Automobile Supply Chain Issues in Japan Affect Denso's Quarterly Margin, but We Maintain FVE

Denso’s June-quarter operating margin fell 3.4 percentage points from last year to 4.5% as a result of lower sales in Japan and high labor and logistics costs in North America, which were worse than we expected. We reflect this by lowering our operating margin projection for fiscal 2022 (ending March 2023) to 7.3% (IFRS) from 8.6%. However, this does not affect our fair value estimate of JPY 9,200 per share, as we maintain our outlook that a higher portion of rising component costs will be passed on to prices from the second half of fiscal 2022, and we continue to believe the company can surpass its midterm operating margin target of 10.0% in fiscal 2025. We expect improved product mix from higher sales of electrification systems, third-generation advanced driver-assistance systems, and heat pump components for electric vehicles, as well as a gradual improvement in the supply/demand imbalance of components, will lead to an operating margin of 10.8% in fiscal 2025. With the market discounting Denso’s medium-term prospects, we think the shares are undervalued.