Senior Technology Analyst, Japanese Equities, LightStream Research

Scott Foster

Senior Technology Analyst, Japanese Equities

Long-Short Analysis on Japan, Asia and the World

LightStream Research

LightStream conducts quantitatively rigorous and data-driven analysis with a focus on Japan and Asia.

We consistently cover the Tech, Consumer and Industrial sectors, and provide ECM and Events coverage more broadly.

We supplement traditional qualitative insights from company relationships with a robust quantitative foundation that examines as much historical data as is available.
We further refine the accuracy of our insights and calls through the use of alternative data to flesh out current trends, and through a valuation framework that emphasises non-superficial peer group selection and a proper attempt to understand the metrics and changes that have driven security valuations in the past.

Equity Bottom-Up

<ul>
<li>3Q results were above guidance, as expected. Full-year guidance looks conservative, as usual. New orders ahead of sales, pointing to one or two good quarters ahead. </li>
<li>Shares down 10% since the beginning of January. Valuation reasonable but not compelling given the risk of a cyclical peak in SPE demand this year.</li>
<li>Uncertainty likely to keep the shares in a trading range.</li>
</ul>


3Q results were above guidance, as expected. Full-year guidance looks conservative, as usual. New orders ahead of sales, pointing to one or two good quarters ahead. 
Shares down 10% since the beginning of January. Valuation reasonable but not compelling given the risk of a cyclical peak in SPE demand this year.
Uncertainty likely to keep the shares in a trading range.


Disco (6146 JP): Valuation Reasonable but Not Compelling

Disco's share price has rebounded by 10% since October 5 in conjunction with the announcement of record quarterly sales and profits on October 21 (results for 2Q of FY Mar-22).But new orders received peaked six months earlier (in 4Q of FY Mar-21) and management is guiding for declines in sales, operating profit and the operating margin in the three months to December.Even assuming a tendency to low-ball and a conservative forex assumption (¥105/$), further sustainable growth looks unlikely.The shares are now selling at 20x management's EPS guidance for the nine months to December, extrapolated out to Mar-22 on the assumption that 4Q EPS will be the average of 1Q, 2Q and 3Q. However, operating profit gearing to changes in sales is nearly 50%, leaving substantial risk on the downside as the semiconductor shortage eases and orders for silicon wafer dicing and grinding equipment plateaus and then retreats.

Disco's share price has rebounded by 10% since October 5 in conjunction with the announcement of record quarterly sales and profits on October 21 (results for 2Q of FY Mar-22).But new orders received peaked six months earlier (in 4Q of FY Mar-21) and management is guiding for declines in sales, operating profit and the operating margin in the three months to December.Even assuming a tendency to low-ball and a conservative forex assumption (¥105/$), further sustainable growth looks unlikely.The shares are now selling at 20x management's EPS guidance for the nine months to December, extrapolated out to Mar-22 on the assumption that 4Q EPS will be the average of 1Q, 2Q and 3Q. However, operating profit gearing to changes in sales is nearly 50%, leaving substantial risk on the downside as the semiconductor shortage eases and orders for silicon wafer dicing and grinding equipment plateaus and then retreats. 

The Nikkei reports that order-to-delivery lead times for silicon wafer dicing machines, most of which are made by Disco, have expanded from 1 to 3 months to 5 to 8 months. And since Disco recognizes revenue on an acceptance basis, the order-to-sales lag could be even longer. Disco told the media, "We are making individual adjustments with clients and striving to meet the delivery time." (Nikkei Asia, April 15, 2021)This implies that the company is at full capacity, and that sales and profits are likely to remain strong for another two quarters. FY Mar-21 guidance looks conservative. FY Mar-22 guidance is likely to be front-loaded, 1H stronger than 2H due to lack of visibility more than six months out.Lead times for wire bonders and other equipment are reportedly as long as 12 months and there is widespread concern about double ordering in the semiconductor supply chain. With growth hitting physical limits and valuations having gone to new highs at what appears to be the top of the cycle, we continue to recommend selling into strength.

The Nikkei reports that order-to-delivery lead times for silicon wafer dicing machines, most of which are made by Disco, have expanded from 1 to 3 months to 5 to 8 months. And since Disco recognizes revenue on an acceptance basis, the order-to-sales lag could be even longer. Disco told the media, "We are making individual adjustments with clients and striving to meet the delivery time." (Nikkei Asia, April 15, 2021)This implies that the company is at full capacity, and that sales and profits are likely to remain strong for another two quarters. FY Mar-21 guidance looks conservative. FY Mar-22 guidance is likely to be front-loaded, 1H stronger than 2H due to lack of visibility more than six months out.Lead times for wire bonders and other equipment are reportedly as long as 12 months and there is widespread concern about double ordering in the semiconductor supply chain. With growth hitting physical limits and valuations having gone to new highs at what appears to be the top of the cycle, we continue to recommend selling into strength.

Disco (6146 JP): 5-To-8 Month Lead Times in the Price

Disco's share price has nearly doubled from its COVID low of last March and has risen by more than 40% since September, reaching a new all-time high of ¥33,700 on November 30. This reflects very strong results in the three months to September (2Q of FY Mar-21).But as Campbell Gunn pointed out in <a href="https://www.smartkarma.com/insights/japan-results-revisions-10-22-chugai-disco-benefit-one-pasona-oisix" target="_blank" data-smartkarma-citation="insights:44452" rel="noopener">🇯🇵 JAPAN • Results &amp; Revisions 10/​​​​​​​​​​​​​​​22 </a> , the shares are now Overbought and at a new post-listing Relative Price Score high ... the upside will be constrained as the market-implied growth rate of four times GDP is unrealistic... We expect the current cycle to peak ... and the shares to mean-revert out of Overbought territory.New orders and the order backlog peaked in 4Q of FY Mar-20, shipments peaked in 1Q of this fiscal year, and sales and profits peaked in 2Q. Management is guiding for substantially lower sales and profits in 3Q. Operating and net profit were up nearly 40% year-on-year in 2Q; management is guiding for low single-digit growth in 3Q. So far, there is no guidance for FY Mar-21 as a whole, but extrapolating from 3Q guidance and industry trends points to a 12% increase in net profit, which would put the shares on a P/E of 38.5. Japanese SPE industry leader Tokyo Electron, by comparison, is selling at 27.5x management's EPS guidance for FY Mar-21.

Disco's share price has nearly doubled from its COVID low of last March and has risen by more than 40% since September, reaching a new all-time high of ¥33,700 on November 30. This reflects very strong results in the three months to September (2Q of FY Mar-21).But as Campbell Gunn pointed out in 🇯🇵 JAPAN • Results &amp; Revisions 10/​​​​​​​​​​​​​​​22  , the shares are now Overbought and at a new post-listing Relative Price Score high ... the upside will be constrained as the market-implied growth rate of four times GDP is unrealistic... We expect the current cycle to peak ... and the shares to mean-revert out of Overbought territory.New orders and the order backlog peaked in 4Q of FY Mar-20, shipments peaked in 1Q of this fiscal year, and sales and profits peaked in 2Q. Management is guiding for substantially lower sales and profits in 3Q. Operating and net profit were up nearly 40% year-on-year in 2Q; management is guiding for low single-digit growth in 3Q. So far, there is no guidance for FY Mar-21 as a whole, but extrapolating from 3Q guidance and industry trends points to a 12% increase in net profit, which would put the shares on a P/E of 38.5. Japanese SPE industry leader Tokyo Electron, by comparison, is selling at 27.5x management's EPS guidance for FY Mar-21.

Disco (6146 JP): 2Q Growth Unsustainable, Shares Overbought

'Quantamental' Japan Specialist, LightStream Research

Campbell Gunn

'Quantamental' Japan Specialist

<section class="figure"><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/176/175/original/2020-12-03_05-39-01.png?1606941555" class="editor-image img-responsive" data-smartkarma-image-id="176175"></figure><div class="content-caption">Source for all charts &amp; tables: Japan Analytics </div></section><div>FOUR QUADRANTS PICKS - Our recent series of Insights covering companies that are extreme outliers in our Relative Price Score/Results &amp; Revision Score matrix has featured the following seven companies:-  </div><div>
<ul style="list-style-type: disc;">
<li>
CONTRARIAN BUYS - <a href="https://www.smartkarma.com/entities/nikon-corp" target="_blank" data-smartkarma-citation="entities:7117:1" rel="noopener">Nikon (7731 JP)</a>, <a href="https://www.smartkarma.com/entities/fuji-media-holdings-inc" target="_blank" data-smartkarma-citation="entities:3191:1" rel="noopener">Fuji Media (4676 JP)</a>, <a href="https://www.smartkarma.com/entities/east-japan-railway-co" target="_blank" data-smartkarma-citation="entities:14271:1" rel="noopener">East Japan Railway (9020 JP)</a> </li>
<li>
CONTRARIAN SELLS - <a href="https://www.smartkarma.com/entities/m3-inc" target="_blank" data-smartkarma-citation="entities:13316:1" rel="noopener">M3 (2413 JP)</a>, <a href="https://www.smartkarma.com/entities/disco-corp" target="_blank" data-smartkarma-citation="entities:15817:1" rel="noopener">DISCO (6146 JP)</a> </li>
<li>
TURNAROUND BUYS - <a href="https://www.smartkarma.com/entities/softbank-corp" target="_blank" data-smartkarma-citation="entities:27445:1" rel="noopener">Softbank Corp (9434 JP)</a> </li>
<li>
EX-GROWTH SELLS - <a href="https://www.smartkarma.com/entities/kao-corp" target="_blank" data-smartkarma-citation="entities:12933:1" rel="noopener">Kao  (4452 JP)</a> </li>
</ul>
2021 HIGH CONVICTION COLLECTION - For Smartkarma's '2021 High Conviction Collection' we have chosen one of the seven to be our selection. Given the lack of short ideas so far - only two and both in the US - our pick, <a href="https://www.smartkarma.com/entities/m3-inc" target="_blank" data-smartkarma-citation="entities:13316:1" rel="noopener">M3 (2413 JP)</a>, is the first Asian, and first Japanese, 'short' to join the Collection.
<section class="figure"><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/176/209/original/2020-12-03_10-35-14.png?1606959327" class="editor-image img-responsive" data-smartkarma-image-id="176209"></figure></section><a href="https://www.smartkarma.com/entities/m3-inc" target="_blank" data-smartkarma-citation="entities:13316:1" rel="noopener">M3</a>- M3 is the most extreme outlier of the seven stocks we have featured and was recommended as a 'Suga Growth Long in our Smartkarma Original - <a href="https://www.smartkarma.com/insights/japan-in-the-suga-era-policy-priorities-suga-stocks" target="_blank" data-smartkarma-citation="insights:43773" rel="noopener">Japan in the Suga Era - Policy Priorities &amp; 'Suga Stocks'</a>. Since then the stock has appreciated by 40% and by 10% since we published <a href="https://www.smartkarma.com/insights/japan-four-quadrants-contrarian-sells" target="_blank" data-smartkarma-citation="insights:45725" rel="noopener">Contrarian Sells</a>, adding almost ¥2 trillion in market value M3 is Japan's fifteenth largest company with a market value of ¥6.4 trillion, despite having only ¥144 billion in trailing revenues, ¥43 billion in trailing operating income, and just ¥18 billion in trailing CITC. While valuations may be less of a concern in the momentum-driven post-COVID era, we have highlighted several areas of concern regarding the company's margin-diluting diversification, that suggest that M3's tripling in value seen in 2020 will not be repeated. M3 is our 2021 'High Conviction Sell'      
</div>

Source for all charts &amp; tables: Japan Analytics FOUR QUADRANTS PICKS - Our recent series of Insights covering companies that are extreme outliers in our Relative Price Score/Results &amp; Revision Score matrix has featured the following seven companies:-  


CONTRARIAN BUYS - Nikon (7731 JP), Fuji Media (4676 JP), East Japan Railway (9020 JP) 

CONTRARIAN SELLS - M3 (2413 JP), DISCO (6146 JP) 

TURNAROUND BUYS - Softbank Corp (9434 JP) 

EX-GROWTH SELLS - Kao  (4452 JP) 

2021 HIGH CONVICTION COLLECTION - For Smartkarma's '2021 High Conviction Collection' we have chosen one of the seven to be our selection. Given the lack of short ideas so far - only two and both in the US - our pick, M3 (2413 JP), is the first Asian, and first Japanese, 'short' to join the Collection.
M3- M3 is the most extreme outlier of the seven stocks we have featured and was recommended as a 'Suga Growth Long in our Smartkarma Original - Japan in the Suga Era - Policy Priorities &amp; 'Suga Stocks'. Since then the stock has appreciated by 40% and by 10% since we published Contrarian Sells, adding almost ¥2 trillion in market value M3 is Japan's fifteenth largest company with a market value of ¥6.4 trillion, despite having only ¥144 billion in trailing revenues, ¥43 billion in trailing operating income, and just ¥18 billion in trailing CITC. While valuations may be less of a concern in the momentum-driven post-COVID era, we have highlighted several areas of concern regarding the company's margin-diluting diversification, that suggest that M3's tripling in value seen in 2020 will not be repeated. M3 is our 2021 'High Conviction Sell'      


2021 High Conviction 🇯🇵 Sell M3 (2413 JP)

Japan

DISCO CORPORATION manufactures abrasive and precision industrial machinery for cutting and grinding purposes.  The Company's products are applied in the semiconductor, electronics, and construction industries to produce consumer goods such as personal computers, digital cameras, video game systems, and Digital Video Disc (DVD) players.

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DISCO Corp (6146 JP)

Disco (6146 JP): Valuation Reasonable but Not Compelling

3Q results ahead of guidance and FY guidance looks conservative, but this should have been expected. Valuation reasonable but not compelling due to...

Scott Foster

Disco (6146 JP): Sell into the Rebound

Disco reported record sales and profits in the three months to September, but new orders peaked six months earlier. Demand should decline as the...

Scott Foster

Disco (6146 JP): 5-To-8 Month Lead Times in the Price

With growth hitting physical limits, double-ordering in the semiconductor supply chain, and valuations at new highs, we recommend selling into...

Scott Foster

Disco (6146 JP): 2Q Growth Unsustainable, Shares Overbought

Disco's share price has appreciated by more than 40% since September despite declining orders and guidance for sharp declines in sales and profits...

Scott Foster

2021 High Conviction 🇯🇵 Sell M3 (2413 JP)

2021 HIGH CONVICTION COLLECTION - For Smartkarma's '2021 High Conviction Collection' we have chosen one of our seven RPS/RRS outliers to be our...

Campbell Gunn

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