February 22, 2013

Will Nikon’s Profits Prove to Be Canon Fodder?

by Sridharan Raman

A hectic price war between Nikon and arch-rival Canon during the holiday season has already taken its toll on Nikon’s third-quarter results, and now analysts are scrambling to cut their outlook for the full year, and into the next fiscal year.

Black Friday and the holiday shopping season are receding in the rear-view mirror, leaving consumer products companies to take stock of how they performed during that crucial period. For Japanese camera manufacturer Nikon (7731.T), the news isn’t very good, thanks in large part to a price war with archrival Canon (7751.T) involving their digital cameras that took a toll on its margins for the company’s fiscal third quarter, which ended December 31, 2012. Nike reported that its trailing four-quarter operating margin tumbled to 5.1% in the third quarter, half of the 10.3% level it could boast only 15 months earlier.

Nikon reported its fiscal third quarter earnings on Feb 6, announcing an operating profit of ¥2.14 billion, a figure that fell far short of the consensus of ¥22.39 billion. On that occasion, it confirmed its guidance for the company’s revenues of ¥1 trillion for the full year, but lowered guidance for the company’s operating profit for the full year. In response, Nikon’s stock plunged 20% on the day of the third-quarter earnings release. Since then, most sell-side analysts who cover the stock have cut their estimates for the company’s operating profit in the fourth quarter.

Currently, the I/B/E/S consensus estimate predicts that Nikon will report an operating profit (the preferred measure of profitability among Japanese companies) of ¥60.6 billion for the fiscal year ending March 31, 2013. That forecast has fallen from the ¥78.5 billion that analysts were expecting right before Nikon reported its third quarter earnings, as analysts reacted to the comments by the camera manufacturer’s management about its weaker margins and the tough competitive environment that it is facing.

The StarMine SmartEstimate is even lower, with the most recent estimates published by analysts with the greatest track record for accuracy now anticipating that the company’s operating profit will be only ¥48.8 billion for the fiscal year. While some sell-side analysts haven’t yet updated their earnings forecasts since Nikon announced its earnings in early February, the odds are in favor of more estimate reductions coming in the next several weeks that, cumulatively, will pull the consensus forecast lower between now and the date in early May on which Nikon is expected to release its annual results. At present, however, the gap between that consensus and the SmartEstimate remains so wide that the Predicted Surprise is a hefty -21.6%.


The reason we can be somewhat confident that those remaining analysts will cut their forecasts is the extent to which negativity among analysts has soared over the last months. In the last 30 days, the number of analysts rating Nikon as either a ‘buy’ or a ‘strong buy’ has fallen by three, leaving only a third of the analysts who cover the stock bullish on its prospects. Meanwhile, 14 analysts now rate Nikon as a ‘hold’, a ‘sell’ or a ‘strong sell’, three more than previously. True, analysts now expect Nikon’s revenues to be 2% higher in the coming fiscal year (ending March 31, 2014), but they are cutting their forecasts for the company’s operating profits (by 10%) and earnings per share (by 9%) for the coming year. Clearly, those analysts don’t expect Nikon to solve the problem of its weak profit margins rapidly.


In each of the last four quarters, Nikon’s capital expenditures have been higher than they have been in any quarter over the last five years. Further, that surge in capital expediture is not funded by operations. In three of the last four quarters, Nikon’s capital spending has exceeded its cash flow from operations, a warning sign that a company’s earnings may well be unsustainable. (In contrast, earnings backed by strong cash flows is serve as a sign of good earnings quality.Those weak cash flows are a major reason that Nikon scores so poorly on the StarMine Earnings Quality Model, where it ranks only 4 out of a possible 100.


During the holiday season, Nikon offered large mail-in rebates to shoppers who decided to buy their digital cameras, in an effort to lure customers away from Canon. But Nikon’s initiative was matched by Canon’s own decision to offer big rebates on its own digital camera. Unsurprisingly, the full-blown price war that followed damaged both companies.True, Nikon’s quarterly revenues hit the highest level recorded in the last three years (the point at which the company began reporting its earnings on a quarterly basis), but it achieved that only by severely discounting its products, providing other incentives and, in the process, seriously eroding its own margins.The chances are that this will result in either analysts reducing their forecast for the company’s fourth quarter and full year operating profits or lead to a negative surprise when Nikon announces its results for the year on May 5, 2013.

SmartEstimates: Thomson Reuters StarMine Professional quantitatively analyzes the earnings estimate accuracy of sell-side analysts and uses this information to create proprietary SmartEstimates®.SmartEstimates help you better predict future earnings and analyst revisions with estimates that place more weight on recent forecasts by top-rated analysts.
Predicted Surprise %: The Predicted Surprise% is the percentage difference between the SmartEstimate and the I/B/E/S consensus estimate. When SmartEstimates diverge significantly from consensus, it serves as a leading indicator of the direction of future revisions and/or surprises. In aggregate, this indicator gets earnings surprises directionally correct 70% of the time.

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