Harmonic Drive Earnings: Headwinds To Continue in 2023, but Shares Have Long-Term Upside Potential

Harmonic Drive Systems’ 6324 June-quarter order decline of 32% year on year was in line with our expectations, as its industrial robotics and semiconductor production equipment, or SPE, maker customers undergo inventory adjustments. However, we see signs of demand having bottomed out, as June-quarter orders in the Japan/Asia segment (constituting the majority of orders) sequentially recovered 4%, which we think caused the positive market reaction. We attribute this to a recovery in small robot demand, as electronics makers look to increase production amid the final stages of inventory destocking, and to a lesser extent, new infrastructure demand in China. Although we have lowered our fair value estimate to JPY 5,900 per share from JPY 6,100 based on a slower near-term demand recovery, our longer-term outlook is intact. We think the market is underestimating the strain wave gear market leader’s midterm prospects, driven by demand for industrial robots, SPE, and new applications like surgical robots. We believe that as the inventory correction for robots/SPE nears its end in the first half of 2024, a stronger order recovery will be the catalyst for HDS shares.

In the meantime, we think investors will need to be patient, as HDS’ high exposure to smaller-size robots (often used for electronics production) and SPE demand will affect sales for fiscal 2023, ending March. Limited signs of improved electronics/semiconductor production have contributed to the year-to-date underperformance of HDS shares relative to most peers. However, we believe much of the downside risk is priced in. While we account for our weaker near-term outlook by revising our 2023 revenue growth projection to a 24% year-on-year decline, down from an 18% decline previously, we expect a top-line recovery of 23% in 2024. As a result, we expect capacity utilization to improve next year, with operating margin increasing from 8.5% in 2023 to 15.5% in 2024, which is 1.2 percentage points above 2022′s margin.