Hi
This article serves as a value investing research summary on Toshiba.
Key Finding
A weak balance sheet may derail Toshiba’s turnaround chances.
(A) Business description
Toshiba manufactures a variety of products and is also a solution provider and marketer of advanced electronic and electrical products and systems. Toshiba Group brings innovation to a wide range of business segments, mainly: (i) Energy Systems & Solutions; (ii) Infrastructure Systems & Solutions; (iii) Retail & Printing Solutions; (iv) Storage & Electronic Devices Solutions; and (v) Industrial ICT Solutions to consumers around the world. Unfortunately, a recent accounting scandal has damaged their financials that resulted in the sale of Toshiba Memory Corporation.
(B) Financial analysis
1) Income Sheet Analysis
Toshiba is able to bounce back from the losses sustained for the previous 2 years and recorded a positive net income in FY2017 third quarter. This is an encouraging sign for Toshiba as this shows that they are still able to generate profit despite discontinuing the Westinghouse’s Nuclear Power business and the crown jewel Memory business. More specifically, all segments recorded positive operating income gain except for Energy Systems & Solutions, Industrial ICT Solutions and Others.
2) Balance Sheet Analysis
For Toshiba to tide through this period is its ability to survive a raid by its creditors. From the FY2017 third quarter financial report, it is noticeable that Toshiba do not have enough cash to repay its short-term borrowings and with its quick ratio of 0.479, it is probable that Toshiba might go bankrupt if creditors demand their money back in the future. Furthermore, its liquidating value is a cause of concern for the equity investors as the sale of Toshiba’s total assets is unable to cover even its current liabilities which means that it is highly likely that equity investors would lose all of its money.
3) Cash Flow Analysis
Based on the FY2017 third quarter financial report, Toshiba’s cash flow is mainly generated from its financing activities with significant contributions from the increase in short-term borrowings and proceeds from stock offering. The negative cash flow from operations is mainly caused by the increase in depreciation, inventories and others. This increase in depreciation could be due to the continue CapEx investment and there is no obvious improvement in any business segments that warrants the increase in inventories. Also, Toshiba’s rise in investments in affiliates could be used to support its affiliates from obtaining raw materials for their Infrastructure System & Solutions business operations and it is vital for Toshiba to support them as this segment contributes the most towards Toshiba’s overall net sales.
(C) Investment summary
The improved profitability of Toshiba could be a step towards improving its balance sheet and cash flow statement but we have to weigh the possibilities of sustaining the positive net income of Toshiba through the analysis of the top 3 contributors of net sales under Toshiba’s current business model.
1) Energy System & Solutions
Contributing 20% of the total revenue as of FY2017 third quarter, this segment manufactures (i) Large scale power generation systems (thermal power and nuclear power); (ii) Renewable energy (hydro power, geothermal power and photovoltaic); and (iii) Transmission and distribution energy storage.
There is certainly potential for growth in this area as the International Energy Agency forecasts that renewable energy will comprise 40% of global power generation by 2040 and in the coming 5 years, the contribution of renewable worldwide is set to grow faster than any other source (Figure 2). Furthermore, the feed-in tariff system introduced in Japan in 2012 is starting to yield results as official figures from METI showed that renewable energy nationwide accounted for 15% of Japan’s total electricity production in fiscal 2016 while petroleum and coal accounted for 11% and 30% respectively. Additionally, the production of petroleum is facing decline (Figure 1) for the past few years and the energy gap could be filled by the renewable energy which is targeted by the government to account between 22% and 24% of the total energy mix by 2030 in Japan.
However, Toshiba, which is not known for its renewable energy expertise, has to play catch up if they were to focus on this industry and they would have to compete mainly with China (the leader in low cost production) and United States of America (the leader in innovation). Thus, a lot of effort and time would be needed to propel Toshiba into the forerunners position in the renewable energy industry.
2) Infrastructure System & Solutions
Contributing the most of Toshiba’s revenue at 27%, it consists of building (i) Public infrastructure (water treatment systems, security and automation systems, broadcasting systems and air traffic control systems); (ii) Building & Facilities/Offices & Stores (lightings, elevators, air-conditionings and POS system); and (iii) Transportation and Industrial Systems (railways systems, industrial systems and lithium-ion rechargeable battery).
Demand for these services is limited domestically as Japan is already a developed country with most amenities, railways systems and buildings already built. Furthermore, public works and national defence has been facing little emphasis in the Japan’s annual budget (Figure 3) which dampens demand for Toshiba’s services. Venturing abroad is challenging as there are many other international and local firms that provides similar services too. Thus, under a super competitive industry with little growth opportunities, Infrastructure & Solution segment may not be a feasible future growth channel for Toshiba.
3) Storage & Electronic Devices Solutions
After selling off its NAND and SSD memory business, Toshiba is left with the HDD and electronic devices solutions business and it has contributed 22% of total revenue as of FY2017 third quarter. Toshiba’s market share in the HDD market is 22.9% – 23.5%, behind leader Western Digital (39.8% – 40.1%) and Seagate (36.7% – 37%) but despite capturing almost a quarter of the market, this sector may not be a long term growth contributor as the market demand of HDD is declining (Figure 4). On the other hand, the global demand for other semiconductor products are increasing (Figure 5) which could offset the fall in HDD. Thus, Toshiba could utilise its expertise in this area to further improve on providing more innovative electronic devices solutions that the world advances technologically. Hence, this business segment looks the most viable for Toshiba to get itself back on track and seems most likely to be pursued as they have the relevant experience and equipment to start work on it immediately.
(D) Potential catalyst
1) Innovative electronic devices solutions
With continuous focus into this business segment, Toshiba may come up with unique solutions that is greatly demanded and this could propel them towards the leader position in the semiconductor industry once again.
2) Stabilised financials
Under the leadership of new CEO Nobuaki Kurumatani, Toshiba could make use of his experience in the banking sector to repair its balance sheet and make calculated risk when making investments in the future at Toshiba.
(E) Risks
1) Repayment of debt
If the creditors do demand the clearance of debt during this period, Toshiba might face bankruptcy as it do not have enough assets to pay them. Furthermore, Toshiba is currently maintaining its positive cash flow through its financing activities which would not be a reliable source of money to repay its debt.
2) Failure of innovation
A common risk of large investment into Research & Development is that it may not yield positive results and this is incredibly risky for Toshiba because based on its current business operations, the profit generated is not enough to support its borrowings that were used to fund its research and capital expenditures.
Conclusion
In conclusion, Toshiba do have the potential to tide through this rough patch they are going through currently but if they do not have proper financial management, it could derail their turnaround efforts.
Jia Yang
Research Analyst, Mind Kinesis Value Investing Academy
Disclaimer: Please note that all information stated in this article is just for education purpose only and should not be used as any form of recommendation or advice.
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