Deep Dive: Keyence Corp (6861, KYCCF)

The crown jewel of industrial automation

Keyence is a true compounder and ranks amongst the finest businesses globally. Over the last decade, Keyence has compounded its revenue and net profit at a rate of 18% per annum, achieving operating margins over 50%, and Return on Invested Capital (ROIC) of around 100%. Even at its size, it has outgrown both local and overseas competitors!

Investing in a true compounder requires strong conviction for two reasons.

• First, compounders seldom trade down to very ‘obvious’ multiples. You need conviction to actually get in.

• Second, they must be held over extended periods and through cycles. The biggest detractor of returns on compounders is the urge to trade or sell.

We believe that compounders may be easy to spot, but hard to make money on.

Importantly, with the surge of global investor interest in Japan, we think now is the right time to sharpen the pencil on Keyence. As arguably the best publicly listed business in Japan, we think Keyence will likely find its way into more global investors’ portfolios over time.

We have distilled over a decade worth of experience in studying and investing in Keyence into this report.

We hope this will give our readers a deeper understanding and conviction on this one-of-a-kind asset.

Business Description

Keyence is a leading global supplier of industrial automation equipment and solutions, including sensors, vision systems, measurement equipment, and process control.

Most of Keyence’s products deal with the detection, identification, or measurement of various objects and matters. Sensors are the company’s bread and butter, but the product portfolio is much more diverse, with over 10k SKUs that spans five major product groups. We describe them below.

Sensors are used on assembly lines for quality inspection and control. Sensors can detect defects and inconsistencies in various objects, such as height, thickness, angle, elevation, positioning, and more. It does so with extreme speed and sensitivity, capable of measuring 4,000-5,000 parts per hour at micron-level accuracy (1/1,000th of a millimeter).

Keyence also has sensors that detect non-static properties, including vibration, rate of flow (liquid), gas pressure, and temperature.

Measurement systems and microscopes are capital equipment used in laboratory or factory workstation settings, mostly for R&D or detailed parts inspections. Here are some of Keyence’s main products in this category:

• Image Dimension Measurement System generates high-definition images of objects of all sizes and shapes, and uses image processing software to automatically measure and output its various internal dimensions.

• Elemental Analyzer predicts the composition and concentration of different elements in a sample (e.g. copper 76%, tin 23%, nickel 0.85%, sulfur 0.15%) by projecting a special laser and analyzing the unique energy signatures emitted from the sample. This can be done on a wide range of materials, from metals and alloys to plastics, ceramics, and organic compounds.

• 3D Surface Profilers captures and analyzes surface topography of objects, such as surface roughness, waviness, irregularities, and other surface parameters at an extremely fine resolution (up to 0.01 nanometer).

Vision systems make use of high-speed camera and advanced lighting technologies to capture 2D and 3D imagery of objects on an assembly line, which is then analyzed by image processing software. Vision systems can be integrated with industrial robots to serve as the “eyes” for the robot.

Keyence is particularly strong when it comes to its innovative lighting technology and the quality of its image acquisition, and is widely regarded as the global leader in 3D vision.

Marking and printing includes laser markers which are used for engraving texts, such as batch number or product expiry date, on the assembly line. Industrial inkjet printer does the same thing with ink rather than laser. Keyence also sells 3D printers.

Process control: Main products here include PLCs (programmable logic controllers), servomotors, and industrial touchscreens. An intuitive way to think of these would be the “brain” (PLC), “muscle” (servomotors), and “interface” (touchscreen) in a factory. These work closely with Keyence’s other products including sensors and vision systems, and there are cross-selling synergies.

Keyence is far from being alone in the global industrial automation sector. With a plethora of competitors - mainly from Japan, Germany, and the United States - there is a lot of competition in each of the above five product categories.

So, what sets Keyence apart from the crowd?

The answer is innovation.

Keyence proudly claims that 70% of all new products that it releases each year incorporates either “world’s first” or “industry first” features. These unique features helps customers improve their productivity, and allows Keyence to both differentiate its product from competitors as well as to charge a premium price.

Consider the 3D robotics vision system as an example. Traditionally, these systems required a lot of time and expertise for installation and calibration. Sensors have to be precisely positioned, initial data collected for baseline measurements, and then fine-tuned through many iterations to make sure the robot could accurately perceive the 3D world. This entire process could take several days. Keyence has streamlined this process down to just 15 minutes through innovations in learning software. Essentially, the system self-calibrates and fine-tunes, significantly reducing the need for human intervention.

While competitors might eventually catch up and reproduce these innovations, by that time, Keyence has already moved onto launching newer, more innovative products. Keyence has maintained this pace of innovation, consistently staying one step ahead of their competition. How does Keyence do this? We explore this next.