Planned Share Split Will Create A More Attractive Investment Environment

Key Takeaways

• Strong growth in IT services and national security businesses indicates a positive trajectory for revenue and profitability.
  
• Enhanced demand in public services and manufacturing sectors, along with financial forecast adjustments, suggests continued growth and improved earnings.
  
• Delays and costs in submarine projects, telecom revenue decline, and restructuring expenses threaten growth, margins, and earnings if not addressed.
  

Catalysts

Provides information and communication technology solutions in Japan and internationally.

• The significant improvement in domestic IT Services and the aerospace and national security business, with a 7% increase in domestic revenue and an 8% increase in international business, suggests a strong growth trajectory. This is expected to positively impact both revenue and profitability.
  
• Increased demand in sectors such as public services, where orders rose 36% year-on-year, manufacturing with a 13% increase, and ABeam Consulting's 10% performance boost, hint at continued revenue growth and expansion in market share.
  
• The Social Infrastructure segment's steady project execution and operational improvements are likely to drive an increase in operating profit, contributing to overall earnings growth.
  
• Positive revision in financial forecasts, with a significant upward adjustment in non-GAAP operating profit by ¥25 billion, reflects increased earnings expectations due to improved performance across core segments.
  
• The planned share split is aimed at creating a more attractive investment environment, potentially improving stock liquidity and making the stock more accessible, which could enhance investor sentiment and impact earnings per share positively.

NEC Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming NEC's revenue will grow by 5.0% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.5% today to 6.4% in 3 years time.
• Analysts expect earnings to reach ¥252.5 billion (and earnings per share of ¥189.44) by about April 2028, up from ¥187.0 billion today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.5x on those 2028 earnings, down from 21.9x today. This future PE is greater than the current PE for the JP IT industry at 15.9x.
• 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 6.94%, as per the Simply Wall St company report.

NEC Future Earnings Per Share Growth

Risks

• There are scheduled delays and increased costs in submarine systems projects, which could impact future revenue growth and net margins due to potential difficulties in execution.
  
• The decline in telecom services revenue due to risks around achieving 5G and submarine systems targets could affect overall earnings and operating profit.
  
• The deconsolidation of JAE has led to a revenue and OP decline in some segments, which may continue to influence net margins adversely if not compensated through other segments.
  
• Financing and retail services sectors experienced a decrease in demand due to reversal effects from the previous year, which could impact revenue sustainability and profit margins in these domains.
  
• The non-GAAP adjustment items include a substantial restructuring-related expense, potentially impacting net earnings if such costs persist or increase.

Valuation

• The analysts have a consensus price target of ¥3324.167 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 ¥3800.0, 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 ¥3938.2 billion, earnings will come to ¥252.5 billion, and it would be trading on a PE ratio of 21.5x, assuming you use a discount rate of 6.9%.
• Given the current share price of ¥3070.0, the analyst price target of ¥3324.17 is 7.6% 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.