Denso Earnings: Unexpected Quality-Related Costs Dent Margins but Outlook Unchanged

We leave our fair value estimate for Denso 6902 unchanged at JPY 2,375 with September-quarter operating margin disappointingly lower and dampening better-than-expected revenue growth. While we tweak our fiscal 2023 (ending March 2024) assumptions, our medium-term outlook remains intact. We believe Denso’s shares are fairly valued. Our fair value estimate prices Denso at 15.9 times fiscal 2023 price/earnings. We forecast five-year EPS to average 16.9% growth.

The September-quarter operating margin of 6.5% fell short of our estimate by 3.3 percentage points, due to quality-related provisions and slow progress in cost pass-throughs. The company continues to guide operating margin for the full year to be 9.0%, which we think will be challenging to meet as we think capacity utilization is unlikely to rise while a complete cost pass-through may still lag and high labor costs at its U.S. operations remain. We now expect fiscal 2023 operating margin of 8.3% versus 8.6% previously. Nonetheless, we continue to project operating margin to increase to 9.8% by 2025, driven by further sales of its high-margin electrification/heat pump products for electric vehicles as well as the restructuring of its North America business, which includes the production transfer of its lower-margin thermal products to Mexico. We expect the shift to help lower operating costs over the next three years.

September-quarter revenue was stronger than expected, growing 12% year on year, mainly due to the domestic production volume recovery of its largest customer, Toyota, which grew 24% in the same period. We raise our revenue growth projection by 1.5 percentage points to 9.8% year on year, but our top-line projection in the second half remains largely unchanged.