Rising 4.3% to JPY18,220, Shimano stocks last month posted their biggest daily gain since the beginning of the year, precipitated by the release of Credit Suisse’s first ratings upgrade since the Swiss investment bank initiated coverage of the world’s largest bicycle sector company by revenue in February 2014. Not everyone will agree with what makes for a great read, but we think the accompanying analysts’ research report is worth a closer look.
GRAPHS: Credit Suisse
Most of the components that Shimano makes are small, but its influence in the global bicycle industry is huge. This market power stems from two realities: 1) Shimano has near-monopoly status in the global market for sports bicycles (generally-speaking, road and mountain bikes sold in specialty bike shops); 2) if you don’t have bicycle components, you don’t have bicycles.
While Shimano doesn’t make bicycles itself, it doesn’t need to: even without the contribution of high-unit-value bikes, it still managed to rake in 73% more revenue (USD3.3Bn) than Giant Bicycles (USD1.9Bn) over the course of the 2015 financial year.
These are all reasons why the Japanese part maker’s operational health is of vital interest to anyone who makes, or wants to make, money from the worldwide cycling community; and there is a growing number of investment banks and PE firms who fit that description.
THE REPORT IN BRIEF
In addition to its Outperform rating upgrade, Credit Suisse has set its FY2017 Shimano stock target price at JPY20,000 based on a price-earnings ratio of 30x. When pared back to its kernel, the upgrade is predicated on commonsense facts and a few blindfolded arrow throws.
For those people who don’t have time to read through the entire research report, it’s clear that Credit Suisse’s analysts like Shimano a lot, noting Shimano’s post-GFC performance demonstrated a company that is “highly resilient to macroeconomic shocks” and highlighting “the absence of even one single annual operating loss in the 40 years since (1975)”. With production costs “among the lowest in the sector” and “substantial price spread” (the difference between Shimano’s retail prices and prices of rival products), the analysts suggest price increases (and increased margins) are “possible”.
After establishing Shimano’s excellent financial health over several pages, there comes an interesting but questionable scatter graph (compiled from UN and Japan External Trade Organization data and combined with CS estimates) that suggests global penetration of sports bicycles is “around 1%”.
It therefore seems reasonable to suggest, as Credit Suisse’s analysts have done, that there is “substantial growth potential” for Shimano. Naturally, the same could be said of every year since Shimano started doing business, or for any other company that sells into the same space, but that’s besides the point.
The report’s authors then drill down, estimating Shimano’s global market share of sports bicycle parts to be “70-80% on a value basis” and include some pretty neat bar graphs which look at specification across ten well-known bicycle brands to support a point that any cyclist who cares to open their eyes would see: Shimano enjoys near blanket specification with most sports bike manufacturers. SRAM’s CEO Stan Day readily admits this, saying: “the biggest difficulty is that Shimano is like IBM in the 80s and 90s. They get the specification by default. We only get specified when we’re better.”
Factors working in favour of the analysts’ estimated FY2017 operating profit of JPY82B are also neatly tallied, with a jump in bicycle component sales (JPY11.8Bn) and improvement in cost reductions (JPY2Bn) accounting for almost 92% of the estimated JPY15Bn spike in YoY operating profit compared to FY2016.
Though currency translation losses (when Shimano converts its foreign currency-denominated income to JPY) were a drag on previous operating profit forecasts, the report seems optimistic about their impact on FY2017 estimates.
Overall, Credit Suisse’s analysts have produced a solid report that looks more insightful than it actually is. This is not to discredit their work – I certainly couldn’t have put together anything close to this at the current time – however the biggest problem with estimating where any company (even a publicly listed one) in the bicycle industry is going lies in the industry’s fragmented nature and total absence of meaningful aggregate data.
To underscore this point, consider another outtake from the Credit Suisse report on Shimano: “there are more than 10’000 (small cycle shops) in Japan…which makes it difficult to get a good grip on the inventory situation. Shimano provides qualitative data on the inventory situation in each country based on the information gathered by its sales personnel during delivery of bicycle parts to small shops.” [Italics my emphasis]
To paraphrase, “the current data we have on global sales of bicycle components is the aggregate of notes that potentially hundreds of people have written down after quickly eyeballing the stock during a sales call.”
Still, as I wrote to another inquisitive analyst from a UK investment firm earlier this week, the information available via Shimano’s IR page is the best proxy for global information that we have. So who’s buying?