Keiretsu Safe Haven Fading For Mitsubishi Heavy Industries (TSE: 7011)

Thinking Points

  • Mitsubishi Heavy Industries (TSE: 7011) has faced strong headwinds in recent years.
  • Like many of the Japanese Keiretsus (business groups), the Mitsubishi Keiretsu has been known to help one another out during difficult times.
  • It seems the Keiretsu structure is changing as Mitsubishi Heavy didn’t get the helping hand it was looking for.

Overview

Mitsubishi Heavy Industries, the largest of the “3 Japanese Heavies” (Mitsubishi, Kawasaki, and Subaru), appears to be bleeding out unstoppably. Plagued with recent fumbles, investor sentiment for Mitsubishi Heavy is grim at best. Among the recent fumbles are:

  • 283 billion yen ($2.6 billion USD) cumulative one-time losses (so far) in shipbuilding.
  • 7th delay in Mitsubishi Regional Jet (MRJ) delivery.
  • Lagging thermal power plant gas turbine orders.

To be fair, 2017 wasn’t all bad for Mitsubishi Heavy. Despite the cumulative 283 billion yen one-time losses, Mitsubishi Heavy is still expected to report a profit, thanks to its sleeping real estate assets. Additionally, its H2A rocket recorded 6 successful launches (31 consecutive successes) along with its first “dual launch” – putting two satellites into orbit with one rocket. Still, Mitsubishi Heavy had a rough few years and the 5,000 billion yen ($46 billion USD) sales target that the company hoped to achieve by fiscal 2017 looks like it’ll have to wait. The share price, which halved over the past two and a half years, seems to reflect the overall negative investor sentiment:

Source: Google Finance

Changing dynamics within the Mitsubishi group

What caught my attention about the recent developments isn’t so much the turmoil itself, but the Mitsubishi Group’s stance toward the turmoil. Mitsubishi is one of the major “zaibatsu” (pre-WWII Japanese conglomerate) which was separated into several smaller companies at the end of World War 2. Today, the group is often referred to as “Mitsubishi Keiretsu” or Mitsubishi business group in plain English. Even after the formal separation, like many of the other keiretsus, the Mitsubishi Keiretsu maintained close relationships and helped one another during difficult times.

A prime example is when Mitsubishi Automotive’s (TSE: 7211) recall-hiding came into the limelight back in 2000 and again in 2004. The scandal quickly put Mitsubishi Automotive into financial distress. Lead by Tokyo Mitsubishi Bank (Current Mitsubishi UFJ Financial Group [TSE: 8306] Banking Operation), Mitsubishi Heavy and Mitsubishi Corporation (TSE: 8058) pitched in to support Mitsubishi Automotive.

Recently, Mitsubishi Heavy has been in a less-than-ideal position. The 283 billion yen loss (so far) in its shipbuilding operation mainly came from orders placed by Germany’s Aida Cruises in 2011. Originally, Mitsubishi Heavy quoted 2 large scale cruise ships for about 100 billion yen. Not having built a large scale cruise ship in over a decade, Mitsubishi Heavy soon found itself falling behind schedule, performing seemingly endless design changes and rework. Between fiscal 2013 and Q3 2017, the company recorded a painful 283 billion yen loss. Considering Mitsubishi Heavy recorded historical high operating income of 310 billion yen in fiscal 2016, the 283 billion yen loss over 5 years is more than significant.

Source: e-techasia

In mid-2017, a cruise ship inquiry came from Nippon Yusen (TSE: 9101), a Mitsubishi Keiretsu company. The inquiry was about building the next generation of Japan’s largest cruise ship “Asuka”. With Mitsubishi Heavy having built the first generation of Asuka and also being part of the Mitsubishi Keiretsu, Mitsubishi Heavy was Nippon Yusen’s natural first candidate for a quote. Yusen expected the quote to come in around 500 billion yen ($4.6 billion USD), however, Mitsubishi Heavy’s quote came in about 20% higher. Mitsubishi Heavy was trying to sell Yusen on the knowledge gained from the Aida Cruises projects. Yusen, also sailing through difficult times, rejected the quote.

Perhaps Prime Minister Abe’s Stewardship Code is taking effect. Mitsubishi UFJ Trust and Banking Corporation rejected a proposal to put Mitsubishi Heavy’s CEO and Mitsubishi Corporation’s Chairman of the Board as outside directors on Mitsubishi Automotive’s board.

Going forward

If there is one thing that became clear from recent events and dynamics, it’s that Mitsubishi Heavy can no longer comfortably depend on the Mitsubishi Keiretsu during difficult times. Fortunately, with Aida Cruises’ second ship completed in May 2017, it’s likely that Mitsubishi Heavy’s losses from shipbuilding operations will be reduced considerably or eliminated going forward. That said, life isn’t easy yet with management expecting full fiscal 2017 orders to come in considerably lower for its Power Systems and Aircraft, Defense, and Space segments:

Source: Fiscal 2017 Q3 Presentation (English)

Still, with the weight of the expensive cruise ships mostly lifted, Mitsubishi Heavy management must be somewhat relieved.

Today, Mitsubishi Heavy trades below book at 0.71x P/B and at an unadjusted EV/EBIT multiple of 11x. Though the 7th delay for the Mitsubishi Regional Jet isn’t encouraging, it’s a relatively small part of Mitsubishi Heavy’s business. It’s also worth noting that the successful dual launch for the H2A rocket is probably a bigger deal than most people realize. Mitsubishi Heavy certainly isn’t the first to do this (France’s Arianespace has done it many times). In simple terms, the cost for a customer to launch a satellite just got cut in half. Overall, the near-term future still looks a little grim. An uptick in Power Systems orders for fiscal 2018 might be the extra “umph” that Mitsubishi Heavy needs to get back on track with its overdue 5,000 billion yen sales target.

Clayton Young

Author: Clayton Young

Hi! I’m Clayton. My value investing journey began in 2012 during my college days. It was not until recently (2016!) that I decided to leverage my Japanese language skills to research Japanese equities. I hope to provide valuable insight on Japanese companies to the English-speaking world through this blog!

Clayton Young

Author: Clayton Young

Hi! I'm Clayton. My value investing journey began in 2012 during my college days. It was not until recently (2016!) that I decided to leverage my Japanese language skills to research Japanese equities. I hope to provide valuable insight on Japanese companies to the English-speaking world through this blog!

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