Elevator Pitch

Keyence Corporation's (OTCPK:KYCCF) [6861:JP] shares are rated as a Buy. My previous January 17, 2024 update was focused on the factory automation market's recovery prospects and the AI (Artificial Intelligence) tailwinds for the company's vision sensors.

The current write-up previews KYCCF's Q1 FY 2025 (YE March 31, 2025) financial performance. I maintain a Buy rating for Keyence, as I think that the company's shares will continue to do well with a potential first quarter results beat. New products and geographical expansion will likely boost KYCCF's top line performance, while the company's profitability should benefit from positive operating leverage and the cost management flexibility afforded by its operating model.

The Market Expects An Improvement In Keyence's Q1 Financial Performance

July 26, 2024 is the expected date of Keyence's financial results announcement for the first quarter of fiscal 2025 (April 1, 2024 to June 30, 2024).

KYCCF's most recent Q4 FY 2024 performance was good. Top line for Keyence expanded by +7.9% QoQ and +7.6% YoY to JPY260.1 billion in the final quarter of the previous fiscal year. The company's operating profit rose by +11.2% QoQ and +4.3% YoY to JPY135.5 billion for the latest quarter. Keyence's actual Q4 FY 2024 revenue and operating income beat the sell-side's consensus forecasts by +1.3% and +1.7%, respectively according to S&P Capital IQ data.

In my earlier January 2024 article, I outlined my view that "the worst is over for the factory automation market and Keyence", considering that December 2023 was the "second straight month running that Japan's machine tool orders had increased in MoM (Month-on-Month) terms." I was proven to be right, as KYCCF managed to deliver positive revenue and operating earnings growth in the most recent quarter that exceeded expectations.

Looking forward, the analysts think that Keyence's positive growth momentum can be sustained. KYCCF's top line growth is forecasted to accelerate from +7.6% YoY for Q4 FY 2024 to +10.5% (source: S&P Capital IQ) YoY in the first quarter of fiscal 2025. Also, the company's operating income is estimated to grow by +10.6% YoY in Q1 FY 2025 as per S&P Capital IQ data, which will be better than its actual +4.3% YoY operating income increase for the preceding quarter.

I touch on Keyence's chances of achieving above-expectations results in the next section.

My Bet Is On A First Quarter Results Beat

I am of the opinion that KYCCF's actual Q1 FY 2025 financial performance will surpass expectations.

In terms of the company's top line, my view is that Keyence's first quarter revenue can expand faster than the +10.5% sales increase projected by the market. The two key top line growth drivers for KYCCF are new product offerings and expansion in foreign markets outside Japan.

According to research firm Morningstar's earlier April 29, 2024 report, KYCCF has been introducing new "value-added solutions" like "a wide area scanner that can replace inspectors" and "radar level sensors that conserve energy." It is natural that businesses in general are looking to cut labor and energy costs in a tough economic environment. Keyence has made the right move by introducing product offerings that are in demand during weak economic conditions, so the company's revenue could potentially surprise on the upside.

Also, Keyence's complete product portfolio is only available in its home market Japan for now, so there is huge potential for the company to expand its range of products in international markets. As per an April 23, 2024 research report (not publicly available) titled "Japan Core 30 Basket" issued by JPMorgan (JPM), only about half of KYCCF's full product suite is currently sold in Europe and Asia ex-China markets.

With respect to its profitability, the current consensus Q1 FY 2025 operating income projection for Keyence is conservative.

As mentioned above, the sell-side analysts estimate that Keyence's operating profit will increase by +10.6% YoY in the first quarter of this fiscal year. But this implies an expected -2 percentage points contraction in the company's operating margin from 52.1% in Q4 FY 2024 to 50.1% for Q1 FY 2025.

KYCCF's operating margin improved by +160 basis points QoQ from 50.5% for Q3 FY 2024 to 52.1% in the fourth quarter of the previous fiscal year. This was +20 basis points higher than the market's consensus forecast of 51.9% (source: S&P Capital IQ).

I think that Keyence's operating margin should be at the same level or even better than the preceding quarter, as opposed to a lower operating margin on a sequential basis as projected by the sell side.

One factor is that KYCCF should benefit from positive operating leverage, as the acceleration in its YoY top line growth from +7.6% in Q4 FY 2024 to +10.5% for Q1 FY 2025 is expected to translate into faster pace of operating profit expansion. As it stands now, the consensus financial forecasts point to a similar pace of growth for Keyence's top line (+10.5%) and operating income (+10.6%) in the first quarter.

Another factor is that Keyence operates on a business model that gives it greater flexibility to manage costs. Asset management firm FSSA Investment Managers' 2023 portfolio update report highlighted that KYCCF runs a "direct sales model" and "its resources are concentrated in research and development and sales and marketing." This means that Keyence isn't reliant on external distributors, and it can possibly pull back on marketing and distribution expenses if the demand environment is weaker than expected.

In summary, I am betting on Keyence to register better-than-expected financial results for Q1 FY 2024.

Variant View

There are scenarios which could see Keyence suffer from a first quarter results miss.

A weakening of factory automation demand, a failure to gain traction with new offerings, and slower-than-expected geographical expansion might translate into below-expectations revenue.

An unexpected increase in certain cost items could hurt Keyence's profitability. For example, the company could have ramped up research & development expenses to support new product launches in certain segments.

Final Thoughts

A potential positive surprise associated with KYCCF's first quarter performance is likely to be a valuation re-rating catalyst. Keyence is currently trading at a consensus forward fiscal 2026 P/E of 37 times, and this is 26% below its historical 5-year average P/E ratio of 50 times as per S&P Capital IQ data. Keyence is deserving of premium valuations, considering that it is a play on the growth of factory automation in the long run and the company runs on a good operating model that offers cost management flexibility.

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