Toyota-backed car-parts maker a sound bet on electrification trend
Tokyo-listed Denso Corp is a global automotive components manufacturer and is one of the largest auto parts suppliers in the world. Roughly one-third of the company is owned by Toyota Motor and approximately 60% of its revenue is derived from Japan, 20% from Asia, 12.5% from North America and 7.5% from Europe. Denso operates two main businesses — automotive and non-automotive.
The automotive business consists of many segments. The first is electrification systems which contributes around 20% of the revenue, and develops and manufactures driving and power supply systems, to name a few examples.
The next segment is powertrain systems, which develops and manufactures engine management systems and valve-related products, and contributes around 23% of the revenue. The following segment is thermal systems, which also contributes 23% of the revenue and is involved in the development and manufacture of cooling products and thermal management, to name a few.
The mobility electronics segment focuses on the development and manufacture of environmental products and the provision of mobility related electronic systems and platforms, and contributes roughly 25% of the revenue.
The last segment is advanced devices, which contributes 3% and is involved in the development and manufacture of control valves and microelectronic devices, to name a few.
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For its non-automotive business, Denso has two main segments. The first is industrial solutions, which focuses on the development and manufacture of industrial equipment such as industrial-use robots, while the other segment is the food value chain, which is involved in the manufacture and sale of turnkey solutions and systems for digitisation of food distribution and data-linked services. These two segments together contribute roughly 3% of the company’s total revenue.
Denso’s primary business strategy is focused on electrification, while restructuring its business to capitalise on the growth of technology in the automotive industry, as it moves away from traditional internal combustion engine (ICE) systems. As demand for automobiles picks up following the tapering effects of the pandemic on the demand, Denso aims to expand its sales beyond the Toyota group, from which it currently derives 50% of its revenue. Being less reliant on Toyota should enable the company to meet medium-term goals, such as achieving its 10% operating margin target in the next three years.
Further, the company is aggressively spending on R&D and forming partnerships with other businesses to focus on the automation and technology for electrification. This allows the company to leverage the knowledge and expertise of these businesses and move away from the traditional ICE business better, and targets for the growth of its advanced systems should be easily achieved.
Further, Denso’s competitive advantage includes its global network and reach, which should enable it to focus on technology related to CASE (connected, autonomous, shared and electrification), while adhering to ESG standards through its “green” and “peace of mind” strategy.
The company’s one-year total return was –31.6%, although its financials were solid. Denso has had over five years of positive net income, operating cash flow and free cash flow, as shown in the chart. Financial safety-wise, Denso has excellent liquidity with a current ratio of 1.86 times, and good solvency with a net debt-to-equity ratio of just 0.04 times. In terms of yield, the company’s earnings, operating cash flow, free cash flow and dividend yields are 5.0%, 6.5%, 0.5% and 2.6% respectively, which is significantly more attractive than the risk-free rate of 0.3%. The company also trades at 3% and 16% discounts for its EV/Ebit and P/B ratios respectively, compared to global peers, which makes it a relatively attractive pick-up.
Sentiments-wise, the company has 18 “buy” calls, three “hold” calls, and no “sell” calls, with a consensus target price of almost 40% above its current trading price of JPY6,514 (about $65.80). Based on our in-house valuations of the company, we believe that the intrinsic value of the company is roughly 30% above its current trading price. Denso is a company that can adapt well to the transition into electrification, and at current prices, it is a cheap pick-up.
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Photo Credit: Bloomberg
Data for Charts & Tables were sourced from Bloomberg; Stock returns include capital adjustments and dividends, and excludes currency exchange fluctuations.
