Description

Security: 6981 (Murata Manufacturing Co.)        

Shares: 212.7M

Price: 15,450.00 

Fiscal year ending March

All figures in JPY unless otherwise noted

Thesis Summary

Murata is an electronics components company leveraged to the secular growth themes of connectivity (Internet-of-Things), electrification of autos, and increased components complexity of low- to mid-end smartphones sold in emerging markets.  Murata operates in the attractive analog semiconductor niche (which includes familiar US players like Skyworks, QRVO, and Broadcom) with barriers to entry and limited threat of new entrants. 

Murata is an above average business with 15% ROIC, 40-50% incremental margins, and mid- to high-single digit long term sales growth.  While the business is inherently lumpy due to short product cycles and quarterly volatility, Murata enjoys stable and growing market share (in the high 40-90% range) as a preferred supplier to the major OEMs and is somewhat insulated from long-term structural share shifts in the industry.

While quarterly projections are difficult in this inherently lumpy business, one can build a long-term EPS bridge to FY2021 (ending March 2021) in a few different ways arriving at an earnings power of JPY950-1600/share and net cash of JPY6000-7600/share. At the current share price of JPY15450 the stock is trading at 5-10x (ex cash) FY2021 earnings.  At a more reasonable 10-18x multiple, shares could be trading at JPY15500-36000 by FY2020 for up-to 140% upside.

Murata has an excellent balance sheet, prudent shareholder-friendly management and is attractively priced, with 12% of its market cap in net cash increasing to 40-50% by FY2021 (before share buybacks and dividends) and trading at 14x FY2018 (ending March) earnings limiting downside.  Management appears competent and shareholder-friendly with a 15-year history of paying and raising dividends (except for 2009).  

It’s worth noting that Murata’s earnings are highly leveraged to a depreciating Yen with each 1.0 move in the JPY/USD rate translating into JPY3.5B impact to EBIT (JPY12/share in EPS).

The recent strength in the Yen, a temporary slowdown after a year of strong growth, and substantial use of FCF for capacity expansion and pension contribution, have all weighed on the stock, creating the opportunity.  The sales slowdown is less concerning because Murata’s large market opportunity in the Internet-of-Things, automotive, and smartphones markets offer many years of mid-single digit growth.  FCF has been depressed in FY2016-FY2017 because Murata is investing to grow capacity for its filters which are operating near-capacity and Murata also made a large cash contribution to its pension plan which increased dramatically due to changes in its actuarial assumptions (discount rate down to 0.5% from 1.1%).  As the capacity expansion completes and the pension contributions normalize, FCF should positively inflect.

BUSINESS DESCRIPTION

Market opportunity

The connectivity components market is very large. One way to size the market is as follows: IDC projects Internet-of-Things (IoT) units to grow 18% per annum to 28B units by 2020.  Murata makes JPY400-450/unit today with prices declining 10% per annum on a like-for-like basis to around JPY280/unit, offset by increased content per unit (note Murata’s blended pricing per unit has actually grown last 2 years).  If Murata is able to capture 10% of the market (2.8B units), that translates into JPY1358/share in earnings, which is almost 2x their FY2017 EPS (assuming 50% incremental margins, 26% tax rate).

Components segment (70% of sales and 85% of earnings)

This is a good business with 50% incremental margins, high market share in most sub-segments (40-95% for some components), some customer captivity (manufacturing advantage, strict performance requirements, short product cycles, analog learning curve) and good long-term growth prospects. The segment includes small high performance components such as monolithic ceramic capacitors (MLCC), where Murata has 40% market share, used in communication applications from autos to smartphones. The business is running at close to 100% utilization prompting management to expand capacity depressing near-term FCF.  Murata also builds SAW filters (50% global market share) which are used in low- and mid-end smartphones for signal receptivity.  Growth in SAW filters is not only tied to growth in smartphone units but also to increased content per phone as phones are designed to support multiple channels.  Due to lower cost and perceived lower quality, SAW filters are preferred to FBAR filters (from Avago/Broadcom) for lower end phones and the latter to high end smartphones.  To address the higher end market, Murata is now shipping a higher performance SAW filter, called IHP-SAW, which management believes can compete successfully with FBAR filters enabling the firm to capture share at the high end.  Other products in this segment are piezoelectric shock sensors (95% share), MEMS sensors used in electronic stability control in autos.

If components sales grow 6% per annum through FY2021 (half the growth rate in the period FY2009-FY 2016), it translates into JPY1167/share in earnings (50% incremental margins, 26% tax rate).

Modules segment (35% of sales and 15% of earnings)

The modules business comprises wireless, RF, and power supply modules. This business is somewhat less attractive with lower incremental margins at around 40% and greater risk of share loss as OEMs can more easily switch out one supplier for another. 

If modules sales grow 4% per annum through FY2021 (versus a 14% CAGR in FY2009-FY2016 and below management’s mid-term goal of 5-10% overall sales growth) it translates to around JPY180/share in earnings (40% incremental margins, 26% tax rate), which is almost completely offset by corporate overhead expenses.

SEGMENTS BASED FY2021 EPS BRIDGE

On a consolidated basis, adding JPY1167/share Components earnings, JPY180/share Modules, JPY17/share Other, offset by JPY196/share in Corporate overhead translates to FY2021 earnings of around JPY1168/share and net cash (before dividends, buybacks, and M&A) of JPY6600/share.

ALTERNATE TOP-DOWN EPS BRIDGE

Building on FY2017 EPS of JPY730/share, projecting sales growth of 0-10% in FY2017-FY2021 (versus management’s medium term sales growth target of 5-10%), 45% incremental margins (with 5% of sales cost savings in the no-growth scenario), and 26% tax rate, translates into FY2021 earnings of JPY930-1560/share and net cash, before dividends, buybacks, and M&A of JPY6000-7600/sh.

On these estimates, shares are trading at 5-10x, ex cash. At a 10-18x multiple, ex cash, shares could be worth JPY15000-36000 (0-140% upside).

Risks

·         Ongoing pricing pressure: As with most semiconductor/consumer electronics, the business is highly deflationary on a like-for-like basis. If Murata is unable to offset these price declines with more content, earnings will decline and the multiple could compress to below 10x.

·         Risk of an ill-conceived or poorly executed acquisition

·         Threat of increased modularization which can potentially increase commoditization of the RF business (as it did for many parts of the digital semi industry) which can translate into a lower multiple.

Catalyst

Wind-down of growth capex

Time