Company Reports

Keyence's stronger-than-expected March-quarter results were greeted positively by the market, as the firm not only realized 8% year-on-year revenue growth despite macro headwinds, but also a record gross margin of 83.7%. Keyence has been offering solutions that add value in the current downcycle through new products, such as a wide area scanner that can replace inspectors to measure large components as well as radar level sensors that conserve energy. While we slightly cut our revenue estimate for fiscal 2024 (ending March 2025) after reflecting delayed investments in Asia, our medium-term growth of about 12% CAGR between fiscal 2024 and 2028 is intact. Therefore, we maintain our fair value estimate of Keyence at JPY 63,000. Despite our top-line growth projection above its factory automation peers, we think the market is overestimating its prospects.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With its consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end product, thus preventing them from becoming competitors.

We raise our fair value estimate of Keyence to JPY 63,000 from JPY 58,000, as we expect the company will weather the current industry headwinds better than our previous expectations. We raise our fiscal 2023 revenue growth assumption (ending March 2024) to 4% year on year, up from a flat top-line growth, based on stronger-than-expected overseas sales. We forecast stronger sales, as Keyence continues to utilize its specialization in the vision sensor/machine vision field to provide low-cost solutions that immediately solve issues like rising wages and high energy costs. Further, the company’s direct sales model will continue to be an advantage, as Keyence is not affected by the ongoing inventory adjustments by distributors—which have been affecting factory automation, or FA, peers like Omron—and it allows for a rapid development of products that address evolving needs amid industry headwinds. We believe its shares are fairly valued.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With its consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end product, thus preventing them from becoming competitors.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With its consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end product, thus preventing them from becoming competitors.

Our outlook for Keyence is unchanged as September-quarter results reaffirm that demand is affected by sluggish semiconductor/electronics investment in Asia, while sales in other areas/regions remain resilient. Quarterly revenue declined 3% year on year, but sales in the Americas and Europe grew 7.5% and 10% year on year, respectively, on a local currency basis. We think the company outperformed its peers, as this was in contrast with the September-quarter exports of Japanese control equipment including sensors, factory automation systems, and others, which declined 27% and 16% year on year in North America and Europe, according to the Nippon Electric Control Equipment Industries Association. We attribute this to Keyence’s strong know-how with machine vision/sensors, which has enabled the company to offer low-cost solutions that immediately realize savings and address labor shortages. We expect this to continue and maintain our fair value estimate for Keyence at JPY 58,000. We believe its shares are fairly valued.

Keyence’s June-quarter revenue growth of 15.8% year on year was largely in line with expectations, excluding the effects of a weak Japanese yen. With top-line growth stronger than the sales/orders of its Japanese factory automation peers, we expect the company will continue to outperform throughout 2023, while Omron and Mitsubishi Electric’s automation businesses face declining sales growth amid macroeconomic headwinds. Our expectation is based on its ability to propose machine vision-based solutions (where the company has strengths) that require less upfront investment and can immediately lead to cost savings and labor shortage issues. While we lower our 2023 revenue projection to 1.6% year-on-year growth, from 5% growth, after reflecting weaker semiconductor/electronics-related demand in Asia, we maintain our fair value estimate for Keyence at JPY 58,000. We believe its shares are fairly valued.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With its consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end product, thus preventing them from becoming competitors.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With its consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end product, thus preventing them from becoming competitors.

The Japanese factory automation, or FA, control equipment suppliers (Keyence, Omron, and Mitsubishi Electric, or MEC) posted lower year-on-year revenue growth in the March quarter than in the December quarter. According to the Nippon Electric Control Equipment Industries Association, shipments of FA electric control equipment, including switches and relays, grew about 12% year on year in the March quarter, slowing down from 19% in the December quarter. In addition, FA-related orders for Omron and MEC declined year on year in the past two quarters, due to weak capital investments in the semiconductor/electronics industries. Therefore, our expectation of a slowdown in shipments in 2023 remains unchanged, and we maintain our fair value estimates for Omron and Keyence at JPY 9,100 and JPY 58,000, respectively. Meanwhile, we slightly increase our fair value estimate for MEC to JPY 2,000 from JPY 1,900 after revising our margin assumptions.

Keyence’s December-quarter revenue growth of 24.5% year on year, exceeded our previous projection by about 12 percentage points, driven by solid demand overseas amid macroeconomic headwinds. We previously anticipated a slowdown in factory automation, or FA, investments in China, quarterly sales in Asia ex-Japan were up 10.6% year on year on a local currency basis, with China outperforming other Asian countries. Despite the economic slowdown, we believe FA demand is more resilient than we anticipated before; therefore, we raise our 2021-2026 revenue CAGR to 12.4% from 11.2%, and our fair value estimate for Keyence to JPY 58,000 from JPY 54,000. We believe the firm's shares are fairly valued.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end-product, thus preventing them from becoming competitors.

We maintain Keyence’s fair value estimate at JPY 54,000, implying shares are fairly valued, as our higher revenue projection in 2022 from a weaker Japanese yen is counteracted by reduced sales growth expectations in Asia in 2023. While the company’s revenue in the September quarter surpassed our estimate, growing 36% year on year, this was largely contributed by a weaker-than-expected Japanese yen and post-lockdown shipment recovery, after logistics delays in the June quarter. On a local currency basis, sales in the Asia region (which excludes Japan) in the first fiscal half, ending September, only grew 10.0% year on year, which was lower than 15.9% in both Japan and the entire overseas area. We expect lower consumer spending will lead to further slowdown in capital investments by electronics and low/medium-end machine tool makers, which tend to be in Asia, until at least the first half of 2023. Although we raise our 2022 revenue growth projection to 16.7% year on year from 12.5% (due to the weaker Japanese yen), we lower 2023 revenue growth to 5.5% from 10.3%.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end-product, thus preventing them from becoming competitors.

We maintain Keyence’s fair value estimate at JPY 54,000, as our medium-term outlook is unchanged, and we think shares are fairly valued. Despite this, we think the negative reaction from Keyence's June-quarter results announcement suggests increased concerns over demand in China as well as quarterly operating margin falling short of expectations. While customer industries that are directly affected by declining consumer confidence, like electronics, will likely hold back on investments, we also expect continued near- and medium-term demand in other areas. We think ongoing issues in factories, like labor shortages and higher wages, will serve as a tailwind for Keyence, as its machine vision equipment/sensors would provide low-cost alternatives to deal with this, while saving energy and equipment running costs. Further, with medium-term expectations that the company will continue to find/meet automation needs during various types of headwinds and a balanced customer industry-base, we lower our Morningstar Uncertainty Rating to Medium from High to reflect this.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end-product, thus preventing them from becoming competitors.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that allows the company to minimize risk of potential competition by suppliers. With consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end-product, thus preventing them from becoming competitors.

Keyence finished fiscal 2021, ending in March, with 40.3% revenue growth and operating margin improved to 55.4% from 51.4%, from previous year, suggesting strong margin resiliency amid rising components/logistics costs. We raise our fair value estimate to JPY 54,000 from JPY 51,000, to reflect higher operating margins over medium-term. Despite strong results, Keyence’s shares have fallen over recent months, as concerns over increasing uncertainties from the conflict in Ukraine and lockdowns in China have likely led investors to reconsider sales growth expectations that were previously too high. As a result, we think the company’s shares are now fairly valued.

As a “fabless manufacturer,” Keyence outsources its production in a highly effective manner that minimizes risk of potential competition by suppliers. With consistently high gross margins over the long term, even with an outsourcing model, we believe Keyence has some negotiating leverage regarding cost with its network of suppliers. The company buys raw materials in bulk, which are then sent to the suppliers of its products’ components. It then collects the finished components before sending them to the assemblers. This way, the assemblers do not know the component suppliers, and this prevents Keyence’s suppliers from being aware of the entire production process of the end-product, thus preventing them from becoming competitors.

Keyence’s latest results for the third quarter of fiscal 2021 (ending in December) were stronger than expected, with a 37.7% year-on-year revenue growth, implying record quarterly sales. We slightly raise our fair value estimate to JPY 51,000 from JPY 49,000, to reflect our revised 2021 sales and profit expectations for the current fiscal year, while maintaining medium-term sales growth and margin expansion assumptions. We, however, continue to believe that its shares are overvalued, despite our expectation that the company’s share in the factory automation, or FA, sensors/machine vision market will increase in the near term, as it manages the components shortage problem far better than competitors. We think the market continues to have higher expectations of both near- and medium-term revenue growth as well as market share expansion.