Like Tesla? You’ll Love Panasonic – Panasonic Corporation (OTCMKTS:PCRFY)

Introduction

Tesla (NASDAQ:TSLA) has a good product, but its stock has run up too far considering its limited profitability. Are there other companies leveraged to the same trends that trade at a more reasonable valuation? I present Panasonic (OTCPK:PCRFY). Panasonic manufactures battery cells which Tesla combines into battery packs at its Gigafactory. It is the sole supplier for Tesla’s US production.

The company has excellent brand awareness, and most consumers know it for its appliances and consumer electronics. Maybe you have a Panasonic DVD player or a toaster oven, rated the best in its category by Wirecutter.

The company’s battery business was not profitable last year, just like Tesla’s car business was not. Tesla has indicated that it will be profitable this year, and Panasonic wants to make a push to have its business be profitable as well.

On Feb 3, the company announced a joint venture with Toyota (NYSE:TM) to make batteries for hybrid and electric vehicles. Toyota is the world’s largest car manufacturer and is committed to making a push into electric vehicles. Panasonic owns 49% of the JV.

The stock trades at 12x earnings and I believe offers 30% upside to fair value as investors recognize the company’s enviable position as a key supplier for electric vehicles.

Company background

Panasonic is a 100-year-old company that is based in Japan, but it has an ADR that trades on the US stock market. The exchange ratio between the ADR and common shares is 1:1. Liquidity is moderate as the ADR trades a few hundred thousand shares a day.

45% of the company’s revenue comes from Japan, with the rest from international markets (i.e. international for the company, which includes the US).

The company manages its operations in five segments:

  • Appliances: Consumer electronics products like TVs, refrigerators, washing machines, ovens, air conditioners and devices. 32% of revenue, and 39% of segment operating profit (4.0% segment margin).
  • Life Solutions: Lighting, wiring, home automation, ventilation equipment. 23% of revenue, and 34% of segment operating profit (4.7% segment margin).
  • Connected Solutions: B2B solutions like process automation and innovation. 12% of revenue, and 36% of segment operating profit (9.9% segment margin).
  • Automotive: Infotainment, electronics, mirrors and batteries. 17% of revenue, and -14% of segment operating profit (-2.6% segment margin).
  • Industrial Solutions: Control devices, LCD panels, motors, components. 15% of revenue, and 5% of segment operating profit (1.0% segment margin).

As you can see, the automotive business is the only one that is unprofitable. If the company’s automotive business got to a 5% operating margin, its total operating profit would rise by 35%!

The company’s international competitors include LG Chem of Korea and CATL of China. It is unclear what the profitability of their automotive business is.

Financial overview

In the nine months ending December 2019, revenue was 5.76 trillion yen, equivalent to $52 billion at an exchange rate of 110 yen to a $. Revenue was down 5% as the company felt the effects of a manufacturing slowdown around the world. The company had a 4% operating margin and net profit attributable to shareholders of 178 billion yen or 76.3 per share. This equated to EPS of $0.70 for the nine month period. Annualized, this amounts to $0.93 per share. Going forward, the company is expected to have stable revenues and margins.

The company has $8 billion of cash and $10 billion of debt. With 2.3 billion shares, its market cap is $26 billion and Enterprise Value is $28 billion or 0.4x revenue. I believe the company can unlock value by using some of its cash balance to buy back its stock which it currently does not do. It pays a modest dividend with a current yield of 2.5%.

For a fun comparison, Tesla is estimated to earn $8 per share this year, but this is a non-GAAP estimate that ignores $5 per share of stock compensation. So on a GAAP basis, earnings are expected to be $3 per share. Thus Tesla trades at more than 200x earnings compared to 12x for Panasonic.

Valuation: Fair value of $15 for the stock

Put a reasonable 16x multiple on current earnings and you get a fair value for the stock of $15. That is more than 30% upside from the current $11.4 price.

In a bull case, the company will increase its revenue and operating income a bit and get to $1 of EPS. Assigning an 18x multiple to reflect growth would translate to a $18 target price or more than 50% upside.

In a bear case, the company’s revenue and operating income will decline and it will generate only $0.75 of EPS. Disappointed investors will assign a 12x multiple, resulting in a $9 stock price for a 20% downside.

The Japanese 10-year government bond yields zero, so it is somewhat surprising that Japanese investors aren’t falling over themselves to buy one of their best-known companies at an 8% earnings yield and 2.5% dividend yield. Granted, there are risks like half the company’s revenue coming from abroad and subject to exchange rate risks, but I think these are manageable.

Risks are moderate

The biggest risk here is that the company’s earnings will come in lower than expected due to macroeconomic, competitive, or execution factors. The current coronavirus outbreak could disrupt supply chains, dampen consumer demand, and increase costs.

It is possible that the company’s automotive business will continue to be a drag and that it will not turn profitable anytime soon.

The company may go out and make a value-destroying acquisition, siphoning off shareholders’ funds.

The company may continue to stockpile cash, leaving shareholders with just a measly dividend and no growth.

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Disclosure: I am/we are long PCRFY. 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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