Denso Affected by Toyota’s Weak Production but Expects Further Operating Income Growth in 2023

We maintain our fair value estimate of JPY 9,100 per share for Denso, even though December-quarter operating income of JPY 108 billion, for an operating margin of 7.0%, fell short of our projection by about JPY 39 billion. We attribute this to capacity utilization hurt by Toyota Motor’s weak production and slow progress in passing through components/logistics costs in North America, where negotiations have been lagging. However, our longer-term outlook is intact. We think the market is underestimating Denso’s ability to meet its midterm operating margin target of 10.0% in fiscal 2025, ending March. We expect this target will be met by improved product mix from new-generation products and the restructuring of its low-margin North America business.

To meet its midterm operating margin target, Denso needs to increase sales of its higher-margin new-generation electric vehicle components outside Toyota, which has been lagging competitors in producing battery EVs. On this end, management confirmed progress in selling to non-Toyota customers in Japan, the United States, and China. We think this partly explains the higher sales growth for non-Toyota original equipment manufacturers as well as electrification/thermal systems compared with overall revenue in first three quarters of fiscal 2022. We expect Denso will be competitive in the electrification and thermal spaces, as it can leverage its record with inverters/motor generators (since supplying them to hybrid cars) and leading position with thermal components.