FANUC Maintains Its Reputation for Being the Best

June 2, 2015

Rating: Market Perform Price target: Consensus ¥26,468 O'Neil ¥26,442 Closing price on 6/2/15: ¥27,700

Romeo Alvarez senior equity analyst [email protected] 310.448.6913 800.545.8940 | williamoneil.com

Source: FANUC America Corp.

FANUC Maintains Its Reputation for Being the Best

FANUC Corp. ([email protected]; 6954:JP), producer of robotic and industrial automation systems, holds a dominant global market position, due in part to its highly efficient manufacturing base. Along with KUKA AG (IWKX. DE; KU2:GR), ABB Ltd. (ABB.CH; ABBN:VX), As of 06/2/2015 FANUC and Yaskawa Electric ([email protected]; 6506:JP), FANUC is part of the Symbol [email protected]; 6954:JP “the Big 4” vying for China’s rapidly expanding industrial robot Price ¥ 27,700 market, and like some of these competitors, it is launching new, Market cap (US$ bil) 53.3 non-automotive applications to fill emerging demand. We be- Shares outstanding (mil) 240 50-day avg daily volume lieve that FANUC will continue to post stable revenue and profit 42.4 (US$ mil) growth over the next few years, as one of the few pure-plays in 52-week high/low ¥28,575/¥16,940 the factory automation market. We are initiating coverage of this 2014 ROE 16.1 stock under our Robotics and Automation theme with a Market Dividend yield 2.3% Perform rating. P/E 26 Company Profile 1-year return 63% Relative Strength rating 87 Japan-based FANUC develops and manufactures computer nu- Accumulation/Distribution C merical control (CNC) equipment, factory automation systems, rating and industrial robots. The Company has a global reach, with over 230 locations in 45 countries, and serves a wide range of industries, including automotive, electronics, aerospace, alternative energy, logistics, metal fabrication, medical, and food and beverage. FA- NUC has multiple factories, all based in Japan, including a CNC

LoseAngeles • NeweYork • Boston • London Page 1 June 2, 2015

production plant that can produce 25,000 CNCs and robot con- trollers per month, and a robot factory that can produce 5,000 ro- Romeo Alvarez senior equity analyst bots per month. [email protected] 310.448.6913 The Company has a long history of being the best in everything 800.545.8940 | williamoneil.com it does, as well as the fastest to market. Its visionary founder, Dr. Seiuemon Inaba, describes the Company's mission as "walking the narrow path," which refers to its focus on developing a concentrat- FY2015 Sales by ed line-up of products that are technically superior, with the lowest Geographic Area possible cost structure. FANUC has now become the standard for machine tool control software and motors, with a global market share of approximately 60%.

FANUC’s primary activity, through its Robomachine division, is mak- ing machining centers that provide factories with the tools needed to shape metal into Apple’s iPhone© cases, Tesla’s Model S vehicles, or the ribs of Boeing’s airplanes. The Company is well-positioned in this market, as it has a lower cost base and also more capacity than all of its competitors combined. This division accounted for 40% of total revenue in fiscal year 2015, followed by 35% from the Source: Company data, William O’Neil + Co. Inc. Factory Automation division, and 25% from the Robot division (see details below).

Business Segments

Robomachines Factory Automation (FA) Robots

40% of revenues 35% of revenues 25% of revenues Robodrills, electric injec- Computerized numeri- Articulated robots, tion molding machines cally-controlled (CNC) robot hands, and related (ROBOSHOT), wire-cut hardware and software, software electric discharge ma- servo motors, and high- chines (ROBOCUT), and power CO2 lasers. CNC nano control machines systems serve as the (ROBONANO) brains of machine tools and robots

Source: Company website

Smartphone Casings Drive Robodrill Demand In recent years, manufacturers of mid- and high-end smartphones have been opting for aluminum frames for a distinctive look. As the popularity of handsets such as Apple’s iPhone continues to increase, metal casing manufacturers are having to ramp up their CNC machining capacity to keep up with demand. Conse- quently, smartphone manufacturing is now one of FANUC’s largest end-markets for its Robodrill product, a small CNC machining center used to cut the metal casings on smartphones. Part of the

LoseAngeles • NeweYork • Boston • London Page 2 June 2, 2015

solid performance in the Company’s FY2015 financials was due to stronger-than-expected recovery in orders for Robodrills from Romeo Alvarez senior equity analyst smartphone manufacturers based in Asia. [email protected] 310.448.6913 FANUC's Robodrill is just one example of the Company’s ability to 800.545.8940 | williamoneil.com become the manufacturing standard in new end-markets. A little known product a few years ago, used only by Apple in its unibody metal casings process, Robodrill sales now have increased six-fold Robot Applications over the past five years. Apple today uses the Robodrill for all of its products, prompting some of its direct competitors, such as Sam- sung and Xiaomi, to follow suit. Looking forward, we believe Robo- drill demand will grow, as metal casings become the standard for most smartphone manufacturers. Robot Applications FANUC develops the most complete line of industrial robots for most manufacturing applications, including arc welding, assembly, material removal, painting, palletizing, part transfer, spot welding, Transfer robot and picking and packaging. Additionally, the Company’s robots can be retrofitted to complete any application within the manufacturing process. The FANUC M-1iA robot is best suited for small part assembly but can be retrofitted for other applications, such as part transfer and finishing. Lotte Confectionery, South Korea’s largest maker of sweets and chocolate, has installed a fleet of FANUC’s new Genkotsu robots that can grab more than 100 pieces of candy a minute off conveyor belts. At Marshalls, a U.K.-based building-supply company, FANUC robots perform a chore that was unpopular with its human employees: placing concrete slabs in an oven and removing the blocks after they have been baked. These Palletizing robot are just two of the many applications that FANUC robots undertake to help companies in various industries become more competitive and efficient, while reducing work-related injuries. New $830 Million Factory In September 2014, FANUC announced the acquisition of land for a new cutting-edge factory that will increase its capacity to produce CNCs, servo motors, and servo amplifiers. Construction is cur- rently under way to put the factory into operation in October 2016, part of the Company’s preparation to meet growing demand in China and other emerging economies. This factory represents Arc welding robot the Company’s fourth manufacturing base in Japan, following Source: Company website the factory at FANUC’s headquarters (Yamanashi Prefecture), the Tsukuba Factory (Ibaraki Prefecture), and the Hayato Factory (Ka-

LoseAngeles • NeweYork • Boston • London Page 3 June 2, 2015

goshima Prefecture). In Phase 1, the new plant will have a monthly production capacity of 10,000 CNC units, 60,000 servo motor units, Romeo Alvarez senior equity analyst and 35,000 servo amplifiers. Combined with production at its CNC [email protected] plant in the Yamanashi Prefecture, Fanuc's monthly output capac- 310.448.6913 800.545.8940 | williamoneil.com ity will grow 40% to 35,000 CNC units. Total cost of the new facility is expected to reach approximately 100 billion yen ($830 million). China’s Automation Boom According to the International Federation of Robotics (IFR), 2014 was another record year for industrial robots: 225,000 robots were sold, representing a 27% increase over 2013, with growth largely driven by demand from the auto industry. By geographic area, growth was widespread across all regions, with China and South Korea reaching new peak levels. For a second year in a row, Chi- na was the largest market for industrial robots, with approximately 56,000 units sold (+54% over 2013). Of those robots, 71% were sup- plied by international vendors, while Chinese robot suppliers deliv- ered the remainder. FANUC is aiming to challenge other members of “the Big Four,” Yaskawa Electric, ABB Ltd., and Kuka AG, to take the lead in China’s robot market, where shipments are expected to grow to 12% annually over the next few years (2014-2017).

2014: Sales Rapidly Increasing Worldwide annual supply of industrial robots 2005-2014*

*preliminary result Source: IFR Statistical Department

The automation of China's production plants is still nascent. The country's CNC penetration rate of 30% equals Japan's levels 40 years ago. Today, almost all Japan's machine tools are CNC machines. By robot density, China is projected to have over 100 robots

LoseAngeles • NeweYork • Boston • London Page 4 June 2, 2015

per 10,000 workers by 2020, according to the country’s Vice Minis- ter of Industry and Information Technology. That ratio lags Japan Romeo Alvarez senior equity analyst and Germany’s rate of 332-273 units per 10,000 employees, but is [email protected] a large increase from China’s current rate of 30. According to IFR, 310.448.6913 800.545.8940 | williamoneil.com around one million new robots will need to be activated in China over the next few years for it to catch up, and certain provinces in the country are creating incentives that could help it reach that Robotics Investments goal (see sidebar). Encouraged

Guangdong province, China’s The 'Big Four' in the Automation Market southern manufacturing base, will invest 943 billion yuan ($152 billion) to Market FY14 FY2014 FY2015e FY2014 FY2015e Company Cap EBITDA Revenue Revenue EPS EPS replace human workers with robots (US$ bil) Margin Growth Growth Growth Growth within three years. According to a plan published in March 2015, Guang- KUKA $2.8 8.9% 18% 36% 16% 22% dong will encourage 1,950 companies ABB Ltd. $50.4 14.5% -4% -7% -7% 9% to adopt robots, starting in industries Yaskawa $3.7 9.6% 17% 10% 150% 46% Electric such as automobile, home appliance, FANUC Corp $53.2 40.5% -10% 62% -8% 87% textile, electronics, and construction Source: Company filings; William O’Neil + Co. Inc. materials. The province also plans to build two advanced industrial bases for robot production. The increase in Chinese factory automation is being driven by sev- eral long-term, fundamental factors including:

• Quickly rising labor costs. Wages have been rising at a rate of 10% annually over the past decade, while the cost of robot production has been decreasing by 5%, year-over-year, over the same period. The rapidly rising salaries of factory workers could cause China to lose up to 85 million manufacturing jobs to other countries in the region, according to FANUC management.

• A shortage of workers. Workers are scarce partly because of the government’s “one child” policy. China’s workforce shrank for the first time in 2012.

• The rapid expansion of the university system. Many born between 1990 and 1999 now shun manufacturing jobs for other pursuits.

• In 2011, China started its 12th Five-Year Plan, and for the first time ever, factory automation was identified as an important area for development.

• Local governments are stimulating manufacturing companies in

LoseAngeles • NeweYork • Boston • London Page 5 June 2, 2015

their automation drive. The provincial government of Guangdong has decided to invest 943 billion yuan ($152 billion) to replace hu- Romeo Alvarez senior equity analyst man workers with robots, and the municipal government of Dong- [email protected] guan has also set up a 600-million-yuan ($97 million) fund to en- 310.448.6913 800.545.8940 | williamoneil.com courage local companies to install robots.

• The need for standardized quality to compete in global markets. Collaborative Robots: Opening a New Era for Manufacturing Traditionally, the auto industry has driven global demand for automation solutions, with welding robots leading the charge. In China, the auto industry accounts for approximately 60% of demand for robots, with the rest coming from other sectors. But the trend is starting to reverse, as collaborative robots enter the market.

Robot makers are developing a completely new generation of robots designed to work next to humans and perform tasks that involve more agility than older robots can offer. The newer robots have sensors and cameras, signaling them to slow down or halt when people get too near. This prevents injuries, without the need for fences surrounding the robots. In April 2015, ABB launched the latest such robot, named YuMi, at an automation trade event in Germany. Also in April, FANUC introduced the CR-35iA robot, which claims to be the first heavy-lifting industrial collaborative robot. The robot, which can lift objects weighing up to 77 pounds, could be Source: Company website used for transferring heavy work pieces or assembling parts. New orders are increasingly being placed by companies in industries such as food and beverage, machine tools, electronics, plastics, transportation, manufacturing, and metal processing, according to FANUC management. Financials In FY2015 ended March 31, FANUC's strong performance was driven by a combination of the weak yen (the majority of the Compa-

FY2013A FY2014A FY2015A FY2016E FY2017E

Revenues (¥ mil) 498,395 450,976 729,760 704,148 727,474 Growth, % -10% 62% -4% 3% Operating profit (¥ mil) 202,688 182,528 319,524 300,364 316,234 Growth, % -10% 75% -6% 5% EPS (¥) 616 567 1,061 1,012 1,047 Growth, % -8% 87% -5% 3% E= consensus estimates

LoseAngeles • NeweYork • Boston • London Page 6 June 2, 2015

ny’s clients are based outside Japan), and by a recovery in capi- tal investments across multiple industries. Those contributing most Romeo Alvarez senior equity analyst were the machine tool industry in Asia and Europe, the automotive [email protected] industry in the Americas, and the consumer electronics industry in 310.448.6913 800.545.8940 | williamoneil.com Asia. As a result, during FY2015, FANUC posted revenue growth of 62% and earnings growth of 87% versus the previous year.

For FY2016, FANUC issued the following forecast: net sales of ¥680 billion (-7%) and earnings of ¥191.2 billion (-8%). Management is being cautious in its expectations and warned that short-term de- mands from makers of metal cases for smartphones (which drove the strong robomachines sales last year) are expected to subside in FY2016. In fact, FANUC gave sales guidance of +12% for 1H FY2016 and a gloomy 2H forecast of a 23% sales decline. Risk Factors Key factors that could cause the shares to fail to reach our target price include:

• Weaker-than-expected orders for CNC and robotic solutions caused by a slowdown in global capex.

• A steep drop in Robodrill orders, which have already fallen below the previous year’s levels for the first time in 16 months (9% year- over-year drop in March 2015). The Robomachine segment (which includes robodrills) accounted for 40% of FY2015 sales.

• Softer manufacturing activity in China.

• Renewed strength of the yen against the U.S. dollar and the euro. Looking Forward FANUC’s position in the “Big 4” and its ability to shape the automation manufacturing standard in multiple industries bode well for its prospects as global automation expands. Although we consider the current share price to be reflective of the Company’s growth potential, we regard FANUC as a core holding within the Robotics and Automation theme and remain bullish over the long term. We believe revenue will remain high, as increased sales of CNC systems and robots may offset the expected reduction in orders for robomachines. Positive developments for the Company include China’s increasing demand for factory robots and the in- troduction of collaborative robots for non-automotive applications. We initiate coverage of FANUC shares with a Market Perform rating.

LoseAngeles • NeweYork • Boston • London Page 7 June 2, 2015

Datagraph

Fanuc [email protected] TOKYO Exch JP3802400006 Machinery-Gen Industrial MktCap ¥6.63T Sales ¥650.18B Shares 240M Float 240M CFO +81 555 845555 fanuc.co.jp Yamanashi, JAPAN MGMT owns -- -1% from Pivot in 6 Weeks OH -3% LOG (Fixed) PRICE 20 x EPS Rank 86 90K FANUC CORPORATION IS A JAPAN-BASED MANUFACTURING COMPANY MAINLY ENGAGED IN THE PROVISION OF FACTORY AUTOMATION (FA) MACHINERY. ANNUAL - MAR END 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Es�mate 2017 Es�mate 80K EPS ¥ 499.83 611.14 467.55 187.75 613.75 709.20 615.59 566.86 1,061 1,017 -4%▲ 1,051 3%▲ CASH FLOW/SHR ¥ 589.59 671.09 368.29 286.36 803.14 871.19 658.68 707.38 1,363 Earnings Growth Rate Sales Growth Rate 70K PRETAX MARGIN % 43% 45% 38% 22% 43% 42% 38% 39% 43% 2013-15 10% (20 Stability) 1% RETURN ON EQUITY % 14% 15% 11% 5% 14% 15% 12% 10% 16% 2011-15 17% (32 Stability) 14% SALES % CHANGE 10% 12% -17% -35% 76% 21% -7% -10% 62% COMP RATING SMR RATING -- 60K SALES (BIL) ¥ 420 468 388 253 446 539 498 451 730 INV T/O 3.4x 19 WEEKLY 10-Apr 17-Apr 24-Apr 1-May 8-May 15-May 22-May 29-May 2-Jun DEBT % 2013-15 0% 0% 0% DATAGRAPH RATING 82 79 79 81 80 78 78 79 78 TAX RATE 2013-15 37% 36% 33% 50K AVG DAILY VOL (000) 1,301 1,277 1,206 1,268 1,296 1,297 1,332 1,230 1,216 BACKLOG 2013-15 ------46K UP DOWN VOLUME 1.4 1.4 1.2 1.2 1.0 1.1 1.0 1.1 1.1 R & D 4.10% BK VAL 3.93x '15 ACCUM/DIST RATING 16 18 14 10 -24 -25 -36 -3 -1 DIV ¥ 636.62(2.3%) DIV GR RT+24% (43) 42K RELATIVE STRENGTH 89 86 84 90 84 83 78 87 87 BETA 1.22(80.00) ALPHA 0.08 (-0.01) 38K GROUP RANK 33 39 50 47 64 51 61 40 48 2015 EMPLOYEES 5,469 (4%) 34K

30K 27,700 JPY 26K 24K+160.00+0.58% 22K

19K 17K

15K

13K 12K 11K 10K 87 9000 C 8000

7000

6000

5000 4600 4200 3800 3400

3000

LIN VOLUME

13M 10M

+13%7M 4M 2.5M

FINANCIALSJUN 10 SEP 10 DEC 10 MAR 11 JUN 11 SEP 11 DEC 11 MAR 12 JUN 12 SEP 12 DEC 12 MAR 13 JUN 13 SEP 13 DEC 13 MAR 14 JUN 14 SEP 14 DEC 14 MAR 15 JUN 15 SEP 15 PE 26 EPS (¥)126.45 158.67 157.08 171.55 177.15 202.03 162.14 167.88 179.90 162.23 144.17 129.29 116.05 139.92 137.89 172.99 230.95 251.32 281.55 297.20 230.01e 255.57e EPS %+431 CHA%NGE +688% +172% +100% +40% +27% +3% -2% +2% -20% -11% -23% -35% -14% -4% +34% +99% +80% +104% +72% 0%e +2%e 2016 Est.: 27 SALES (BIL99.7 ¥) 109.6 118.1 118.8 131.5 135.0 136.8 135.3 137.8 125.8 121.5 113.3 106.4 109.7 111.1 123.8 163.3 179.5 183.6 190.0e 194.6e 5-yr High: 37 SALE+118S % CHA% NGE+156% +125% +6% +32% +23% +16% +14% +5% -7% -11% -16% -23% -13% -9% +9% +54% +64% +65% +16%e +8%e 5-yr Low: 14 EPS %+0.8 SURPRISE% +5.6% -10.2% -11.1% -6.8% -10.7% -1.7% -6.2% +8.9% +21.2% +5.4% vs Ind. Avg: 0.9x FUNDS1,087 1,132 1,121 1,272 1,301 1,351 1,367 1,343 1,402 1,399 1,368 1,280 1,265 1,235 1,172 1,156 1,215 1,315 1,360 1,390 SHAR52,272,352ES HELD BY FU53NMDS 52M 58M 62M 59M 58M 59M 58M 60M 60M 60M 59M 57M 61M 59M 57M 57M 57M 59M ® 2015 WILLIAM O'NEIL + CO. INC. Fanuc ([email protected]) Weekly as of TUE 02 June 2015

FANUC shares broke out of a cup with handle formation limited disclosure to investors. The stock advanced higher on February 12, 2015, after U.S. activist hedge fund Third after the Company announced plans to adopt a new Point disclosed that it had begun investing in the Com- shareholder engagement policy and an increase in its pany. In a quarterly letter sent to its clients, Third Point shareholder returns. Since then, the stock has gained claimed that FANUC shares offered potential for signifi- over 30%, and it now looks poised to break out of a new cant share appreciation, as it believed the stock was not consolidation area. trading at appropriate levels due to FANUC’s policy of

William O’Neil + Company, Incorporated Offers the world’s leading institutional investment managers a distinct blend of quantitative, fundamental, and technical expertise in global stock buy-and-sell recommendations. Its core method profiles stocks displaying the characteristics of outperformance proven persistent over market history — drawn from the firm’s industry-leading database.

William O’Neil + Co., Incorporated is a Registered Investment Advisor with the State of California and certain other states. The firm and its affiliates may now or in the future have positions in the securities mentioned in this or other publications. Charts are intended to be used as tools to assist institutional investors in identifying equity ideas worthy for further review. Charts provide certain current and historical information, but are not a substitute for comprehensive analysis of the individual stocks. For further information about our business and legal policies, please see williamoneil.com/legal.

LoseAngeles • NeweYork • Boston • London Page 8