Description

We and our affiliates are short Shimano. We may buy or sell shares without notification. This is not a recommendation to buy or sell shares.

Company Overview

Shimano is the largest producer of bicycle parts in the world. They have up to a 75% share in their categories. They have particularly strong positions in running gears and brakes. Bicycle parts represent approximately 80% of sales. The remaining 20% is fishing equipment, including rods, reels, and tackle. The company is heavily exposed to Europe, which accounts for around 60% of sales. North America is another 16%, Japan 6%, with ROW (weighted toward other Asia) the remaining 15-20%.

Investment Thesis

Shimano has been a significant covid beneficiary in both segments. Estimates for 2022 (fiscal year ending December) are for revenues to be up close to 60% in two years versus typical low- to mid-single digit growth. This is a clean number as 2020 was also an up year. Coupled with a bicycle buying mania during the pandemic supply was genuinely short. Shimano took advantage. Gross margins were up 400bp and operating margins were up 900bp over 2019.

Japanese investors are anchoring on this strong recent performance. Consensus is calling for revenue to be down 1% in 2023 followed by up 1% in 2024 before re-accelerating to 7% and 5% in 2025 and 2026, respectively. Japanese investors are relatively fixed on covid beneficiaries, both temporarily and long-term. Shimano is also seen as a secular winner from decarbonization trends.

We believe this bullish narrative is wrong. Shimano’s cycles have been fairly predictable historically with past booms corresponding to multi-year hangovers in performance. We expect this to repeat with destocking contributing to an undershoot of trend on the downside. We have already seen this in bicycle accessories (helmets, racks, etc.) and it has begun on low- to mid-end bikes with the high-end soon to follow.

Bicycle booms deflate and this one is already showing the tell-tale signs

There have been two past bicycle mega-cycles in the past 20 years, 2007/2008 and 2014/2015. In 2007/2008 Shimano’s bicycle segment sales were up > 50%. The spike in oil played a large role. There was a sharp downturn in 2009 (down 22%), not surprisingly, followed by a modest rebound. Peak bicycle sales were not regained until 2012. In 2014/2015 sales were up 45%. 2017 sales were down 17% and the 2015 peak was only regained in 2021. We expect a similar pattern to play out this cycle and model in a Base Case sales marginally undershooting trend in 2024, where trend assumes a robust 5.8% revenue CAGR from 2019.

We believe this correction is already underway. Shimano’s recent reports have highlighted robust trends in high end bikes but noted now normal to above normal inventories in the low- to mid-end. Dick’s has indicated bike inventories are now above normal levels. The helmet manufacturer MIPS has already corrected significantly. Q3 sales were down 39% YoY and Q4 is expected to be down 42%. Through Q2 ’23 consensus is calling for a 33% sales correction. Thule, which makes bike racks and other cargo carriers, showed a sales decline of 23% in Q3. Through Q2 ’23 consensus expects an 18% decline in revenue.

Margins are inflated and will also correct

In the 2007/2008 cycle gross margins declined 200bp before rebounding to new highs as the company diversified its production base. The 2014/2015 is more indicative of what we believe will happen. Gross margins peaked in 2015 at 40.8% and then declined to 38.7% in 2019. They reached a new all time high in Q3 ’22 of 42.9%. We see them moving back to around 40% in 2014. Flowing through to operating margins, we model flat to down SG&A, which looks conservative. This implies operating margins of 21.2% in ’24 versus 18.7% in ’19. The route to lower gross margins is through normalized inventories at the high-end. Our checks suggest this is following the low- to mid-.

The shift to e-bikes is negative for Shimano

Shimano has been slow to the e-bike revolution. Five years ago they were highly dismissive that the category would take off. Since then they have tried to play catch-up deploying capital through M&A. By our estimation Shimano holds closer to 20% share of e-bike components and even less on the critical drivetrain. There is considerably more upstart Chinese competition in e-bike components, so we see the gap as hard to close. Furthermore, like with autos, e-bikes should be less component intensive over time.

Risk-reward

Our Base Case has 2024 earnings getting below 800 yen per share (with buybacks). This compares to 2019 earnings of 544 yen per share. At 23x we see 20-25% downside. In a Bear Case where the cycle really undershoots trend earnings could be as low as 600. At 20x that would be close to 50% downside. It may not get there given the clean balance sheet and historical multiples, but somewhere between the Base and Bear Cases seems quite reasonable. To really get hurt you need to use peak a 25x+ mutiple on peak earnings. 25x the consensus ’23 EPS number of 1,311 is 42% upside.

Catalyst

-High-end bike inventories become full

-Remaining pent-up demand is satisfied

-Continued e-bike penetration leads to Shimano share loss