Tuesday, April 24, 2007

How I added to Canon's results

There's a pretty good summary of Canon's Q1 at the Motley Fool. As it happens, I feel partially responsible. You see, earlier this year I bought my wife a Canon Rebel XT . It was intended to replace the A85 I bought her a few years ago and the Rebel 2000 I gave her a few years before. For at least this consumer, Canon has been able to sell higher margin products as the years go by.

The financial statements support this. In 1999, the year the Rebel 2000 was first introduced in Japan, Canon converted ¥3 of every ¥100 in sales to profit. In 2006, it converted ¥11. There are lots of reasons for this, such as the move from film to digital, point & shoot to SLRs, black and white to color copiers and printers, currency benefits, and operating efficiencies. Meanwhile, Canon has taken a hit in asset turnover, which has fallen from ¥98 to ¥92 of revenue per ¥100 of assets. This is to be expected since higher margins usually imply lower sales. Fortunately, the overall effect has been positive as measured by ROA, which went from 2.71% to 10.07%.

Meanwhile, Canon has been de-leveraging over that same time-frame. Its equity to asset ratio dropped from 2.15 to 1.51 thanks to decreases in long-term debt and capital leases. Normally this has a negative effect on return on equity, but because of Canon's stellar margins, ROE has improved from 5.84% to 15.25%. Mathematically, it doesn't much matter which of the ROE component ratios improve, but financially its nice to "front-load" the ratios. In general, it is easier to improve asset turnover through discounting or leverage through borrowing than it is to increase margins. This is especially true in a highly competitive business like digital cameras and printers.

I don't imagine margins will improve much from here on out, but there is hope for further growth in new products. Currently the company is working on launching SED TVs and have announced a medical device initiative. I'm a bit worried about the plan to develop (and I'm not making this up) intelligent robots. Whatever that means. I'm confident that Canon's R&D investments will pay off over time, but it's nice to have such strong operations while we wait.

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