Company Reports

Harmonic Drive Systems’ June-quarter orders declined 5% sequentially, which was a negative surprise, as channel inventory adjustments of healthcare equipment in North America and industrial robot makers in Japan are progressing slower than expected. Due to weak demand/capacity utilization, quarterly operating margin of negative 1.8% was below our estimate, making it the fourth consecutive quarter of unprofitability. Although we expect the company to return to profitability in the September quarter, we expect a slower recovery in utilization levels in fiscal 2024, ending March 2025. Therefore, we cut our fiscal 2024 operating income estimate by 18% to JPY 3 billion and lower our fair value estimate to JPY 5,100 per share from JPY 5,500. Despite the downward revision, we project operating income to increase to JPY 10 billion in fiscal 2025, driven by top-line growth of 17% year on year (after 5% growth in 2024) and operating margin expansion of 9.3 percentage points to 14.5%.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment; its compact strain wave reduction gears (also known as speed reducers) serve as critical components of both. The company seeks to refine its product quality toward existing applications as well as find new applications that can serve as new long-term growth drivers. We think small industrial robots and semiconductor equipment will continue to serve as key target markets.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as critical components of both. The company seeks to continue refining its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think small industrial robots and semiconductor equipment will continue to serve as key target markets.

Despite the revenue guidance being in line with our estimate, wide-moat Harmonic Drive Systems, or HDS, guided for a 4.6% operating margin for fiscal 2024 (ending March 2025), up from 0.2% in fiscal 2023, but below our previous assumption of 9.0%, as we had assumed stronger margin recovery from improved capacity utilization. While we expect further details to be provided in the upcoming earnings call, we think the guidance is conservative, as HDS will be able to realize cost pass-throughs by leveraging its pricing power.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

We maintain our fair value estimate for Harmonic Drive Systems at JPY 5,700, as our medium-term outlook remains unchanged after the current headwinds. The 6% sequential decline in third-quarter fiscal 2023 orders was slightly below our expectations due to sluggish capital spending by semiconductor production equipment makers and inventory adjustments by customers in the U.S. and Europe. On the other hand, orders for industrial robot applications (the largest application by sales) in Asia have been recovering as expected. Although we lower our fiscal 2024 revenue assumption ending March 2025 to 12% growth from 17%, largely due to a slower recovery for SPE applications over the next three quarters, we continue to expect stronger growth in the second half of fiscal 2024 as the inventory adjustments are completed.

Our outlook for Harmonic Drive Systems is unchanged, as orders for the company's mainstay reduction gears for robotics applications are showing continued sequential recovery amid headwinds, as expected. Although September-quarter consolidated orders declined 29.5% year on year and 5% sequentially, orders for the parent entity increased sequentially by 17% for the industrial robot application, which we think caused the positive market reaction. HDS has been affected by sluggish electronics/semiconductor investments in Asia as well as inventory adjustments by the industrial robot original equipment manufacturer customers, which we expect to near their end in the first half of fiscal 2024 (ending March 2025). As a result, our revenue projection is largely intact, assuming a 23% year-on-year decline in 2023 followed by 17% growth in 2024. We have lowered our fair value estimate to JPY 5,700 per share from JPY 5,900 after cutting our operating margin assumptions.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

Harmonic Drive Systems' 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.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

Harmonic Drive Systems', or HDS’, March-quarter orders declined 43.5% year over year due to weaker-than-expected demand for semiconductor production equipment, or SPE, and small-sized robots used in electronics manufacturing. As a result, we now expect HDS’ fiscal 2023 (ending March 2024) revenue to decline 18% year on year, down from our previous forecast of a 5% decline. However, we maintain its fair value estimate at JPY 6,100, as we continue to forecast midteens sales growth in the midterm, driven by growing demand for industrial robots/cobots in factories, surgical robots, and SPE, which the market underestimates. As the inventory correction in IT equipment is nearing an end, we believe that orders have already bottomed out and that further order recovery will be the catalyst for HDS’ shares.

Harmonic Drive Systems, or HDS, has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think both small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think both small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

Harmonic Drive System's orders declined 50.7% year on year in the December quarter, which we attribute to weaker demand for semiconductor production equipment and small robots, which are often used in electronics manufacturing. However, this was not surprising given the massive upfront orders in the September-quarter last year, which previously led to about 170% growth. While we lower our fair value estimate to JPY 6,100 from JPY 6,300 due to declining capital spending in the electronics/semiconductor industries in 2023, we expect a top-line recovery in 2024 as semiconductor investments pick up. Over the longer term, we see upside potential, as HDS grows along with demand for high-end industrial robots, collaborative robots, and surgical robots, given its dominant positioning in the strain-wave-reduction-gear market.

Harmonic Drive Systems', or HDS’, September-quarter orders declined 40.1% year on year, mainly due to lower orders of its reduction gears from industrial robot makers in Japan. However, this was not surprising, as there were massive upfront orders in the September quarter in 2021, which previously led to a 229.0% year-on-year increase in orders. Although we expect orders to fall below the previous year’s level for the next few quarters, we maintain our view that orders will not drop to 2018-19 levels during the U.S.-China trade friction. In fact, on a monthly level, management forecasts orders to gradually improve from around December-January, initially from inventories bottoming out by customers (like robot manufacturers and distributors), followed by an eventual pick-up in end-user demand. Over the longer term, we think the wide-moat company’s reduction gear demand will grow, along with the market for smaller robots/collaborative robots (or cobots) and surgical robots, where many of them use HDS’ gears. As such, we believe shares are undervalued, despite slightly lowering our fair value estimate to JPY 6,300 from JPY 6,400 after adjusting our near-term revenue/margin assumptions.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think both small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

Harmonic Drive Systems' June-quarter orders declined 29.2% year on year, but this was within expectations, and our projected medium-term sales trajectory is largely unchanged. Much of the decline came from lower orders related to industrial robot applications in Japan and significant up-front purchases by customers last year. Despite this, HDS’ share price has continued to recover, which we attribute to increased market confidence that orders will not drop to levels of the U.S.-China trade friction in 2018-19 and the upcoming downcycle will be shorter than the previous one. We believe the shares are still undervalued, as HDS’ medium-term top-line growth prospects are being underestimated. As the strain wave gear market leader, the wide-moat company is best positioned to capitalize on increased use of gears in robotic applications, like those for electric vehicle/battery production, collaborative robots for general manufacturing, and newer types like surgical/humanoid robots. With this outlook intact, we retain our fair value estimate at JPY 6,400 per share.

Harmonic Drive Systems has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think both small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.

We slightly lower our fair value estimate for Harmonic Drive Systems, or HDS, to JPY 6,400 from JPY 6,600, after adjusting our medium-term operating margin assumptions. However, we continue to believe its shares are undervalued, as we think the market has been overreacting mainly to concerns of orders suddenly dropping like in 2018-19 (during the trade friction between the U.S. and China), as a result of ongoing headwinds such as lockdowns in China. March quarter orders dropped 24.8% from the previous quarter, but this is within expectations given the massive upfront orders over the past three quarters, and it is still near the past-peak levels in 2017. Moreover, although management acknowledges orders may remain stagnant in the short term, it also believes that the underlying demand is still quite strong, unlike in 2018 and 2019. We also believe that the announcement of a share buyback was a positive signal to investors.

Harmonic Drive Systems, or HDS, has been able to capitalize on demand growth with industrial robots and semiconductor production equipment, by having its compact strain wave reduction gears (also known as speed reducers) serve as core components of both. The company seeks to continue improving its product quality toward existing applications as well as to find new applications that can serve as new long-term growth drivers. We think both small industrial robots and semiconductor equipment will continue to serve as key target markets, as miniaturization of equipment will require small gears with high precision and durability.