POSTED BY ANGUS GEDDES
Shares of leading automation and robotics player Fanuc have underperformed the Nikkei index over the past six weeks or so by a mid-single digit percentage amount, giving back some of the outperformance the Japanese-listed company delivered over the past twelve months. Over the past year, the stock (held in our Global Opportunities and Asian Managed Account Portfolios) has delivered a return of circa 33% versus 24% for the Nikkei.
We believe the recent modest underperformance can be attributed to a few factors, although they don’t detract from the long-term investment case. The factors include cautious guidance, a slight strengthening of the yen and a small correction in the smartphone supply chain.
Fanuc’s initial guidance for FY17 (ending March 2018) is for net sales to expand 6.1% from FY16 to ¥569.8 billion yen. However, an increase in expected cost of sales is anticipated to crimp profit growth, with operating income forecast to edge up just 1.5% to ¥155.5 billion as the operating profit margin contracts 1.2 percentage points to 27.3%. Net income is forecast to slip 8.5% to ¥116.9 billion.
Fanuc is known for issuing conservative guidance and we believe the company has done so again here. The company is forecasting a material increase in the yen exchange rate at 100 yen to a US$ and 110 yen per euro (i.e. 7.7% and 7.4% appreciation respectively). Operating income is sensitive to the exchange rate. Fanuc has also outlined new plans in April 2017 to invest roughly another ¥63 billion in expanding its Robotics production, with the first phase of production forecast for August 2018. The latter will weigh on the bottom line in the short term, but given a robust demand profile for industrial robots we are confident this will be a boost over the medium term.
Robotics demand is set to be strong over the next decade and while it is non-industrial robotics forecast to grow at the highest rate, industrial robotics demand (the area where Fanuc’s excels) is also anticipated to be robust, with a 13% compound annual growth rate (CAGR) from 2017 to 2019.
Source: International Federation of Robotics
Fanuc currently has monthly robot production capacity of 5,000 units, set to expand to 7,000 by year end. The new plant (due to open August 2018) will initially add another 2,000 units of capacity, with a blueprint to add another 4,000 over time. Fanuc management expect the China market to grow at above average rates for another 5-10 years, by which time the Indian market should be stepping into its shoes.
Technavio Research from last year estimated the broader Global Industrial Automation Control market will grow at a compound annual growth rate (CAGR) of close to 8% from 2016 through 2020. This is a more mature market (and another where Fanuc is a leader via its Computerized Numerical Control (CNC) and servo motors).
Benefits of automation include cost savings (especially as labour costs rise), faster speeds, quality stability, safety (i.e. reducing human exposure to high-risk work) and making things that cannot be processed manually – which is an increasing range of products.
In terms of the other two factors weighing on Fanuc shares recently, the yen has strengthened modestly against the US$ over the past month or so. As an exporter, the ebbs and flows of the yen can impact sales and sentiment towards the stock. On balance we still see the yen being weaker over the medium term versus the US$ given where the Fed sits versus the Bank of Japan in the overall scheme of tightening.
Finally, the Chinese smartphone industry saw an adjustment in the supply chain this year, which potentially impacts demand for Fanuc’s Robodrill product. A product that was relatively obscure when Fanuc first introduced it, the product is now in wide-use for metal uni-body casings on smartphones and the like.
The smartphone supply chain endures inventory adjustments every so often, but has bounced back historically and we don’t expect this time to be much different.
Fanuc reported solid fourth quarter numbers, with a sequential (i.e. compared to the fiscal third quarter) improvement in all major areas. The balance sheet is strong, with a net cash position equivalent to about one-fifth of the market capitalisation. Meanwhile, the new Internet of Things FIELD (Fanuc Intelligent Link & Drive) platform promises to take factory automation to the next level (referred to as industry 4.0) and add to Fanuc’s service/recurring revenue stream in the upcoming years.