Nikon: I've got that ma-ma feeling...

Neutral impression. Nikon (7731) suffered a harsh downward revision in Q3 owing to weak performance of the camera division as a drop in demand in Asia last November hurt sales. Nikon also revised down its FY forecast in Q2 due to softness in its IC stepper business to non-Intel clients. Normally there would be a buying opportunity for a quality name like Nikon after a sharp sell-off alla 2009, 2010, and 2011. However, we believe that there is limited upside despite the massive underperformance in the past 3 months.

Cameras

Since November 2012, SLR camera demand has been noticeably softer than expected, particular in Asia. SLR camera demand “tanked” in November, which created excess inventory and price cuts. Nikon produced too many SLR units last summer in anticipation of strong demand in Asia/China. Asia is about 30% of total global camera market and Nikon expected 10-15% YoY growth in Q3, but growth was only 7% YoY. Inventories should be reduced to a reasonable level this past quarter (Q4). Nikon believes that Canon also produced too many camera units. Reasons for the subdued SLR demand in China could be popularity of iPhones which cannibalize camera sales or the new premier’s (Li Keqiang) desire to reduce luxury goods consumption in China. In another push to stem reckless consumption, China banned radio and TV ads promoting gift giving last month, according to a story published in the China Daily.

Q4 camera sales appear to be rather sluggish. The latest CIPA data showed -21% YoY growth for SLR value in February. Mirrorless camera sales were worse, falling 34% YoY in February. We think that Nikon will have to produce strong growth in March in order to make its Q4 camera 36% YoY forecast.

In February, Nikon cut Y20bn in its OP projection for the camera division on lower margins as inventory is cleared out. Nikon believes that ASPs will be soft until Q1 of FY3/14, and recover in Q2. Profit margin did not benefit from the yen depreciation in Q3 as prices were already fixed and the yen didn’t weaken until the end of November. Q4 Nikon should get a Y3bn OP tailwind from the weaker yen but still needs to clear out some excess inventory, which will hurt pricing.

OP in cameras        31,796	15,621	3,791	2,792	54,000	Q1       19,600	Q2       22,200	Q3       10,600
19.0%	9.9%	2.8%	2.2%	9.2%	10.3%	11.6%	5.1%

What’s the next driver of growth? Nikon still believes that SLR growth will be 10-15% YoY for 2013-2015. We find this more difficult to swallow given the proliferation of smart phone cameras and recent demand problems in China.

Lithography

Nikon’s litho outlook remains relatively unchanged, although recent weakness in PC sales does not bode well for capex growth in 2013. One long-term key issue is how will 450 mm impact Nikon’s competitiveness. Nikon claims that the shift to 450 mm wafers will provide a good opportunity to gain market share because ASML’s twinscan tool is disadvantaged when the wafer area doubles in 450 mm wafers. (alignment accuracy of 2.0 difficult to achieve). Nikon has sent prototypes to Intel for 450 mm. Only 3 firms are investing in 450mm now: Intel, Samsung, TSMC, but only Intel is investing in Nikon (450 mm ArF immersion). All 3 firms are investing in ASML however. One bright spot in lithography for Nikon is LCD steppers, which are slated to recover to 20% YoY growth in FY3/14.

FOREX: The profit sensitivity is large for Nikon at about 2.5% of OP per Y1 move against the dollar and euro. For next year, OP should rise by Y0.6bn for each Y1 depreciation against the $1USD, and Y1.5bn for each Y1 move against the euro. We calculate euro impact as Y30bn, and $USD impact as Y9bn for a total of Y39bn increase from FOREX in FY3/14. If OP is the company forecast of Y48bn for FY3/13, the FOREX OP gain itself would prop earnings by 81% to Y87bn. Consensus is currently Y83bn for FY3/14 OP, and thus most of these FOREX gains appear to be factored in assuming limited revenue growth in cameras and litho tools.