IHI Corp (7013) - Part 1
Japan's leading aerospace conglomerate follows the "Hitachi playbook" to unlock value
Disclaimer: The information in this article reflects the personal views of the author and is provided for informational purposes only. It should not be construed as investment advice. The author holds a position in the security at the time of publication. Investment funds or other entities with which the author has consulting or advisory relationships may or may not hold a position in the security/securities discussed. The views expressed are solely those of the author and do not reflect those of any other parties. Readers should conduct their own research and consult a qualified financial advisor before making any investment decisions.
IHI has had a great run in the last 12 months (along with the other two Japanese heavy industry names, MHI and KHI). Although the stock is no longer trading at 3,000 yen like it did a year ago, I still think it’s compelling at 9-10k yen.
For some context, here’s my journey with IHI. A year ago, I built a 5-6% position at an average price in the low 3,000s. In 2024, the stock tripled. When it hit around 8,000s in Q4 I gave into the temptation to “risk manage” and trimmed half of my position. After some reflection, I began to think I took money off the table too soon. So in January, I bought back the position and some more (again, in the low 8000s). As of today (April 2) IHI is a 19% position for me.
This deep dive (>11k words) will be split into two parts:
Part 1: IHI’s value-unlock strategy, looking at how IHI is adopting the “Hitachi playbook” (which resulted in Hitachi’s stock becoming a seven-bagger in five years). We will also dive deep into IHI’s civilian aerospace engine business.
Part 2: IHI’s defense business and the company’s resources and energy segment, and valuation/risks.
Below is a summary:
Thesis summary
IHI is one of Japan’s oldest industrial conglomerates, tracing its origins back to the Ishikawajima Shipyard in 1853. Today, it operates a diversified business portfolio spanning aerospace and defense, resources and energy, social infrastructure, and industrial systems and machinery. IHI enjoys high market shares and significant barriers to entry across multiple business areas.
Shareholder value unlock
For most of its history, IHI was a sleepy Japanese conglomerate with total disregard for shareholder value. However, this is changing as I believe IHI’s management is serious about transforming. Hitachi is a compelling case study. It shows us how much these century-old conglomerates can evolve, and I think IHI is now following in Hitachi’s footsteps: prioritizing capital efficiency through selection and concentration of business portfolio, divesting non-business assets including real estate and policy shareholdings, improving WC and cash flows, and expanding its recurring revenue (lifecycle business) and profit margins.
The value unlock story is still quite recent. It’s only been a few quarters since it has really started, and it usually takes time for investors to gain confidence in these things (AND especially IHI which was terrible historically). This is why the opportunity still exists, in my view. Hitachi is now a consensus “shareholder friendly” name but it took years for this perception to crystallize.
IHI is “moated” and enjoys strong business growth
In the civilian jet engine business, IHI is the leading partner in Asia to GE Aerospace and Pratt & Whitney (RTX), the #1 and #2 global jet engine OEMs. In my view, IHI is the most important and highest quality aerospace name listed in Asia — something investors should increasingly recognize over time. The business is enjoying growth amid a tight aerospace market in both new deliveries and aftermarket. It’s worth noting that historically, air traffic has only declined five times in the last five decades. A key driver is MRO (an area that IHI has historically under-earned) and management expects its MRO sales to quadruple in the coming years.
IHI is also a major defense contractor, involved in the production and aftermarket for every model of fighter jet engine used by the Japanese air force. It’s involved in Japan’s 6th generation fighter jet development (a global partnership with UK and Italy) and also has exposure to missiles, one of the most significant areas of Japan’s defense spending increases.
In the resources and energy segment, IHI is an end-to-end player in Asia’s power generation value chain, operating across both EPC and manufacturing. It manufactures and services gas turbines (where it’s a partner to GE Vernova in Asia) and one of the two key players (along with MHI) in Japan’s emerging ammonia value chain. IHI also has a nuclear business where it produces containment vessels and other key components for nuclear power plants. Another little-known fact: IHI is an investor in NuScale, the leading player in SMR (small modular reactors). It also owns a 35% stake in Japan Marine United, Japan’s second-largest shipbuilder.
Valuation, catalysts, and flows
Valuation: At 9,000 yen per share (EV/EBIT at 9.2x), IHI trades at less than half the multiple of its domestic peers (MHI, KHI, Hitachi) and international peers (MTU, Safran).
Given the similarity of their businesses, I think IHI’s aerospace segment deserves a “MTU/Safran-like” multiple. If investors are willing to value IHI on this basis, then the value of IHI’s aerospace segment alone would exceed IHI’s entire market cap today. This means all the other businesses, which generates more than JPY 1 trillion in revenue combined, are unaccounted for.
Catalysts: it may appear that the “defense” theme has played out already, but I think we are still in the early stages in terms of the positive news-flows to come, including potential upward revision to Japan’s defense spending (3% of GDP) and further easing of arms export restrictions (e.g. Italy’s reported interest in purchasing Japan’s P-1 plane, which by the way uses IHI’s engine). Even after the notable run-up we’ve seen, I find myself asking “what if we are not bullish enough on defense” (yes, crazy I know).
Flows: the market sees IHI as a defense name (even though defense is only 10% of its revenue), which means stock performance is heavily tied to the flow of hot money playing the defense theme. However, within this I see two opportunities for IHI:
Fund managers have crowded into Hitachi and MHI as consensus longs. Going forward, IHI could serve as a reservoir for owners of Hitachi and MHI as they look for a similar but cheaper alternative (note that IHI is currently 1/13th the market cap of Hitachi and 1/5th the market cap of MHI).
European managers are revisiting their ESG policies to potentially remove investment restrictions on the defense sector. There are reports that Amundi, Europe’s largest asset manager, has been working on the launch of European defense ETF, along with Vaneck following suit. Fund flows into defense names may still be in the early stages.
Despite the recent run-up in stock price, I continue to see IHI as a compelling bargain, with a potential upside of 2-3x to reach its fair value, and also a good chance to overshoot its fair value given the geopolitical optionality. My price target (if that means anything) is 30k yen.
Once again, this is only the personal opinion of the author and NOT investment advice.
Value unlock
Following in Hitachi’s footsteps
By the time I heard about Hitachi’s incredible turnaround, I had completely missed it. Actually, I met Hitachi’s CFO back in 2013, shortly after starting my buyside career. Looking back, they had already started their transformation. I was too skeptical in thinking anything could change, and my status quo bias (i.e. lazy mind) was ultimately proven wrong.
So when I started noticing signs that IHI was following a similar path, I paid attention. Then, progressively over the course of the past year, the signs became more and more clear. My conviction grew that IHI could be the next Hitachi.
So let’s look at what Hitachi did.