Having established itself as a leader in multiple segments of the Japanese factory automation sector, Yaskawa Electric (OTCPK:YASKY) is trying to repeat its success in China as that country increasingly adopts automation. The company has done well thus far, but the cyclical nature of the industry and its dependence upon customer capex (not to mention forex exposure) have made for choppy share price performance over the past five years.
The shares are now off more than 10% from their recent high and look as though they could be slightly undervalued. I’m not looking for exceptional revenue growth in the coming years, but I do think the company can improve its margins and continue to leverage its strong share in servomotors. If adoption of servomotors, inverters, and robots can spread beyond today’s core markets (and if Yaskawa can broaden its horizons in robotics), there could additional upside to sweeten the prospects.
Yaskawa’s ADRs are not especially liquid. I would suggest that investors consider the Japan-listed shares instead.
A Significant Player In Factory Automation
“Automation” means a lot of different things, including everything from motors and drives to servomotors and linear guides, to robots, control systems, and software. Yaskawa’s expertise is in servomotors (a key component in many types of factory automation equipment), inverters, and robots.
Close to half of the company’s revenue comes from its motion control products (servomotors and inverters), and this business contributes more than 60% of profits. Servomotors are more accurate than conventional AC and DC motors, and they are used in a range of applications like robots, machine tools, injection molding machines, pressure devices, and other types of factory equipment. Yaskawa is the leading player in the world, with close to 20% share, though it’s much stronger in Japan (where it competes with MELCO) than in North America or Europe, where companies like Bosch (OTC:BSWQY), Siemens (OTCPK:SIEGY), and Rockwell (NYSE:ROK) are more significant. Inverters alter the frequency or voltage to regulate motors, leading to improved performance and greater energy efficiency; air conditioners, elevators, and escalators are key markets. Yaskawa is a co-leader in the field with ABB (NYSE:ABB), but again Yaskawa’s market position is stronger in Asia than in Europe and North America.
Robots contribute more than a third of Yaskawa’s revenue and more than 40% of operating income. Yaskawa is one of the major players in factory robots, offering a suite of products including more complex multi-arm/multi-joined systems. While the company’s share of approximately 20% places it second behind Fanuc (OTCPK:FANUY), it has stronger positions in specific segments like arc welding, painting, and glass sheet transfer.
The remainder of Yaskawa’s revenue comes from Systems Engineering, something of a catch-all business that includes electrical control systems for steel plants, electrical systems for wind power, and so on. This business has been generating small operating losses for a little while, though management is bullish on the long-term prospects for its wind power business.
Leveraging China And Looking For New Opportunities
China is a fast-growing market for automation, as companies here look to improve product quality and consistency and control production costs. China has grown from a mid-teens percentage of Yaskawa’s sales to more than 20%, and the company generates more revenue in its robot business from China than anywhere else (at least in recent quarters).
Competition is a threat. China’s government has actively encouraged local companies in factory automation, and a few companies like Siasun (in robotics) are becoming more credible players. Thus far, the offerings from Chinese companies are less sophisticated and capable, but the gap is shrinking and shrinking faster than companies like Fanuc, Yaskawa, and ABB would care to admit. That said, Yaskawa’s strong position in servomotors and inverters is an important factor to remember, as it sells servomotors to some Chinese robotic manufacturers (particularly on the lower end of the market).
Yaskawa is looking to extend its strong Japanese share in motion control and robotics into China, and thus far, it has been executing well. While most industry demand for servomotors is in machine tools, Yaskawa actually skews more strongly toward electronics, with its products used in semiconductor and LCD manufacturing, smartphone manufacturing, and so on.
Yaskawa is also looking to leverage opportunities to grow outside traditional markets. While servomotor demand has in the past largely been driven by machine tools and semiconductor/LCD equipment, the improving cost/benefit ratio of these components is leading to wider adoption in areas like injection molding and other new markets.
Wider adoption of robots could be an even bigger opportunity. The auto and electronics sectors have historically been the largest customers for robots and by a wide margin (roughly 70% of demand). More recently, though, adoption has started picking up in markets like aerospace, food/beverage, materials handling, as well as overall “general industrial” applications. Yaskawa has been a little slow to get involved in the emerging cobot trend (small robots that can work safely around humans) that has attracted a lot of attention for Teradyne (NYSE:TER), but management has laid out some ambitious goals for the development of cobots in service settings (robots that could help people in a caregiving setting).
Yaskawa has been shifting more and more production away from Japan (where it used to manufacture about 70% of its products), improving margins and giving it more flexibility to work with local partners. Margins in the motion control business have been pretty consistent in the low-double digits, but margin leverage in the robot business has been harder to come by. Unlike Fanuc, which is exceptionally good at standardizing components to maximize margins, Yaskawa is still working on achieving better component standardization without compromising its ability to work with customers to deliver customizable solutions.
The cyclicality of the semiconductor and smartphone markets is a challenge for Yaskawa, not to mention the cyclicality of capex spending on industrial manufacturing. I’m not looking for especially robust revenue growth for Yaskawa, due in large part to its heavy skew (roughly one-third of revenue) to the low-growth market of Japan and the risk of increasing competition in China. The wind power systems business could be a bigger driver than I estimate, though, and Yaskawa could likewise find more success in smaller robots than I currently model.
I do expect better things on the margin side, as the company leverages improving volumes and works to drive costs out of its robot business. Companies like ABB and Fanuc are of limited use as comps because the product mixes are different, but I do believe Yaskawa can drive its FCF margins into the mid-single digits, allowing the company to leverage low-single-digit revenue growth into double-digit FCF growth in the coming years.
The Bottom Line
Discounting back the cash flows, I think Yaskawa is around 5% undervalued today. That’s admittedly not “strong buy” territory, but the company could still have some outperformance left – particularly if machine tool orders improve and the next iPhone launch goes well. Longer term, a recovering Chinese economy and greater investment in automation within China should help return Yaskawa to double-digit ROICs and the shares could be a decent holding for patient investors.
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Disclosure: I am/we are long ABB.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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