What is good news for Apple (AAPL.O) isn’t always great for its suppliers, as the deteriorating earnings quality at Murata Manufacturing (6981.OS) demonstrates quite clearly.
Apple (AAPL.O) may be booming as a result of its sales of the iconic iPhone, but that good news isn’t necessarily great for its suppliers. Apple is notorious for putting pressure on its component manufacturers, such as Murata Manufacturing Co. Ltd. (6981.OS), in order to maintain its own margins. That leaves Murata, one of the largest producers of MLCCs (multilayer ceramic capacitors), which permit Bluetooth and wireless reception and are a key component in smartphones, struggling in vain to sustain its own profit margins, the trailing four-quarter margin has slumped to only 5.8% in the quarter ended June 30, 2012, from 12.5% a little more than a year ago.
To meet the demand created by the hectic pace of iPhone sales, Murata has boosted manufacturing capacity. But the opening of new facilities didn’t produce the kind of per-unit cost savings that management had expected, meaning that the company hasn’t been able to count on cost savings to boost its margins. Ironically, therefore, Murata, a key supplier to the iPhone, has become a victim of the device’s success – or rather, Apple’s success in keeping its costs as low as possible. Unsurprisingly, perhaps, the company’s earnings quality has suffered. Today, Murata’s score on the StarMine Earnings Quality (EQ) model is only 11, a warning that its earnings may not be sustainable in the coming months.
The industry’s return on net operating assets (RNOA) has remained mostly flat in recent years after recovering from the recession of 2009, but Murata’s RNOA has fallen on a trailing four-quarter basis for the last five quarters, as shown in the chart below. Currently it stands at only 4.7%, less than half the industry median.
Moreover, Murata consistently fails to generate positive free cash flow, another common warning signal of poor earnings quality. In four of the last five quarters, the company has reported negative free cash flow. Most recently, it announced that free cash flow hit a new five year low: a free cash flow shortfall of 26.5 billion yen. (In the chart below, the red portion of the bars represents the amount by which free cash flow trails net income at Murata.) Investors looking for solid earnings quality are likely to shy away from Murata, as profits backed by strong free cash flow tend to be more sustainable going forward.
These aren’t Murata’s only trouble spots, however. The company’s inventory levels appear to be on the rise, and that’s particularly worrying news when the company in question is part of the technology industry. Technology is constantly evolving, and companies in this business are all too aware that inventory on the shelf for very long runs the risk of becoming obsolete and unsellable. Nonetheless, inventory days have crept higher to hit their highest level in two years – 145 days – in the quarter ended June 30. While it is possible that this inventory buildup is in anticipation of a new product launch by Apple (the consumer electronics industry expects a new iPhone to make its debut this autumn), that isn’t probable. In that kind of situation, a run up in inventory tends to occur quickly; the increase at Murata has been steady and gradual, occurring over many months.
Logically, analysts have responded to Murata’s margin problems by trimming their earnings estimates for the company. Today, it scores only 8 on the StarMine Analyst Revisions Model (ARM), putting it in the bottom decile of all companies of the region. Murata fares even worse when it comes to the StarMine Valuation-Momentum (Val-Mo) model, which blends StarMine’s momentum and valuation factors, is only 4.
Despite Murata’s struggles, its share price has recovered some of the ground it lost earlier this year over the first weeks of August. At the beginning of the month, the stock traded at around 3550 yen per share; today, that is closer to 4200 yen. That’s not as high as the 5100 yen it commanded less than six months ago, but is still a respectable recovery. Sadly for Murata, the StarMine models suggest that there are few fundamental reasons for becoming more optimistic about the company’s prospects. Given the signals being sent by these models, the recent run up may end up being remembered more as a selling opportunity than as the beginning of a longer-term rally.
Learn more about how StarMine analytics can help you pinpoint critical developments in your portfolio or watch list.
Request a free trial today.
