Ichigo Inc

TSE:2337

Earnings Call Transcript 2019-Q3

[Scott Callon, executive]

Hi, this is Scott Callon from Ichigo. Thank you everybody very much for joining me. We appreciate your time. I'm working off of our FY '19 2 -- fiscal year 2019 February Q3 corporate presentation that's on our website. So let's dive in.

Turning to Page 6. We show what we think are some of the highlights for the quarter. We continue to have a very durable earnings model. We have not only higher stock earnings, meaning ongoing picked earnings relative to our expenses. Those earnings are growing across the board.

If you take a look at asset management, it looks like we're forecasting JPY 2 billion versus JPY 2 billion for what we did last year. We expect to beat this forecast. Similar in clean energy where we've done JPY 1.7 billion on our first 3 quarters and a full year forecast of JPY 1.6 billion. We fully expect to beat that.

We did a share buyback during the quarter. We -- and I'll go through in more detail of these topics. We're making some progress on some people call it re tax, real estate tax. Some people call it prop tax or property tax. We're making some progress there with our AI-based hotel revenue management system. We've done a new entry in smart agriculture.

The firm is deeply committed to serving both society and to serve our shareholders by being a growth company, and there are a number of initiatives underway that we're very excited about.

Let me turn to the quarter that just ended, that's on Page 7. Operating profit is up -- was up 24%. Net income, up 11%; up -- EPS, up 12% year-on-year. So we're on track to deliver record earnings for the firm this fiscal year.

Page 8 shows you the breakdown. Asset Management, as I said earlier, our stock earnings are growing NOL across the board. So base Asset Management fees were up 11% year-on-year. So you see in the breakdown with the Asset Management, it's actually down 1.3% because it's a mixed changed, it's been very positive. Stable earnings have gone up, kind of spot earnings, specifically. Cash flow-base foreign fees at Ichigo Office REIT are down, but the mix is, as I said, very, very positive. So we're flattish for Asset Management on a year-to-date basis, and we expect to beat last year's numbers when we finish the year at the end of February.

In Value-Add, we're up 24.6% year-on-year. That has got rental income up 15% year-on-year and gains on value-add sales by up 34%. So as you can see also across the board, we're at 90% versus our full year forecast for Asset Management, 82% for Value-Add, 82% for Clean Energy. We're well on track, as I said earlier, to be beating this year's forecast.

Clean Energy has got the biggest move. There's, again, a mix change that is very positive in terms of what it implies for ongoing earnings stability. 64% increase in OP year-on-year. That is being delivered by a complete zeroing out of gains on sales of a power plant that we had last year, and an increase of 1.5X increase in our power generation revenues. We've got 7 new power plants that came on board.

We'll go forward. Page 10 shows you -- begin showing some of the characteristics of our business model. You can see FY '19 this last 2 Q3, the breakdown of our flow -- of our stock and our flow earnings there about 50/50.

It is our intent to continue to grow the durability of our earnings, both by increasing the stock component and by also increasing the diversity of the flow earnings such that there's less cyclicality in it. This is going to be another year of strong growth in terms of the complete movement for that agenda.

Page 11 shows kind of another element of the business model, which is that we actually -- we create significant value to our value-add activities. We think our economic earnings are higher than our accounting earnings. In fact, we have an earnings back -- bank in future periods when you actually record the value-add that you've generated by doing an actual asset sale.

Page 12 shows an update as to where we are. So on the previous page, we suggest we have -- for the external third-party appraisers, we have $45 billion of unrealized gains. Page 12 shows you that, in fact, over time, we've demonstrated that we create overwhelmingly more value than what the appraisers would indicate. And so year-to-date, we've generated 2.2x in terms of actual realized gains versus what the unrealized gains were for the appraisers. The gross margin continues to be very, very high at 31%.

13 gives you kind of the balance sheet that supports the business. We believe we should have, as much as possible, a bullet-proof balance sheet that is deeply related to having stable long-term borrowing. So you can see that the average borrowing loan period continues to be 10 periods -- 10 years. Their loan maturity is 7.5 years. We borrow at less than 1%. It is an extraordinary benefit to being a Japanese company with the credit markets open to us.

I put on the -- on the most recent call, and it's true and continues to be true, there has been some wobbliness with respect to access to bank credit amongst some of the weaker players in the market, certainly with respect to individuals with high leverage transactions against assets that are not particularly good. That is just not the case for us. We have overwhelming access to credit.

That's the good news. Bad news is that it's a very competitive market out there with respect to acquisitions, but our credit position is durable and continues to get stronger.

We'll look at Page 15 where we point to both kind of what the stock earnings growth does look like, which is 41% within our Value-Add business over the last 3 years, up 50% year-on-year. On the right-hand side of the page, you see the sales and acquisitions within the Value-Add segment. We sold about JPY 40 billion worth of assets, so JPY 100 to $1, $400 million worth of assets. We bought about the same amount, JPY 43 billion. It's interesting. The -- I'm not going to -- don't know if I'm preempting a question, the market for real estate in Japan continues to be very, very robust. Kind of the wheels seem to be coming off and not coming off, and there's a lot of volatility in global capital market. But cap rates, if anything, continue to be kind of inching downward.

The one thing that's pretty noticeable, though, is it used to be that kind of 10 people would want to buy assets. And at this current pricing, like half the people are dropping. So it's like it was a 4 cap, and there were 10 buyers for it. Now it's a 3.8 cap, and there are 5 buyers for it. They clearly are market spins, we are pulling back at this point time. That does imply if you want to get the kind of best possible price, you possibly have to have your asset in the market longer. But there has been no -- I mean, a room of people talking about kind of apartment, investment in apartments in bad areas and done by amateurs at very high leverage, keeping that kind of toxic, very, very small part of the market aside. And the core activity that we're involved, good assets with good location, cap rates are -- continue to be kind of creeping down a little bit, which means we're cautious on the buying side. We work very, very hard to add value assets. We only buy assets that we're comfortable we can add value to. We have done substantial work to continue to build our capabilities in this area, but it's a tough place, it's a tough environment to buy. It's an extraordinary great environment to sell. That has not changed at all in the last 3 months.

Page 16 shows, I think, for the first time, gives you some data on what we've done with our lifestyle hotel brand. For those who've heard us before, my apologies to those who are new to the story, there is a shortage of high-quality kind of boutique-like, the industry calls them lifestyle hotels that, in Japan, it's really easy to find a business hotel that's a box, in a very small box and it costs $80 a night. And it's relatively easy to find places that costs $300 and $500 a night. But if you really want to stay in a place, something that's nice for $150 a night, there aren't a lot of options. So we think this is a massive market opportunity. If you're interested in the data on -- in the first half, in October, we actually have some data on this in the presentation in terms of the under delivery against this need in the current -- in the Japanese market.

But anyway, we've taken 2 hotels that were 33 years old and 39 years old, respectively, with kind of relatively aging infrastructure and an out-of-date kind of offer to hotel guests. One of them is in Yokohama, it's called The KNOT YOKOHAMA, so that's our brand, The KNOT, and that opened in the end of 2017. The KNOT TOKYO Shinjuku opened in August of 2018, so just in the last 6 months. And you can see what happens when you invest enough in the hotel to provide an offer. I mean, as an investor, there was actually a very, very substantial rework in both cases of the infrastructure of the hotel in order to bring them up to spec with what we need today. But the result of that is you drive ADR in the case of Yokohama, about 22%. You drive the ADR, so the average daily rate, in KNOT -- The KNOT TOKYO by 60-plus-percent.

So at this point, you can see on the page, The KNOT TOKYO Shinjuku is just an absolute home run. And we will have follow-on to this. We expect to open up THE KNOT in Sapporo and Hiroshima in 2020. This is clear in the case. As you know about Ichigo, we tend to start small. We verify it as an actual need. We verify the economics make sense. We verify we have the capability to deliver through the cycle on those economics and to the client and the need and the economics to our shareholders, and then we begin and expand. So THE KNOT, we think, is a potential important value driver for us in the hotel space going forward.

Page 17 shows the Clean Energy growth road map, hasn't particularly changed. You may have seen in the last 3 months, you may have seen that we brought online our 40th utility scale solar plant this month. So this is a business that we entered in 2012. We're up to 40 plants operating nationwide.

Wind, as you can see on Page 18, continues to be a place that we expect to be active. And the one thing that has happened unfortunately is that we've had to push back the operation start date for the very first wind power plant to September 2020. That's nothing on our side. That actually is the client who is the opco, had to do some work in terms of grid hookups and that sort of thing. So that is now a September 2021 for us in the wind business.

Page 19 shows what we're trying to do in the Asset Management business to be innovative and deliver value for our shareholders. Look, I think we all understand that the J-REIT market has been challenged by a reputation of sponsors not necessarily serving the interests of REIT shareholders. And at Ichigo, we work intensely hard for our shareholders, all shareholders, our REIT shareholders. We manage conflicts by delivering a governance structure that is rare, if not unique, within the J-REIT business. We have entirely independent boards at our REIT. One of the things we decided that we would do to -- going to demonstrate our ongoing commitment to serve our REIT shareholders in a way that we think is unmatched in the market. We've introduced the first no fixed fee J-REIT. This is, as you can see on the page, we eliminated kind of fees that are common in Japan for J-REITs that have nothing to do to creating value for shareholders. So you buy an asset, you get some money on it. You have assets under management, you get money for it. So we've moved entirely to a fee structure that is performance fee-based in order to generate significant higher alignment with our shareholders.

And you know what? Investors are smart. And so what was so interesting about this was this is brand new. No one's done it. You always wonder if the market is going to say this is a good idea. If you're a shareholder, you're going to say this is a good idea. We -- this is material non-public information. We weren't able to announce it. We're thinking about doing this. We just had to announce it because we thought it was right. And it got 99.3% support. In other words -- and maybe the people didn't vote for Mark [ Barcarstrom ]. So that's a gratifying response on the part of the investor community in recognizing that the things that we propose makes sense for them.

So look, the Asset Management business is a great business. It has not grown nearly as much as we wanted to do in the last couple of years, and so we're continuing to work in ways to deliver value that allow us to grow this business some more.

Page 20 gives you some data on what's happening with our hotel AI-based revenue management system. We -- again, for the first time, we've got some disclosures here in terms of when we're doing the algorithms that we've embedded into the system manually for 9 hotels. It's done in '17. We saw an uplift in hotel revenue growth with [ happening ] of 38%.

And so this is now -- these algorithms have been embedded inside the AI system, which is now in test mode, and we expect to finish the testing by next spring. The goal then will be to have a full rollout of this with, again, Ichigo's own hotels. And actually, to the extent that the market is interested in this, we are fully prepared to sell this externally, and that could be a very interesting non-asset-based earnings stream for us, should we succeed in doing so. So things are happening on the hotel side with respect to kind of other activities we're doing, both that drive growth out of our own hotels and also grow -- drive a new earnings stream for the hotel business.

Page 21 points to a new entry we've done in agriculture. This is very early days. As I said earlier, we tend to make a very small entry. The agriculture market is massive. It's massively -- everywhere in the world, it's massive in Japan. We think there's some interesting things that can be done. We bought an agricultural technology company last year as part of our acquisition of Centro. There was a smart agriculture technology start-up called Tenuto inside of that, and so we're beginning to incorporate some of the new technology in our deliverable to farmers. It's -- very specifically, it's environment-controlled IOT-based greenhouse systems.

In terms of the technology offer, the financial offer is that we're actually not taking -- we're actually participating with the farmer. We're doing -- in what the greenhouse environment, they will deliver, and we're not charging the cost up front and doing some risk-sharing and getting an additional element of what the harvest is in terms of Ichigo's participation in it. So we think this is interesting. It's very, very small at the moment. That's the Ichigo way, but we would be very soon doing more in this area if we can.

Page 22 speaks to another initiative. We are very long term. We think carefully about how we need to grow the firm over time. We've come to understand that there are opportunities in Japanese real estate. It is a very traditional space. It is not necessarily IT sophisticated. It's not necessarily kind of open innovation-oriented. We think there are a number of opportunities for us in terms of building a network. So we're doing -- we've developed an Ichigo sustainable lab. We've launched it internally. Its focus is on identifying new ways in which real estate and public infrastructure can be used to support a higher quality of life. We do have a hard-earned belief that, ultimately, companies need to serve the needs of customers and society or they're going to get weeded out. And certainly, that's the right outcome, so there is a significant focus on how we can add value and how we can do so in a sustainable way.

The 3 sub labs within the Ichigo sustainable lab, our community lab, which is working on building kind of community in the network, the network effects. And the basic idea of being that you have all these tenants and all these Ichigo buildings and assets who are not interconnected in any sort of way. And to seek ways to develop a platform that would add value for them, them meaning our tenants, as Ichigo tenants is the key focus of the community lab.

The 100-year real estate lab is focusing on how we can take assets. As you know, at the heart of what we do is value-add. We tend not to tear buildings down. We're trying to figure out how to take 30-year old buildings and 50-year old buildings and make them sustainable. The economics of that are extraordinarily powerful. The sustainability is, therefore, powerful. So a technology effort, primarily kind of architectural and structural engineering-based in an open architecture way to work on what we can do with Japanese real estate.

And finally, incubation lab is -- in the last couple of years, we spun out 2 ventures. One is Ichigo Owners and also Ichigo [ Otochi ] Shinjuku, which is working on kind of neighborhood and kind of development activity. A little bit longer term value-add activity. The incubation lab is going to support ongoing start-up activity from the firm in order to seek to create value.

Page 23 points to the buyback that we did in the last couple of months. We've won JPY 3 billion worth of shares, about 1.7%, I think, of shares outstanding at an average price of JPY 381 per share.

So that is the summary of what we've done and the kind of some of the key initiatives underway. And that concludes my presentation. Thank you, everyone, for joining. It's an honor and a privilege to work for you. Have a good day.