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EV growth propels Denso to close value gap with Honda and Ford

Japanese parts supplier combines scale with cash-generating efficiency

A Denso assembly line: The Japanese auto parts maker is nearly a quarter owned by Toyota.

NAGOYA -- Is a car worth more than the sum of its parts? This is a question posed by Japanese automotive supplier Denso's near dead heat in market capitalization with Honda Motor and Ford Motor.

Denso's market cap stood at 5.78 trillion yen ($52.59 billion) as of Thursday, roughly 70% higher than a year earlier. Honda's market cap was in the low 6 trillion yen range, while Ford's was at $55 billion.

As the world's second-largest automotive parts supplier after Germany's Bosch, Denso made a name for itself in engine components and air conditioners, an area where it holds an estimated 30% market share. But its parts for electric vehicles have emerged as a key cash generator.

Denso -- the "den" in its name means electricity in Japanese -- leads the pack in the number of patents for inverters, which are essential for EVs and hybrid vehicles. They form the core of a business that is forecast to produce 1 trillion yen in annual sales for Denso by the middle of the decade.

Denso made 4.93 trillion yen in sales for the previous fiscal year ended March, putting it roughly 700 billion yen, or $6.37 billion, ahead of third-ranked global auto parts supplier ZF of Germany. Half of Denso's sales are to Toyota Motor, which owns 24% of the company. The rest goes to a long list of automakers, such as Honda and Stellantis, whose brands include Chrysler, Jeep and Fiat.

Last fall, Denso's market cap started closing in on Honda's, and between February and March of this year it sometimes surpassed its rival. Denso's market value nearly doubles that of Continental of Germany and Magna International of Canada. On June 7, Denso's share price briefly hit an all-time high of 7,970 yen.

Toru Iwai, an analyst at Mitsubishi UFJ Morgan Stanley Securities, raised Denso's target share price to 10,000 yen last month. Compared to gasoline vehicles, sales per vehicle "will be 1.5 times for hybrid vehicles, and 1.1 times for EVs," Iwai said.

A Tesla Model Y sport utility vehicle in Beijing: Electric vehicles can help parts makers boost sales per car, analysts say.   © Reuters

Anticipated earnings growth is fueling Denso's share price gains. For this fiscal year, the company forecasts a record-breaking group operating profit of 413 billion yen, or 2.7 times the previous result.

That projection is modest compared to analyst predictions. The QUICK Consensus survey of brokerages yields an outlook of 452.7 billion yen.

A recall of fuel pumps that weighed down earnings last fiscal year has faded into the background. Meanwhile, efficiency gains in product development are expected.

Besides scale, Denso boasts relatively strong moneymaking efficiency. The company had an 8.9% ratio of operating cash flow to revenue in the previous fiscal year.

By this measure, Denso falls short of Bosch, Aptiv and Magna, which had ratios of 12.6%, 10.7% and 10%, respectively. Bosch's earnings are supported by power tools. Aptiv specializes in technology for autonomous vehicles, while Magna supplies doors and other large components that are bigger earners.

But Denso's operating cash flow to revenue exceeds ZF's 5.9%, Continental's 7.2% and South Korea's Hyundai Mobis' 6.5%, according to QUICK FactSet.

Inverters are a key driver of Denso's earnings. A critical component in hybrids, EVs and fuel-cell vehicles, inverters need to be able to fine-tune electric currents.

Based in the central Japanese city of Kariya, near Toyota's hometown, Denso became a serious player in inverters in the 1990s. It now holds an estimated global market share of 35%, with a client list that includes Ford as well as emerging Chinese automakers.

Denso holds or has applied for 3,168 inverter-related patents, according to Tokyo-based intellectual property research company NGB -- more than any other company in the world and roughly four times as many as Bosch.

Denso's inverters have gone into many hybrid models, and automakers are reportedly eager to use them in their EVs too. Denso in May said it aims to increase annual sales of EV components by 80% to 1 trillion yen by fiscal 2025 compared with fiscal 2020.

In addition, Denso makes sensors and cameras that are crucial to advanced driver-assistance systems, another growing field. But components for gas cars still account for a substantial amount of its business.

"Its challenge now is how to effectively cut down on 'legacy costs' -- parts that will become obsolete with electrification," said Seiji Sugiura, an analyst at Tokai Tokyo Research Institute.

The company has signaled a measured approach.

"We need to be intentional about downsizing in mature fields, like engine parts, and in unprofitable products," Denso Senior Executive Officer Yasushi Matsui said.

But Denso "will not quit irresponsibly," Matsui noted. "We will maintain a trust-based relationship with automakers and suppliers as we consider how to gradually exit these fields."

Tesla's rise vividly illustrates how EV hopes can supercharge stock market performance. The U.S. electric carmaker's market capitalization, now at about $625 billion, at one point surpassed the combined values of Toyota, Volkswagen and General Motors.

Policymakers are driving the shift to EVs. The European Union has proposed a de facto ban on sales of all new vehicles with internal combustion engines, including hybrids, by 2035, under a sweeping plan to slash greenhouse gas emissions.

EVs will comprise 28% of new cars sold across the world in 2030, up from 4% in 2021, according to the Boston Consulting Group. But with gasoline-powered cars still making up the majority of the market, investors will be keeping a close eye on how smoothly Denso navigates this transitional period in the auto industry.

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