Yokogawa Electric Corp

TSE:6841

Earnings Call Transcript 2019-Q2

[Junichi Anabuki, executive]

Good afternoon, ladies and gentlemen. My name is Anabuki of Corporate Administration Headquarters. Thank you for attending the financial results briefing of Yokogawa Electric Corporation today.

I'll start my presentation on financial results for the first half of fiscal year 2018. Please refer to your handout material.

Page 4, which shows the key points of my presentation. Fiscal year '18 first half results were characterized by strong positive growth on both sales and the profits. The main content is as shown here. Details will be given later in my presentation. FY '18 full year forecast has been revised upward with a year-on-year increase in sales and profits. The upward revision was by JPY 10 billion in orders, JPY 5 billion in sales, JPY 3 billion in operating income and JPY 4 billion in net income.

Please turn to Page 5, for summary of fiscal year 2018 first half results. As you can see, we had JPY 213.7 billion in orders, JPY 190.4 billion in sales, JPY 14.8 billion in operating income and JPY 10.1 billion in profit attributable to owners of parent. Orders and sales were up, thanks to firm results of the control segment. Operating income was up due to increased sales and improvement of gross margin. Profit attributable to owners of parent was nearly at the same level as last year, as there was extraordinary income of JPY 2.5 billion for the same period of the previous year.

Page 6 shows analysis of operating income with the waterfall chart. Operating income for the first half was up JPY 2.4 billion year-on-year, the factors were as follows: From left, increase in gross profit from higher sales, JPY 2 billion, higher gross margin ratio, JPY 1.7 billion. Organic increase in SG&A, negative JPY 1.2 billion, including JPY 0.9 billion in strategic investment.

Effect of KBC acquisition or a decrease in goodwill as shown here. Changes in accounting method negative JPY 0.2 billion, which is smaller compared with the full year figure. Exchange rate impact negative JPY 0.5 billion.

Page 7 shows comparison of orders, sales and operating income by segment. The control segment saw both orders and sales increasing year-on-year, mainly due to rising product demand outside of Japan. The business enjoyed a firm trend on other areas as well.

Operating income was up due to the impact of increased sales and improvement of gross margin, mainly in Japan, including the absence of low gross margin jobs, concentrated at the same time of the last year in Japan.

The measurement segment remained flat from last year. The aviation and other segment saw the operating income declining year-on-year due to lower gross margin compared with the previous year. Another negative factor was an increase in personnel cost and some development orders this year.

Page 8 shows orders and sales by region for the control segment. Mainly in China and India, orders showed a firm trend. Orders in Europe, the Middle East and North America showed a stronger momentum this year than last year. Sales grew year-on-year mainly in Asia. Sales also grew in Europe and North America. On the other hand, in Central and South America and India, there was a negative growth year-on-year. This is inclusive of the major decline in foreign exchange rates. The trend was solid on a local currency basis.

Page 9 is just for information, ratio of orders and sales by industry in the control segment.

In orders, upstream is recovering. The share is up 3 percentage points year-on-year. The main driver is the inflow of large ticket jobs in the Middle East. The trend is positive, particularly with the chemicals industry with strong results, mainly in India.

Please turn to Page 10 for FY '18 forecast. This time we revised up orders to JPY 420 billion, sales JPY 410 billion by JPY 10 billion and JPY 5 billion, respectively, from the forecast on May 8.

Operating income was revised up from JPY 33 billion to JPY 36 billion, up JPY 3 billion. Profit attributable to owners of parent was revised up to JPY 25.5 billion, up JPY 4 billion. Exchange rate assumption was revised from JPY 105 to $1 in May, to JPY 110, JPY 5 weaker than the previous forecast.

Foreign exchange impact is plus JPY 0.7 billion in orders, plus JPY 0.7 billion in sales and plus JPY 1.7 billion in operating income. Sensitivity in orders and sales, in particular, are very limited.

In dollars-yen exchange rate, yen depreciated by JPY 5 to $1, but other currencies moved in opposite direction against yen, so we are affected by appreciation of yen. We revised up orders by JPY 10 billion and sales by JPY 5 billion, but foreign exchange impact is minor.

We announced our transfer of a subsidiary in aviation and other segment. And that would negatively affect orders in the first quarter, having no contribution. But that negative impact was more of the offset and orders were revised upward.

Page 11 shows factors for increased decrease in operating income. As for the factors for change from JPY 32.7 billion to JPY 36 billion, the changes from the ones announced on May 8 are shown here. Increase in gross profit from higher sales increased from JPY 1.5 billion in the previous forecast to JPY 3.3 billion this time, up JPY 1.8 billion.

Gross profit improvement decreased by JPY 0.5 billion. Organic increase in SG&A and effect of KBC acquisition accounting remain unchanged. Exchange rate impact of JPY 1.7 billion improvement was incorporated, as I said before, and operating income forecasting FY '18 is JPY 36 billion.

Page 12 shows a forecast for orders, sales and operating income by segment after revision. Control segment orders were revised up JPY 15 billion, sales were up JPY 10 billion and operating income was up JPY 4.5 billion. Measurement segment remains unchanged.

As for aviation and other segment, mainly due to the transfer of a subsidiary, orders and the sales decreased. And also due to weaker sales, sales and operating income are revised down.

Page 13 shows the forecast of orders and sales by region in control segment. Here also we had revisions. Orders on the left for Japan remains unchanged at JPY 110 billion and sales also kept intact as JPY 110 billion. But as for the overseas, based on the results in the first half and the forecast in the second half, we made upward revisions. In particular, we revised up substantially in Asia and Middle East and Africa. But generally speaking, both in orders and sales, in most of the regions, except Central and South America, we revised up the forecasts.

Page 14 for shareholders returns. It has been decided to pay JPY 15 interim dividend as initially planned. Though we made upward revisions, the annual dividend payout remains unchanged at JPY 30 per share. As a result, payout ratio is 31.4%, which is above 30% that is shown in our dividend policy.

From Page 15, as appendix, quarterly financial results, orders and sales by region, nonoperating an extraordinary income and expenses, order backlog, R&D depreciation and CapEx, balance sheet, cash flow, news and the trend of stock price are attached.

That concludes my presentation on financial results for the first half of FY 2018. Thank you.

[Takashi Nishijima, executive]

This is Nishijima, President of the company. Thank you very much for attending our interim results briefing despite your tight schedules. Mr. Anabuki has given you an overview of the first half results and the full year forecast. What I would like to cover in my presentation is the current situation as perceived by the company as well as the outlook from a medium- to long-term perspective.

These are the contents. Our share, our perception of the market under the current situation, discuss the progress on the medium-term business plan being executed for the last 6 months and finish my presentation with future forecast.

This is the same slide as the one used during the MTBP meeting in May this year. Our perception of the external environment is as follows: We basically see no major changes to the extent that force a change in our strategic direction. It should be noted, however, that an investment climate for energy resources, especially natural gas related appears to be rising rather faster than anticipated.

A number of investments are being made, especially in downstream, including several construction projects, aimed at increased petrochemical supply. It might take some time until the FID or final investment decision is given, but clearly, investment sentiment is turning positive. How long this trend will go on is not clear, but it is surely a positive trend for our business.

Next page depicts the current situation, in terms of markets, regions and industries, on a short-term as well as on a long-term basis. As mentioned earlier, overall, the natural gas activity is gaining momentum. You may be aware of LNG Canada announcing an FID. At Gastech, an event held in September each year, in Barcelona, Spain, with all major gas buyers, we were one of the exhibitors this year. I stayed there to meet with customers face-to-face. Helped by rising demand in China and other parts of Asia, during 2017 and 2018, projects are now competing against one another and accelerating the pace of investment. This is my impression.

The rise in investment climate was seen not only in CapEx but also in OpEx, such as full productivity improvement. By region, we see a strong trend in system sales in the Middle East and in India, and product sales in China and Japan. In North America, there are some major petrochemical complex projects by non-American companies. These are not reflected on numbers yet, while there is some concern about rising resources prices and labor cost, the trend is fairly positive. In Russia, there are some investment projects in progress in the areas of natural gas and chemical. By industry, as mentioned by Mr. Anabuki earlier, the chemical industry is showing a firm trend and so is the natural gas industry and the LNG industry with brisk investment in downstream.

Under the medium-term business plan started this year, we are trying to abort overdependence on CapEx and focus on OpEx. The market growth rate of the CapEx area, however, may turn out to be higher than expected. On the other hand, there are some risk factors there as well, such as the U.S. China trade friction and the Middle East situation, possibly affecting macroeconomy and investment trends going forward. China is also experiencing some slowdown in capital expenditure into assembly facilities, which may or may not have impact on our process industry usually with some time lag. So there are some risks though none of them have materialized yet.

Next is the discussion on the LNG market, which was already mentioned a few times. The chart shows the LNG supply-demand outlook published by JOGMEC. The general assumption is that LNG demand is growing on a medium- to long-term basis widening the gap between demand and supply toward 2030. At the top right corner of the graph, there is a gray area. This area indicates projects in the planning phase. A large number of projects are in this phase at the moment.

I'll show you a breakdown of this by region on next page. This was taken from a public information source. It's a summary of all major projects in the world, if not all, including LNG Canada. This is the first major LNG project, which announced an FID since the Yamal project, 5 years ago. We are currently working toward winning the order. Currently, projects are nicely distributed across different areas of the world. They mostly count on demand coming from China and other Asian countries, that's my understanding. We will try to win as many projects as possible while monitoring the projects -- progress.

Next page shows how we are expanding the OpEx project. In the entire energy supply chain, including natural gas, which covers a large area from upstream to downstream. On this chart, the reddish part indicates gas related. Natural gas comes from either underground or seabed. It is obtained through the exploration process. The main component is methane. After separation, refining, it is transported either through the pipeline or as LNG after cooling and compression process. The majority of gas in the world is transported through the gas pipeline, with LNG being only 30% of the market. Nevertheless, because the pipeline is fixed, it lacks flexibility. We believe the share of LNG is going to rise in the future, due to the flexibility.

Yokogawa is a Japanese company. Japan is a country where both businesses and households and power generation facilities consume large amounts of LNG emitting as CO2. The country used to import more LNG than what China is importing today.

Japanese ABCs have sophisticated LNG-related technologies. They are our customers. We have about 2/3 of the market share of the Japanese receiving terminals and abundant know-how in the automation of the entire supply chain. We have the top class market share globally as well.

The next slide shows the supply chain of LNG and Yokogawa's coverage of different areas. The pie chart at the bottom show our estimated market share in each area, liquefaction, transportation, and regasification. We have 87 trains for liquefaction, 73 vessels for LNG and 50 terminals for regasification.

Once we deliver these orders for the supply chain, which is the CapEx business, we can enjoy subsequent orders for production, management operation, optimization, simulation and energy optimization management, which is the OpEx business. That's why we are trying to expand the coverage of the supply chain.

This chart depicts the concept of the OpEx business. You may think that large part of Yokogawa's business is the CapEx business. To avoid misunderstanding, let me explain. In plant construction, Yokogawa's CapEx-related orders amount to only 1% or 2% of the overall construction cost, even in large-size natural gas projects. Suppose the size of the project is JPY 1 trillion, JPY 10 billion or JPY 20 billion is our CapEx business, covering from fleet design to operating setup. This JPY 10 billion to JPY 20 billion represents a few percent of Yokogawa's overall sales. But the CapEx business will lead to the OpEx business eventually. That's why we will continue to focus on winning these major CapEx projects. But at the same time, we will expand our coverage and maximize the OpEx business, that's the key.

Plant life cycle is as long as 30 to 40 years. And once any systems for infrastructure or control systems are deployed, we tend to have very long-standing relationship with customers as the cost of switching to other vendor is substantial. By providing sustained quality services, we can sustain a long customer relationship. In the last 10-odd years, we have expanded installed base considerably in Middle East, South East Asia and Russia. Our share of market in the Middle East is close to 50% as in Russia.

Due to such installed base, our policy to expand OpEx as growth driver remains unchanged.

I would like to review the mid-term plan Transformation 2020 with 3 basic strategies and its driver, digital transformation. Basic strategy was also presented when we announced a mid-term plan. Transformation of existing businesses is based on the expansion of the OpEx business and the strengthening of target industries. In creation of new businesses and the transformation of business model, we will create life innovation business and recurring model business.

In improvement of productivity through group-wide optimization, in addition to enhancing cost competitiveness, we optimize utilization of HR resources, monitoring their capabilities as well. We will drive them further by maximizing the use of digital transformation.

This shows brief summary of initiatives after half year, vis-à-vis the mid-term plan. In transformation of existing businesses, in addition to the expansion of our own brand portfolio of products and the solutions, we signed a global license agreement for supply chain management solution package PETRO with Chevron. And we are proactively striving to expand product portfolio. Global structure was enhanced to expand the business in chemicals. We began to deliver results in China and India.

In creation of new businesses and transformation of business model, as for creation of life innovation business, business structure including R&D is enhanced. And we are employing steps with expertise.

At the same time, we are focused on launch of the cell-based manufacturing solution business. As for transformation of business model, we are trying to launch new business utilizing IIoT architecture and established amnimo Inc., a startup company, which is currently in the process of the launch. The company opened a both in recent CEATEC and attracted a great attention. As for improvement of productivity through group-wide optimization as shown here, some of them are the follow-up of the initiatives in TF2017, but we started to introduce RPA and opened the Yokogawa University for HR development as well.

This summary includes initiatives for short-term quick win and mid- to long-term initiatives. As for the quick-win measures, the procurement cost reduction has been materialized gradually in line with the plan, cutting several hundred million of yen. With regard to the mid- to long-term measures, for Renewable Energy and regarding model establishment, we need to stay focused for longer time. Their driver will be digital transformation. In this April, we established a new headquarter, Digital Strategy Headquarter with a new head who was higher anew.

Thus we'll do a draft for transformation and have already taken some specific actions. The future direction is to integrate OT and IT, both in-house and at customers premises. We plan to invest around JPY 2 billion, mainly in the second half. To provide values for customers, IIoT architecture will be used and the security business growth has been notable. You may remind of the IT-based office security when it comes to the security, but controller security is slightly different.

Controllers in office ITs are virtually almost separated by firewalls, then antivirus files are not necessarily automatically renewed. But appropriate system and the services really required to ensure security with separated controllers structure.

Demand for evaluation services before deliveries is also growing, and it will be growing in future as well. As for us, global optimization of IT application will be required. In our case, we have 112 companies globally, in terms of integration of application and infrastructures, we still have some room for improvement. So we have more of the shared systems. We set up new organization for further use of cloud. Therefore, we will promote the digital transformation, both in-house and at customers' premises.

Finally, let me talk about the future forecast. FY 2018 forecast was already presented by Mr. Anabuki. This table shows our revised numbers. First of all, we achieved this revised target steadily and make a good start as initial year of TF2020. Global economic prospect is increasingly uncertain, but our top priority is transformation and then we'll strive to achieve the targets of this fiscal year.

This shows the management indicators for TF2020 for 3 years. It is just 6 months, but we are getting off to a slow start. As already mentioned and partially shown here, in these 3 years, we've been less affected by market environment, especially CapEx. And top line growth would exceed that of the market and profitability would increase.

We'll achieve these target toward 2020. On final slide, let me reiterate on some points. On this slide, mid- to long-term directions of management are shown here. First of all, management will have mid- to long-term perspectives as in business. Our business life cycle tends to be long by nature. We continue to commit to provide values in mid- to long-term for customers and all the stakeholders. Secondly, we'll continue to pursue both the growth and efficiency, though sometimes it may seem different because they may look to run counter. For growth, instead of growing top line, simply organically, if we find a good deal, we'll proactively carry out M&A according to the plan. For efficiency, we realize that, that digital transformation is the key driver through our actual businesses. So we'll continue to drive with it. Thirdly, we will focus on growing the business and strengthening its competitiveness. And through those initiatives, corporate value will be maximized.

In 3 years under TF2020, creation of growth opportunity and establishment of foundation for growth are the objectives. And also since we have commitment for 3 goals to build a sustainable society, we will carry them out.

I'd like to have your consistent support and cooperation. With this, I will conclude my presentation. Thank you.