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Japan
Technology Electronics/Components
17 June 2008
Electronic components
Initiating coverage: three component
firms; enterprise value to be the key
Akinori Kanemoto
Research Analyst
(+81) 3 5156-6767
akinori.kanemoto@db.com
Stock valuation shifting to enterprise valuation creation ability
Deutsche Securities Inc.
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DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Initiation of Coverage
Top picks
Murata (6981.OS),¥5,510 Buy
Companies featured
Murata (6981.OS),¥5,510 Buy
2008A 2009E 2010E
EPS (¥) 353 297 337
P/E (x) 21.0 18.5 16.3
EV/EBITDA (x) 7.1 5.0 4.6
TDK (6762.T),¥7,240 Hold
2008A 2009E 2010E
EPS (¥) 554 472 546
P/E (x) 16.6 15.3 13.3
EV/EBITDA (x) 6.5 4.9 4.5
Taiyo Yuden (6976.T),¥1,216 Hold
2008A 2009E 2010E
EPS (¥) 85 86 97
P/E (x) 24.1 14.2 12.6
EV/EBITDA (x) 5.9 3.7 3.2
Global Markets Research Company
We initiate coverage on Murata, TDK, and Taiyo Yuden. We project earnings
momentum of electronic component makers to decline as volume growth of key
electronic equipment slows. We think valuation of the electronic components
sector will shift to comprehensive enterprise value creation capability, including
balance sheet efficiency improvements, from an emphasis on growth momentum.
Murata: Initiating at Buy on hopes of sustainable asset efficiency gains
We expect the pace of NOPAT margin improvement to slow, but think proactive
capex in growth fields and the 100% return of free cash flow to shareholders will
sustain medium-term asset efficiency improvements. We do not see significant
upside near term potential, for the stock price but do expect the share price to
begin gradually factoring in medium-term prospects for enterprise value creation
as a result of asset efficiency gains. We expect sector growth momentum to slow,
and as that happens the valuation of Murata within the sector should gradually rise.
We derive a target price of ¥6,100 using an ROC model based on our FY3/09
estimates and assuming an improved invested capital turnover ratio in FY3/10. This
represents upside potential of 10.7% from the current level and a P/E of 20.5x our
FY3/09 EPS estimate, a premium to the sector-average P/E of 18.5x to reflect
expected sustainable asset efficiency improvements.
TDK: waiting for new ROC drive to follow HDD heads, initiating with a Hold
We see no drivers of ROC gains to follow HDD heads. We expect HDD head
volume trends to determine the share price for the time being. We think ROC
drivers such as improved asset efficiency and better MLCC margins are essential
for medium-term valuation. We don’t expect MLCC to regain market share and
improve margins sharply in the current slowing market. But focusing on HDD
heads, which are profitable for TDK, has ample FCF creation capability, and we
believe improved asset efficiency is required to improve shareholder returns.
Equating to an FY3/09 P/E of 16x, our ¥7,370 target price represents 1.8% upside
from the current level. Based on our ROC model, to derive our target price we
apply a further 1ppt discount to our WACC to reflect risks of long-term
competition from NAND flash memory and further MLCC share loss (see Taiyo
Yuden on page 2).
Valuation and risk
To value the sector, we think an ROC model based on sustainable earnings is
effective. R2 for the ROC model (EV/IC=ROC/WACC) for Murata, TDK, and Taiyo
Yuden for last 18-years has exceeded 0.6. P/E in recovery phases and P/B in
correction phases have been used. We believe these traditional metrics are valid
to test relative levels. But while expecting earnings momentum to slow, we
believe evaluation of the creation capability of enterprise value will become more
important. So the use of the ROC model, which can reflect both earnings
momentum and asset efficiency, should increase. Risks include 1) forex and risk
premium trends, 2) a macroeconomic slowdown, and 3) more severe-thanexpected
price declines for MLCC.
Taiyo Yuden: Share price is cyclical and we expect it to firm up near term on a seasonal
recovery
We initiate coverage of Taiyo Yuden with a Hold. The target price based on our ROC model
and FY3/09 earnings estimates is ¥1,300, which represents upside potential of 6.9% from the
current level and a P/E of 15.2x our FY3/09 EPS estimate. Due to slowdown of growth in
capacitor business, we expect improvement in ROC will be slowing down. ROC driver to
follow the capacitor business, which make bulk of company-wide profits, takes more time.
And we see Taiyo Yuden as a cyclical name for the time being.
Table of Contents
Time to consider the ability to create enterprise value ................. 4
Basis for stock selection shifting from growth to enterprise valuation creation capability .......4
Murata: initiating coverage with a Buy rating on a mid-term view on expectations of
sustainable asset efficiency improvements ..............................................................................4
TDK: initiating with a Hold rating; waiting for new ROC drivers to follow HDD heads,
expecting HDD head volume trends to determine the share price for the time being .............5
Taiyo Yuden: initiating coverage with a Hold rating; currently viewed as a cyclical stock.........5
Risks ........................................................................................................................................5
Traditional methods of valuing the sector ...................................... 8
Electronic components sector reaches a turning point as earnings growth momentum
declines....................................................................................................................................8
Sector share prices are trading at the lower end of the historical P/B range and have
limited downside risk in our view............................................................................................13
Order cycle suggests share prices have bottomed ................................................................14
Change in inventory cycle; increased risk of quarterly share price volatility............................15
Paradigm shift to enterprise value-based valuations................... 17
Valuation based on our ROC model, which reflects enterprise value .....................................17
Target prices based on our ROC model..................................................................................19
ROC, EVA spreads set to move in tandem for all three companies........................................20
Murata's ROC driver differs vastly from TDK’s and Taiyo Yuden's .........................................21
Murata: Theoretical share price of ¥6,100 on FY3/10 improvement in invested
capital turnover .......................................................................................................................23
Comparison on traditional valuation metrics ...........................................................................24
Risks.................................................................................................. 29
Changes in exchange rates and risk premium ........................................................................29
Slowing macro economy centered on North America ............................................................31
Pricing/competition for general-use components centered on MLCCs ..................................33
MLCC industry outlook ................................................................... 34
Growth of market value to slow from 10%+ to low single digits ...........................................34
Supply/demand could soften slightly in 2008, but major deterioration unlikely ......................36
Aggregate market share of Big 3 Japanese MLCC companies recovers to around 60% .......37
High-capacitance MLCC market to grow at roughly 10% pace ..............................................37
Average unit price among Big 3 MLCC manufacturers to fall 16% in FY3/09, 9% in FY3/10..39
Near-term focus trends at TDK following launch of new Honjo plant .....................................40
Comparison of semiconductors and MLCCs in terms of technological development ............42
Competitive relationship with Asian manufacturers from the perspective of the
capacitance cycle....................................................................................................................45
Long-term concerns: Set makers’ short-term profit orientation, stagnation in development of
new killer apps ........................................................................................................................46
Company
Murata....................................................................................................................................47
TDK ........................................................................................................................................70
Taiyo Yuden..........................................................................................................................109
Time to consider the ability to
create enterprise value
Basis for stock selection shifting from growth to enterprise
valuation creation capability
Many electronic component makers have created enterprise value up to now by improving
the profitability of existing businesses based on volume growth of key electronic equipment.
With earnings momentum expected to slow, however, we think there is less scope to
improve the profitability of existing businesses. In this environment, we expect an expansion
in business scale via proactive growth of new businesses and M&A, and extraordinary
initiatives such as creating enterprise value through balance sheet efficiency improvements
(an area electronic component makers have hardly touched) to lead to a widening disparity
among sector stock prices.
We think the latter in particular could warrant assigning a premium to the sector-average P/E.
We think the criterion for selecting electronic components sector stocks is approaching a
major turning point, from an emphasis on growth momentum to comprehensive enterprise
value creation ability.
In this report we focus on Murata, TDK, and Taiyo Yuden’s ability to create enterprise value
and analyze share price trends based on the direction of ROC, the driver of enterprise value.
Murata: initiating coverage with a Buy rating on a mid-term view
on expectations of sustainable asset efficiency improvements
We initiate coverage of Murata with a Buy rating. Our target price is ¥6,100, which
represents upside potential of 10.7% from the current level and a P/E of 20.5x our FY3/09
EPS estimate. Our target price is based on our ROC model and FY3/09 earnings estimates,
and assumes a sustainable improvement in asset efficiency and an invested capital turnover
ratio of 0.83 in FY3/10.
While we expect the pace of NOPAT margin growth to slow, we project proactive capex in
growth fields and the return of 100% of free cash flow to shareholders will sustain asset
efficiency improvements. We do not see significant upside potential in the stock near term,
but do expect the share price to begin gradually factoring in medium-term potential for
enterprise value creation as a result of asset efficiency gains. We expect growth momentum
in the electronic components sector to slow, and as that happens the relative valuation of
Murata within the sector should rise.
We would see the stock as accurately valued at a premium of around 3-4x to Murata’s P/E
over those of TDK and Taiyo Yuden. We think this is reasonable because it reflects (1)
creation of enterprise value as a result of medium-term asset efficiency improvements, and
(2) net cash of around ¥1,500 per share (equivalent to around 30% of market cap). Murata’s
shares are currently trading at 18.1x our FY3/09 EPS forecast, which is around the sector
average P/E (18.5x) and if we factor in mid-term asset efficiency improvements the share
price should gradually rise to our target price of ¥6,100 (a P/E of 20.5x our FY3/09 EPS
estimate).
TDK: initiating with a Hold rating; waiting for new ROC drivers to
follow HDD heads, expecting HDD head volume trends to
determine the share price for the time being
We initiate coverage of TDK with a Hold rating. Equating to an FY3/09 P/E of 16x, our ¥7,370
target price represents 1.8% upside form the current level. Based on our ROC model (zerogrowth
DCF model, using 4.5% risk premium, 1.7% risk free rate),we derive our target price
by applying a further 1ppt discount to our WACC to reflect the risks of long-term competition
from NAND flash memory and further MLCC share loss. We think the stock is roughly valued
accurately at its current level.
We expect HDD heads to remain a stable profit generator for the time being because TDK
has established winner position in technology for advanced perpendicular products. While
much depends on the acquisition effects of Alps Electric HDD assets and Magnecomp
Precision Technology, we see possible upside for FY3/10 earnings. However, at this stage
wee see no drivers of ROC improvement to follow HDD heads, but we think ROC drivers
such as improved asset efficiency, better MLCC margins) are essential for mid-term valuation.
Taiyo Yuden: initiating coverage with a Hold rating; currently
viewed as a cyclical stock
We initiate on Taiyo Yuden with a Hold rating. Our target price is ¥1,300 (implied upside of
6.9%) based on our ROC model for the current fiscal year (zero-growth DCF model, risk
premium of 4.5%, risk free rate of 1.7%). This equates to a P/E of 15.2 on our FY3/09
estimates.
The valuation premium that formerly reflected strong growth in capacitor earnings up through
FY3/08 has disappeared. With capacitor earnings unlikely to return to a high growth track, we
expect the market to continue to assign the stock a discount for its high beta, which reflects
high earnings volatility, and think the below-sector-average P/E of 14x (vs 18.5x) our FY3/09
EPS estimate is not attractive. Even so, the low P/B ratios of 0.8x our FY3/09 and FY3/10
forecasts suggest downside risk is limited.
For share price upside in the medium-term, market share expansion is essential, but we think
a slowdown in market growth momentum will win out for the time being, we view Taiyo
Yuden as a cyclical stock at this time.
Risks
Risks include changes in exchange rates and the risk premium, a slowdown in macro
economic growth, and unexpectedly large declines in MLCC prices. Refer to the section on
risks for a more detailed description.
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