High Debt And Declining Engine Sales Will Hurt Future Profits

Key Takeaways

• Revenue growth may be at risk due to declining engine sales and lower demand for spare parts, impacting future revenue streams.
  
• Financial stability is a concern with high debt levels and restructuring costs threatening profitability and limiting earnings improvement.
  
• Strategic reforms and strong aero engine performance could enhance profitability, revenue, and cash flow, while addressing working capital inefficiencies supports long-term financial health.

Catalysts

Designs and builds engineering solutions in Japan and internationally.

• Investors might believe that IHI's revenue growth is at risk due to potential declines in the number of new engine sales, projecting a drop from 1,398 units to 1,143 units. This decline in volume could negatively impact future revenue streams as the less profitable early production stages diminish, particularly in the civil aero engine segment.
  
• Concerns over potential compression of net margins may arise from restructuring expenses, such as those related to consolidating vehicular turbocharger sites in Europe. Such restructuring activities could incur significant costs, impacting profitability in the short to medium term.
  
• The anticipated decrease in demand for spare parts towards the end of the fiscal year, along with prolonged maintenance for models like PW1100G, could suggest a slowdown in expected revenue growth, thereby affecting both revenue and operating margins organically over time.
  
• IHI's stock could be considered overvalued if investors perceive risks in stabilizing financial solidity, primarily due to high debt-to-equity ratios and issues in working capital despite efforts to divest cross-shareholdings. Such balance sheet challenges might limit the company’s capacity to improve net earnings effectively.
  
• The strategic plan for shifting the business portfolio to focus more heavily on civil aero engines, while essential for future growth, presents a risk of heightened volatility and cyclicality. Investors might worry that this could lead to inconsistent earnings and potential declines in net margins if not adequately offset by stable revenue flows from other segments like defense.

IHI Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming IHI's revenue will grow by 3.9% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 6.8% today to 5.4% in 3 years time.
• Analysts expect earnings to reach ¥98.1 billion (and earnings per share of ¥649.2) by about December 2027, down from ¥108.7 billion today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as ¥120.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.1x on those 2027 earnings, up from 12.2x today. This future PE is lower than the current PE for the JP Machinery industry at 24.4x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.32%, as per the Simply Wall St company report.

IHI Future Earnings Per Share Growth

Risks

• The civil aero engines business remains a strong profit driver for IHI, with record profits in operating profit categories due to robust sales of spare parts and favorable changes in foreign exchange rates. This could bolster revenue and net margins.
  
• There has been a significant increase in operating profit for the Aero Engine, Space, and Defense business segment, driven by strong sales of spare parts and delayed maintenance costs. This suggests a positive impact on earnings.
  
• IHI's strategic focus on growth and development-focused businesses, including fuel ammonia value chain and aero engines, is expected to enhance capital efficiency, potentially stabilizing net margins and boosting future revenue.
  
• The implementation of business portfolio reforms, including restructuring and divestments, is aimed at improving profitability and cash flows, which could positively affect earnings and net margins.
  
• IHI is strategically addressing high working capital and balance sheet inefficiencies by reducing working capital and optimizing invested capital, which could improve cash flows and financial soundness, impacting net margins and long-term earnings positively.

Valuation

• The analysts have a consensus price target of ¥8722.22 for IHI based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of ¥12000.0, and the most bearish reporting a price target of just ¥6900.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be ¥1806.7 billion, earnings will come to ¥98.1 billion, and it would be trading on a PE ratio of 16.1x, assuming you use a discount rate of 6.3%.
• Given the current share price of ¥8739.0, the analyst's price target of ¥8722.22 is 0.2% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.