Koito Manufacturing and Stanley Electric
Leading automotive lighting franchises globally selling at deeply discounted valuations
Koito is the largest global automotive lighting manufacturer accounting for a quarter of the global market. In the Japanese tradition of automotive suppliers, Koito is aligned with Toyota which owns 20% of the company while Stanley Electric, another Japanese auto electric company, is aligned with Honda. Toyota accounted for about 14% of Koito’s revenues.
This is a cyclical business with the cycle of the business aligned with that of the global auto sales volume. While the business experienced a strong upcycle between 2010 and 2018 driven by higher auto sales, it has since been caught in a downcycle. The chart below shows Koito’s sales vs its Trend and SD bands. The strength of the recent upcycle was similar to that of the early 90s and the downcycle, thus far, has been similar to that of late 2000s.
Driven by the lower sales volumes and elevated cost pressures, the company’s profit margins have declined since 2019, an industry-wide trend.
The company is working on a cost reduction initiative by automating much of its production processes in a bid to lower its unit costs and improve profitability.
Source: 1st Medium-Term Management Plan announcement, March 28, 2024
Koito’s medium-term plan is for its operating profitability to return to its pre-COVID highs of 10%+. While I am not betting on a return to such profitability levels, there is significant optionality to the company’s valuations if it were to sustainably operate at such elevated levels of profit margins.
Source: 1st Medium-Term Management Plan announcement, March 28, 2024
INDUSTRY:
The global auto lighting market is an oligopoly with Koito Manufacturing, Stanley Electric, Forvia Hella, and Valeo Lighting accounting for a majority of the industry’s revenues. The business is driven by new vehicle sales >> healthy volume growth between 2009 and 2018, 2020 saw a large decline with vehicle sales dropping towards 2010 levels and haven’t recovered their peak levels yet. The volume decline combined with cost pressures has resulted in lower profitability for the auto lighting industry.
The charts below show Koito’s relative market share against Stanley Electric over the past four decades and against the combined revenues of the four large players, namely Koito, Stanley, Hella (Lighting segment), and Valeo (Lighting segment). The relative market share against Stanley is affected by the non-lighting businesses of Stanley which make it seem like a persistent gain by Koito. However, that isn’t an entirely correct conclusion. Market shares, when looked at against the four large players, reflect lower sales volume of Japanese companies within the total global volumes. However, this is a trend that seems to be reversing. At the same time, Koito’s is increasingly making a bigger push amongst the non-Japanese OEMs.
Source: Company reports, Factset, MAEG’s calculations
Capital cycle. During the upcycle of 2010s, the industry spent significantly on capex with the Capex to D&A ratio averaging at about 1.4x between 2012 and 2020. Since then, the industry has been controlling its capital spend with Koito and Stanley being quicker at it and Hella following suite in 2023. As can be seen, the tightening of capital spending by Koito is similar to what occurred around the GFC and in the late 1990s.
An important thing to note here is the profitability differences between Stanley and others. Stanley has historically generated superior profitability and continues to maintain that edge.
The differential in profitability of Stanley over others is even more pronounced in cash generation with OCF margins being significantly greater than others. However, when it comes to FCF generation, Koito has fairly similar normalized FCF margins to that of Stanley. Both the Japanese companies generate significantly superior FCF margins in comparison to their European peers, Hella and Valeo. This cash generation differential is also reflected in their balance sheets. While both Koito and Stanely have an extremely large amount of net cash on their balance sheet, Hella and Valeo carry leverage. While Hella’s leverage is moderate at about 1x OCF and about 5x normalized FCF, Valeo is extremely highly levered at about 2.5x OCF and about 20x normalized FCF.
Corporate Governance, Capital Allocation, QoE
Koito:
No instances of poor corporate governance. Strong FCF generation with FCF conversion ratio of about 90%. No significant M&A. Much of the cash, apart from the dividend payments which have amounted to a payout of 30% over the past 40 years, has accumulated on the balance sheet. Net cash of JPY 335 B as of March 31, 2024. At current market prices, about half of the market cap is represented by net cash. OCF generation has been about JPY 100B per year.
The company has now resolved to optimize its capital structure. Over the next five years, it expects to generate about JPY 550 B in OCF and expects to invest about $350B in Capex and return JPY 350B to shareholders via dividends of about JPY 100B and JPY 250 in buybacks. Note that the proposed buybacks amount to about a third of the current market cap, i.e., over the next five years, the company plans to return as much as half of the current market cap to shareholders via dividends and buybacks.
No QoE issues with strong FCF generation and extremely healthy F-score and M-score profile over the past 25 years.
Stanley:
No instances of poor corporate governance. Strong FCF generation with FCF conversion ratio of about 90%. No significant M&A. Dividend payments have amounted to a payout of about 30% over the past 40 years. Stanley has been buying back shares over the past 20 years spending about JPY 95B on buybacks since 2002 with number of shares outstanding declining by about 20%. Over the past few years, total payout (dividend + buybacks) has been averaging at about 50%.
Net cash of JPY 232 B as of March 31, 2024. At current market prices, about half of the market cap is represented by net cash. OCF generation has been about JPY 100B per year.
Valuation
Koito
Our PB of the stock is JPY 2400 – 4800 and is based on the historical and EV/NGV modules. At current prices, the stock trades at FCF yield on the EV of 12% while the business has a trend growth rate of 5%. The charts below show the company’s pricing behavior around the NGV and Tangible TA. On both metrics, it is nearly the cheapest it has ever been.
Stanley Electric
Our PB of the stock is JPY 3000 – 6000 and is based on the historical and EV/NGV modules. At current prices, the stock trades at FCF yield on the EV of 15% while the business has a trend growth rate of about 3%. The charts below show the company’s pricing behavior around the NGV and Tangible TA. On both metrics, it is nearly the cheapest it has ever been.
In comparison to the double-digit FCF yields at which Koito and Stanley are trading at, Hella is priced at just about a 2% FCF yield on the EV.
What do the charts say?
Koito
The stock has been locked into a consolidation and is trying to turn to reverse from the support zone.
Stanley Electric
Has been trading in a strong value zone of 2350 – 3350 which has been in place for 10 years. The price action here looks constructive.
Summary
Both Koito and Stanley come across as reasonably good businesses that are well priced. Underlying returns for both businesses are about 15% with significant potential valuation upside. Given Koito’s management plan of returning JPY 350 B to shareholders via buybacks and dividends over the next 5 years, the stock has catalysts in place for healthy shareholder outcomes.