Trend Micro: Overseas Demand Recovery Offsets Cost Pressure; Neutral Maintained but Target Price Raised

Overview

This report updates Trend Micro’s earnings forecasts following 1Q12/26. Goldman Sachs believes the company’s overseas demand environment is bottoming out and recovering, improving the sales outlook, but headcount expansion, increased cloud usage, SG&A, and investments in start-up subsidiaries will pressure FY12/26 profits. Therefore, Goldman Sachs only slightly lowers its FY12/26-FY12/28 operating profit forecasts, maintains a Neutral rating, and raises the target price to ¥6,600 as the valuation base rolls from FY12/26 to FY12/27.

Core views

The core view is that demand recovery and cost pressure coexist. On the positive side, overseas demand is improving, with FY12/26 sales expected to grow 9% YoY; the U.S. is likely to return to positive growth for the first time in three years, Asia remains strong driven by Australia and the Middle East, Europe is steady, and Japan’s enterprise segment also maintains stable growth. On the negative side, upfront investment will increase significantly in FY12/26, with operating expenses expected to rise 12% YoY, including a 14% YoY increase in personnel costs and a 34% YoY increase in cloud-related costs, while start-up subsidiaries such as Magna AI and VicOne may generate close to ¥3bn in operating losses. Goldman Sachs expects operating profit growth to resume in FY12/27 as the pace of upfront investment expansion slows.

Analysis framework

Based on the company’s 1Q12/26 results, the report updates FY12/26-FY12/28 earnings forecasts, assessing sales growth by region and breaking down profit pressure by expense category. The valuation method uses a weighted average: 70% P/E-based fundamental value and 30% EV/sales-based M&A value.

Methodology notes

• equity valuationweighted P/E and M&A EV/sales valuation

  The target price is derived from a weighting of 70% fundamental value and 30% M&A value.

  Goldman Sachs applies a target P/E slightly above 14x to FY12/27E EPS of ¥305, a 20% discount to the industry average P/E of 18.0x, resulting in a fundamental value of about ¥4,390; it also applies 4.0x EV/sales, a 20% discount to the 5.0x average of historical global endpoint security M&A transactions, resulting in an M&A value of about ¥11,800. Weighting the two at 70/30 yields the ¥6,600 target price.

• factor frameworkGS Factor Profile

  Growth, financial returns, valuation multiples, and composite percentiles.

  Goldman Sachs’ factor profile uses forecast sales, EBITDA, and EPS growth; financial returns such as ROE, ROCE, and CROCI; and valuation indicators such as P/E, P/B, dividend yield, EV/EBITDA, and EV/FCF to compare stocks on a percentile basis versus the market and industry peers.

• event and optionality frameworkM&A Rank

  M&A probability ranking.

  Goldman Sachs classifies covered companies into ranks 1 to 3 based on the probability of being acquired, where 1 represents high probability, 2 medium probability, and 3 low probability; for rank 1 or 2 companies, an M&A component may be included in the target price. Trend Micro’s key data shows an M&A Rank of 1.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Trend Micro Inc. (4704.T)

  covered company in the report

  Strengths

  A leading player in Japan’s endpoint security software market, with about 70% of revenue from overseas, technological expertise in cloud-environment server endpoint security, and a strong Asian customer base plus notable potential M&A value.

  Weaknesses

  Near-term profitability is pressured by headcount expansion, cloud usage, selling expenses, and investments in start-up subsidiaries; its track record on cost control is relatively weak versus company guidance, with relatively high earnings volatility.

  Comparison

  The P/E portion of the valuation applies a 20% discount to the industry average P/E of 18.0x; the EV/sales portion applies a 20% discount to the 5.0x average of historical global endpoint security M&A transactions.

  Risks

  An increase in cyberattacks could accelerate security market growth and create upside; new technologies or intensified competition could lead to market share loss; changes in cost strategy could increase the expense burden.

Key data

• RatingNeutralGoldman Sachs maintains a Neutral rating.
• 12-month target price¥6,600Raised from ¥6,200; implies about 21-22x FY12/27E P/E.
• FY12/26 operating profit forecast¥55.0bnDown 5% YoY, below the company’s ¥56.4bn guidance.
• FY12/26 sales forecast¥300.0bnUp 9% YoY, or up 5% YoY at constant currency.
• FY12/26 operating expense forecast+12% yoyUp 8% YoY at constant currency; personnel costs expected at +14%, cloud-related costs expected at +34%.
• 2Q FY12/26 operating profit forecast¥12.9bnDown 4% YoY.
• Enterprise ARR forecast+5.4% yoyIn U.S. dollar terms, referring to TrendAI ARR, slightly accelerating from +3.6% in FY12/25.
• Market capitalization¥828.1bn / $5.2bnListed in the report’s key data.
• Enterprise value¥604.6bn / $3.8bnListed in the report’s key data.
• 3-month average daily trading value¥8.0bn / $50.3mnListed in the report’s key data.

Impact & implications

From an investment perspective, Trend Micro sits between improving cybersecurity demand and peak cost investment. Bottoming overseas demand, high endpoint security market share, more unknown vulnerabilities driven by AI, and Japanese security compliance investment support medium-term revenue improvement; however, FY12/26 expense growth and losses at start-up subsidiaries constrain near-term profit elasticity. The target price increase mainly reflects the rolled valuation base and the weighting of M&A value, rather than a more bullish rating shift.

Risks

• The security market could grow faster due to an increase in cyberattacks, potentially leading to better-than-expected performance or valuation upside.
• The emergence of new technologies or intensifying global competition could lead to market share loss.
• Personnel, cloud, sales and marketing, SG&A, or start-up subsidiary investments exceeding expectations could increase the cost burden and compress margins.
• If U.S. sales underperform expectations, pressure from FY12/26 profits falling below guidance could intensify.

What to watch

• Whether U.S. sales in FY12/26 return to positive growth and whether the order environment continues to bottom out and improve.
• Whether growth in Asia, Europe, and Japan’s enterprise segment continues, especially demand in Australia and the Middle East.
• The growth rate of operating expenses, personnel costs, cloud-related costs, and the scale of losses at Magna AI and VicOne.
• Whether enterprise ARR and demand related to Vision One can continue improving.
• Changes in the Japanese government’s security assessment framework, discoveries of unknown vulnerabilities driven by AI tools, and enterprise security budgets.