Old Wine In A New Bottle, Is it Time For A New Ceo At Canon?

[Anonymous]

Old Wine In A New Bottle, Is it Time For A New Ceo At Canon?

Big challenges dog the giant maker of cameras, copiers and printers. New perspectives and maybe even a new face at the top might help.Old wine in a new bottle isn’t necessarily better, argue critics of Canon, the Japanese imaging-equipment powerhouse.

That’s why they have been unenthusiastic about the board’s January decision to ask Chairman and Chief Executive Fujio Mitarai, 76, to take on the added role of company president, a position he had held from 1995 until 2006, putting him back in charge of the company’s day-to-day operations, as well as its long-term strategy.

That Mitarai, who’s been CEO since 1995, has been an effective leader in the past is indisputable. Indeed, Barron’s rated him as one of the world’s top 50 CEOs from 2008 through 2011, before dropping him this year, on concerns about the company’s profits and prospects. Can the man who, in a career that began in 1961, helped to transform Canon from unheralded camera maker into one of the world’s most recognized brands, lead the company effectively in a changed world, or are new perspectives needed?.

BEFORE THE 2008-2009 financial crisis, Canon promised shareholders a generational change in management by 2010. Then the board did an about-face, arguing the need to retain experienced leadership to cope with global economic instability.

Concerns about Canon’s leadership and competitive position have hurt its stock, which trades in New York in the form of American depositary receipts (ticker: CAJ) and in Tokyo as ordinary shares (7751.Japan). Since the start of last year, the American depositary receipts have fallen about 27.5%, to a recent $37. Barring a change at the top, there’s little reason to expect a rebound.

Canon shares appear to be inexpensive, trading at 10.8 times their 12-month forward earnings, compared with 12.4 for Nikon and 13 for the sector. Looking closer, however, Todd Lowenstein, a portfolio manager at HighMark Capital, says, "Canon’s multiples are roughly in line with its long-term historic averages." "But the company is materially under-earning, based on its normalized earnings power and returns on invested capital, by about 25% from the last peak level," reached in 2007. Lowenstein has held Canon shares in the past, but doesn’t now.

Hisashi Moriyama, a JPMorgan analyst in Tokyo, downgraded the stock to Underweight last month and halved his price target for the Japanese shares to 2,500 yen; they now trade around ¥2,878. His problems with the company include pressure from smartphones on Canon’s low-end cameras, continued loss of market share in laser printers, rising competition from Samsung Electronics (005930.Korea) in the copier market and from Nikon (7731.Japan) in the lucrative single-lens-reflex camera market. Nor has Canon introduced a "mirrorless" SLR, one of the hottest new entries in the camera market. Mirrorless SLRs are cheaper than traditional SLRs and almost as good. The segment is seen as a bridge between inexpensive compact point-and-shoot cameras and pricey SLRs. Canon is expected to enter the market by August.

MORIYAMA LIKES MANAGEMENT’S plan to buy back up to 1.4% of its shares this summer, and its commitment to maintaining a 4% dividend, one of the electronics industry’s highest. But he maintains the plan isn’t "enough to offset the risks emerging across the company’s core businesses and buoy earnings and the share price."

Located in a Tokyo suburb, a stone’s throw from the port city of Yokohama, Canon designs, manufactures, and distributes cameras; digital machines that print, scan, fax, and network documents; plain-paper copiers; laser and ink-jet printers; and equipment for the semiconductor industry. Some 80% of its sales come from outside Japan, leaving the company very vulnerable to fluctuations in foreign-exchange rates.

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Recent Price     $37.22
12-Month Change     -19.5%
Market Value (bil)     $49.5
Revenue 2012E (bil)     $47
EPS 2012E     $3.07
EPS 2013E     $3.58
P/E 2013E     10.4
Dividend Yield     3.6%
E=Estimate
Sources: Thomson Reuters; FactSet

Last year, camera sales slid 4.6%, and Canon’s other products suffered from a weak global economy, flooding in key manufacturing sites in Thailand, and the devastating earthquake in northern Japan. And a strong yen relative to the dollar and euro made its products more expensive overseas and cut the value of profits repatriated to Japan. Over all, revenue fell 4%, to ¥3.56 trillion ($45.3 billion) last year, while operating profits slid 2.4%, to ¥378 billion ($4.8 billion).

A weaker yen this year has let the big manufacturer forecast operating profits of ¥450 billion ($5.7 billion) and net profit of ¥300 billion. Canon forecasts a 10% gain in sales, assuming the yen stays around 80 to the dollar and 105 to the euro. (The numbers now are 78.60 and 96.50.) It also hopes to cut costs by a further ¥400 billion yen ($5 billion) over the next three years. In fact, if things go Mitarai’s way and the global economy recovers, consolidated sales could hit ¥5 trillion by 2015. Profits could rise to 10% of sales, from 7% in 2011.

"LAST YEAR WAS A DIFFICULT year for everyone, not only us," Mitarai told Barron’s recently at his Tokyo headquarters. "But we’ve been able to maintain our leadership position in our core products and our imaging technologies, which will enable us to grow significantly in the years ahead." The CEO contends that Canon can lift revenue by 7% a year through 2015.

To do that, says analyst Yu Yoshida of Credit Suisse, who has a Neutral rating on the stock and recently slashed his 12-month price target to ¥3,200 from ¥4,400, the company would have to overcome problems such as its heavy reliance on laser printers. This sector provides 25% of sales and about 40% of operating profits, Yoshida estimates, and its top customers include troubled Hewlett-Packard (HPQ), for which Canon makes printers sold under the HP name.
The Bottom Line

Canon ADRs, now in the mid-$30s, won’t have any upside until the company makes big changes in its operations and governance. They could fall 20% in the next 12 months.

Canon will also have to shift more manufacturing abroad—27 of its 44 plants are in high-cost Japan—and maybe come up with a blockbuster product that would drive growth as analog cameras did in the 1970s, multifunctional copiers did in the 1980s, and laser printers and digital cameras did in the 1990s and early 2000s. It also has to speed up its shift from commodity products, like copiers, into high-margin items like video cameras for the television and movie industries and enhanced security cameras.

And in the semiconductor lithography market, where Canon was once a leader, it will have to make up a lot of ground, as well, having fallen behind ASML Holding (ASML) and Nikon, says Michael Holt, a Morningstar analyst in Tokyo.

Just how Mitarai will deal with all these problems is unclear; he wasn’t particularly forthcoming with Barron’s about his strategy. One thing investors would like to see is a board with some independent members who might push for change; Canon has no outside directors.

Says David Rubenstein, who tracks the company for Religare Institutional Research in Tokyo: "Mitarai is revered like a god in the company, but some investors view him as old school. They believe a new face is needed to guide Canon’s future growth—someone with vision and charisma who can engineer the next round of growth for Canon."

Mitarai, for his part, says he had no plans to retire. While one of his stated goals is to find a successor, he’s not likely to do so until 2015. "I’m still very young," he says with a laugh.

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July 24, 2012 at 8:58 AM