growth Expectations

According to the sell-side's consensus financial estimates sourced from S&P Capital IQ, the analysts expect Hitachi's EBIT to grow by a decent +10% CAGR from JPY739 billion in FY 2022 to JPY991 billion in FY 2025.

In my view, the market's consensus operating income growth expectations for Hitachi in the intermediate term are realistic. The positive outlook of GlobalLogic, a company that Hitachi acquired last year, and Hitachi's plans to sell the stakes in some of its listed businesses will be supportive of its mid-term growth as detailed in the next section.

New Growth Engine And Divestment Of Interests In Listed Businesses

In the medium term, I am of the view that faster-than-expected growth for GlobalLogic and capital recycling plans should be the key drivers for Hitachi.

On July 14, 2021, Hitachi issued a media release revealing that it had concluded the deal to buy over GlobalLogic. In the press release, Hitachi described GlobalLogic as a company which "specializes in advanced digital engineering, experience design, and data services" to assist its customers with "the development of new digital products and experiences."

Digital transformation is a global trend, and there is demand for digital transformation services as well. But there are fewer companies focused on providing such digital transformation services in Japan, and this represents an opportunity which Hitachi can exploit with GlobalLogic, its new growth engine.

At its Q1 FY 2022 results briefing, Hitachi emphasized that "although demand in market for DX (or Digital Transformation) is high (in the Japanese market), supply has not been enough." Hitachi also disclosed at the recent quarterly earnings call that the company's goal is to increase the number of employees for GlobalLogic and the digital transformation business to as many as 1,500 people to be in a good position to capitalize on strong demand in this area.

Separately, Hitachi has indicated at its first-quarter investor briefing that it aims to sell its stakes in Hitachi Metals (OTCPK:HMTLY) (OTCPK:HMTLF) [5486:JP] and Hitachi Transport System [9086:JP] by March 31, 2023, at the latest. The funds raised from such sales can help to finance future growth opportunities, by allowing Hitachi to recycle capital from divestments into new businesses boasting faster top-line growth and superior profitability.

Closing Thoughts

Hitachi is a Hold-rated stock. I have a mixed view of the stock, in consideration of the challenges for Astemo, GlobalLogic's growth opportunities, and potential corporate actions.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.