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COMMENTARY

Investors shouldn't rage against the machine, or Fanuc

Hong Kong

CRACKS are beginning to appear in the investment theses pinned to the future of robots and the rise of machines.

Over the past 30 years, the cost of robots, now a feature of almost any production line, has fallen by about 50 per cent, according to McKinsey & Co. Demand from industries from automotive to food, where the marginal value of humans is diminishing, continues to rise. So it's no surprise that confidence in companies that make robots has skyrocketed.

Expectations have climbed so far that some firms are finding it hard to sate investors.

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Take Fanuc Corp, the Japanese factory automation giant. It reported full-year sales of 726.6 billion yen (S$8.8 billion) last week, beating the average estimate, while operating income for the 12 months increased almost 50 per cent. But investors weren't impressed, sending the Tokyo-traded stock down as much as 13.8 per cent.

Actually, the company's performance wasn't that bad.

Orders for the fourth quarter slipped about 3 per cent on the previous three months but were still up more than 20 per cent from a year earlier. Annual sales in China increased 30 per cent and rose 20 per cent in the Americas. All of Fanuc's various business segments, barring services, expanded by around 30 per cent.

Granted, Fanuc's inherent conservatism is also at play. Outside of 2016, when a slowdown in China meant things really were bad, the company has tended towards guidance at the moderate end of the spectrum, and then typically reported results that beat it. For the 12 months through March 2017, Fanuc said it expected China to remain "difficult and unpredictable". Operating income for the period rose 31 per cent.

Now, however, it seems investors are getting skittish, with the slightest hint of a change in pace sending many scurrying for the exit. Orders from China, where the future of automation lies, dropped in March but shareholders forget they more than doubled in March last year.

Others are worried about escalating trade tensions between China and the US, but there isn't much that's concrete in that regard. Still others fear that technology will up-end business models.

The reality is, how do you know where a future-looking robotics and automation-focused company should be? Fanuc, for instance, is working on FIELD, a new platform and next-generation robot series, but investors don't seem to be giving it credit.

There's also the issue of how to value any company's R&D work. Manufacturing firms account for 85 per cent of R&D private sector spending in South Korea, Japan and Germany, and that feeds into a country's broader economic expansion.

Investors need to accept the fact that the pace of change and, sometimes, the rate of adoption, will be slow. Even now, only 29 per cent of industrial companies globally are starting to roll out new technologies for their production processes, according to McKinsey. Complete adoption is often hamstrung by high costs.

Unlike the first and third industrial revolutions, replacement of equipment and technology will be done at a reduced rate, but it will still be about 40 to 50 per cent higher than what's currently installed. The so-called fourth industrial revolution is expected to come with much higher costs, and higher risks.

And while Fanuc will have to invest to stay ahead of the pack - rival Yaskawa Electric Corp recently set up a joint venture with China's largest home appliance maker Midea Group Co - that's all necessary spending for future growth.

Fanuc is building a new factory in Chikusei, in Japan's Ibaraki prefecture, and construction costs will doubtless weigh on margins. But the firm has a better investment track record than its peers, with capital expenditure running at about 14 per cent of sales.

If Fanuc doesn't plough money into its operations, it risks being stuck with outmoded businesses. Lasers is a good example. It isn't a particularly difficult technology to master and that means competitors like Shenzhen's Han's Laser Technology Industry Group Co have quickly made inroads.

Fanuc is trading at 23 times forward earnings, seemingly expensive, but below the 30 times valuation some of its peers command. With talk surrounding the demise of high-powered robots almost certainly premature, it may be time for a reassessment. BLOOMBERG GADFLY