International IT Services And Headquarters Relocation Will Unlock Future Opportunities

Key Takeaways

• IT Services expected to see improved profitability due to margin improvements and absence of prior one-time expenses, positively impacting earnings.
  
• Strategic moves, including optimized real estate and reduced cross shareholdings, aim to improve cash flows and streamline operations, enhancing financial health.
  
• Structural reforms and external risks may increase costs and uncertainties, potentially affecting NEC's revenue prospects and profitability.

Catalysts

Provides information and communication technology solutions in Japan and internationally.

• The IT Services segment is expected to post significant improvement in profitability for FY March 2026 due to continuous margin improvement and the absence of one-time expenses recorded in the previous fiscal year, impacting earnings positively.
  
• ANS is factoring in investments to capture future business opportunities, and despite increased investments, the profit margin is expected to remain flat, suggesting a stable revenue outlook with a potential for growth in revenue due to increased government budget allocations.
  
• The planned move of international IT DGDF headquarters to Europe is aimed at accelerating growth strategy, which could result in increased revenue and improved margins for this segment.
  
• Continuing efforts in optimizing the real estate portfolio and improving the cash conversion cycle could enhance the company's net margins and free cash flows, bolstering overall financial health.
  
• The ongoing focus on reducing cross shareholdings and potential divestiture of low-profit businesses by the end of FY March 2026 indicates strategic actions to enhance earnings and streamline operations, potentially leading to a more favorable valuation.

NEC Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming NEC's revenue will grow by 4.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.1% today to 6.8% in 3 years time.
• Analysts expect earnings to reach ¥264.1 billion (and earnings per share of ¥197.32) by about May 2028, up from ¥175.2 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting ¥293.0 billion in earnings, and the most bearish expecting ¥234.0 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.6x on those 2028 earnings, down from 26.4x today. This future PE is greater than the current PE for the JP IT industry at 17.3x.
• 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 7.02%, as per the Simply Wall St company report.

NEC Future Earnings Per Share Growth

Risks

• The deconsolidation of JAE has had a negative impact, reducing revenue and adjusted operating profit, which could affect NEC's growth outlook and revenue stability.
  
• The submarine cable business has experienced significant losses due to force majeure and project delays, which could lead to increased costs and impact NEC's overall net margins.
  
• Investment restraints in Telecom Services and one-off expenses in IT Services indicate potential challenges in maintaining profitability, thereby affecting net earnings and operating profits.
  
• Continued structural reforms and macroeconomic risks could incur additional costs and uncertainties, possibly impacting NEC's revenue and net margins.
  
• The transfer of corporate PC sales function may lead to declining revenues in Domestic IT, potentially affecting NEC's revenue forecast and overall earnings.

Valuation

• The analysts have a consensus price target of ¥3498.75 for NEC 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 ¥4000.0, and the most bearish reporting a price target of just ¥2720.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be ¥3886.1 billion, earnings will come to ¥264.1 billion, and it would be trading on a PE ratio of 21.6x, assuming you use a discount rate of 7.0%.
  
• Given the current share price of ¥3476.0, the analyst price target of ¥3498.75 is 0.7% higher. 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.