We apply a PER of 18x to our goodwill-adjusted FY3/26 EPS forecast to arrive at a target price of ¥20,000. This multiple is a discount to the company's three- and five-year averages of 25x-27x, which seems appropriate given the greater importance attached to top-line growth over improving operating margins and RoE. We agree that the impact of global warming (especially in emerging markets) plus growing demand for improved IAQ (indoor air quality) and better ventilation means HVAC makers should see steady growth for residential ACs over the next few years, with steady demand also to service/upgrade commercial units with additional growth for applied units from data center operators. Also, we continue to believe that Daikin's global presence, vertically integrated business model, and strong brand mean the shares probably deserve to trade at a premium to the average for the industrial and consumer discretionary sectors. However, the low absolute level of its operating margin in the Americas HVAC business relative to its comps is an ongoing issue, and expansion in India could also weigh on margins. Moreover, the sustainability of high margins in China is an increasing source of debate, as is the near-term outlook for a recovery in its European business (especially the high-profile heat pump business where demand has slumped). At the same time, their M&A strategy has not been a resounding success, and given the high level of capex FCF generation has not been great. RoIC has also trended down over the past few years. As Daikin amortizes the annual goodwill associated with its acquisitions we think it appropriate to adjust our EPS forecast by approximately ¥165/share (before tax), which is equivalent to c¥48bn.

Factors that could cause the shares to undershoot our target price include 1) a slowdown in global economic activity in general especially in the main AC markets of North America, China and Europe; 2) intensifying competition for its multi-unit VRV series in China and/or a prolonged property slump; 3) yen strength against the US$, euro, and/or RMB (our FY3/26 forecasts are based on ¥145/$, ¥165/EUR, and ¥20.0/RMB); 4) higher raw material prices for copper, steel, aluminum, components, resins, fluorite, etc.; 5) an inability to push through price hikes; 6) another write-down of goodwill on acquisitions; and 7) an accident at one of the company's chemical plants and/or an earthquake close to one of the company's own plants or those of its suppliers could cause supply chain disruptions. On the upside, faster-than-expected improvement in margins in the North American HVAC operations and/or a rebound in Chinese growth, a rebound in demand for energy-efficient heat pumps in Europe and/or a change in attitude about the need for A/Cs, and lower raw material prices could mean overall profits exceed our forecasts.