Taps and dies: better than the rest

by SR on July 11, 2012

Japan cutting tool sales, cumulative (million units)

Some machine tool parts better than others

Last week in this post I pointed to an article about OSG, a manufacturer of cutting parts for machine tools and the world’s leading supplier of taps. The article said that OSG is having difficulty keeping up with demand and is therefore investing in new capacity at one of its factories. This surprised me a little as machine tool demand itself is not that great and indeed, as we noted in that post, are actually tracking below 2011 levels. Still, this is consumables, so we went off looking for some confirmation.

The data from METI on ‘Tools for machines’ looks like the obvious place to start. This contains four categories, with ‘High speed steel cutting tools’ being the one that looks appropriate. Up to May 2012, the sales data are shown in the chart at the top of this page. (Click on the chart for a larger image.) Sales volumes are up 5.8% YoY for the January to May 2012 period, which is certainly better than machine tool demand.

But sales can be deceptive as an indicator of demand for items with a long lead time, because you can sell out of inventory, thus supporting your sales, even while production is plunging. Let’s look at production in units. (Click on the chart for a larger image.) As illustrated in the graphic below, production of cutting tools is not rising year-on-year – indeed it has actually fallen by 0.7% for the January to May 2012 period compared to the same period in 2011.

Japan cutting tool production, cumulative (million units)

Inventory an issue, but fading

Hmm, so that doesn’t seem to fit with what the article said about OSG and indeed OSG’s own actions in investing in more capacity. Sales are up, but production is down. Why the difference? Well, as I said above the obvious place to check is inventory. Here’s a chart showing the inventory of cutting tool parts over the past few years. There’s a few interesting things about this. Note the green line, showing inventory in 2008, then see how in 2009 (the orange line) inventories dive as suppliers belatedly turn off production in response to plunging demand. Inventories stay low in 2010 (the purple line) but look how they take off in 2011, which is the blue line running from bottom left to top right. What this means is that by early 2012 the industry is carrying very high inventory in absolute terms, higher even than during the global financial crisis.

Japan cutting tool inventory (million units)

Still, absolute values – such as the 15.35 million units of inventory at the end of February 2012 – don’t tell the whole story. Let’s look at inventory in relation to production. As the figure below shows (click on the chart for a larger image), compared to production inventory is at high levels but it is nothing like as bad as during the GFC. Moreover, inventory has been coming down over the past couple of months both in absolute terms and compared to production. So things seem to be more or less under control.

Japan cutting tools, inventory-to-production ratio(x)

Why did inventory rise in the first place? I can think of two reasons. First, machine tool demand was strong in 2011. Second, cutting tool suppliers may have deliberately built inventory in expectation of recovering demand (and new model launches, as new models drive demand for tooling) in the auto industry and they may have erred slightly on the side of too much rather than too little.

Taps and dies do look better

On the other hand, this brief exploration hasn’t helped us confirm whether or not demand for OSG’s products really is strong or not, which is the point of this exercise. So let’s dig a little deeper. The high speed steel cutting tools category actually contains six sub-categories: drills, milling cutters, broaches, reamers, gear cutters and taps and dies. So let’s take taps and dies and look at this. Now, these detailed figures are quite slow to come out, so the last figure we have is for April 2012, rather than May.

Japan tap and die production, cumulative (million units)

Still, the picture that emerges is clear enough, as you can see below. (Click on the chart above for a larger image.) Cumulative shipments are up 8.1% YoY for the January to April 2012 period, compared to the same period in 2011. Sales were up 10.8% YoY up to April. By comparison, for cutting tools as a whole (i.e. not just taps and dies) the same figure for January to April 2012 was +0.5% YoY and January and February were both negative, whereas tap and die production has been solidly positive all year. Tap and dies are doing far better than the category as a whole.

This bird has flown

This then looks like independent verification of the strong demand that OSG seeing, as reported in the original article. Now the question is whether the market knows this or not. The answer, going by the chart below, is that it has recognised this strength in orders. As you can see, OSG has outperformed not only the Topix index but also every other Japan machinery stock I could bring to mind. For now, OSG’s stock may have shot its bolt.

The other angle on this is that if taps and dies are doing well, something in the ‘cutting tools’ category must be doing pretty badly. Who is hurting? This would require more digging and given that we may end up looking at a short on a small or mid-cap stock for which there may not even be any borrow, it’s probably not worth our time.

Share price performance of Japan machinery stocks year-to-date

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