Komatsu Ltd

TSE:6301

Earnings Call Transcript 2020-Q2

[Unknown Executive]

Hello. Thank you for joining us despite your busy schedules. We will now start the fiscal 2019 Q2 results meeting. First, let me confirm the materials we will be using. We will present based on the handout entitled Business Results for 3 and 6 Months Ended September 30, 2019. If you don't have a copy, please contact a staff member nearby.

It seems that everyone has a copy. So now without further ado, I'd like to introduce who is here today. Sitting in the middle is Mr. Hiroyuki Ogawa, our President and CEO; on the right is Mr. Takeshi Horikoshi, Executive Officer and CFO; and on the left is Mr. Takuya Imayoshi, Executive Officer and General Manager of the Business Coordination Department. And I will serve as emcee. I am [ Takahashi ] from the IR department.

First, Mr. Horikoshi will walk you through second quarter and first half results, followed by an explanation of the outlook for the second half of the year by Mr. Imayoshi. We will have a Q&A session after the presentations. The meeting will be 90 minutes long. Taking pictures, videos or audio recordings of the results meeting is strictly prohibited. Thank you for your understanding.

Now I'd like to hand over to Mr. Horikoshi, CFO, who will explain Q2 and first half results.

[Takeshi Horikoshi, executive]

Hello. I am Horikoshi, CFO, at Komatsu. I will explain the overview of the results for the second quarter of fiscal 2019. First, I'll talk about the overview of fiscal 2019 first half results on Page 4. Currency rates are JPY 107.9 to the U.S. dollar, JPY 120 to the EUR and JPY 15.5 to the Chinese renminbi. The yen strengthened across the board against the dollar, euro and renminbi compared to the same period a year ago. Although it's not shown on the slide, the yen also strengthened against the Australian dollar, the South African rand and the Russian ruble.

Consolidated net sales for fiscal 2019 Q2 declined by 10.2% from the corresponding period a year ago to JPY 603.7 billion. Operating income dropped by 35.5% to JPY 67.2 billion. The operating income ratio decreased by 4.4 points to 11.1%. Consolidated net sales declined due to the negative impact from lower sales volume and currency impact. Operating income decreased due to volume decline and the change in geographical composition. Net income attributable to Komatsu Ltd. fell by 31.8% to JPY 42.5 billion.

On Page 5, I'll talk about segment sales and profit results. Sales for the Construction, Mining & Utility Equipment segment declined by 9.3% from the corresponding period a year ago to JPY 550.1 billion. Segment profit dropped by 36.1% to JPY 61.1 billion. Sales declined due to the negative impact from volume decline in FX. Profits decreased due to reduced sales volume and change in geographical composition.

Revenues in the Retail Finance business advanced by 15.3% to JPY 17.5 billion. Segment profit declined by 16.7% to JPY 3.4 billion. Revenues advanced supported by an increase in average asset balance. Segment profit fell, mainly reflecting the absence of reversal gains for doubtful accounts in China, which were recorded for the corresponding period a year ago.

Sales for the Industrial Machinery & Others segment dropped by 28.8% to JPY 39.7 billion. Segment profit fell by 22% to JPY 3.4 billion. Both sales and segment profit declined due to reduced sales of presses and machine tools to the automobile industry as well as a sales decline of Excimer laser-related products in the semiconductor market.

Page 6 shows sales by region in Construction and Mining & Utility Equipment. Sales in Construction and Mining & Utility Equipment were JPY 548.7 billion, down by 9% year-on-year. Sales increased in Japan, CIS and Europe, but decreased sharply in Asia, Oceania and Africa, and overall sales decreased. As servicing strategic markets in Asia, Oceania and Africa dropped, the ratio of sales in traditional markets increased from 45% of the same period of the previous year to 51% this year.

From Page 7, let me show you the highlight of the first 6 months in FY 2019. Exchange rates were JPY 109 to $1, JPY 121.6 to euro, and JPY 15.8 to renminbi. Yen appreciated against all currencies of dollar, euro and renminbi year-on-year. And although they are not listed here, yen appreciated against Australian dollar, South African rand and Russian ruble as well.

Net sales were JPY 1,213.4 trillion, down by 7.9% year-on-year due to volume declines and negative impact by FX. Operating income was JPY 141.9 billion, down 29.1% year-on-year due to volume decline and regional mix. Profit ratio was 11.7%, down by 3.5 points.

Net income was JPY 90 billion, down by 28.2% year-on-year. Interim dividend per share remains unchanged from the initial announcement of JPY 55. It increased JPY 4 from the interim dividend of the previous year.

Page 8 shows segment sales and profit. Sales in Construction, Mining & Utility Equipment were JPY 1,111.6 trillion, down by 7.4% year-on-year. And the segment profit was JPY 129.8 billion, down 29.4% year-on-year. Sales decreased due to reduced volume and the differences in FX rates. Profit decreased due to reduced volume and regional mix changes.

Revenues in retail financing increased to JPY 34.7 billion, up 18.2% year-on-year. But the segment profit decreased to JPY 6.8 billion, down 28.9% year-on-year. Sales increased due to increase in average asset balance and segment profit decreased due to absence of reversal of allowances for doubtful accounts in China, which were recorded in the same period of the previous year.

Sales in Industrial Machinery & Others were JPY 73.7 billion, down by 24% year-on-year. And segment profit was JPY 4 billion, down 46.2% year-on-year. Both sales and profit declined due to reduced sales of presses and machine tools for automotive industries as well as declined sales of Excimer laser-related products for the semiconductor market. Variants analysis by segment will be explained later.

Page 9 shows sales by region in Construction, Mining & Utility Equipment. Sales in Construction, Mining & Utility Equipment were JPY 1,109.3 trillion, down 7.2% year-on-year. Sales increased mainly in Japan, CIS and Europe, but they dropped sharply in Asia, China and Africa, and the entire sales declined. As sales in strategic markets of Asia, China and Africa, among others decreased, the ratio of sales in traditional markets increased from 44% of the previous year to 49% this year.

Page 10 shows the increase and decrease of sales and profit for the Construction, Mining & Utility Equipment segment. Sales impact [indiscernible] from selling price increase. However, due to the impact of lesser volume and negative ForEx, sales dropped by JPY 88.9 billion from the corresponding period a year ago.

Segment profit, as was with sales, enjoyed effects with the raised selling price. Volume decrease and geographic differences were contained against our initial forecast. However, fixed costs rose due to strategic investments for growth, and the segment profit fell by JPY 54.1 billion versus same period last year. Segment profit ratio decreased by 3.6 points versus same period last year and stands at 11.7%.

Page 11 describes retail finance assets and profits. Assets mainly due to ForEx rates dropped by JPY 11.6 billion from the previous fiscal year-end. Revenues from new contracts increased from the corresponding previous year, mainly due to sales increase in North America and Oceania. Revenues increased due to an increase in average asset balance. Segment profit declined because of no longer reflecting reversal allowance of doubtful accounts in China. These were acknowledged in the corresponding period a year ago.

Page 12, the sales and segment profit for the Industrial Machinery & Others segment. Sales for this segment fell 24.0% and landing at JPY 73.7 billion due to sales decline in presses and machine tools for the automotive industry as well as Excimer laser-related products for the semiconductor market. Segment profit was JPY 4 billion, a minus of JPY 3.4 billion versus the same period last year. Segment profit ratio was 5.5%, a decline of 2.2% from the previous year same period.

Allow me to move to Page 38 to describe the book-to-bill ratio for industrial machinery. This page depicts the evolution of book-to-bill index for industrial machinery. The graph shows orders received divided by sales for the immediate 6 months. Komatsu Industries covers sales and service for press and sheet metal machinery, the index exceeds 100%. Komatsu NTC handles the design, manufacturing and sales of transfer machines, machining centers and crankshaft processing machines. The automotive industry has deferred investments, thus resulting in a drop of orders, and the index is consequently below 100%.

Now using Page 13, I will explain our balance sheet. Total assets is JPY 3,637.5 trillion, a decrease of JPY 600 million versus the same period last year. For accounts receivable, debt recovery has advanced. However, containing stock at agents and in light of sales of mining equipment, we elevated our inventory, and our inventories increased versus in last year. The new accounting standards have been applied. And under other assets, operating lease right-of-use assets has increased since the end of the last fiscal year.

Interest-bearing debt increased by $20.6 billion since year-end and stands at JPY 951.3 billion. Shareholders' equity ratio is 49.2%, a decline of 0.7 points since year-end. Net D/E ratio increased by 0.01% to 0.44%. That is all.

[Unknown Executive]

Next, Mr. Imayoshi, General Manager of the Business Coordination Department, will speak about the outlook for fiscal 2019.

[Takuya Imayoshi, executive]

Hello, I'm Imayoshi from the Business Coordination Department. From here on, I'll elaborate on the outlook for fiscal 2019 and the condition of our main markets. Based off the results of the first half and current conditions, we have revised the outlook for the fiscal year.

The outline of our projections for fiscal 2019 are shown on Page 15. Results for fiscal 2018 are shown on the very left of the chart, followed by the latest projection for fiscal 2019. On its right are the initial projections. The year-on-year comparisons are made between the latest fiscal 2019 outlook and fiscal 2018 results.

In the first half of the year, sales went below projections, especially in China. In the second half, we expect demand to be softer than projected as the external environment will remain uncertain, including the outlook of the ongoing China-U.S. trade war. We've also reassessed foreign exchange rate assumptions applied to our forecast, and hence, we'll revise sales and profit projections for the year ending March 2020, from the initial projections announced on April 26.

Regarding foreign exchange rates, second half rates were revised, assuming JPY 100 against the U.S. dollar, JPY 111 against the euro and JPY 14 against the renminbi. This will change the average full year currency rate assumptions to JPY 104.5 against the dollar, JPY 116.3 against the euro and JPY 14.9 against the renminbi.

Consolidated net sales have been revised down by JPY 145 billion against initial projections to JPY 2,472 trillion. Operating income was also revised down to JPY 279 billion, a decrease of JPY 58 billion from the original projection. The operating income ratio is expected to reach 11.3%. Net income projections have also been revised down to JPY 180 billion.

We will keep our dividends at JPY 110 a share, which is in line with what was announced at the beginning of the year. As a result, the consolidated dividend payout ratio will increase to 57.7% from the initial projection of 48.3%.

On Page 16, I will talk about the projection for segment sales and profits. Regarding the Construction, Mining & Utility Equipment segment. First half sales went below projections in Asia, especially China. As for the second half, sales were revised down by JPY 129 billion to JPY 2,230 trillion due to softer-than-expected demand and FX assumptions being reassessed. Segment profit was also revised down from the initial projection by JPY 58 billion to JPY 253 billion.

Retail Finance sales were revised down by JPY 1 billion to JPY 69 billion due to less sales in North America and the oceanic region, et cetera, leading to a decrease in new originations. Segment profit will be kept as originally projected at JPY 13 billion.

For the Industrial Machinery & Other segment, we have revised the sales projection down by JPY 18 billion to JPY 189 billion against the backdrop of lower general projected machine tool sales to China as well as lower capital expenditures by chip manufacturers. Segment profit has also been revised down by JPY 6 billion to JPY 15 billion. The analysis of changes from the previous fiscal year in the respective segments will be explained later.

Page 17 shows the projection for sales by region for the Construction, Mining & Utility Equipment segment. Year-over-year sales, mainly in Asia, North America and Africa are expected to decline. The sales decline in North America is due to foreign exchange impact and distributor inventory adjustments. Due to the underperformance of Asia, which includes Indonesia and Africa as well as a decline expected in mining equipment sales, mainly in the CIS region, we revised down the sales outlook. The traditional market ratio is expected to increase to 50% from 46%.

Page 18 shows the causes of differences in projected sales and segment profit. Sales is projected to decline by JPY 245.9 billion year-over-year, due to volume decline and negative FX impact despite sales price increases. Even when comparing against the initial projection, the outlook was revised down due to sales volume decline and FX negative impact. Segment profit is expected to drop by JPY 112.3 billion due to sales volume decline, negative FX impact and worsening geographic composition as well as a rise in strategic fixed cost investments, although curtailed against initial plans.

Page 19 shows projection of Retail Finance. We project that assets will decrease from the previous fiscal year-end, mainly due to FX rates. Revenues from new contracts will decline year-on-year due to FX impacts and reduced revenues, mainly in North America and Oceania.

Revenues rerate increased due to an increase in average asset balance, but its growth will be slightly less than the initial forecast. Segment profit will decline due to the absence of reversal of allowances for doubtful accounts in China, which were recorded in the previous year, but it remains unchanged from the initial forecast.

Page 20 shows projection of sales and segment profit in Industrial Machinery & Others. Sales will decrease by 7% year-on-year to JPY 189 billion, and segment profit will decline by JPY 3.6 billion to JPY 15 billion. They are revised down due to machine tool sales weakness for China in Komatsu NTC, which was weaker than the initial forecast and reduced capital investment by semiconductor makers in Gigaphoton. Segment profit will be JPY 15 billion, and profit ratio will be 7.9%.

Page 21 shows the actual and projected demand for 7 major products. Demand for 7 major products in mining machinery are shown here, and the second quarter number is our estimated interim figure. In the first half of FY 2019, demand presumably declined 5% year-on-year. While demand in Japan and North America increased, demand in strategic markets such as Indonesia was lower than forecast.

In the second half, demand decline in China and Southeast Asia will be moderating, but the prospect of external environment, including U.S.-China trade friction, still remains uncertain and will be weaker than our forecast. Therefore, we revised down the full year demand projection from the initially forecasted minus 5% to 0%, to minus 8% to minus 3%.

Following pages will show you the major market conditions. Page 22 shows actual and projected demand in Japan. In the first half of FY 2019, demand in Japan presumably increased 28%. It was pushed up by the recovery from the reactionary drop of demand surge prior to the new emission control enforced in September 2017 and the strong demand for infrastructure construction as well as the demand spike prior to the consumption tax hike.

In the second half, the recovery from the reactionary drop already started in the second half of the previous year. Year-on-year figure will return to negative. Full year demand forecast remains unchanged at 0 to plus 5%.

Page 23 shows actual and projected demand in North America. In the first half of FY 2019, demand presumably increased by 7% year-on-year. Demand for construction equipment remained strong mainly for residential housing, and demand for mining continued to be steady, marking growth for 10 consecutive quarters.

By nation, America has been steady, but demand in Canada has been negative for 3 consecutive quarters showing sluggishness. Demand in North America continued to be stronger than forecast, and we revised up the full year demand to plus 5%.

Page 24 shows demand in Europe. In the first half of FY 2019, demand presumably remained flat year-on-year. Demand in major markets such as Germany and France has been firm, driven by those for transportation infrastructures such as highways and railways. But due to the uncertain economic prospects affected by Brexit, demand in the second quarter turned to negative. However, given the latest firm infrastructure investment, we revised down the full year demand forecast from the initial plus 5% to 10%, to 0 to plus 5%. As European macroeconomic indicators have been rather weak as a whole, we will continue to monitor the demand trend cautiously.

Page 25 shows China market. Demand figure is for foreign makers. In the first half of fiscal year 2019, demand presumably declined 18% year-on-year. Domestic manufacturers increased their market shares, and economic uncertainty is enhanced due to prolonged U.S.-China trade friction. Under these circumstances, demand dropped year-on-year. It is a demand decline for 4 consecutive quarters since the third quarter of the previous year.

For reference, total demand growth of hydraulic excavators, including mini shovels, including the local makers in the first half FY 2019 was plus 4% year-on-year. Although policy for expansion of infrastructure investment was announced, future uncertainty in Chinese market still remains, and we will continue to monitor demand trend closely, watching the U.S.-China trade friction, among others. Latest full year demand projection was revised down to minus 20% to minus 10% as the first half demand was weaker than the initial forecast.

On Page 26, I will outline the outlook for demand in Southeast Asia. First half 2019 Southeast Asia demand dropped by 25% versus the same period last year. In the largest market, Indonesia, demand for construction equipment was impacted by the presidential election, and mining equipment demand was adversely affected by the drop in thermal coal prices. Demand in Thailand and the Philippines were deteriorated mainly due to the impact of elections. We expect a demand recovery for the second half in Thailand and the Philippines and the negative range in demand for Southeast Asia overall is expected to shrink. However, the weak demand in Indonesia from mining equipment is expected to continue. For the full year demand outlook, our initial projection of minus 10% to 5% is now revised to minus 20% to 15%.

Here on Page 27, demand evolution and outlook for mining equipment will be explained. 2019 first half demand is a 13% minus versus the same period last year. Indonesia saw a major decline in demand due to low thermal coal prices. In Africa, demand was strong for Southern Africa, but other regions were weak, and we see an overall decline from the corresponding period of last year. We anticipate a demand decline in CIS for the second half. Again, due to the drop in thermal coal prices. Note that the majority of declines will be in Indonesia and CIS. Other regions are expected to continue to enjoy strong growth. Projection for the full year remains unchanged at minus 20% to 10%.

Let me jump to Pages 36 and 37 to illustrate the status of book-to-bill for mining equipment. This shows the progression of orders received and sales. The graph shows new orders received divided by sales for the immediate 6 months.

Komatsu America produces and sells ultra large dump trucks. Orders recently was strong and index exceeds 100%. Komatsu Germany manufactures and sells ultra large hydraulic shovels. The recent index due to solid orders is slightly above 100%. Komatsu Ltd. is below 100%. This is due to decline in Indonesia's appetite for 100-ton class dump trucks.

Page 37 next shows KMC Mining equipment book to ratio. Recently trending at 100%, both orders and bill are solid. For 2019, first half sales due to Russia met coal and Central South America Panama copper mining equipment, both surface and underground increased like-for-like. The second half is expected to enjoy sustained growth mainly in North America and Central South America.

Now back to Page 28, I will explain sales of mining equipment. For the second quarter of FY 2019, mostly due to sales decline in Asia and Africa, sales dropped by 13% like-for-like and is JPY 237 billion. Considering the results for the first half along with recent performance, we have revised our full year projection by minus 11% versus the same period last year to JPY 941.9 billion. If we exclude ForEx impact, this is a decrease of 4% versus last year.

On Page 29, I will explain sales of parts. For the second quarter of FY 2019, sales of parts decreased by 6% from the same period last year to JPY 149.1 billion. If we exclude ForEx impact, it is minus 2%. North America saw an increase in sales, but Indonesia's demand for mining equipment overhaul was weak and sales declined. However, all in all, parts sales are strong, and this trend continues. Because of the low demand in Indonesia for overhaul, along with foreign exchange review for performance outlook, we have revised our full year forecast downward to JPY 582 billion, a decline of 7% from FY 2018. If we exclude ForEx impact, it will be a slight decline of 1%.

Moving on to the very last page. Since FY 2013, we have issued a commence report, which is an augmentation of our CSR report, environmental report and annual report on our home page. Starting from this fiscal year, for all of our stakeholders to facilitate deeper understanding of our mid-term management plan down to its value forward together for sustainable growth, we have put together an integrated report dubbed Komatsu Report 2019.

In this report, we focus on the value creation business model by circulating a virtuous cycle to improving earnings through our growth strategy, financial indices and overcoming ESG issues nonfinancial indices. We also include the President's message pertaining to our mid-term management plan, the CFO message relating financial strategy and management goals, KPIs designed to track Komatsu's contribution in solving ESG issues and human rights policies designated for this year. It covers our ongoing activities toward environment, social contribution and corporate governance, ESG. This is disclosed on our home page, and we encourage you to take a look.

This will conclude my presentation. Thank you for your kind attention.

[Unknown Executive]

We would like to now move on to Q&A. If you have a question, please raise your hand. And please speak through the microphone that a staff will bring to you. Who has a question? Mr. Isayama, please.

[Yuichiro Isayama, analyst]

I am Isayama from Goldman Sachs. I have 3 large questions. First of all, is regarding inventories. Competition has been talking about it as well. And Mr. Horikoshi, I believe you touched upon it back in Q1. You talked about the JPY 100 billion inventory reduction target. But when you look at Q2, inventories were up. Horikoshi-san, you talked about the need to build up inventory in mining equipment, and you also talked about, in the previous quarter, inventory piling up in the U.S.

So can you break out construction and mining equipment and tell us how inventory trends are right now? And reported by the media was the JPY 100 billion inventory current target, but it seems to be a challenging target to reach. So can you talk about what's happening to this target?

[Takeshi Horikoshi, executive]

So with regards to inventory levels, compared to June, September inventories were up. Production adjustments were implemented from long ago. However, it does take time to feel the effects of it. In reality, inventories peaked in August. And from August going into September, inventories have come down. And for the second half, we project a substantial decline during the half of the year.

I believe after Q1, we said that compared to the end of June, we'd like to cut inventories by JPY 100 billion. The outlook still is the same. We view that current inventory trends are also broadly in line with expectations.

[Yuichiro Isayama, analyst]

I just wanted to confirm what you've just said. So sales in the construction equipment segment for the first and second halves, do you need to take any additional production adjustments? Because for the first and second halves, sales is probably flat and profits, too, are at similar levels when accounting for FX. So I was wondering that if you are going to cut inventories by JPY 100 billion, you may need to take further production adjustments. But it seems that production is already down. So my question is at this rate, are you able to cut inventories and generate profits with no additional fixed cost? Is this the right way to look at it?

[Takeshi Horikoshi, executive]

Yes, it is. I said this after Q1, but the current inventory pile up, especially in North America, is due to the reduction of independent distributor inventory. We cut inventories level substantially and this process is almost over. So inventories going forward should decline based off retail demand. That's why we expect inventories to come down overall, and that is why we believe that inventory cuts will be in line with plan.

[Yuichiro Isayama, analyst]

I apologize for pressing you with inventory questions, but for mining equipment, which are typically produced based on orders, has there been any order cancellations due to market conditions. Do you have any mining equipment inventory concerns?

[Takeshi Horikoshi, executive]

No. I don't think you need to worry about that. It's true that we mentioned an expected drop-off in CIS goal. And indeed, demand has been weaker slightly. However, this kind of inventory can be allocated to other places. However, for mining overall, excluding Indonesia and CIS coal, the mining businesses in other countries is brisk. That's our view. Hence, we are not concerned about inventory.

[Yuichiro Isayama, analyst]

My third question is about coal. I believe it was back in June or July, there was an interview piece with Mr. Ogawa in the media. So I'd like Mr. Ogawa to answer the question. It was talking about coal and how it's being vilified as the world's enemy these days. Apart from the sluggish market, have you been seeing any changes in actual demand for coal?

For example, have you been seeing any projects being canceled all of a sudden? And your company has been talking about the need to reduce exposure to coal over the longer term. But are you at a point where you need to change business plans at KMC, which is engaged in underground business? Or at conventional Komatsu? Has a substantial change in coal mining started to take place?

[Hiroyuki Ogawa, executive]

I think for coal, there has been no big change when looking at current conditions. I think I mentioned this before, but for emerging markets, coal continues to be an important source of energy and coal supports the local economy of commodity-producing countries. So over the short term, I don't think we'll be seeing a decline in coal. And generally speaking, people say that the demand for coal is not going to decline substantially. So currently, we are not thinking about fundamentally changing our point of view on coal. But of course, like I said before, overall, we do believe it's necessary to reduce our exposure against coal.

And also, like I said before, for the underground business, we'll be focusing mainly on hard rock going forward to strengthen this business. And we would like to also grow smart construction for construction equipment. So this stance is not changed. Simply put, are we just seeing sluggishness due to the market conditions? Yes. It's fine to look at it that way.

[Unknown Executive]

Thank you very much. Next person is Mr. Ibara.

[Yoshinao Ibara, analyst]

I'm Ibara from Morgan Stanley. I also have 3 questions. The first one is about your point of view on sales in Asia.

Page 26 was explained by Imayoshi-san. And when you look at Southeast Asian demand trends, I presume that for 7 major products, the demand was up in the second quarter compared to the first quarter. And then when you look at Indonesia at the bottom, it seems that mining was flat, but other sectors were up.

On the other hand, when you look at your sales in Asia, Q1 was JPY 62.3 billion, and Q2 was JPY 53 billion, and it has decreased somewhat. Of course, there may be a difference in FX translation or because we're talking about Southeast Asia, India may not be included. But it seems that there's a gap between demand trends and your sales.

So can you explain this discrepancy? Is it due to certain mining projects? Or is it due to lead time? Can you please elaborate?

[Takuya Imayoshi, executive]

For Page 26, the demand in Indonesia, as shown on the bottom right, to your point, Q2 demand was higher than Q1. But overall, as you can see on the left, Indonesia accounts for 50% of demand. So for Komatsu Indonesia sales, it accounts for half of sales in the region. And there is considerably high amount of mining equipment sales, so the amount of sales compared to sales volume is different. Although it may not be a macro analysis, that's probably the reason for the discrepancy.

[Yoshinao Ibara, analyst]

Actually, my point was that demand trends and your sales trends were not in sync. So I was wondering if there were any changes in market share or some impact from projects.

[Takuya Imayoshi, executive]

No, I don't think there were any special reasons. There are mining projects in other countries like the Philippines as well. So that may be a factor. So it's probably a mix difference and not a big change.

[Takeshi Horikoshi, executive]

If I may follow-up. Looking at the full year projections on Page 17, on an Asia-wide basis, sales is expected to decline by JPY 112.4 billion, out of which, sales volume is expected to be JPY 99 billion, excluding FX impact. And then on Page 9, for Asia, you can see sales decrease by JPY 62 billion in the first half. The sales volume impact was JPY 61.6 billion. This means the breakout between the first and second half was JPY 60 billion and JPY 30 billion, respectively.

[Yoshinao Ibara, analyst]

I understand. My second question is about selling price difference in your cost analysis. At the beginning of the year, you had plus JPY 20.4 billion here, which was revised down to JPY 14.3 billion. Net-net, this means that in the second half, we're only going to see JPY 3.9 billion. Of course, when sales volume goes down, it has an impact. However, when you look back at the past, because you do regular price increases, I recall that I haven't seen drastic changes in selling price impact during the middle of the period in the billions. This time around, the revision was quite large. So I was wondering what has happened.

[Takeshi Horikoshi, executive]

You have a very good memory. There are 2 big factors. Out of which, one of them is the timing of price increases in the U.S. Typically, we raise prices from April. However, for last year, we started from January, so the contribution was reduced from 1 year to 9 months. One more reason is the mining business. A portion of our customers switched to an annual global contract. Therefore, compared to our original expectations, the price levels declined. However, as we concluded a global contract now, we are expecting a certain level of sales volume over the longer term. And as you've mentioned, Mr. Ibara, although we talk about sales price difference, it does contain some sales volume impact. So the expected second half decline will have an impact. So these 3 main reasons are the reasons why sales price difference has a smaller impact during the second half.

[Yoshinao Ibara, analyst]

So for global contracts, you're talking about customers who did not have a contract with you before, with which you concluded a contract. Are you recognizing future parts price losses upfront by provisioning? Or is it based on shipments made? I wasn't able to keep up with your logic.

[Takeshi Horikoshi, executive]

So if it's not a global contract, our assumptions for prices are different because the transactions were one-off. However, the contracts that we concluded are set in stone. So there are clauses linked with CPI, for example, as well as the contract will cover parts and services. So all of these things added together will create the difference.

[Yoshinao Ibara, analyst]

So the conditions of the contracts have had a difference on the impact?

[Takeshi Horikoshi, executive]

Yes.

[Yoshinao Ibara, analyst]

So my last question is with regards to second half FX assumptions. You've adopted rates that deviate from real rates. Also, there's typically a time lag as well until real rates affect you. So I'm sure you have run some simulations. But if today's FX rates were to be applied and were to persist during the second half, what would the impact be on business performance? I'm confident that you have such numbers.

[Takeshi Horikoshi, executive]

Actually, no, we don't have such numbers. But as usual, let me share with you our sensitivity. Sensitivity-wise, a JPY 1 move against the U.S. dollar will have a JPY 4.4 billion impact. However, you need to discount this by 30% to 40% due to interim inventory. And I'm talking about full year sensitivity. So for 6 months, it would be half of this amount. A JPY 1 move against the euro will impact us by approximately JPY 600 million. A JPY 1 move against the renminbi -- or actually, a JPY 0.1 move against the renminbi will affect us by approximately JPY 200 million.

[Yoshinao Ibara, analyst]

So the impact is not so great. So it seems that the dollar impact is the largest sensitivity-wise. So discounting JPY 4.4 billion by 30% is about JPY 3 billion. But I think the interim inventory impact should be less in the second half. So what would the sensitivity be for the second half alone with a JPY 1 move?

[Takeshi Horikoshi, executive]

Well, you need to speak about internal profits. But when demand goes down, generally speaking, what happens is gross margins worsen due to fixed cost allocation. As a result, the amount of retained internal profits decrease as well, which leads to higher realized profits.

[Yoshinao Ibara, analyst]

How about the second half?

[Takeshi Horikoshi, executive]

Yes, we will see internal profits generated.

[Yoshinao Ibara, analyst]

So applying the FX sensitivity you mentioned, I won't say as high as JPY 2 billion, but with a JPY 1 move, do you think there will be a JPY 1 billion to JPY 2 billion impact?

[Takeshi Horikoshi, executive]

I'm not sure about it. Let's leave it there.

[Unknown Executive]

The next question is from Mr. Saito.

[Katsushi Saito, analyst]

I'm Saito from Nomura Securities. First, I would like to confirm some numbers with Mr. Horikoshi. For the first half and the full year, in the profit cost analysis, I'd like you to break down the volume, product mix, et cetera, item; especially pure volume and other items. Can you start off with the first half on Page 10?

[Takeshi Horikoshi, executive]

So Page 10. So volume product mix was minus JPY 54.5 billion, out of which pure volume was minus JPY 26.3 billion. The cost was minus JPY 7.1 billion. Geographical and product mix as well as a portion of tariffs between U.S. and China added up to minus JPY 11.8 billion. The rest, the balance is minus JPY 9.3 billion. This includes internal cancellation which accounts for some losses, and this was approximately a little bit over JPY 4 billion, and it's partially expenses.

[Katsushi Saito, analyst]

How much is the impact of U.S. China tariff?

[Takeshi Horikoshi, executive]

Compared with the previous year, it was up JPY 2 billion. The previous year was about JPY 2.4 billion, so it is about EUR 4.4 billion or JPY 4.5 billion.

[Katsushi Saito, analyst]

As for the full year guidance, is it on Page 18?

[Takeshi Horikoshi, executive]

Volume and product mix is substantial, JPY 84.6 billion, of which volume is JPY 48 billion. And the cost difference is JPY 10 billion, and the selling price difference is JPY 14.3 billion. So I'd like to emphasize that cost increase is more than offset by selling price difference. Regional mix, product mix and the tariff, as I mentioned before, made up JPY 22.4 billion, and one-off expense of restricted stock compensation is close to JPY 2 billion. And as I mentioned before, changing internal elimination is a little over JPY 4 billion.

[Katsushi Saito, analyst]

How much is the impact of tariff for the full year?

[Takeshi Horikoshi, executive]

JPY 4.5 billion. Tariff impact in the first half of the previous year was very small and started to affect from the second half. The gross impact is JPY 4.5 billion.

[Katsushi Saito, analyst]

Understood. The second question is for the present. You made that downward revision this time, and I assume that from the initial forecast, you were rather conservative. Most part of profit decline comes from sales volume decline for both of construction equipment and mining equipment. Where did you observe the gap between your projection and actuals? And as for the next year, especially in terms of construction equipment in Asia and North America and mining equipment in the world, in the second half and the next year, what should we monitor closely?

[Takeshi Horikoshi, executive]

I think that in Asia, going through adjustment, we may see some recoveries next year. And in North America and Europe, they are positioned at a relatively high cyclical point, and the prospect that they continuously stay at high cyclical points seem to be changing slightly.

[Katsushi Saito, analyst]

So what's your take on this?

[Takeshi Horikoshi, executive]

As for your first question concerning construction equipment and mining equipment, where did you observe the gap from your initial forecast, I think that was your question. As for service and construction equipment, in Southeast Asia, we anticipated some impacts of elections, but actual impacts were much more than our projection. And in China, our forecast of the growth of local makers were a little optimistic. The ratio of Chinese makers in 2017 was 56%, and in 2018, it was 63%. And in 2019, our initial forecast was about 65%. But the latest number in the first half was 69%, and we revised the number to 70%. So we had a wrong projection of local makers ratio. These are the 2 major factors for the gap in sales of construction equipment.

As for mining equipment, the key factor is Indonesia. We began to see decline in Indonesia from last autumn, but our observation is still optimistic. With regard to the latest idle rate, in the previous meeting, I said it was 1% or 2%. But latest one is around 7%, showing much tougher situation, especially the coal price currently is $30 or so, falling substantially. Import control in China will continue this year. But at this moment, in September, we are not informed of major import controls yet. However, in the previous year, they put forward the large import controls from September to December, so that may recur this year again. Broadly speaking, the gap existed in China and Asia in construction equipment, and in mining equipment, Indonesia had a substantial gap.

As for the next year prospect in Asia, as we mentioned, demand will come back in construction equipment and Philippines' demand will come back in the second half. In Indonesia, cabinet member appointment started in October. And so far, we have not seen any good sign yet. But from the fourth quarter, I expect that the budget fulfillment will be starting and the gradual recovery will be achieved.

In mining, there was a substantial drop in summer coal, and the demand will be correlating to the core price. So unless a core price picks up, FY 2020 will be the level of this year or even worse. And projection for North America is very difficult. And to be frank with you, it's hard to tell. But as you all know, since global financial crisis, demand has been up. So we may see peak out sometime soon. And some say that a bubble burst may happen. And bearing those in mind, in North America, we continue to monitor orders trend and others closely.

[Unknown Executive]

Mr. Sasaki, please.

[Tsubasa Sasaki, analyst]

I'm Sasaki, Mitsubishi UFJ Securities. I have 3 questions. The first question is a follow-up question. This time, in mining, you said Russia and the CIS and Africa are deteriorating, which are new input. Is this simply because some are core price dropped? Please let us know again what is happening there.

[Takeshi Horikoshi, executive]

I said in CIS, in the second half, it will be getting worse than initially projected. It is, as we mentioned, due to price. Customers are cutting back investment due to competitiveness. And that led us to revise down sales guidance. In Russia, majority of sales is gold and coal. And 50% gold, and coal, about 29% or 30% of our sales. As Imayoshi mentioned now, the bottleneck is price decline. Russia export is mainly for Japan, Korea and partly to Europe. And given the expensive transport cost for Far East, with the drop of coal price, it would lose the competitiveness. And the gasification in Europe is another reason for the demand drop for coals. In Indonesia, coal account for about 75%. But in CIS, it is about 30%. So in terms of the impact on our business, CIS is smaller than Indonesia.

[Tsubasa Sasaki, analyst]

Second question is about the profitability. Originally, conventional Komatsu mining op margin was about 20% and KMC was about 15%. In the first half, what was op margin of overall mining business?

[Takeshi Horikoshi, executive]

Sorry, I cannot specify op margin per se, but mining business includes Indonesia, whose op margin is distinctively higher. But since that business is shrinking, op margin of mining segment is shrinking as well.

[Tsubasa Sasaki, analyst]

But is it still double-digit on average?

[Takeshi Horikoshi, executive]

Op margin of entire business is 10% plus, so mining OP margin is not lower than that.

[Tsubasa Sasaki, analyst]

Finally, let me ask about profit structure. I think structure profitability of mining has been good. And in construction equipment, strategic market profitability is better than that of traditional market. Given the op margin of the second quarter is 11% and if the margin of mining is better than the average, then the construction equipment margin will be high single digit. My question is, for example, when I looked at the competitor, in the case of Caterpillar, their construction equipment margin is 18%. Then I think you have a good room for further improvement in margin for construction equipment. Although the external environment is not very good, do you think you have a room for further improvement in construction equipment margin? I'd like to have your observation on this.

[Takeshi Horikoshi, executive]

Yes, your observation is correct. In our case, it is true that op margin of mining is better than construction equipment. And it is also true that we are behind in terms of construction equipment op margin. Management is well aware of the issue, and we need to improve that.

Let me add a comment on Appendix Page 32, which has not been referred recently. This slide shows quarterly sales and the segment profit of Construction, Mining & Utility equipment, with a sales breakdown at the bottom. The bottom part of bar in dark blue indicates construction equipment sales in traditional markets. And second from the bottom is those in strategic market. Third one is mining equipment, and the top one is parts and others. As you know, gross margin of parts and others is better than equipment. And we see in equipment, mining margin is better. And within construction equipment, strategic market margin is better. Now when you refer to the second quarter FY '19, the traditional market is 22%, and this kept on growing gradually, as was explained. And because of the growth in traditional market sales, the strategic market sales declined. When you referred to 2 years ago in the second quarter 2017, the breakdown was similar with the traditional market at 21%, and the following 2 segment, 12% respectively. This is just coincidence, but with these structures, op margin of the entire company will fall. In order to give you the overview of the structure, this slide has been included, though rarely, it was used recently. But this time also due to that structure, margin tends to fall.

[Unknown Executive]

Mr. Sano, please?

[Tomohiko Sano, analyst]

I'm Sano at JPMorgan Securities. I have 2 questions. First one is about the growth trend of Chinese manufacturers as the President mentioned. I'd like to know more in detail. Demand for smaller equipment is growing in area where local companies have higher presence, and as a result, is their market share increasing? Or even in your stronger area of over 20-ton equipment, are you losing shares? Do you think it conceivable that the local makers' ratio will be 80% around this time next year? What is your strategy in this regard.

[Unknown Executive]

Referring to the slide, I made a brief comment on the data, including local makers on the left top chart as reference. But we are explaining on the foreign makers demand trend. It is true that the local makers' ratio has been up, but still, there is a clear gap in terms of price and performance. So we continue to appeal the benefit of Komatsu product from the viewpoint of life cycle cost and others. As for demand, as shown on the left top chart, although foreign makers, the demand is about 30% of total market, still when you refer to the unit number, even with a decline, still, it has been around 40,000 to 60,000, which is substantial market, equivalent to Europe and America. So how to secure the market is very important. Whether the local makers' share will be 80% is not known yet. But anyway, Komatsu continues to do what it should do in China, and we maintain our selling price and our policy to prioritize profit remains unchanged. As I said before, we are taking a number of initiatives in China, including launching new models, reorganizing distributors network, adopting new extended guarantee and the plant restructuring, which was completed at the end of September. And the certified premium used machine business and finance services, they are also [ DUCs ] businesses, but we will implement them steadily. And we are not competing against the local players, but rather strive to improve presence in foreign players' market. As we mentioned, in the trend shifting for the smaller unit, it doesn't make much sense to pursue volume. What matters to us most is how we can increase presence in the mid- to large segment of more than 20 ton of excavators. This is a field we like to focus, where a number of players is limited. In October, sales began to grow, and we expect to see the recovery in the second half.

[Tomohiko Sano, analyst]

As for the second question, let me ask about the demand forecast for mining equipment. Despite weak Indonesia and Russia, you kept demand forecast unchanged. But as for BB ratio in America and Germany, they are over 100%. For next year, having those in mind, do you think that the full year forecast will be picking up? And please tell me about the sign of change out of the current stable area, if any, not necessarily out of the current weak area.

[Unknown Executive]

As you can see on the right-hand side of the current screen, Page 27, it is color coded. The large portion, third from the top in orange, is Asia. And Indonesia is, of course, the centerpiece. Down below in pink, Japan and China and further down, Europe and CIS. Europe is minimal, so CIS is the main. And when you combine the orange and light blue, as many of you are aware, towards the latter half of 2017, these grew significantly, and steadfast growth was enjoyed last year as well. Now around autumn last year, decline began, and during Q1 and Q2, we saw a further shrinkage. What happens from here onwards is dependent upon price. In other words, the trend of thermal coal prices.

Now if we focus just on North America, Latin America, Oceania, Middle East and Africa, these 4 combined are growing. Our main customers are the commodity measures and their CapEx, as you know, are growing. The growth may not be dramatic. However, a steady capital investment is anticipated and so will our supply. Indonesia and CIS is focused on thermal coal, as I mentioned earlier, and amongst coal, high-quality coking coal is strong, especially in Europe. Iron ore is strong as well. So the mining measures are also strong, and their investment plans underpin this trend. Aside from CIS and Indonesia, in other words, outside from thermal coal, we do foresee a recovery trajectory for next year.

[Unknown Executive]

And Mr. McDonald, please.

[Graeme McDonald, analyst]

I have 3 questions pertaining to mining. Back in September, there was a newspaper article saying that you had received an order of 41 units from BHP. I do believe that Caterpillar have always had a strong foothold in BHP. So can you describe the reasons why you received this order? Was it your technology, unmanned trucks, price?

[Unknown Executive]

I believe last time, Mr. McDonald, we received a question about how we lost with Rio Tinto. It's about competition, so there will be both wins and losses. And the fact that we were successful with BHP is that we learned from our failures with Rio Tinto. We were unsuccessful with Rio Tinto because we could not accommodate the future vision that the customer had. We learned from that. And how we provide solutions to the customer was carefully deliberated with BHP, and this led to the results. We believe that with HS as well, we have an advantage over the performance of Caterpillar. Of course, we are already engaged in upgrading HS. And as mentioned previously, we are establishing platforms to serve overall mining operation optimization. Such endeavors have been discussed with the customer, so how we embrace our customers' future vision, in what way do we pursue it and how we approach this from a technology perspective led to the closure of this deal.

[Graeme McDonald, analyst]

My second question, and I do have to ask about Caterpillar. At their conference call the other day, they were mentioning one of their strengths. They can upgrade other company trucks, refit and onboard their automation system. So how do you view this?

[Unknown Executive]

Our thinking is a bit different from that of Caterpillar's. Their approach is to equip, let's say, a Komatsu dump truck with their unmanned technology and transform it into a Caterpillar truck. Our approach is different. We cannot control Caterpillar itself. So from the future standpoint of interoperability, we would receive data from Caterpillar and then implement central control. So there is a slight difference in our approaches. So if possible, on a separate occasion, we would like to describe these differences in detail. Nevertheless, it is true that our approaches to HS are different.

[Graeme McDonald, analyst]

And my last third question. The CEO spoke of idle rates. Indonesia, highly dependent on thermal coal, is 7%. But for other regions, such as Australia, seem to be low. So what is the status for other regions?

[Unknown Executive]

I'm sorry I don't have any detailed data on hand aside from Indonesia, but I am always monitoring the trends in Indonesia. When I was in Indonesia, it was 20%, maximum 20%. However, in the previous announcement, we did say it was 1% to 2%. So where do we focus ? I look into the components, the aftermarket and when the idle rate rises, sales for components and aftermarket do drop. So it's not actually about the utilization of the utilities, but rather the impact upon the aftermarket. I'm sorry I do not have regional data with me right now, but the utilities are mobilizing. Looking at the minutes from the Caterpillar announcements, their idle rate is at a record low. But as you say, outside of Indonesia, things are strong. So I wanted to know how strong.

[Unknown Executive]

All right. Then, Mr. Tai?

[Hirosuke Tai, analyst]

I am Tai from Daiwa Securities. Just 1 question. Your CapEx and R&D budget for this year, since you have updated your performance outlook, will there be any changes? And if so, can you state the numbers?

And now also 6 months ago, Ogawa-san, you mentioned JPY 160 billion for the 3-year period. Adding that this will not necessarily be fixed cost, which I understand, but will this 3-year scenario be impacted as well for instant, any changes in your priorities perhaps?

[Hiroyuki Ogawa, executive]

As was mentioned last time, the midterm management plan is perceived as flat, and now we are approaching a downturn. Business environment, overall profit, cost efficiency, strategic value, we will closely monitor such aspects and execute strategic investments. Komatsu's strength is our ability to control fixed costs, and with our midterm management plan, are diligently pursuing critical measures. And yes, we will prioritize along the way. Another point is regarding standard CC, which we will contain and control as well. I believe we mentioned this last time as well, but for our strategic investments, we have 3 categories: Projects that will contribute to business during the 3 years, projects with a time line of approximately 6 years where we make upfront investments and go through trial and error; and then long term, 10 to 15 years, where new ideas and concepts are proven. So these 3 categories are applied for investments. This means that there will also be priority steam. Let's say, we first undertake 1 and 2 and then delay slightly 3. In conjunction, we will also be monitoring the business environment as well.

[Hirosuke Tai, analyst]

And then has your annual investment and depreciation plan changed?

[Hiroyuki Ogawa, executive]

When you look at the fixed cost difference versus last year, for instance, on this page, it is JPY 9.2 billion. In comparison to the beginning of the year, just with Construction segment, this is a decrease of JPY 3.1 billion. So overall, a decrease of JPY 5.1 billion. Now compared to the beginning of the year, CC, capacity cost, is managed at a lower rate. When you look at the overall progression, we have not changed the overall budget. But test and research, that is, R&D., in light of the previous years, is more tightly controlled. As for other CapEx, for instance, lease and rental assets and CapEx side for rental, the progress percentage is on par with last year and the allocation is almost the same as the previous years.

[Unknown Executive]

We would like to move on to the next question. Mr. Miyagi?

[Hirokazu Miyagi, analyst]

I am Miyagi from Mizuho Securities. I have 2 quick questions. In your presentation, you spoke of the coal ratio. Inclusive of other minerals of mining for the first half, sales orders or what have you, can you give me a breakdown by mineral?

[Unknown Executive]

We do not have accurate breakdowns for the first half. But again, as we explained previously, for last year, half was coal. For this year, as was presented, Indonesia is declining. So coal ratio, we anticipate will drop as well. To what extent, unfortunately, I do not have the numbers with me, but perhaps down to 40% or less than 40%.

[Hirokazu Miyagi, analyst]

For copper, well, it was just explained that gold and iron ore are trending strongly, but I think that copper prices are dropping. Will there be an impact for you? Copper is trending strongly. Does this mean that the level of decline is not so severe as thermal coal? Because there was mention of overall costs for the Far East as well. So what is the reason for this difference between thermal coal and copper?

[Unknown Executive]

For copper, as we described some time ago, considering global demand and mining capacity, is upfront CapEx adequate? We believe that customers are moving towards capital expenditure.

[Hirokazu Miyagi, analyst]

So it is about demand and supply balance?

[Unknown Executive]

Yes.

[Hirokazu Miyagi, analyst]

One more question, please. On the cost side, with mineral prices dropping, will there be a positive impact from the costs during the second half? Is there a possibility? And if so, is it in the plan?

[Unknown Executive]

At this point in time, we've not incorporated any possibility of cost decrease.

[Hirokazu Miyagi, analyst]

Can I assume is flat.

[Unknown Executive]

The cost difference, as I mentioned earlier, first half is JPY 7.1 billion; annual, JPY 10 billion. So the difference, JPY 3 billion, will manifest in the second half.

[Unknown Executive]

Thank you for the questions. In the interest of time, the next question will be the last question. Are there any questions? If not, this will conclude today's session. We look forward to your future support and guidance. Thank you very much once again.

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