8 December 2014, Sweden | News
Catella's fund manager just returned from an engineering industry trip, two days in Korea and three days in Japan. There were about twenty institutional investors from Sweden, Finland, Norway and Germany at a total of more than twenty visits to companies over five days. Here is Mikael's travel notes.
Industry in these countries is of great importance to us in Europe, and especially in the northern part of Europe, as we export a lot to these countries and also because our engineering competitors are there.
The industry that interested us most was undoubtedly shipping, and the companies that manufacture large freight vessels of various kinds. Also interesting were other engineering industries that are directly relevant to our Swedish engineering companies, like Alfa Laval, ABB, Atlas Copco, Autoliv, Sandvik, SKF and Volvo, to name a few.
Daewoo Shipbuilding & Marine Engineering Co is one of the world's leading shipbuilders, based in Busan, South Korea, and the only sector share in the region that currently has a buy recommendation with US investment banks. Of course it was exciting to hear what they think about the future, not least after order books throughout the industry have slowed down precariously. Alfa Laval is one of the Swedish companies negatively affected by the decline in orders for new vessels at shipyards. The stock has traded down sharply due to concerns about falling orders, which may not be entirely relevant since Alfa Laval supplies to the shipping industry as the boats are built, and especially in the final phase. But the stock has instead been trading down on falling order intake, which has caused delivery times to decrease from two and a half years to a year and a half. What could be negative is if order books decrease so sharply for several years that capacity utilisation drops and fewer ships are built, but, as it is now, it's more about the delivery lead times perhaps falling to one year. The mix of vessels being manufactured has changed as gas has become an increasingly important source of energy. More LNG and LPG carriers are now being built (which carry different types of gas, such as natural gas) than in the past, instead of traditional oil tankers and iron ore carriers, while container vessels have decreased marginally.
Many of the companies we met are conglomerates, which means they have many different areas of business, ranging from automobile manufacturing to building nuclear power plants.
We also met with Hyundai Heavy Industries, which has about one-third of its turnover in shipbuilding and just over a third in refineries. They confirmed the same picture when it comes to new ship orders, but were seeing increased sales growth to refineries, which is also an important business for Alfa Laval.
Doosan Heavy Industries, operating particularly in wind energy, generators, fuel cells for the energy sector, water treatment, desalination plants and the petrochemical industry, spoke of an increase in orders. Doosan is also big in the construction sector.
Most interesting are the huge infrastructure projects underway around the world, ranging from desalination plants in the United Arab Emirates to nuclear energy and power plants worldwide.
More new nuclear power plants are being planned in both Japan and China, and several Swedish companies, such as ABB and Alfa Laval, are involved in much of the procurements for these gigantic projects. It is encouraging to see that the world is moving on, and not least in infrastructure.
In Japan, a lot has happened in politics and the economy in recent times. The Japanese economy has certainly rebounded since the Fukushima disaster, partly through national unity but above all thanks to the weaker yen and reconstruction of ruined infrastructure. As the economy improved, Prime Minister Shinzō Abe had to do something to stem the growing budget deficit. The government introduced a substantial VAT increase, from five percent to eight percent, which will increase revenues. Admittedly revenues have increased, but at the expense of economic growth. Japan's latest GDP figures showed that its economy fell for two consecutive months and is thus in recession. Abe confirms that he will call new elections, and says he will resign if the coalition loses its majority. He also says that his economic policy, known as Abenomics, is showing results and has created one million new jobs. New elections will seek voter support for the economic growth strategy and the decision to postpone a further VAT increase, says Abe, and believes that one should not break a "good cycle" in the economy. He also notes that the forthcoming elections will be a tough test, but he is convinced that the confidence in economic policy will not be lost.
Back to the company visits
One of the more interesting meetings we had in Japan was with ball bearing manufacturer NSK, whose management opened the meeting by showing great surprise at SKF's, in their eyes, very weak report.
NSK has obviously had the advantage of a weaker yen for some time, but one cannot help but get the feeling of success breeding success, and that means confidence. NSK has been very successful, especially with ball bearings for the automotive industry in both the US and China, and is by far the biggest supplier of bearings to the domestic car market, led by Toyota. NSK is represented in 26 countries and has an export share of approximately 43 percent.
Komatsu, a direct competitor to Caterpillar, Volvo CE, Sandvik and, to some extent, Atlas Copco in mining equipment, confirmed the picture of weak order intake from the mining industry. Service and spare parts are what the company is currently making money from, as sales of new equipment are limited. Since the margin on service and parts is higher, the company can manage pretty well anyway.
But just as in the truck industry, machines can only be run and serviced up to a certain point before new ones have to be bought, so perhaps we can hope for improved order intake in late 2015.
While we are on the subject of trucks, it is worth mentioning that the Japanese truck market had a substantial shakedown in the crisis of 2008-2009, and volumes fell to 18,000 units in 2009. This led original equipment manufacturers (OEMs) to eventually remove capacity just as new emission standards (stricter emissions requirements) in 2009 improved the price situation. An outdated fleet, reconstruction after Fukushima, and other infrastructure investment mean that the market now looks set to grow by 15 percent this year, to 39,000 vehicles, and this growth should continue in 2015 as there is some pre-buying before the new emission standards in 2016.
Volvo has greatly reduced its capacity in Japan, from 50,000 to 13,500 (the plant in Japan should only supply to truck markets in Japan), but we believe that the market for UD (a Volvo brand) will remain a five percent margin market, which dilutes the truck group. By contrast, Quester (Volvo UD's brand) could raise profitability if it achieves 30,000 trucks in Asia outside Japan. However, this is exactly the same as the Japanese truck manufacturers are aiming for. We met Hino, which is aiming to go from 205,000 trucks (heavy, medium and light) in 2013 to 300,000 by 2020 through growth in China, EMEA and LatAm. Estimates suggest that Quester will sell 1,500 units this year from its first factory in Thailand, with a capacity of 20,000. Success could be achieved if Volvo can cooperate with Donfeng and sell a Quester Donfeng in China, which in terms of quality and price is between Donfeng and Volvo, since this segment is likely to grow the most in China over the next five years.
Finally, I would like to mention that the most interesting meeting from a future perspective was with Denso, at the Swedish Embassy in Tokyo. The company is, in terms of sales, the world's largest supplier of parts to the automotive industry. It manufactures electronic equipment for the automotive industry in the form of navigation systems, radiators, information and safety systems, and air conditioning equipment, to name a few. The company is owned in part by Toyota, but has less than 50 percent of its sales to Toyota. Our meeting focused largely on Denso developing an operating system, like Windows for example, which will be an open and compliant platform for all manufacturers of services and systems in the automotive industry.
This means that owners of cars can download much of the extra equipment they want instead of ordering it when buying a new car. Instead, it will be possible to install apps just like on a mobile phone. It will also be possible to download software that updates all the technology to new versions, which actually means that the lifetime of a car could be extended. The most exciting part of the open structure is that it could become the operating system that eventually achieves reality with driverless cars.
I cannot help but make you a little envious of the food I enjoyed in Japan. How about, for example, a Sashimi dish with cod milk, fish eyes in vinegar and raw squid. We also got the chance to enjoy raw chicken, which seems to be a specialty in Japan, unlike in the rest of Asia and the rest of the world, but it was really tough to take the first bite.