Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

Veteran investors know better than to just accept every cheap-looking stock as a gift, some of them are more like a sketchy van with “Free Candy” scrawled on the side. That brings me to THK (OTCPK:THKLY), an automation supplier that has certainly recovered, but not to the same valuation extent as others like Fanuc (OTCPK:FANUY) and Yaskawa (OTCPK:YASKY) and may actually be trading at a relatively attractive valuation.

There are definitely some “buts” with THK to consider. First, just as is true for Fanuc and Yaskawa, calls for a cyclical bottom in the September quarter may be too optimistic. Second, THK has seen rivals like Hiwin gain ground by competing on price. Third, THK has a comparatively unattractive segment (the auto parts business) that lacks near-term drivers beyond underlying market recovery. Still, with semiconductor equipment demand set to improve and machine tools quite possibly bottoming, this could be a time to reconsider this name.

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Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

The Market Believes Winter Is Coming For THK

Given where we are in the cycle and the robust valuation of many factory automation stocks, and particularly those in Japan, finding one that doesn’t seem all that expensive leads to a certain level of “what am I missing?” paranoia. In the case of THK (OTCPK:THKLY) it’s not too hard to see why the shares are trading at a seemingly reasonable valuation – a surge in orders from machine tool, semiconductor equipment, and other industrial companies has driven financials, but analysts are now worried that the company is looking at impending bad news as electronics, machine tool, and general industrial orders could all slow in the next 12 months or so.

In my experience I’ve done much better trying to buy stocks like THK around the bottom rather than at the cusp of a downturn. Although that downturn may not come – electronics orders could rebound and machine tool orders may not slow as expected – the DCF valuation isn’t in “can’t miss” territory and I’m concerned that this recent upsurge has breathed a little extra life into THK’s rivals.

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The Market Believes Winter Is Coming For THK

THK Struggles To Translate A Great Business Into Great Financials

In a lot of meaningful ways, Japan's THK (OTCPK:THKLY) is a great company. The company's linear motion systems are mission-critical components for machinery like robots, machine tools, and semiconductor tools that demand precision and reliability, and the company still enjoys roughly 50% global share. On the other hand, THK has struggled to translate that leadership into attractive margins, growth, or returns on capital, and in many cases, customers like DMG Mori (OTCPK:MRSKY) and Applied Materials (NASDAQ:AMAT) have been the better choice for investors.

I'm not optimistic that there will be a profound change for the better on the way. While THK should see an improvement in the machine tool and machinery end markets, competition is rising from component manufacturers in China, Taiwan, and other countries. What's more, I don't think the company's diversification into auto components is likely to build upon the margins and cash flow generation capabilities. THK shares don't seem unreasonably priced on an EV/EBITDA basis, but the cash flow valuation is not compelling and the 60% move from the lows of the past year seems like adequate compensation for the improving end market outlooks.

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THK Struggles To Translate A Great Business Into Great Financials