Another great post by guest blogger Sandesh Trivedi of sandeshtrivedi2.blogspot.com. Sandesh can be reached at [email protected]
Shimano Inc SHMDF.PK
Shimano Inc. is a leading producer of bicycle parts and fishing equipment. It is the world’s largest manufacturer of bicycle components such as gear wheels, derailleurs, and brakes, with a 70 percent market share. Bicycle components make up about 78% of sales, while fishing tackle makes up the rest of sales. Operating margin has averaged about 14% for the past eight years.
For a long time the company has held a dominant market share in components for derailleur- equipped bikes (a derailleur is the device to move a bicycle chain from one exposed gear to another). Shimano began making its famous derailleurs in 1956. Also called external speed changers, derailleurs were the mechanisms that moved the bicycle chain from gear to gear on ten-speed bikes and the like. The next year, the company began producing an internal, three-speed gearing mechanism that was enclosed in the hub of the rear wheel. This internal speed changer was introduced to the U.S. market a few years later and soon became the standard for three-speed bikes. In 1960, Shimano installed a cold forge that enabled stronger products to be made in a more efficient fashion. Manufactures like Shimano, based in Sakai, Japan near Osaka ship bikes and components to distributors. Overseas sales account for 85% of the total sales. The parts supplied by Shimano’s Bicycle Components Division include shifting (or transmission) systems, brakes, front gears, and hubs.
In the bicycle component industry most companies traditionally tend to specialize in one particular part. Shimano, in contrast, handles a comparatively large variety of parts. Although the scope of Shimano’s technologies well matches that of bicycle assemblers, it has never entered the finished product business. In its history of more than 89 years, there have been a number of occasions that can be seen as major turning points for Shimano. One of these was around 1960 with the arrival of the boom for light motorbikes and mopeds (motorbikes with pedals). Many bicycle and bicycle component manufacturers entered the moped business, but Shimano remained a bicycle component specialist. The decision was made after some consideration, based on the outlook that the quality bicycle market that was present in Europe at the time would eventually emerge in Japan. The fact that Shimano did not even enter bicycle assembly was a result of a consistent policy that the company had maintained for many years.
Because of its dominant market share of around 70-80% and brand power it is often called “the Intel of the bicycle industry.” The use of Shimano parts matters more for customers than who assembled the bicycle. Major bicycle manufacturers cannot even start product development before Shimano announces a new product plan. Intel’s former CEO Andrew Grove was reportedly amused to hear that Shimano was called “the Intel of the bicycle industry. The bicycle and the PC industry have a common characteristic. Both bicycles and PCs can be made into finished products from parts brought from a variety of companies.
It is possible to make an original bike that suits one’s needs and preferences by ordering parts from catalogue. This is because the function of each part is well defined and interfaces and performance measures commonly shared by the industry. Such systems are called “open modular architectures”. The reason why many manufacturers specialize in a particular part is that industry standards have been established and it is difficult for final assemblers to take control at their own discretion, while at the same time companies can specialize in a particular part and sell their products worldwide as long as they adhere to the industry standards. One can observe a similar picture in the personal computer industry, where companies are specialized in hard disks, monitors, application software, operating systems, microprocessors, printers and other various peripherals.
Under these circumstances, Shimano has built an overwhelming worldwide
share in gears and brakes, which are key parts of a bicycle. This is the reason why Shimano is being compared with Intel, which has an overwhelming share in the market for microprocessors, which are the heart of a personal computer.
Most critical for the subsequent success of Shimano was that a “system component philosophy” was established in Shimano during 1975 based on the experience of Dura-Ace. It is the philosophy that bicycles are not just a grouping of parts, but represent a collection of inter-functioning components.
Shimano expanded its development activities to areas other than shifting systems, such as drive and brake systems, and increasing emphasis was put on functions and performance as a total system that combines these parts, rather than improvement of individual parts.
Shimano’s success was a result of successively introducing innovative new products to pursue ease of use for the rider. Throughout the history of Shimano’s successful product innovations, the key was the development philosophy of system components that came out in the mid 1970s.
Dura-Ace, SIS, New Deore XT and STI all commonly share the idea that various parts should be optimized to function and perform as a system.
Dura-Ace is the brand name of the series of parts Shimano sells for sporting bicycles in the bicycle industry, where interfaces are standardized and each part is made by a specialist manufacturer rather independently, most manufacturers viewed the derailleur, gearshift lever and brake as separate components. Shimano, however, viewed these as a single unit, and integrated them as a system achieving new functions and higher performance that could not be reached until then. In other words, Shimano changed the architecture of some of key component systems in bicycles from “open, modular” to “closed, integral”. These “architectural” innovations required a variety of ingenuity and a great deal of effort at Shimano.
The number of patents issued can be a good indicator of a company’s commitment to research and development (R&D) and innovation. The STI technology has been protected by one of 477 bicycle related patents the U.S. has granted Shimano since 1976. Shimano is also a diversified company that has other business ventures (fishing reels and snow boots/bindings) in which they have been issued an additional 557 U.S. patents.
Because the company has a dominant market share of around 70-80% in the bicycle components market, the company benefits from the economies of scale in this niche product space of bicycle parts and this acts as strong moat around the company.
Valuation
2009 2008 2007 2006 2005
Revenue (in $ million) 2000 2500 2300 1800 1800
Operating Margin (%) 11 15 14.8 12.3 15
Free Cash Flow (in $ million) 373 109 252 98 200
A quick and dirty analysis shows that the company is not very cheap at the current levels but is worth considering at a lower price. The company is sitting on a massive pile of cash of around 52% of the total assets, which the company has been deploying for share buybacks. The five year average operating margin is around 14%. Assuming a sales growth of 10% for year FY10 and an operating margin of 14% I came up with distributable earnings of around $250 million.
The market cap of the company is around $3.8 billion from which the excess cash of around $1 billion can be subtracted, and we get a market cap of around $2.8 billion. Hence the earnings yield (250/2800) is around 8.9%, out of which 30% is returned to the shareholders in the form of cash dividends and share buybacks and the rest is reinvested in the business. The return to the shareholders in the form of cash and stock buybacks is 2.6% whereas 6.2 % is reinvested in the business at a rate of 20% which results in a reinvestment rate of 12%. So the total return to the shareholders is 14.6% (2.6% plus 12%) and an organic growth rate of 8% results in a return of around 22%.
Disclousre: None
