Ichigo Inc

TSE:2337

Earnings Call Transcript 2020-Q3

[Scott Callon, executive]

Hi, this is Scott Callon. Thank you, everybody, for joining today. We really appreciate your time.

I'm working off of the FY20/2, so February 2020 Q3 corporate presentation that is on our website. So let's dive into it.

Turning to Page 7. We have a summary of -- I mean it's a summary, so I'm not going to go through it in detail. But some key elements here are that the earnings model is really very durable. We have -- we're structurally profitable. We have stock earnings, so baked in earnings that are more than double our fixed expenses.

On the right-hand side, we point to our stock earnings. One of the things that we've done from this year is we've gotten much more careful about trying to be tax-efficient for all of you, for our shareholders and investors, which is to say, we've come to focus much more on any and all opportunities to generate cash and to use a tax shield in the form of depreciation. So one of the things that's happening this year is we're getting a hit to EPS because we have moved assets on an accounting basis and also on a tax basis from real estate for sale to fixed assets. The advantage of that is it means that you can do -- you can depreciate the assets. And that gives -- it gives you a 30% tax shield because that's what the corporate rate that we pay. So that's actually very, very helpful.

We want to generate as much money as we can, real cash, in order to either invest in the business to grow EPS through earnings growth or to grow through EPS by buying in our shares. So you can see, it looks relatively flat in terms of what the stock earnings have done on a -- excluding the depreciation effect, on depreciation. And when you include that, we're actually, on a cash-on-cash basis, up about 4%.

The flow earnings have been very, very strong. We completed a share buyback, and I'll touch upon what we're doing with our hotel AI system later in the presentation.

Going to Page 8. I think the right way of describing this is, well, operating profit, OP is up 22% year-on-year; net income is up 24%; EPS is up 26%. I'll touch upon it later. We bought back about 5% of our shares outstanding in the last 3 years. You should -- I'm not telling you anything new. You should fully expect us to continue to be buying shares going forward. We have extraordinary robust cash generation. Business is becoming more efficient -- more capital-efficient, and so we have the ability to do that.

One way to think about it, if you take a look, though, you can see that we're effectively at our full year forecast right now. And it's a way of saying, we did a full year in 9 months. There are 2 things going on. The Japanese real estate market continues to be extraordinarily robust in a world that's deeply uncertain, in a world that continues to have really no yield. Japan -- Japanese real estate offers the largest pickup globally against funding rates and in any major country. It's a very strong labor market. Corporate profits are growing, the GDP -- it's Japan, it's not going to grow through roof, but it's growing steadily. So the ability to buy assets and yield somewhere between the 3% cap and a 5% cap, typically, with rents growing and funded at somewhere between 50 basis points and 200 basis points depending on where you are. It's just enormously attractive. So the market is doing very, very well.

And within that, we've worked really, really hard to be better, to be different. It's competition that erodes away returns. It's not enough to be good. You need to be differentiated and good, and we've done a bunch of work on that, and it's coming through. So very, very strong first 9 months.

The way we think about the world is we don't manage on a year-to-year basis, we manage for the long run. The reason why we announced the Ichigo 2030 long-term plan in April this year is because we think we can grow a lot and that involves spending for growth. We've made some choices this year in terms of, as I said earlier, moving assets into accounts that allow us to take depreciation, so that hits EPS we're spending on IT for growth at EPS, that's all fine. These are all going to be drivers of future EPS growth for all of you.

So the result of that, though, is, I think, probably what will happen -- we haven't chosen to upgrade our full year forecast. I mean we'll see what happens in the fourth quarter. It ought to be somewhat light and from a stock perspective, which is to say that the fourth quarter is the lightest quarter for our solar power generation. During the winter, you get less sun, you also get some -- more snow and cloud covering that blocks power generation. Depending on what happens on flow earnings side, we'll see what happens. But a very, very -- bottom line is we did in 9 months what we expected to do in a year. Our focus has already turned to what we're going to do in next year and going forward.

At the same time, we have all these assets that are incredibly high-quality and gotten more high-quality over time. We have potential buyers for them. If we transact with those buyers, and that will generate more profits in Q4. So we'll find out together.

Turning to segment details on Page 9. Asset Management Base AM fees were up 2%. So relatively straightforward other than -- rental income was down 1% in sustainable real estate; predepreciation, that's up 5%. The big move is on gains on sales is as I said. We -- the irony is we're generating these big gains on sales by lightening up on what we think are -- we're trying to have the best possible portfolio going forward. So I mean -- the buyers are buying good assets from us. But if we think something is absolutely super prime and should be kept forever, we're not selling it. No need to. You can earn huge returns on assets that aren't in that same category. So very, very strong earnings being generated over a sustainable real estate business.

And Clean Energy is down 2% year-on-year; on predepreciation basis, it's flat. And I'll touch on this later, but we -- this is going to be a light year in terms of growth in the Clean Energy business, and then it picks up again from [productivity].

Turning to Page 11, you can see our stock and flow earnings breakdown. We target roughly 50-50 from stock and flow. That's actually been such a good year for flow that -- in the first 9 months. We'll have, we'll have -- we expect stock to outpace flow in the fourth quarter, so this will become more similar through the year unless of course we have some transactions where people decided to try some of our good assets at really good prices and so -- again, we'll find out together.

Page 12 points to one of the things we think the most important characteristics of the business model is that we have embedded forward earnings. We built all this additional functionality and value in the assets that we own, and we only record those earnings that we actually transact. And so you can see on Page 12, it suggests that we have JPY 51 billion, so about USD 500 million of unrealized gains according to third-party appraisers.

If you turn to Page 13, however, you'll also see the update on year-to-date is that we have generated 2.8x the earnings relative to what third-party appraisers have said we're going to have in terms of our unrealized gains. So if you take a look at this, I think, we've been guiding people that you should assume something 2x at least in terms of what our stated third-party appraisal, unrealized gains are, so not JPY 50 billion, but JPY 100 billion. So remember, this company has a market cap right now of about JPY 230 billion, a little bit over USD 2 billion. Against that, the appraisers say we have JPY 50 billion of unrealized gains. It looks recently that we have something more like 2.5x or 3x that, so it could conceivably be the fact that on JPY 250 billion. In real estate, right now, we have JPY 150 billion of unrealized gains or up 60%. It's a way of saying that this is what you do. In good markets, you create capability, you do -- in a sense -- we haven't intended to, other than we're very -- trying to be very efficient about taxes. You're banking future earnings. I mean sell stuff now, you pay taxes now. You don't sell it, you pay taxes later. We like that. But it is an extraordinary operating environment. Every year, Hasegawa and I, CEO, we talk about, this is the peak in every year, the continuing robustness of -- I think the Japanese economy is surprisingly upside, Japanese real estate is surprisingly upside, but there's some durability here. There are economic fundamentals that are driving the attractiveness of these assets in a very uncertain world. Japan as a country and Japanese real estate specifically offers a very powerful return.

Page 14 also points to one of the other elements that's important to our business model is, this is real cash generation. We're not guys who have kind of announced earnings that aren't backed by cash. In fact, you would see that the cash generation that tends to be substantially higher than what our net income is.

15 points to what's happening with funding and the duration of our debt. We continue to fund at ever lower rates. That, actually, at this point, rates have flattened across Japan. So this is not speaking actually to an overall drop in market funding, this is speaking to an overall drop in funding costs for Ichigo because of our increased -- understanding of our creditworthiness. The other thing that's interesting about this is, again, you take advantage of good times to do things to protect you and build for the future, it is not a high priority for the firm, right? If the bankers are on the phone, this is fine because I tell them this is awesome to decrease our funding cost. We have done everything we can to improve terms and conditions. We have kind of the world's lightest kind of nonexisting covenants on our debt. That's been a much, much bigger focus. Covenant light, fixed rates, long term. And on the margin, if you're willing to fund it with all those things having held at lower rates, fine, we'll take that. And so that's -- it's really kind of speaks pretty powerfully to how our -- to say, understanding of our creditworthiness has increased.

Let me turn to specific topics in terms of acquisition and sales and things we're up to. So on Page 17, you can see that it is Seller's market. We recognize where we are in terms of -- it's great now. It doesn't mean it has to be a great 6 months from now. Given how robust economic conditions are, they probably have to have something going bump in the night in the world for us to suddenly changed from where we are, but we accept that as an ongoing scenario and ongoing possibility. We're generating a deep gross profit margin of 29%.

Ichigo Owners continues. That's the new business we set up 3 years ago, which is a very high turnover business, generally holding period between 6 to 12 months, but we do kind of very fast value add, primarily, we're giving buyers comfort that we have checked the assets. We verified the assets. They have Ichigo stamp both of quality and approval to them. That business continues to be very, very active for us. If you can see on the table. And I have one correction here. It says office 3 acquisitions and retail 2 acquisitions. We may have mistaken in the first half presentation, it said 4 for office and 1 for retail, should have said 3 and 2, my apologies. So we've corrected that today in here.

You can see that most -- we have been sellers in hotel -- of hotels. It's very interesting. In the long run, Japanese hotels are possibly perfectly fine. Got competition from BNB sorts of alternative business models. The reality of the last year has been biblical levels of things going wrong in terms of natural disasters, a very, very serious -- and a huge drop off inflows of Korean tourists, which are the #1 source of arrivals in Japan. So kind of everything going wrong in the hotel market, NOI has been impacted. And so nonetheless, they are very, very strong base for our Japanese hotels. So thank you. We were happy to sell hotels as we think are very good levels.

The other thing you'll see is on the residential, where we are not only the most active. The acquisitions are almost entirely Ichigo Owners. So I'll touch it on the next page, but the business model is prime Tokyo residential. This is very, very durable. Residential is the most [defensible], well, as you know, of all the real estate asset class is. It's a wonderful way to substitute for a minus 6 basis point return on a JDB you own. Prime Tokyo residential at kind of 300 basis points or something like that.

I'll also point out that on the other category down below, this is primarily self-storage on the acquisition side. As you know, we have, we think, one of the best self-storage. It's all internal, highly automated, air-conditioned, beautiful self-storage business.

Page 18 points to -- this is really an opportunity for us to talk through how our core sustainable real estate business, which is Ichigo Estate standard as that compares to the owners, sustainable real estate business. You can see that both entities transacted and residential assets in the third quarter. Slightly bigger on the part of Ichigo estate. The key difference is the holding period in Ichigo estate, which is our core SRE business, was 5 years. The gross profit margin reflected overwhelmingly the much more work we have done to grow the value of assets during that period. And on the other -- on the right-hand side of the page, you can see the owners' activity, which is a holding period of only about 0.5 year and a gross margin about 15%. By the way, I mean, we target only a 10% margin in this business. We're delivering right now 15%. It just tells you desperate hunger for really good assets in the good locations which Owners have been providing.

The other 2 things that have happened, and we are definitely trying to go with as many birds as possible with one stone. We've also used the Ichigo estate transaction to win a long-term asset management mandate with a very large, very sophisticated global investor. So we're very happy with that. And on the Owners' case, Owners has clearly been a broadening of our sales channel and a kind of a diversifying and therefore stabilizing new elements to our sustainable real estate business.

Page 19 discusses what's going on with the ongoing kind of value-add activity we're doing at Tradepia Odaiba, which is the biggest asset that we own. We paid about $300 million for it a couple of years ago. That -- I mean it's gone enormously well. I was asked -- we were asked on the Japanese language call, analyst call, a couple of -- I guess, 2 hours ago, about what's going on in this asset and what we think our future views are on earnings. And a quite simple answer is, when we sell this asset, we will have these massive earnings. To be clear, we have grown NOI during our holding period, which I think at this point is 3 years, it could be 4, over 50% in a period where cap rates have compressed. So we bought this as a 4% cap, it's now a 6% cap. And now we put $300 million into it. It just going to be the year we sell this asset. And at some point we will. It's going to be massively earnings and cash generative.

So -- but we're not done. I mean we own that asset. We're going to continue to do more work there. As you know, one of the hallmarks of what we are is we are an owner that likes to be intimate with our tenants. In other words, not like most owners who never want to see the tenant and most tenants who don't want to see the owner, right? So we want to be there for our tenants. So we've done -- we continue to do ongoing tenant activity. A recent survey. We did all this work based on the previous survey results. There's more things that they think we can do at the asset. That's great. We're doing all those types of things we can be of use to the tenants and the community.

Turning to Page 20. We have 3 listed investment corporations, 2 REITs, and the Yieldco continue to work on behalf of all those shareholders. I think the -- probably the highlight is in the center of Ichigo Hotel, which we think is trading very cheap. And one of the things you should do, if you're nonconflicted, actually work for your REIT shareholders, if you think your assets are being underpriced by the public market is you sell them. And so there is an ongoing sale program at Ichigo Hotel because it's trading below NAV. And what we think NAV is, as I spoke to earlier, probably underprices the value of the assets. So that -- the NAVs are based on third-party appraisals. So there's an ongoing sell program there, which we think is very much of a benefit of the REIT shareholders. And also have to speak to, okay, this is so clearly a monetization on behalf of shareholders. It's -- it is possibly a way to also drive up the share price.

Turning to the Clean Energy business. We'll continue to grow rapidly. We have brought up 2 new plants online this month at -- feed-in tariffs, JPY 36 and JPY 32. As you know, right now, the feed-in tariff is JPY 14. So these are -- these 2 continue to drive supernormal returns for you, our shareholders and investors.

On Page 22, shows the road map as what happened year-to-date. So what we'll do 2x in terms of the megawatt growth this year relative to last year.

Page 23 speaks to what we're doing in the hotel space. This is all -- we think it's very, very important. As I said earlier, we need to be better, and we need to be differentiated in delivering better, of course, because that's how you get to be better. So we have a 39-hotel platform right now. It's not on the page. But as you know, one of the biggest successes we've had over the last 2 years is the rollout of a new hotel brand, called THE KNOT. It is going extraordinarily well. There are 2 KNOTs right now in Tokyo and Yokohama, massively outperforming the market, year-on-year growth in NOI is enormous. We have plans to -- and we're proceeding with putting KNOTs into, let's say, support Hiroshima and Fukuoka. So more will be coming. We announced yesterday with a PR release. So policy was just in Japanese, but that we are introducing another brand, called The OneFive. It's the OneFive Villa Fukuoka. So it's -- we're introducing a slightly -- The KNOT brand is basically $100 to $200 a night. And instead of just having a cheap box, it's a very high-quality experience, which is why it's going so well. Full language support for visitors overseas, massive inbound. And not just kind of Asian, but global inbound. Significant North American European component of visitors at THE KNOT, particularly in Tokyo Shinjuku.

The OneFive brand is more -- it's simpler. It's more of a budget brand. It's basically going to be kind of $70 to $100 a night. But as always, we do things that are different. I mean why would you want to be at the OneFive and the OneFive [indiscernible]. So Ichigo -- hope I'm not taking you too much into a rabbit hole, but Japanese has lots of homonyms. Very few sounds kind of like Hawaiian. So when you say a word, it can mean a lot of things. So Ichigo can mean Ichigo from Buddhism, which is our Ichigo, can also mean strawberry. It can also add -- ichi and go mean OneFive. And so we've called this the OneFive, which is essentially fun, so we are. This particular hotel is -- what is distinctive of about that? Because we want to offer a distinct and unique experience to our visitors, is that it is run by a patisserie. And so it has this incredibly delicious bakery and the guest can choose whatever they want. It opens on February 1 and if you're going to Fukuoka, if you want a low cost, super high-value experience relative to the price point, you are welcome to OneFive Villa Fukuoka.

The other thing that's here that we should speak to is we did buy a hotel operator. It's a nonasset business, early in the year. It speeds up decision-making and reduces cost. We also think it uses -- it will provide effective testbed. One -- as you know, we primarily operate through operators. We're very hands-on owner, but we've mostly not chosen to actually own the operational element of the business. We understand it's asset-light, also means you're managing lots and lots of people. And we've chosen to try to be kind of 200 people generating among the highest OP per head of any company in Japan. But we also came to realize that we don't have our own operator, when we go to our stable of operator partners, and we talk to them about stuff like, yes, it could be possible. So we wanted to have something where we can actually directly test things ourselves. And that's what Hakata hotels is.

Also, we continue to move forward with our artificial and base revenue management system. We announced today after the close that we had signed up. We had already signed up the biggest online travel, it is the wrong word, but connector and for hotels in Japan. We brought in #2 and #3 today, also. We'll continue to expand the data and number of the hotels are going through the system. It is driving, at hotels, we've introduced revenue growth of 10% to 40% Propera. It is a very, very big breakthrough. We think we're getting close to the point. This is, again, an element of Ichigo. We do not want to overpromise. And so probably in the sense we underpromise. We don't promise. We just going to say, hey, we're doing something in the [ ag space ]. And then people spend a couple of years trying to figure out, if it's going to be valuable. We're thinking we're getting, at this point, some pretty good incoming evidence that this could be very, very valuable for you. Meaning that is potentially a driver, not only returns in our own hotels and the hotels we manage, but an ongoing as we began to sell it externally, a brand-new revenue stream, completely unlinked to the real estate market with a winner-take-all kind of -- we have the best and the best capabilities, and we can allow hotel operators that generate so much more return from the hotels that we will be able to participate in the growth of value that occurs there. So hopefully, we'll be able to provide more details on that for you in the next 6 months.

Page 24, our -- this is much more earlier days. I mean we've been selected as the operator of the Yokosuka Port market, well, which is an area in Tokyo. We'll have to go through and kind of verify how we're going to take this forward. There's an agricultural theme park that we're also working on. These are, again, kind of opportunities to figure out what can be done. You should expect very high returns on capital from because that's what we do. But is example of us, continue to experiment. To be Ichigo is to make small moves, see and test areas, see what more can be done if we decided it's productive, we can expand pretty rapidly.

Page 25 touches on the J.League Shareholder program that we began this year, that's been very successful. We have 55,000 shareholders among, both Ichigo ICH 637 this phone call and also the 3 listed entities. 7,000 of them registered for this program. So that's a 13% yield with basically almost no publicity. We end up having about 750 of our shareholders going to games, courtesy of Ichigo, J.League matches all over the country. We had -- we also had special events for children for them to kind of go onto the pitch and meet the players and carry flags onto the field, all sorts of things And it's been very, very successful. And it started kind of mid-season. So next year, we ought to have even higher throughput in terms of our shareholders being able to participate in something that's really pretty real and pretty special.

And finally, we -- on Page 26, we did complete the share buyback that we announced earlier in the year. As you know, we've started it, but didn't complete. And of course, when we announce a buyback, we intend to complete. So we took a second shot at it and fully completed. And as you can see over the last few years, we bought back about 5% of our shares.

So those are the prepared remarks. And at this point, I'm happy to take questions or any feedback.

[Scott Callon, executive]

[Operator Instructions] But anybody on the line who has anything that they want to bring to us, we're grateful to have you with us. [Operator Instructions]

Greg, I think you're on.

[Unknown Analyst]

Yes. Scott, this is [ Greg ] at Point72. One quick question, please, on regarding Ichigo Owners and the residential program. As you mentioned, this seems to have been quite strong over those past months. Could you perhaps highlight what are the drivers that continues to generate good turnover from the point of view of the client? Is it just normal kind of push Hoboken people wanting to put money to work? Is it related to inheritance? What are the drivers that you see generally looking among your clients? And how those drivers kind of changing over time?

[Scott Callon, executive]

So [ Greg ], one of the things, and thank you so much for joining. One of the things that has become more clear this year is an increasing global participation in Japanese real estate. And so the implication of that is actually, the owners clientele has shifted. When we started 3 years ago, it was almost entirely domestic, high net worth and cash for its corporates. This year, it will be overwhelmingly global institutional investors. So a complete [indiscernible]. And so it is not actually Japanese inheritance tax. It is -- we want really good assets. And to be clear, Owners only does Central Tokyo, new residential. I mean it's something we've chosen to specialize in because we felt comfortable that it would have ongoing kind of robust demand. No matter what the circumstances, it's defensive. And -- but the clients have shifted to our global institutions.

[Unknown Analyst]

And what kind of cap rates would they be willing to buy at given the current circumstances?

[Scott Callon, executive]

High 2s to low 3s. Well, yes. We have a huge book of earnings sitting in our balance sheet right now. As you know, we bought more in Owners this year. It's not -- and we -- so we're substantial in the sense of what we bought this year. It's not because we're not able to sell them. We just kind of work you through carefully, who are going to sell the assets to as a recent example, but there's been very substantial cap rate compression.

[ Richard ], we registered as you being online, but you're clearly not.

[Unknown Analyst]

Sorry, so Scott -- and congratulations on the results. Regarding the hotel competition, so you are very confident in slowly expanding THE KNOT and the OneFive hotel operations. But how do you see the competitive environment with OYO and APA and -- just in the hotel business, generally?

[Scott Callon, executive]

Well, OYO has kind of blown itself up, I mean I don't want to speak to it, everywhere in the world. But that's not really an issue. Look, I mean, the issue is there has been simultaneously an increase in supply and a drop-off of demand. And the drop-off of demand is related to, as I say, both the national disasters and particularly the impact on Korean inflows. And the key is you need to have something differentiated. So we have 2 things that are going on that are very powerful that we think are differentiating. One is the rollout of these new brands, but that's more limited, although THE KNOT terms have been explosive. I mean they've been phenomenal. But more powerfully, I think, in the long run is probably PROPERA, the AI system. I mean we're literally taking into hotels and driving revenues up 10% to 40%. And that's like magic. So that ability to do that, to buy a hotel,that somebody else owns and to take the revenues up at that level is really very, very powerful.

[Unknown Analyst]

Okay. And then that's in a way also competing with the OYO promise of applying AI and then really rolling out a standardized format extremely quickly and using AI to basically improve the revenues and the returns?

[Scott Callon, executive]

Yes, that's right. I mean they're part of this offering here. We take them seriously. But -- yes, it's -- we're not experiencing anything particular in terms of competitive right at this point.

[Unknown Analyst]

Yes, because the hotels using PROPERA will keep their own identity. It's not like converting everything into one brand.

[Scott Callon, executive]

That's right. And so if you have a power brand, you want to try to push the brand. I mean there's -- I think we're all aware. I'm not going to comment on OYO, but we all aware what's happening globally. And so clearly a big headwind for them.

Thank you. Okay. I think we're done. Thank you, everybody. We really appreciate your time. It's an honor and a privilege to work for all of you. Have a very good day.