These are still challenging times for companies that remain leveraged to warehouse and logistics capex, as Cognex (CGNX) and KION (OTCPK:KIGRY) both sold off sharply after recent quarterly results on still-weak results. Japan’s Daifuku Co., Ltd. (OTCPK:DAIUF) (6383.T) hasn’t done all that much better; while the stock rebounded after better-than-expected quarterly earnings, the ADRs are down about 16% since my last update, while the local shares are down closer to 6% — a performance that has broadly tracked Cognex and KION despite the differences in business mix.
There are many moving parts to consider with Daifuku. While this is one of the still relatively rare ways to play warehouse/logistics automation, that’s only about 20%-35% of the business (depending upon how you define terms), and other end-markets like automotive, semiconductor, and airport are significant. Even so, I do like the growth outlook for the company’s core automation capabilities, including material handling, sorting, and picking. If the company can achieve long-term revenue growth of 5% to 6% and low double-digit free cash flow growth, the shares do look modestly undervalued now and “modestly undervalued” has historically been about the best value-conscious investors can expect.
A Strong Fiscal Q1, But Follow-Through Is A Question
Daifuku is in the midst of a transition to a calendar fiscal year, but for now, I am sticking with the historical convention that the calendar second quarter is the company’s first fiscal quarter.
Revenue in the quarter rose 8%, with better results from the company’s semiconductor/electronic end-markets (up almost 8%), strong results from the airport equipment business (up almost 24%), softer growth in auto (up about 2%), and weakness in retail (down 7%). Core “intralogistics” growth was positive, but the company did note ongoing “stagnation” in warehouse automation investments in North America and Japan, as well as strong semi capex investment from Chinese chipmakers focused on legacy nodes.
Gross margin improved more than five points (from 16% to 21.7%), with the company continuing to benefit from mix and pricing actions taken in the North American intralogistics business. This helped drive 100% year-over-year operating income growth, driving a 32% beat as operating margin improved 520bps to 11.3%. Core intralogistics and cleanroom margins improved in Japan (by more than three points) and the company got a significant boost from strong demand in China, while margins in the North American business remain fairly weak (up 70bps, but still less than 6%).
Despite the strong beat, Daifuku management was relatively cautious about raising expectations for the remainder of the year – boosting operating income guidance by about 8%. Management remains relatively cautious on the near-term outlook for warehouse/logistics automation capex spending, and seems more concerned now about slowing auto capex.
Good Order Growth, But Orders Have Always Been Volatile
Among the company’s businesses, my sense is that management is least concerned about the cleanroom operations in the near term. Orders from electronics customers (which includes semi fab operators) rose 21% in the quarter and is still only half the level of the most recent peak (the first quarter two years ago).
Chinese semiconductor companies have been adding considerable capacity at legacy nodes. While it’s fair to question how much longer that party will continue, Daifuku should start seeing core logic and memory recover toward the end of the year, with management expecting a two or three-year recovery cycle in cleanroom equipment demand (Daifuku provides a range of automated material handling systems, including wafer and panel conveyance systems, with a growing back-end business).
Orders from the retail end-market (which includes a lot of the company’s warehouse automation business) rose 78%, but that was off a low comp. At JPY 39.6B, orders are still at around half of the former peak, but have at least moved ahead of the trailing 12-month average. Although I do think warehouse automation equipment demand is bottoming (I believe this is true for others like Cognex and Honeywell (HON) as well), a strong recovery will take some time to materialize, and management has warned that the near-term deliverable backlog here is more skewed toward less sophisticated, lower-margin products (particularly in North America).
In the auto business, orders declined 3% and while this business too is often quite volatile in terms of quarter to quarter order figures, the arrow seems to be pointing down. Management spoke about good xEV-related demand (electrics and hybrids), but with many automakers scaling back their xEV production plans and capacity expansions, I do expect softer results from this business. That said, the company does have good leverage to China’s still-growing xEV market, and this is likely to cushion the blow from softer capex investment from Western automakers.
Work To Do, But A Good Future
Relative to my last update on Daifuku, not a lot has changed in terms of the long-term outlook for the company’s core markets and competencies. Warehouse construction has slowed considerably this year in North America as companies “digest” prior capex investments, but overall warehouse automation penetration is still likely somewhere in the 20% range (sources vary widely, depending in large part on how “automation” is defined).
Given labor challenges in North America and Japan, companies’ constant push for supply chain and manufacturing efficiencies, and ongoing growth in e-commerce, I see no reason to believe that long-term demand for warehouse and logistics automation won’t be healthy. As the last couple of years have demonstrated, though, a healthy long-term outlook does not exempt the industry from considerable cyclicality.
I also still see ample room for self-improvement. Daifuku’s mix in North America still isn’t as strong as it could be relative to the company’s capabilities, and I still believe the company punches below its weight in this market. I likewise continue to believe that the company would benefit from an acquisition or two meant to build scale and higher-end capabilities (in software and services in particular). I also still see opportunities for the company to benefit from increased factory automation overall. Many of the company’s core technologies in material handling, sorting, and picking are applicable to a wide range of end-markets, and more “non-traditional” markets outside of autos and electronics are investing in automation.
The Outlook
I’m modeling revenue for this fiscal year that is about 2% above management’s current guidance (around 5% year-over-year growth), and I’m looking for stronger growth over the coming years as core warehouse and semiconductor markets recover. Over the long term, I expect revenue growth around 5% to 6% (ahead of around 2% underlying IP growth) as customers continue to adopt automation.
On the margin side, I don’t expect much upside this year as the company works through some lower-margin backlog. However, I think EBITDA margin should be flat with the prior year (near 12%) before some modest improvement in the following years (around a point or so over the next three years). At the free cash flow level, I expect gradual improvement to mid-single-digit FCF margins and then mid-to-high single-digit margins (around 8% to 9%) over time, driving low double-digit FCF growth.
Discounted cash flow suggests a high single-digit annualized expected long-term return, and that’s not bad for a Japanese automation stock (Japanese stocks, particularly growth stocks, often trade with low embedded discount rates). Other methodologies like ROE-driven P/BV and margin/return-driven EV/EBITDA suggest around 15% undervaluation at today’s level. Keep in mind, too, that this is based on what I consider to be “fair” multiples based upon what the market has traditionally paid for similar levels of margin and returns (ROIC, et al.) from industrial companies. In the past, the market has been willing to give Daifuku a pretty substantial premium due to its higher growth potential.
The Bottom Line
Warehouse automation stocks are certainly not in favor today and have lagged the larger industrial sector since my last update. Given iffy demand from auto OEMs, still-weak warehouse capex, and an uncertain semiconductor recovery trajectory, I can understand why. I believe Daifuku has been executing fairly well through this challenging period, though. The shares do look attractively priced today, even without assuming that the Street comes back and rewards a premium valuation on improved growth prospects once warehouse spending recovers.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
Read the full article here