JHVEPhoto Dear readers/followers, In this article, I’ll update my thesis on Canon (OTCPK:CAJPY) (OTCPK:CAJFF). This is a successful investment I’ve been making for about a year. I’ve been investing when it was cheap, and in my last few articles, I’ve mostly managed to outperform the market using Canon. In my last article, I changed my thesis to a “HOLD” due to what I viewed as non-trivial overvaluation on the part of this company. I considered that Canon’s market outperformance was limited, and its valuation was no longer sustainable. The company had achieved consecutive quarters of top-line growth and cost reduction, but its profitability wasn’t as strong as it once was. And this was the reason I shifted my thesis. Since that time, the company has underperformed the market. Canon RoR (Seeking Alpha) Canon is by far one of my better Japanese investments over the past few years – and I do invest in a few of them, including Honda (HMC), Toyota, and a few other smaller ones, as well as having a smaller position in a Japanese treasury fund in one of my accounts. You can find my last article on Canon here – and here we’ll look at what makes Canon an investment worth making, should the price drop down again and become attractive. Canon – At the right price, I’m back in I haven’t sold my shares of Canon, which means that I’m actually up quite respectably since I bought my shares, even if I am not outperforming the broader overall market. Despite ongoing challenges for Canon, the company expects a growing operating profit level with continued growth – and I join the company in these expectations. The reason I continue to be positive about Canon is the low debt and that is a sector leader. If there’s something we like about Japanese companies in general is that they tend to use very sparing amounts of overall debt and leverage. Similar to Germany, though even more so, it seems to be a cultural corporate thing that debt is not something you want to over-use – unlike in some other geographies. My Japanese investments have also played a non-trivial role in how I value lower-debt-laden companies over the past two years. I tend to place a higher priority on low debt these days in the core of my investments. Canon is a bit of an extreme here. It has long-term debt to capital of only 5% to a market cap of almost 4.4T JPY. The company also sports a yield of 3.44% which is…so-so, given that’s close to what I get in a savings account today. The latest set of results we have for Canon are the 1Q24 results, and these were okay, given the overall macro. The environment globally remains challenging due to the slowdown, which results in delays for overall purchasing decisions. Because Canon does what it does, purchasing decision delays have a fairly large impact on Canon, and it at times can force the company to act to reduce its inventory that it has on hand – as it did during this quarter. The various segments of Inkjet/laser, Camera/Network, Semi Lithograghy, and Imaging all saw various slowdown impacts. The worst performer was Imaging and Medical, as there was no real recovery in this segment. The company has taken steps to recover the camera/network trends, and the Semi segment did…okay, considering everything. Even amid economic slowdowns, there was good growth here. However, Imaging unfortunately did not do all that well – with top-line decline leading to lower profit volume, but some better profit margins due to other effects. So, good enough given what is going on. Europe is a continued drag on earnings, and the ongoing China real estate crisis is not a happy “place” to be in either. All of these trends in the core market lead to a slowdown in purchasing decisions, as mentioned. Here are the trends. Canon (Canon IR) As I said, mixed. There was also a significant FX of a USD/EUR pairing with the JPY. Also, Canon continues to see significant overall increases in costs and expenses – labor and conversion above all, which drove operating profit down despite increases in sales and gross profit. So what you see above is mainly due to FX and costs. By aforementioned business unit, Imaging did worst by far with a 61.7% profit decline, and 18.9% in medical. Printing grew by almost 30% in profit, and industrial was up most by 62% – but a very small segment overall. The company’s core segment remains printing at this time – it accounts for more than 50% of company sales, and as long as sales and profit are stable or positive here, the company isn’t really going anywhere negative quickly. However, the increase in printing segment sales was not due to hardware, which is why I don’t consider it all that clear or positive, but due to commercial printing equipment where the market grew as well as non-hardware sales of office equipment. Actual laser and inkjet printer sales declined due to weak market conditions. Some one-offs in medical – an anti-corruption campaign in China slowing down sales and pushing out of medical sales due to negotiation and other factors, and this resulted in low sales growth. The company’s outlook remains impacted and unclear, and normalization potential or possibility seems dubious. Some normalization is expected in Imaging and Semis, and the company is launching new products according to plan. Canon, like most companies in a cost increase situation, is also launching a strategic business review. However, in the end, it remains the fourth consecutive year of sales and profit growth, as well as managing a company-wide double-digit operating profit margin. So while negatives exist, this is a positive to take with us. I would project, based on these estimates from the company, that we see a low double-digit 3-5% sales growth, translating to a similar level of profit growth because I expect that most cost increases have already been seen by the company at this time. Because we’re going to see some reversal, I also expect that operating profit will actually grow by more than 5% for the year, and I expect a continual net income margin of 6.5% – 7%, a slight improvement on the top-end compared to the 6.3% net margin for the fiscal of 2023. This assumption assumes an FX of around 135-145 JPY against the USD – if it fluctuates too far from this, then results likely will be different. Canon has a fair bit of overall volatility inherent to it – this translates to this company mostly missing estimates negatively, at least 50% of the time even with a 1-2-year basis with a 10-20% margin of error (Paywalled FAST Graphs source). But even with that in mind, the company’s projections on a forward basis are pretty positive, and I do not disagree with them here. Forecasts (Canon) That, however, is of course not the same as being a “buyable” or attractively priced company – because I do not believe Canon to be there at this time. Canon – Plenty to like, but below the current valuation. When I reviewed Canon in my latest “BUY” article, the company was still at what I considered to be an undervaluation. I gave the company a PT for the ADR CAJPY of $24.5/share. The company now is at $27.73, as I am writing this article. No matter how I work with this valuation, I cannot see an appealing upside here. Other analysts consider the company attractive from the perspective of the potential of share buybacks and improved RoE, and there are some of those. The company also is one of the largest patent holders in its field around – and that is certainly another positive as well. But, if we look at the native ticker that I invest in, known as 7751 (Japanese tickers work with numbers), then we find that the company trades at a JPY of 4,359/share, which represents close to a 15.5x P/E for a company that usually manages only 16-16.5x, and with the current yield and growth projections of around 6% on average, this comes to an overall upside of around 12.5% per year. Canon Upside (FAST Graphs) This is certainly not bad, but it also isn’t market-beating or all that good either compared to what else is available on the market today. This highlights the importance once again of company valuation when investing in a business. Even the S&P Global analysts following the native ticker 7751 don’t consider the company a “BUY” any longer – and that hasn’t changed as of this article, either. With 9 out of 11 analysts still either at a “HOLD” or “SELL” recommendation, I believe the overwhelmingly correct choice, if you believe in the valuation, is to at the very least “HOLD” here. Profit realization remains another possibility here – I have considered it, but I’ve decided against it at this time. The upside in the company is still good enough for me to consider keeping it here, but it also isn’t good enough for me to add more. So for that reason, I remain a neutral recommendation here. For 2024 and for 2H of this quarter, I don’t see a whole lot of catalysts for market-beating RoR, given the macro pressures related to lower demand for the company’s core segments of printing. I will also continue to characterize Canon, given the return, as a successful investment, but with the valuation now significantly changed and the appeal less than 15%, that’s all we have at this time. Thesis Canon is one of the premier imaging, camera, and printing companies on the planet. It has a solid foundation as well as excellent growth prospects. At the right valuation, this company goes from being a possible buy to being a very compelling prospect for long-term investing. At a conservative 14-15x normalized P/E, I now only consider the company somewhat attractive and no longer a “BUY”. My position, since establishing it, has grown to an impressive half-percent of my portfolio, and I’m looking to potentially either divest it, or wait until it becomes attractive again here. The current macro outlook doesn’t support a higher price target for Canon, but I would be interested again once it declines. I follow Canon with a $24.5 ADR price target, or 3,500Y for the native Tokyo ticker. It doesn’t matter if you follow the native or the ADR, the company is no longer buyable here, as I see it. Remember, I’m all about: Buying undervalued – even if that undervaluation is slight and not mind-numbingly massive – companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1. If the company doesn’t go into overvaluation but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1. Here are my criteria and how the company fulfills them (italicized). This company is overall qualitative. This company is fundamentally safe/conservative & well-run. This company pays a well-covered dividend. This company is currently cheap. This company has a realistic upside based on earnings growth or multiple expansion/reversion. The company no longer fulfills my valuation criteria, which makes it a “HOLD” here, and no longer a “BUY”. Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
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