Harmonic Drive Systems Earnings: Fair Value Estimate Cut to JPY 2,800 as Midterm Outlook Lowered

We lower our fair value estimate for wide-moat Harmonic Drive Systems to JPY 2,800 per share from JPY 5,100, as we have lowered our midterm outlook in terms of profit margin and growth rate. We lower our stage II EBI growth rate to 8% from 12.5%. This is as we expect the business to grow at a more moderate pace as key end markets such as industrial robots have shown an apparent slowdown compared with the past decade. In its latest World Robotics report, the International Federation of Robotics lowered the rolling forward four-year (2024-27) compound annual growth rate projection for annual industrial robot installations to 4%, from the 7% in the previous report for 2023-26. In addition, due to the higher fixed costs from aggressive capacity expansion over the past six years, we cut our operating margin assumption for fiscal 2028 to 18% from 21%. As a result of continuous capacity expansion in recent years, HDS' monthly production capacity has now reached to 270,000 units (including 90,000 units for automotive applications), up from 50,000-60,000 units in 2017. Based on its recent quarterly performance, we expect HDS to achieve operating income breakeven when quarterly revenue reaches JPY 14 billion, and operating margin of 17%-18% when quarterly revenue reaches JPY 20 billion. Although we assume the company is not likely to achieve the current midterm sales target of JPY 90 billion in fiscal 2026, we believe the market is being overly pessimistic about HDS’ longer-term prospects, as headwinds in key end markets such as industrial robots and semiconductor production equipment persist.