Thursday, November 29, 2012

Like a virgin tour around Tokyo

Welcome readers to the first report on Japan technology stocks! The goal is to make us all a bit of coin on tech investment ideas while having some fun along the way. I visited several tech names in Tokyo last week with a former colleague who works on the buy-side now, and we had some great meetings. We visited Nikon, Sharp, Tokyo Electron, Advantest, NTT Docomo, Nippon Sheet Glass, and NEC. We liked Nikon, Sharp (not for weak stomached), and Tokyo Electron on the long side.

Nikon (7731 JP)
Positive impression. Stock has outperformed by 20% this year, but has underperformed TOPIX and Canon by 7% in the past 3 months, mainly owing to a downward revision on November 1st. PE 14x FY3/13, 12x FY3/14 does not appear overpriced. Catalysts include continued strength in high-end SLRs, mirrorless growth, rebound in IC capex, and yen depreciation (Stock is currency sensitive).

2102 outlook for market is +11% unit growth for SLRs, 77% for mirrorless, -20% for compacts. SLR OP margin is 13%, mirrorless is in the red, compacts at 2.5% OP margin. Mirrorless should be in red in 2H and turned in to black next year. 2013 outlook is about 10% SLR unit growth, 60-70% mirrorless growth, and negative compacts growth.

Market share for SLRs currently is 41% for Nikon and 50% for Canon. Market share for compacts is 21% for Nikon, #1 is Canon. There are 9 major compact camera makers. Nikon does 100% in-house production for mirrorless, outsources 85% for compacts. High-end Nikon SLRs such as D4, D3x, D800 are made in Japan which helps Nikon's brand particularly amongst high-end Chinese users. We believe that Canon makes higher margin in compact cameras at 4-5% OP margin, but this is half the 8-10% OP margin it enjoyed 3 years ago. Nikon’s high-end SLR products are selling well including D600 and D800.
Mirrorless players are Canon, Sony, Samsung, Nikon, Olympus, and Panasonic. Nikon believes that Canon’s product lacks merit. Sony was one of mirrorless pioneers 3 years ago, but still reports losses in mirrorless.
Camera inventories at Nikon rose as they were worried of lack of inventory due to floods which occurred last year during the Thai floods, so they built inventory in July through September.


China is 14% of total camera sales and should be 20% in next few years. Now USA is 30%, Europe is 30%, BRICs are 25% (should increase to 35% in next few years). Chinese users like to buy high-end SLRs (Nikon marketed low-end SLRs initially). In 2013, Nikon thinks total SLR market will grow by 20% with mirrorless up 60-70% and SLR up 10%. Interestingly, Canon has faster product cycles for SLR versus Nikon owing to lower improvement in specs for each new model. Nikon tends to take more time between cycles and improve on specs more dramatically.

Lithography tools:
Nikon reduced outlook by 5 ArF immersion units for the full year. We understand that the outlook was decreased by 3 units for the USA, 1 unit for Korea, and 1 unit for Japan. Nikon sticks to bearish outlook for EUV, predicting mass production no earlier than 2020. Nikon cites insurance as the reason Intel, Samsung, TSMC bought stakes in rival ASML.

M&A: Policy is to pursue key technologies that would enhance profits. Nikon cares less about market share or revenues, and more about profits. Dividend policy is 25% stable payout ratio. If Nikon can achieve over Y100bn in OP consistently, it might pay out more dividends.

Tokyo Electron (8035 JP)
Positive impression. Guidance is for slight increase QoQ for SPE orders in Q3. There appears to be no change to guidance in October/November. PBR of 1.1x is near a 3-year low, but PE and profits out of control. We think the shares have bottomed out.

To recap the past quarter, in July, market turned down. Management believes that the bottom was Q2 for orders. TSMC should have high capex next year, but Samsung is unclear. MPU and foundry next year should be ok.
Tokyo Electron (TEL) targets etch and clean as 2 areas of market share potential gain. Etch market is $4-5bn, clean is $3bn. Etch target is silicon etch dominated by Lam. Clean tool target is single wafer clean dominated by DNS. TEL recently purchased FSI, a USA company, which could help it compete in cleaning equipment. Clean market share target is to increase to 40% from 20%. FSI share is only 3% now.

Regarding TEL's large net cash position, a key issue is dividend policy and M&A strategy. TEL's dividend payout policy has been a 20% payout ratio, or about 2% yield. The yield has been gradually improving, albeit from a low base. TEL has been aggressively acquiring assets overseas using the strong yen and continues to search in the etch and clean areas. However, Lam acquired Novellus this year, taking away the most attractive target in etch. The yen impact is mainly indirect. Directly there is little affect on profit since most of sales are yen denominated and much of costs are in yen as well. Indirectly, the 2 main rivals are in the USA, and thus a stronger yen reduces TEL's price competitiveness.
Other products: PV still in oversupply with 65 GW of capacity. Much of this is low conversion panels in China which could be mothballed. TEL does not expect much business for a few years. Targets grid parity in 2015. Oerlikon conversion rate now 10.8%. TEL is more positive on FPD and OLED new product outlook.

Advantest (6857 JP) 
Neutral impression. The firm has upside potential in market share gains in logic chip testing as the synergies between Verigy and its logic test business gain traction. However,a lack of memory capex recovery and softer logic capex has dampened the outlook for thisyear, delaying the return to a compelling valuation. Advantest lowered it OP outlook to Y11bn from Y16bn on October 25 (using the mid-point of guidance). Generally the outlook is slower overall owing to a sluggish macro consumer trend in tech. The PC side could offer some upside if utlrabooks gain traction next year. The stock has run ahead of rivals this year, outperforming TOPIX by 36% and Teradyne by 22%. PE is 35x this year and 18x FY3/14.

The firm claims its advantage over other test vendors is its expertise in test and handlers. Handlers manipulate the wafers in the final testing process. The handler tool production is labor intensive and not very profitable. Advantest moved some production to Korea in June. However, for new chip technologies such as TSV and 3D, the handler tool could become critical as the bare wafer temperature becomes an issue, making it more difficult to handle. Handler rivals are Delta Design (USA), Chrome ATE, Seiko Epson. 
 Q2 orders were down sharply QoQ owing to pull-ins in Q1 from Korean customers. Q2 orders were also lower than expected for DRAM. The firm guides Y25-30bn in orders, slightly above the Y25bn in Q2. October was rather sluggish while November appears to be more buoyant overall. Orders and sales guidance for the full year were lowered by Y10bn.
Probe card business is one new pillar of growth. Verigy also produces probe card. Advantest plans to target memory space initially for probe cards, than logic later. 
Logic test: Advantest’s largest business is driven by its customers’s customers (Apple, Samsung, Qualcomm, etc.) in the mobile logic space for high-end processors. However, future business could be enhanced by low-end logic processors such as baseband processors, microprocessors, etc. Some key end users are OSAT (ASE, SPIL, etc.).
 Others: Measuring instruments profits/sales very small. E-beam has small sales for R&D purposes to chipmakers.
Dividend payout ratio target is 20% although current ratio is much higher due to low earnings. Verigy deal was all cash deal and reduced net cash by about Y54bn.(Y87bn to Y33bn)
FOREX impact is Y0.4bn for each Y1 move. This has increased since Verigy takeover, since sales of Verigy's 93000 are in $USD.
5,000 staff currently with 3,000 in Japan 

NTT Docomo (9437 JP)
Neutral impression. Smart phone growth and ARPU potential increase appears feasible, although the disinclination to iPhone remains a stumbling block. PE 9x FY3/14. Stock has underperformed KDDI by 25% in past year. Market share of smart phones is very high at 55% though, higher than its 46% sub share.

The firm is attempting to get ARPU growth through smart ARPU and by staying ahead of rivals in 4G. ARPU is Y1600 higher for smart phones versus feature phones. They are also trying to enhance line-up with smart digital contents, music, e-commerce…ie improve ecosystem.

% of ARPU by application is below:


4G has 7 mn users out of 60mn total Docomo users. Target is 40 mn users by 2015.

Current market share for cell phone subs was 46.2% in Q2 VS. 46.5% in Q1 AND 46.9% last year. For smart phones, share is higher at 55% versus 49% in Q1. The take-up of smartphones appears relatively slow and low (25%->35%). The firm's reasons are that feature phones used in Japan are rather high-end and smart, so there is less urgency to upgrade amongst high school students and senior citizens. However, going forward they see smart phone adoption accelerating. Now replacement average are 2-3 years in Japan versus 9 months in Hong Kong. In Japan, i-imode has a long history which means users were already using phones as smart phones a long time ago.

Regarding exclusive handsets, Docomo used to supply blackberries exclusively but now the supply of handsets is more open. Galaxy S3 is there best selling handset. The goal of the subsidy for phones is to make the phone about Y10,000 to Y20,000 for the user and to provide more incentive if the user switches network.

Data traffic should increase by 12x from 2011 to 2015, but the firm is confident that they “can manage it”. CAPEX increased 3% YOY this year but should decline next year.

M&A: If there is a good opportunity, Docomo would consider M&A with Asia Pacific as the target area. 

Dvidend policy: Yield is close to 5%, which is very high in Japan, and the stock is considered a yield stock. Payout is consisently 40-50% of net income

Sharp (6857 JP)
Positive impression. Note: Not for the faint-hearted.
Will they survive? We believe so. Thus, for those with strong stomachs, we think there’s a long trade. With no earnings in sight, the firm is just trying to shore up funds to stay afloat, and appears confident the rest of the Hon Hai funds will come through by March 2013.

AV Equipment: AV has suffered large losses in mainly LCD TVS and handsets. LCD TVS are terrible, down 80% YOY as eco points in Japan ended last year. Sharp believes it can gain share in large +60” TVs. For example, Sharp can sell A 60” TV in Japan for Y200,000 ($2,500) versus a similar-sized Korean TV in the USA for $1,200.

IGZO is a key for Sharp’s screens. OLED TV is too expensive to produce in Sharp’s view, although they are doing some OLED R&D for small screens. Sharp is pushing its IGZO technology for smart phones. IGZO is high definition and can be made on 8G substrates. IGZO AT its Kamiyama #2 factory is for tablets and could be sold to notebooks as well. Sakai utilization rose to 70-80% in July from 30-40% in the spring. At Kameyama #1, screens are sold for smart phones only.

Health business: Health biz is healthy! This is due mainly to white goods such as air purifiers and refrigerators. Air purifiers were a big hit in Japan over the past 3 years particularly after the earthquake. White goods have high requirements in Japan and are produced cheaply in Asia ex-Japan, allowing for good margins.

Solar panels: Overseas solar prices remain weak and division is in the red. Sharp cut production of overseas solar panels and will focus on the Japan market.

Restructure: Sharp must lower fixed costs to counter lower revenues in Solar, cell phones, etc. There were 2,000 voluntary retirements out of a total of 5,000 reduction in staff. Sharp is also selling hard assets. Staff costs should fall by Y40bn annually.

Debt payments: Sharp issued syndicated loans through Mizuho, MUFJ for Y360bn, which has less than 2% interest. Sharp has about Y1.1 trillion in debt and only Y220bn in cash with perhaps Y66bn more to come through Hon Hai. Sharp appears confident that Hon Hai will inject more funds by March 2013.

Nippon Sheet Glass (5202 JP)
Neutral impression. Stock has been hyped by CS, Barclays, Daiwa recently on the back of the 2nd large restructure plan since 2009. NSG projects that cost savings from the restructure will bear fruit in FY3/15. The street already has PE down in single digits for FY3/15. There is large upside potential to the shares, but the risk obviously would be the need for further restructure if construction or auto glass deteriorates, particularly in Europe. Stock is relatively cheap if the current restructure plan goes as scheduled. NSG promoted Keiji Yoshikawa, an insider with 40 years experience at NSG, to CEO in April this year. Former CEO Craig Naylor, an outsider brought in from the USA (Dupont) in 2010, resigned in 2012.

Construction glass: NSG’s Europe construction glass is one of its most volatile segments. In 2009, 4 mm glass prices fell a whopping 50% while volumes fell 25%. NSG has shut down 5 plants since 2009 in response to the financial crises and more recent Euro debt crises. Japan construction glass is flat YoY as product mix is improving while volumes slump somewhat. Since the quake, double glazed/high insulation glass has been strong as tax incentives in Japan fuel demand. China construction market for glass is growing but low quality glass is mainstream. There are 150-200 float furnaces in total in China, which is more than the demand needs, and thus some of the excess is exported to SE Asia. North American construction glass is picking up after 6 years of pain. NSG handles mainly commercial building glass. South America is a robust market for construction glass. There is a large shortage and NSG and Saint Gobain control 39% and 23% of total market respectively. NSG has a JV with Saint Gobain. However, the demand has been slowing recently. Asahi Glass has recently announced plans to build a factory in South America. Russia has seen good growth. NSG has 1 JV factory in Russia.

Solar glass is included in the BP business. Currently, overcapacity in the solar industry has hurt all players. NSG claims 70% market share for coating glass in thin-film type solar panels, sold largely to First Solar. Margins are lower now than last year, but still profitable. Last year in 2H, prices fell 10% and volumes collapsed by 40%.
Auto glass: Japan auto glass is mainly an OEM business but overseas replacement glass is more prevalent. Europe auto glass had losses in Q2 due to reduction in French and Italian capacity which forced NSG to close 2 fabrication plants in Sweden and Finland. The windshield is the largest single revenue component for automobile glass. US auto glass suffered losses due to seasonal issues and lack of production efficiency. NSG closed 1 auto glass float line this year in March. 

Other glass, tech glass: #1 product is thin glass for displays. NSG makes ultra-thin glass (less than 1 mm) using its float line production for touch panels soda-lime glass. The soda-lime glass layer is made by rivals Asahi Glass and Central Glass as well. NSG doesn’t do the cover glass made by Corning, Asahi Glass, NEG. The soda-lime glass layer for touch screens is between the TFT LCD substrate and cover glass. NSG believes it has top share in ultra-thin soda-lime glass for touch panels. 

Restructure: NSG reduced headcount and cut capacity this year. It aims to get cost savings of Y5bn this year, Y15bn next year, and Y25bn in FY3/15. Restructure costs are Y18bn this year, Y13bn next year, and 0 thereafter. 36,000 staff globally should be reduced by 10% (3,600). Also reducing ¼ of top paid 100 senior managers (25 executives).

NEC (6701 JP)
Neutral impression. Stock has massively outperformed market by 22% in past 3 months on the back of an upward revision to 1H earnings. Q2 OP was Y55bn versus Y26bn last year. NEC cut 10,000 jobs and recieved 1-time patent fees from Hon Hai in Q2. Market still doesn’t like stock with 11 HOLDs, 1 BUY only, and PE of 10x FY3/14 appears fairly valued. Earnings momentum seems firm in Q3.

Core businesses are IT solutions and Carrier Networks. IT solutions were Y900bn in sales per year before 2008, but fell hard from 2009-2011. It has recently had positive growth though. 90% of sales of IT solutions are in Japan. IT orders still positive currently.

Carrier Network Business: Projects (base stations) for telecom carriers is one core business. NEC has 50% market share at Docomo, and Fujitsu has 50% share also. At KDDI, NEC share is under 50% as KDDI also uses Nokia and Siemens equipment. Softbank market share is very low since Softbank uses cheap China base stations. 4G for Docomo started 2 years ago, but difficult to predict how much of 4G is finished. Other products are fiber optic networks and routers. Q3 seems to have decent momentum.

Other products: NEC also makes submarine cables, tsunami observation systems, etc. NEC, Alcatel, Tyco are the 3 main players for trans-ocean projects. Mobile handsets: NEC wants to minimize exposure. NEC also makes digital signs and sells ISP (big globe) services. NEC makes lithium ion batteries for Nissan Leaf and hope to sell to GS Yuasa (Mitsubishi Motors) in future.

Restructure: 2,393 staff took early retirement package, over the 2,000 target. Benefits this year are Y20bn for 6 months and thus Y40bn for next full year. Cost was Y30bn for restructure. Salary must be around Y18mn average, which seems high. Severance packages are about 2 to 2.5 years salary for over 45-year olds. Staff are also taking 5% salary cuts this year only.

If you have any queries or comments, please let me know. I'm happy to discuss the chips and dips in detail. 

All the best, David 

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