Renesas Electronics (OTCPK: RNECF), a leader in automotive microcontrollers based in Japan, has called on many skeptical investors in the past, given its protracted restructuring efforts. But P&L results in recent years have confirmed the negative organic sales trend Growth and market share decline is over. Buoyed by incremental M&A-driven growth following the integration of Intersil, IDT and Dialog, management appears poised to further turn the company into high single-digit percentage steady farms (ie, bypassing the ‘serviceable market’) during the mid-term. While mid-term goals may sound promising (management aims to increase market capitalization sixfold by 2030), physical hurdles are hard to navigate in the near term, especially as Renesas continues to navigate an industry downturn. And given the global overall slowdown, I’m not sure the guidance is conservative enough. In the likely scenario that demand falls short of expectations for an H2 recovery, another adjustment could lower the share price. with The stock is already up 90% since the beginning of the year and is trading at >2x P/Book, and I’ll be on the sidelines.
Acquisition of a strategic share in the main markets
Renesas deserves a lot of credit for reversing its fortunes in recent years – by successfully leveraging key tuck operations like Intersil, IDT and Dialog into more integrated solutions, the company has cemented its number one position in microcontrollers (excluding 8-bit) at 19.5% in 2022 ( up from 18.5% in 2019). However, the largest gain was in 64-bit microprocessors, where its share is now 8% (up from 5% in 2019). Also of note is its steadily growing track record in Industrial Applications/IoT – as of 2022, the company is the #3 player in ex-8-bit microcontrollers, benefiting from strong stock gains in the 16-bit class. While these gains are positive, I am concerned about the sustainability of these gains, as the extent to which recent supply shortages skew results remains unclear. Targets for 2026 for industrial chips/IoT/infrastructure also sound lofty — most notably targets of 25% and 15% for general purpose and AI processors, respectively.
Not surprisingly, Renesas relies mostly on the playbook of inorganic growth to achieve its medium-term growth goals. So far, its acquisition strategy has paid off well despite initial skepticism — it has delivered on all add-ons such as Intersil (+99% over FY22), IDT (+33% over FY22), and Dialog (+7). % during the fiscal year 22). Integration goals before plan. These acquisitions have also improved earnings stability across the Company’s business portfolios, resulting in consistent earnings and increased earnings over the cycles. The next area of focus will be AI/IoT and AI M&A – having invested around $450 million in several additional investments and minority investments, management will ramp up the pace of investment to boost growth. In addition to acquisitions, Renesas will also invest in new production lines to build volume on the energy solutions side, for example, the upcoming line in Takasaki (the in-house SiC fab plant is set for mass production in 2025).
Ramping up medium term financial goals
After years of stagnation, Renesas turned things around in 2017 with its first major acquisition, Intersil; Combined with subsequent additional exploits like IDT and Dialog, the company has dramatically improved its higher growth outlook and, perhaps most importantly, its margins. From here, mergers and acquisitions will continue to be a major feature as the company looks to capitalize on its competitive advantages in key markets. While enhanced mergers and acquisitions should help Renesas grow its revenue quite easily in line with end markets, meeting its margin targets will be more difficult. Since M&A tends to be dilute in the early years, the current gross margin range of 50-55% (just under ~56% in 2022) could prove challenging.
On the capital allocation front, Renesas’ priority over strategic M&A and reinvestment remains, though restoring profits “as soon as possible” or starting a buyback program is also under consideration. How management will balance these goals with the <1x net leverage goal remains unclear; Waiting for a cyclical boom, I wouldn't guarantee a meaningful return anytime soon.
Cyclical weights accrued to H2 forecasts
Amid optimism, investors should not lose sight of the near-term operating background. On the other hand, Renesas results for the first quarter of 2023 crossed the lower guidance bar. However, the quarter-over-quarter slowdown and updated second-quarter forecast of steady sequential growth and margin contraction suggest we’re not quite at the bottom of the cycle. This weakness has reverberated across the industry, with industrial electronics peers such as Hitachi and Rom also heading lower in the first half amid continued consumer spending and weak capex. Nevertheless, management is oriented towards a recovery in the second half, which seems optimistic given the potential for a global economic slowdown and deteriorating end market prospects (eg, the cloud computing price war in China due to weak corporate demand). With the company also boosting overall inventory levels (inventory days up to 120 days) and paused banks in anticipation of a recovery in demand, any disappointments could put pressure on earnings. Given the risks, I don’t see a compelling reason to turn bullish just yet.
Japanese stocks have been the best performers this year, and Renesas is in the lead, up nearly 90% since the start of the year. Some positive aspects are due, given management’s success in leveraging mergers and acquisitions to transition from a passive organic farmer to a positive growth story and margin expansion. The presentation at this year’s Capital Markets Day showed more ambition, setting out a (very ambitious) trajectory for industrial/IoT-based earnings into an outperformance in the medium term and a six-fold increase in share value. While I love the intention, Renesas is still a cyclical name in the midst of a downward spiral. Its relationships with auto demand, which in turn are closely linked to worsening global macro trends, mean more downward adjustments to steering are on the horizon. And at more than twice its book value, the stock isn’t cheap; Pending a meaningful withdrawal, I will finish this withdrawal.
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