Teijin Ltd

TSE:3401

Earnings Call Analysis

Company's ROE Decline and Recovery Plan

The company observed a significant sales decline due to a sudden market slowdown and inventory adjustments. They are shifting to higher profitability products to improve the sales mix, resulting in a positive spread. Challenges in the healthcare division are being addressed by focusing on rare diseases and optimizing resource structure after licensing three hormone drugs. The firm's declining stock price and ROE, below the cost of capital, are key concerns. Measures to improve profitability, tweak the portfolio for growth, and establish robust management to regain credibility and meet market expectations are part of an upcoming midterm management strategy announcement in May.

Company Returns to Profitability with Focus on Improving Operational Efficiency

After a challenging period, the company has seen a turnaround, achieving a net income of JPY 3.5 billion for the first nine months of the fiscal year—a notable improvement from the previous year's loss. This uplift comes even as net sales remained relatively stable at JPY 759.6 billion, suggesting an emphasis on cost management and operational improvements. The company also projects future operating income to rise by nearly 40%. Nevertheless, external factors such as one-off contract fees and competition from generic drugs have resulted in a downward revision of both operating and ordinary income forecasts.

Materials Business Experiences Mixed Results Amidst Market Challenges

The Materials business shows a dual narrative with an improvement of JPY 8 billion in operating income, yet continues to bear losses at JPY 5.8 billion. Factors such as a recovery from a factory fire in the Aramid business and insurance income have provided some respite. However, declining sales volumes and strikes have dampened the performance, leading to a downward revision in the operating income forecast. Improved profitability measures and stabilized natural gas prices are bright spots that point towards resilience within the segment. Specifically addressing the Aramid and Composites subsegments, there are expectations of year-on-year improvements, albeit tempered by market and operational setbacks such as long-lasting effects of a UAW strike.

Healthcare and IT Segments Demonstrate Divergent Trajectories

The Healthcare segment showed a pronounced decrease with a JPY 19.2 billion drop in operating profit, a hit undeniably linked to in-licensing duties for pharmaceutical products and the introduction of generic competition to their mainstay drug, reflecting in a limited operating income of JPY 1.8 billion. Contrasting this, the IT segment enjoyed strong sales growth, especially in Internet and Business Solution fields, resulting in a rise in profit by JPY 0.9 billion to JPY 6.4 billion in operating income. In the broader view, while there have been challenges and expenses like increased interest costs, the company benefited from extraordinary income and has seen an overall upswing in its financial position with total assets now standing at JPY 1,284 billion.

Strategic Measures Taken Towards Stabilizing and Uplifting Profitability

Mr. Uchikawa, the CEO, delineated strategic efforts aimed at enhancing profitability, particularly within underperforming businesses. Recognizing labor productivity as a key area of focus, measures have been implemented to mitigate equipment failure losses and enhance efficiency. While this has temporarily affected overall productivity, it underscores the company's dedication to restructuring and streamlining its management infrastructure to support long-term profitability goals. Although the profitability improvement measures are yet to reach the target of JPY 30 billion, the current progress of JPY 27 billion highlights the company's serious commitment to operational advancements.

Earnings Call Transcript 2024-Q3

[Eiji Ogawa, executive]

I will now go through the results for the first 9 months of the fiscal year and the outlook for the full year. For the third quarter year-to-date period, net sales were JPY 759.6 billion, almost unchanged from the previous year. Operating income decreased by JPY 10 billion from the previous year to JPY 4.9 billion, mainly due to the impact of one-off lump sum contract fee of in-licensed pharmaceutical products announced in last November. Resulting net income was JPY 3.5 billion, turning black from the previous year's loss, but the level of profit remains low. The full year forecast for net sales of JPY 1,030 billion is unchanged from the previous forecast. Operating income is expected to be JPY 18 billion, an increase of slightly less than 40% from the previous year, but a downward revision of JPY 17 billion from the previous forecast.

For the net income compared to the loss of JPY 17.7 billion in the previous fiscal year, we expect a net income of JPY 8 billion in the current fiscal year, which is a JPY 5 billion decrease from the previous forecast. The annual dividend remains unchanged from the previous forecast of JPY 30 per share.

As I mentioned earlier, operating income was down JPY 10 billion from the previous year. Ordinary income was JPY 7.6 billion, mostly due to the same factors as operating income. This is a segment-by-segment analysis of the increase and decrease in operating income. First, let's look at the materials business. Although it increased by JPY 8 billion year-on-year. The level of operating income itself is a negative JPY 5.8 billion, which means it continues to make losses. Analysis of the subsegments, aramid, resin, carbon fibers and composites are shown separately. Sales volume of each business has been declining. In the Aramid business, a factory fire occurred last year. Although we have recovered from the fire, the inventory has not increased as expected. The volume of sales has decreased due to a shortage of available stock.

In the Composites business, we have been affected by a decrease in demand for some programs and a decrease in orders from customers due to the UAW strike that occurred last fall. Meanwhile, a positive factor in aramid business includes stabilization of natural gas prices. We have recorded some income from insurance claims, which was also part of the timely disclosure. In the third quarter, the company recorded insurance income of more than JPY 5 billion. In addition, we have been implementing activities to improve profitability as announced in February last year. The Aramid, Composites and Materials business are all showing positive effects through them. CEO, Uchikawa, will later explain the details of profitability improvement measures.

In the Fibers & Products segment, sales were strong in both the closing textile and industrial materials sectors and operating income increased by JPY 1.4 billion from the previous year to JPY 9.3 billion. The Healthcare business saw a JPY 19.2 billion decrease in operating profit over the previous year, which resulted in a subdued level of JPY 1.8 billion. In the third quarter, we recorded the one-off lump sum contract fee of JPY 10.5 billion for in-licensed pharmaceutical products, which was announced in last November. This has a material impact on the earnings performance.

As we have mentioned in past forecasts, the entry of a generic version of FEBURIC, our mainstay drug, had an impact of about JPY 6 billion compared to the same period of the previous year. On the other hand, in the IT segment, sales in the Internet business field were strong. In addition, Business Solution field also performed well, resulting in a JPY 0.9 billion increase in profit over the previous year. This resulted in an operating income of JPY 6.4 billion. The other segment has been reclassified from this fiscal year. Although operating income slightly worsened by JPY 1.2 billion, sales in the battery materials field, mainly separators and in the implantable medical device field was strong. Although their profit was higher, the overall loss slightly worsened from the previous year due to increased costs associated with the launch of the CDMO business in the field of regenerative medicine.

This is the result of nonoperating income and loss, which was also part of a timely disclosure we made today. Equity and earnings of affiliates includes compensation to be received from a Brazilian subsidiary in connection with the settlement of a lawsuit. On the other hand, interest expense has been affected by the rate hikes in the U.S. and Europe and increased significantly over the previous year. As for extraordinary income and loss, which is also included in a timely disclosure, a portion of the insurance income to be received from the Aramid business related to the fire was recorded as operating income and some portion is extraordinary income. The booked amount through the third quarter was JPY 5.2 billion and JPY 5.8 billion, respectively.

As for impairment losses, we recorded a loss on goodwill of a North American company in the Composites business in the previous fiscal year, but we do not expect any significant loss in the current fiscal year. Meanwhile, a loss of JPY 6.9 billion is posted this fiscal year due to a sale of shares in Chinese subsidiaries in composite business. Regarding the financial position, total assets of the entire company increased by about JPY 40 billion to a level of JPY 1,284 billion, mainly due to an impact from foreign exchanges. The breakdown is shown on the right side. Main factor for increase is inventories, which was up JPY 30 billion. This is because of an ongoing inventory replenishment in the Aramid business. This concludes the results overview for the cumulative 9 months of the fiscal year.

From here, I will explain our full year earnings forecast. As mentioned earlier, net sales are projected to be JPY 1.3 billion, a slight increase over last year. We expect operating income to be JPY 18 billion, up slightly less than 40% from the previous year, and ordinary income to almost double. Compared to the previous forecast, operating income is down JPY 17 billion. Ordinary income is down JPY 12 billion and net income is down JPY 5 billion. By segment, forecast for materials improved by JPY 18.3 billion compared to the previous year. On the other hand, the negative JPY 15.7 billion for Healthcare is due to the impact of lump-sum contract fee for in-licensed pharmaceutical products. In addition, the sales of FEBURIC have been affected by the entry of generic alternatives, resulting in a significantly lower forecast over the previous year. Although the overall forecast exceeds the performance of last year. If you compare it to the previous forecast, it is lower by JPY 10 billion in materials and JPY 7 billion in Healthcare business. In the Materials segment, we have seen improved profitability and stabilized gas prices compared to the previous year. We expect year-on-year increase of operating income in the Aramid and Composite subsegments.

Compared to the previous forecast, it has been revised downward mainly for Aramid and Composites subsegments. In the Aramid business, the sales volume for auto bills, mainly for tire applications and some other industrial applications have been declining since the third quarter due to inventory adjustments by customers. And we have made a downward vision in those areas. As for composites, the impact of the UAW strike last fall lasted longer than expected and equipment breakdowns recurred at some plants, preventing stable operations. The downward revision takes into account these factors. Regarding the Fibers & Products segment, performance has been mostly favorable. As a result, the previous forecast remains unchanged, which indicates a significant profit growth over last year.

Regarding health care, as I mentioned earlier, we did not factor in one-off lump sum contract fee in the previous forecast. On the other hand, we now expect a licensing income in the fourth quarter, which was not fully incorporated in the previous forecast. Hence, the net effect is a downward revision of JPY 7 billion. As for the changes compared to the previous fiscal year, the main factors are those that I explained earlier. As for the IT segment, since the performance shows a favorable trend, we have left the operating income forecast unchanged at JPY 9.5 billion. In the other segment, we have revised the forecast slightly upward from the previous forecast, taking into account strong sales of separators.

This concludes my presentation of the cumulative third quarter results and full year forecast.

[Akimoto Uchikawa, executive]

This is Uchikawa. I will now report on the progress of reforms to improve profitability. The 2 pillars of this project are to improve the profitability of the 3 underperforming businesses and to transform the management structure of corporate offices and headquarter staff to support this improvement. Compared to the usual target of JPY 30 billion or more, the effects of profitability improvement measures are only at JPY 27 billion as of today, as explained by Ogawa on Page 14.

Let me start with the Composites business. The first of the 3 underperforming businesses. As you can see in the table, we have taken 2 measures to improve profitability. First one is concerning the decrease in labor productivity due to equipment failures at some plants and support by nearby factories to cut the loss. Because we did this at a time when labor availability was quite tight, it hampered the overall productivity of [ Teijin ] North America, which needs to be recovered. These consist of the countermeasures of recovery from temporary factors. The second part is that we will pass on to our customers the cost increases that have occurred in the past fiscal year, such as unit labor cost, logistics costs and various other costs other than raw materials to the extent that it's beyond our own efforts or negotiate with them for potential withdrawal. For those that are not, we will negotiate with suppliers to recover some of the costs through purchasing and absorb the increased costs by efficiency improvement through automation and other measures.

This is countermeasure to reforms for profitability improvement. Our intention is to improve an overall profitability by JPY 19 billion. As shown here, number one pertains to restoration of pre covered 9 manufacturing capability in terms of costs and labor. For that, we had reported that it was on a recovery track with the exception of a few plants at the time before the UAW strike. Unfortunately, due to the strike, we have to start all over again. In addition, some plants have failed to repair and maintain their equipment, resulting in recurring breakdowns, which have resulted in significant delays in shortfalls. Meanwhile, the recovery of costs other than raw materials, which I mentioned earlier, is mostly achieved through various means. Furthermore, we promised to concentrate our resources on North America in order to do this, and we have completed the withdrawal from the China business earlier than planned. Here is a summary.

This is the bridge analysis of what I just said. Recovery of productivity to the level before agreement failures at some plants, the recovery from temporary factors was mostly on track. Unfortunately, the strike has forced us to lay off some of our skilled workers again. The newly formed engineering team was also disbanded, which led to equipment failure, resulting in the current situation where recovery from the temporary factor was significantly underachieved. There is no change in the fact that the profit improvement measures indicated in number two are generally being implemented. There are the projected earnings improvement effects. The downside is the recovery from temporary factors, which is significantly lagging behind.

In addition to this, labor costs in the U.S. have risen even more this fiscal year. And as Ogawa mentioned earlier, there has been a UAW strike that lasted more than a month. It forced us to [ free all our ] workers who got more proficient. I said that we managed to make some recovery, but the impact of the strike was so extensive even for the top line decrease. In North America, additional costs were incurred due to quality issuance issues that arose in the previous fiscal year. This is outside of the scope of profitability improvement performance. On the other hand, we have been able to successfully launch new programs in Europe, which is showing a positive earnings trend. These are the circumstances to form the combined projection for fiscal 2023.

The Aramid business is a similar 3-storey structure. Number one, recovery from temporary factors from the fire incident last year; and number two, reforms for profitability improvement even before the fire as the productivity was already squeezed with some troubles, et cetera. In the [ condonation ] number two, which is centered on productivity improvement, we have tackled issues such as soaring natural gas and other raw material costs, especially in Europe, to boost our earnings capability. As shown with the circles on the right, recovery from temporary factors were already achieved in the second half of last fiscal year. So we are ahead of schedule. On the other hand, for the productivity improvement under the profitable improvement measures, we are unable to increase production as planned due to the unavailability of repair parts that require a long turnaround.

Because of the delays in this area, we highlight the status as yellow. In terms of earnings measures to stabilize gas prices through forward contracts, et cetera, and stabilize the price of diversifying gas and raw material suppliers have been more successful than expected. This offset the negative factors. The middle chart in the lower part of this page shows the production volume returning to pre-fire levels. The output from expanded lines as of the end of January was not yet at full capacity due to the effect, the procurement of the repair parts I just mentioned is not yet completed. Gradually, it is becoming fully operational in February.

This is the bridge analysis. As mentioned, the plan for recovery from the fire was formulated at the end of the third quarter in the previous fiscal year. Since the restoration was already completed ahead of schedule in the fourth quarter last year, the anticipated effect for this fiscal year has been slightly diminished. This means that it has already materialized in the last fiscal year. On the other hand, as indicated in number two, profit improvement measures through internal efforts, we struggled to source the required amount of parts with delivery delay, et cetera, due to the issues of suppliers. As I mentioned, our current forecast is that it is offset by the upward swing from natural gas price stabilizes, measures and other factors.

Outside of this, as Ogawa explained earlier, customers in Europe and China for automotive and industrial applications have been experiencing a sudden slowdown since the end of November. Our guess is that they probably had a substantial inventory of specialty materials from suppliers like us based on the difficulties they had experienced to secure enough volume during the pandemic. With the market slowdown, there was a sudden inventory adjustment, resulting in a significant decline in sales volume in the latter half of the third quarter. This is causing us to the negative effect. In terms of the spread, the material and fuel prices are stabilizing, while the production volume is suppressed. We therefore, trade a shift to higher profitability products as much as possible to improve the sales mix, this resulted in a positive spread.

Other factors include labor cost inflation in Europe, better-than-expected insurance income, a negative effect from initial inventory due to an accounting issue. Adding up all of those factors resulted in the forecast of Aramid business I just explained. The third and final area of profitability improvement is healthcare. In the Healthcare business, our challenge is not to achieve specific numeral target this year, but to show our readiness to reshape the business structure. To this end, as indicated in numbers one through three, we promised to focus on rare and intractable diseases through the utilization of our unique business platform created for home health care and licensed drugs for such diseases. We also promised to optimize the resource structure after the licensing arrangement is finalized.

Regarding this, as reported in last November, we have succeeded in licensing 3 hormone drugs. In addition, we have already made organizational changes in the sales division. And we believe that we are on track to accomplish what we have planned for this fiscal year. This includes the progress update of profitability improvement measures.

Today, I will share with you an analysis of current status on our action for management that is conscious of cost of capital and stock price. The stock price and PBR trends are shown on the left. It is clear that our share price keeps declining since its peak in fiscal 2017, and it continues to underform the topics. In terms of PBR, it has remained below 1x since fiscal 2017. Let's look at them in terms of ROE and cost of shareholders' equity. ROE on the upper right, unfortunately, has been declining after hitting the peak in 2016 through 2017, which is a similar trend to the share price. Currently, our ROE level is well below the CAPM-based cost of shareholders' equity. We have set our target a 10% ROE, considering the expected level by the market. Currently, it is way below that, and we recognize that this is clearly a major factor behind the sluggish stock price performance.

Meanwhile, let's assume that PB ratio is a multiple of ROE and PER. For the ROE part I already explained. We have analyzed the situation by looking at PER as medium- to long-term growth potential and decompose ROE to drill down where the problem lies. First, in terms of profitability portion of ROE, as I've already mentioned, this is significantly lower than the cost of shareholders' equity. And we recognize that this is a factor that a significantly lowered PB ratio. In terms of operating income, it peaked in 2017 and has continued its downward trend. Normally, aramid business should serve as the main earnings driver. However, due to production slump or disruptions, its profitability has been depressed, which is an overall drag.

In healthcare, the entry of generics for the market for mainstay drug for uric began in fiscal 2022. This caused a significant erosion of profitability. To offset this, we made great investments into composites business, but the loss in the business widened. It is already an indisputable fact that these 3 factors are the root causes for the declining ROE or stagnant operating income. We also recognize that the postal impairment losses is another factor behind low ROE. We also analyze the status of asset efficiency and financial position. In a larger sense, total asset turnover ratio has not changed much. Having said that, we will have to look at asset efficiency for each business one by one. Overall, we believe that this is unlikely to be the main reason for the decline in ROE.

In terms of the financial condition, our leverage is a little higher compared to industry peers, and our debt-to-equity ratio is also deteriorating. However, we believe that we are currently able to balance financial discipline and capital efficiency by actively utilizing interest-bearing debt while controlling the capital adequacy ratio. We do not see this as a factor in the large decline in ROE either.

In summary, as I have said, the main reason for the low ROE is the decline in profitability. And we believe this is due to the low profitability of the 3 underperforming businesses, as mentioned earlier. Hopefully, this clarifies some of our future path, especially with regard to healthcare business.

I think this answers some of your questions concerning the lack of revenue streams after the patent cliff of FEBURIC and lack of visibility. In any case, we recognize that improving and stabilizing the profitability of these 3 businesses is undoubtedly a key factor in improving ROE. We analyze the medium- to long-term growth expectations, which is PER in the same way. The chart on the left compares our PE ratio against TSE Prime section or industry average. It is clear that our PER, gray line, is lagging behind and inferior to the industry average and TSE Prime section average. In other words, we believe that the market does not see medium- to long-term growth potential on us.

One way to look at it is to consider the inverse of PER as the cost of shareholders' equity and to look at the equity spread with ROE. This is the figure on the right. The blue highlight indicates the size of equity spread. As you can see, it turned positive in 2016 following the structural reform, but there has been no spread since then. I think this is probably how we are unable to meet your mid- to long-term expectations. We recognize that one of the reasons for the decline in PER is due to repeated impairment losses and downward revisions to earnings. In fact, both last year and this year, unfortunately, we have been in a situation we have had to cut the guidance.

Another factor is that we have not been able to demonstrate the relevance of our current business portfolio as a growth driver for our company in a way that convinces the market. I also think that our management team has lost credibility in its ability to execute growth strategies. In addition, the recent trend of dividend cut may be another factor to disappoint our shareholders. We recognize that we must address these issues and come up with a management strategy that will earn the trust of our medium and long-term growth. We recognize that these are the major challenges of improving and stabilizing profitability and are developing a management strategy that will gain the trust of our medium- to long-term growth. To support them, we need to rebuild our intangible management base.

With these 3 major challenges in mind, we will proceed with deliberations in order to present our new midterm management plan to you. Let me elaborate on some of the main agenda. As for improving and stabilizing profitability, I just explained the plan and progress to date. Our job is to complete the plan and evaluate the outcome as promised. Before we started this endeavor, we declared to you that we were fully committed in executing at all costs. If [indiscernible] that the issues persist and the business is unprofitable, we will take required actions that we had promised to take by carefully reviewing the results. On the other hand, for those businesses that have been made successful improvements, it is important to take measures to put it back on recovery track. And we would like to present the strategy to the same. Furthermore, in order to demonstrate their medium- and long-term growth potential, we must clearly state the portfolio that we should aim for. As we promised last February in the medium term, we will look at the achievement status of the above-mentioned profitability improvement plan and formulate a proper action plan based on a review such as exiting from or downsizing in profitable businesses and addressing the nonpriority businesses appropriately for the best owner perspective. Alternatively, we plan to properly specify where we will do our best on that basis and present concrete plans for investment in those areas.

Of course, this includes presenting an underlying capital allocation policy and shareholder return measures. Again, we recognize that the management base to support this is not so robust now. The first step is to redefine Teijin's purpose [indiscernible] with our employees on the domains that we are determined to focus. We should promote this effort internally to build a strong organization and enhance its execution capability. At the same time, we should establish a bit more rigorous governance structure to further strengthen management. In order to promote these reforms and in general, to deal with unprofitable businesses or nonpriority priority businesses, I believe that it is essential for us to review our in capital strategy. We also intend to show you in parallel, how we will develop and make the most of our people in areas where we made a strong commitment to pursue. We are preparing a midterm management plan based on these considerations, which we plan to announce in May.

This concludes my part on the progress of our action plan for profitability improvement and for realizing management structure, which is conscious of the cost of capital and stock price. Thank you for your attention.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]