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Deep-dive 2022-25: Koito Manufacturing (7276 JP)

An automotive volume proxy that will benefit from any easing of the chip shortage

Disclaimer: Asian Century Stocks uses information sources believed to be reliable, but their accuracy cannot be guaranteed. The information contained in this publication is not intended to constitute individual investment advice and is not designed to meet your personal financial situation. The opinions expressed in such publications are those of the publisher and are subject to change without notice. You are advised to discuss your investment options with your financial advisers, including whether any investment is suitable for your specific needs. From time to time, I may have positions in the securities covered in the articles on this website. Full disclosure: I do not hold a position in Koito Manufacturing at the time of publishing this article. Note that this is disclosure and not a recommendation to buy or sell.

Koito Manufacturing (7276 JP) is the world’s largest manufacturer of automotive lighting products. Such products include headlamps, rear-combination lamps, fog lights, etc.

The company was founded by a man called “Genrokuro Koito” in Tokyo in 1915. Initially focused on selling fresnel lenses for railways, the company moved into motorcycle lamps and eventually passenger vehicle lamps in the 1930s. Since then, it has grown with its key customer Toyota, which still represents 40% of Koito’s revenues.

Since the early days of COVID-19, a shortage of semiconductor chips has plagued the auto industry. Auto OEMs were forced to halt production, and the vehicles that did get sold were sold at incredible prices. Many auto OEMs did just fine, with higher prices counteracting the negative effect of lower volumes.

It was a different story for auto parts suppliers. Since they’ve been unable to raise prices quickly, their gross profits have fallen in line with weakening volumes. And even though most of Koito’s customers are Japanese, they sell their vehicles worldwide. So Koito was and continues to be a bet on global production volumes.

There are now early signs that the chip shortage is easing. The most compelling evidence is that the demand for semiconductors from competing consumer electronics is falling. Foundry capacity is finally available for automotive-related chips.

And then there’s the benefit of the weakening yen. While Koito’s contracts are long-term in nature, in the medium-term, there is no doubt that Koito reported profits in yen will benefit from the weaker currency. Over 60% of sales are currently overseas. And its Japanese customers will also benefit significantly from the increased competitiveness that the weak yen has enabled.

Other than a resolution to the chip shortage and the weakening of the Japanese yen, Koito will also benefit from the ongoing shift that’s taking place from halogen and HID lamps to LED. Koito’s adaptive driving beams also drive growth, thanks to their much higher average selling prices and better margins. In 2023, Koito will also release headlamps with integrated LiDARs to enable level 2/3 advanced driver assistance systems.

I think Koito is at the forefront of automotive lighting R&D. It was the first company to mass-produce LED headlamps in 2007. And it’s far ahead in adaptive driving beams as well. The company is skating to where the puck is going, not where it has been. As far as I can tell, Koito is ahead of its Japanese competitors Stanley Electric and Ichikoh, technologically. But it’s probably behind its German competitor Hella.

In light of these factors, I believe that Koito will make close to JPY 90 billion in net profit by 2025, giving the stock a P/E multiple of around 7.0x, despite a solid net cash position of over 40% of the market cap.

The key risks are a delayed recovery of global auto production volumes, perhaps from a 2023 recession or China’s zero-COVID policy. There’s also a risk that Koito loses sales from its key client Toyota if it follows through on its stated aim to diversify among its key suppliers.

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Michael Fritzell