Shimano is the world’s dominant supplier of high-end bicycle components, including the equipment on Lance Armstrong’s Tour de France-winning bike, as well as the parts on 90% of the bikes sold by Trek, Giant, and Specialized, the top three brands in the US. This is a business with more than US$1 billion in annual sales and operating margins north of 17%. It’s a global business, too -- Shimano is based in Japan, but the company derives more than 80% of its sales from outside Japan. It's a great business at a deceptively-good price.
The stock’s P/E of 21.7x masks the fact that Shimano is sitting on a massive pile of cash – cash represents 22.7% of the market cap – which the company has been aggressively deploying for share buybacks. After backing out this cash and adjusting for a lower sharecount, Shimano’s EV to trailing FCF (net income + D&A – capex; thru 6/04) is closer to 14x. Furthermore, Shimano is on pace in 2004 to achieve record sales and earnings, such that based on estimated full-year ’04 FCF, the forward EV/FCF multiple is likely closer to 11-12x.
Shimano trades on the Tokyo exchange (ticker: 7309), but has a pink sheets listing here in the US (SHMDF.PK) which tracks the Tokyo price adjusted for the current JPY/USD exchange rate.
Shimano’s history dates back to 1921 when the company started as a manufacturer of bicycle freewheels (toothed disc on which the chain rotates). To this day, the company remains primarily in the business of bicycle components – derailleurs, pedals, cranks, and brakes – which last year accounted for 74% of sales and 96% of operating income. In 1970, Shimano added a line of fishing rods and reels, which today account for around 24% of sales and a small fraction of operating income. The remaining 2% of sales is comprised of myriad cold-forged metal products including auto supplies, snowboard boots/bindings, and golf clubs.
From 1997 to 2003, Shimano’s annual revenues mostly drifted sideways within a band of ¥130B to ¥150B. Over this same timeframe, profit margins weakened from an EBITDA margin of 21-22% in the late 1990s, down to as low as 15.6% in 2001, and then rebounding to 18-19% over the past two years.
The US recession of 2001 took its toll on Shimano’s sales, which were down about 5.5% versus 2000 and down 17.2% versus 1997. This loss of sales hurt Shimano’s operating leverage, resulting in that year’s cycle-low EBITDA margin. In 2002 and 2003, however, sales rebounded as did the EBITDA margin which improved to around 19%. Of course, even that improvement didn’t bring profitability back to the levels seen in the late 1990s.
Here in 2004, Shimano is experiencing a renaissance of sales growth, with H1 sales up 17.6% to ¥85 billion. The company is on-pace to meet its guidance for full-year 2004 sales of ¥170 billion, up more than 18% over 2003 and 12% higher than the previous peak in 1997 of ¥151.6 billion.
And thanks to tight expense control, profits are growing even faster. In the first six months of 2004 (the most recent results available as of this writing), Shimano’s year-to-date operating income was up 43.7% YOY. Shimano is on pace to spend ¥29 billion on SG&A in 2004, which would be flat versus 2003. That’s significant because SG&A profligacy was the primary culprit behind Shimano’s weakening trend of EBITDA margins over the past seven years.
In Shimano’s Q1 ’04 fact sheet, the company guided for 2004 sales of ¥160 billion and net income of ¥17 billion. In the Q2 ’04 fact sheet, the company upped that guidance to sales of ¥170 billion and net income of ¥19.5 billion. Obviously, good things are happening inside Shimano, and we’ll look forward to getting more detail on those improvements once the 2004 annual report is released.
As for this year’s cash flow, it looks safe to assume 2004 FCF of around ¥21.9 billion. That’s roughly double the FCF achieved through the first six months of 2004, so we’re not relying upon any second-half heroics. This FCF estimate assumes D&A of ¥7.4 billion and capex of ¥5.0 billion – both of which are guestimates based on past results. If you back out an estimate of Shimano’s interest income, FCF purely from operations will probably come in around ¥21.0 billion.
As of the 12/7/04 stock price of ¥2,730 and the year-end 2003 sharecount of 121.7 million, Shimano's market cap stands at ¥332.2 billion; at the current JPY/USD exchange rate of 102.8, that’s a US$ share price of $26.56 and market cap of $3.23 billion. With TTM net income of ¥15.3 billion, Shimano’s P/E is 21.7x, which on the surface would appear to be fully valued for a high-quality, mature business. But that market cap-based valuation ignores two critical facts: 1) Shimano has gobs of excess cash on its balance sheet – as of 6/30/04, the company had net cash and investments of ¥70.5 billion (or in US$ terms, $686 million or $5.64 per share); and, 2) management is using this cash to repurchase shares hand over fist.
Shimano has bought back stock each of the past seven years, typically reducing the sharecount by 1-2% per year. Then, in 2003, management must’ve foreseen 2004’s improved financial results and therefore kicked its repurchase program into overdrive and spent ¥20.5 billion to buy back more than 13 million shares, or 9.8% of total shares outstanding. Shimano President Yozo Shimano pledged in the 2003 annual report that the company would continue its repurchases "as a capital measure to enhance the company's enterprise value."
It’s very interesting, therefore, to see that as of June 30, 2004, Shimano had already spent more than ¥20 billion of its cash versus that available at year-end 2003. Considering that Shimano is FCF positive throughout the year, this reduction in the cash balance implies that the repurchases have in all likelihood continued at 2003’s aggressive pace. Assuming an average stock price of ¥2,500 in H1 ‘04, Shimano has likely bought back another 8 million shares in the first half of 2004 alone.
If we make that small leap of logic, then Shimano’s 6/30/04 sharecount was 113.7 million. (Shimano’s quarterly fact sheets don’t report a sharecount, hence the necessity of guestimating.) Based on this lower sharecount, Shimano’s market cap is reduced to ¥310.4 billion; and when you back out the ¥70.5 billion in remaining net cash and investments, Shimano’s enterprise value is further reduced to ¥239.9 billion. With 2004 FCF (not including interest income) estimated at ¥21 billion, the EV/FCF multiple is a very reasonable 11.4x. This for a business that dominates its niche with double-digit profit margins and an estimated 2004 ROIC upwards of 19%.
What’s fair value? It seems reasonable to believe Shimano can conservatively achieve long-term average growth of 3%, which discounted at 11% equates to a low-end fair value estimate of roughly ¥3,000. If low interest rates continue to prevail, it’s plausible that this business may be valued by global investors at a 10% discount rate, which equates to a high-end fair value estimate of around ¥3,250. Based on this fair value range of ¥3,000 to ¥3,250, Shimano at the current price of ¥2,730 appears to be priced at 84% - 91% of fair value. Not bad for a high-quality, liquid investment.
Market recognition of company's strong 2004 results and management's aggressive share buyback.