Kawasaki Heavy Industries Ltd

TSE:7012

Earnings Call Transcript 2019-Q2

[Kenji Tomida, executive]

Hello, everyone. This is Tomida. Despite the short notice, thank you for attending the meeting held on the 19th. Today, I'd like to explain about mainly the second quarter results, which I was not able to share the other day. And I also would like to go through the forecast for each segment.

First of all, please open Slide 3, summary of financial results. Orders received increased about JPY 50 billion year-on-year basis due to orders received in energy systems and plant engineering segment such as LNG tanks and combined cycle power generation plant for the domestic market. As for the net sales, precision machinery and robot as well as motorcycle engine segments increased. Nevertheless, decline in Aerospace Systems and Rolling Stock segments was significant, pushing down overall net sales.

Regarding the operating income, Ship & Offshore Structure segment improved. However, in the Aerospace Systems segment, we saw a cost increase because of the depreciation of new engine development. We also provisioned for the loss of engineering works in the Rolling Stock segment. The operating profit was down by about JPY 8 billion.

As regards to the recurring profit, in addition to the declining operating profit in the Aerospace Systems segment, approximately JPY 10 billion has been provisioned in the nonoperating expense for issues related to the in-service Trent 1000 engine, thus pushing down the recurring profit by about JPY 15 billion. Now for the net income attributable to owners of parent due to decline in recurring profit, it was down by about JPY 14 billion. Therefore, the loss was JPY 3.5 billion. On the bottom of the page, you can see the weighted average exchange rates and impact on net sales in foreign currencies. Yen was JPY 109.8 to the dollar, although slightly JPY 0.7 higher than the same period from last year.

Now we revised the annual forecast on October 19th and I will be delving into this later on. But take, for example, operating profit. Against the annual forecast of JPY 66 billion, first half results of JPY 8.4 billion is slow in terms of its progress. The imbalance of profit breakdown between first and second half may be a concern for many of you. However, if the net sales and the profit of Rolling Stock segment for which we recognized a loss in second quarter of this year and fourth quarter of last year are deducted from respective years, then the profit for first and second half will strike a balance. In addition, as we always make a note of, public sector and motorcycle sales and profit tend to skew towards latter half of fiscal year, and improved sales in Aerospace Systems segment will lead to better profitability in the second half. Therefore, we believe we can well achieve this forecast.

Page 4 shows results by segment, but let me first explain from Page 5 about factors behind the changes compared to same period of last fiscal year. Operating profit was down JPY 7.6 billion to JPY 8.4 billion from JPY 16.1 billion of last year. I'd like to describe in order about different factors behind this drop.

In the first half of previous fiscal year, related to LNG carrier contract, we provisioned for the loss of construction but no provision this year. So that's plus JPY 3.6 billion. Also about the loss in Rolling Stock segment, additional provision for the base contract of Long Island is included in the second quarter, which is minus JPY 2.5 billion. Also repair costs of Washington project was JPY 3 billion. Whereas for the domestic market, we provisioned JPY 3 billion. These factors were related to Rolling Stock segment.

As for the effects of exchange rate, yen was higher by JPY 0.07, which had an impact of about JPY 1 billion. Regarding the change in sales, net sales dropped in Aerospace Systems and Rolling Stock segments, which reduced the profit. However, Precision Machinery and Motorcycle & Engine segments offset the drop. Therefore, it was plus JPY 1.1 billion.

Next is change in product mix and other factors. Due to depreciation cost of new engine development, profitability of Aerospace Systems segment declined. Also, the ratio of semiconductor robot decreased within the overall sales of Precision Machinery and robot segment, shrinking the segment margin. However, Ship & Offshore Structure segment reduced the number of less profitable projects, and energy segment improved its margin. There were upsides and downsides closing the second quarter up by JPY 800 million compared to the same period of last year.

Finally, SG&A. In the first quarter, we provisioned for doubtful accounts namely overseas distributor of motorcycle business. And between first and second quarter, production increase in Precision Machinery and robot segment led to higher cost. Therefore, SG&A increased by JPY 3.6 billion.

Next, please go to Page 6. I'd like to explain about nonoperating expense. Nonoperating expense grew by JPY 7.2 billion year-on-year basis to JPY 8.2 billion. There were several factors behind this increase in negative that I'd like to touch upon. Income from Chinese joint venture where equity method is applied was reduced, and another joint venture increase in the development cost of healthcare robot generated further loss, therefore, in total, pushed down by JPY 1.7 billion. Exchange gain was plus JPY 1.6 billion since yen depreciated from the end of second quarter of last fiscal year to this fiscal year. And JPY 9.7 billion has been recorded in nonoperating expense for the payment regarding the in-service issue of Trent 1000 engine, as you can see on this slide.

Starting from Page 7, let me share with you some of the highlights of each segment. First off, second quarter results. You'll find the orders received year-on-year comparison. The component parts for commercial aircraft engines increased, but component parts for Ministry of Defense and commercial aircraft decreased. As a result, the segment sales declined. As regards to the aircraft engine with higher depreciation cost due to the development of new programs, operating profit was down JPY 6.2 billion.

Next is the annual forecast. Assumed exchange rate has been revised from JPY 107 to JPY 110. Therefore, segment profit is expected to increase by a little less than JPY 4 billion. We can expect further increase in profit coming from margin improvement of component parts for commercial aircraft engine and cost-reduction effort. Therefore, inclusive of exchange rate, the segment forecast is up JPY 8 billion from previously announced forecast.

Now second quarter operating profit is somewhat low due to higher development cost of jet engine as I had been referring to. And in second quarter -- or in first half, there were many FIAs. In other words, sales discount of jet engines, which were delivered last fiscal year, which is a unique case this term. Nonetheless, we will be able to achieve the forecast through higher sales centering around after-sales from third quarter and onwards.

Let's go to the next page, Energy System & Plant Engineering. We are on Page 8. For the second quarter results, you can see both orders received and the net sales on this slide. Currently, we are experiencing growth in order for LNG tanks and industrial gas turbines for the domestic market. Meanwhile, in terms of sales, there were decrease in construction works of chemical plants overseas. However, construction works in energy segment increased. Therefore, net sales remained at the same level as last year. This chemical plant, by the way, is a gas-to-gasoline plant in Turkmenistan.

Regarding the profit, sales increase in margin improvement in energy segment were enough to offset the drop of sales and profit in the chemical plant project that I just mentioned. Thus, overall segment profit improved by JPY 2.1 billion. Now for the annual forecast. The timing of sales of industrial gas turbine in the second half was revisited, which will impact the sales possibly lowering the profit throughout the year. As for the claim of compensation to the outsourcing company related to overseas LNG tanks, I will explain in the later section.

Next, Page 9, Precision Machinery & Robot. Regarding the second quarter orders received and sales, as you can see on the slide, hydraulic components for construction machinery market and various robots have performed well. Sales increased. However, sales mix of robots, in other words, semiconductor robots, declined. And cost increased due to lift in production of hydraulic components. And as a common factor, fixed cost increased due to business expansion. And therefore, absolute value of the segments' operating income grew, but margin went down slightly. As for the annual forecast. For both orders and sales, hydraulic components for construction machinery will continue to expand while robots will decrease. Changes in product mix due to such factors as decline of semiconductor robot sales is projected to push down the profit by JPY 500 million from the announcement back in July.

Next, Page 10. I'd like to cover Ship & Offshore Structure segment. Second quarter results are illustrated on this page. In terms of sales, compared to second quarter of last fiscal year, LNG carriers decreased. Increase in LPG carriers was not enough to offset the decline, ending slightly behind the previous year. As I explained using the stick chart earlier, operating profit has improved by JPY 6.3 billion year-on-year basis due to recognizing the loss from LNG carrier in the previous year, which is not the case this year. And margin of projects this year have been improving through cost-reduction effort within the larger structural reform project. There is no major fluctuating factor going forward, therefore, the annual forecast remains the same.

Next, Page 11, Rolling Stock segment. This segment was shared earlier so let me be brief. As for the second quarter result, orders received is indicated on the slide and sales declined mainly due to North American projects. Regarding the profit, as was also explained using the stick chart, a total of JPY 8.5 billion loss was posted due to additional loss from M9 Long Island base contract, which was minus JPY 2.5 billion; repair cost of Washington project; and provision for the order received in the domestic market. Although margin improvements were seen in other projects, operating profit for the segment was down JPY 7.9 billion. As to the annual forecast, we revisited the timing of sales of North American projects, namely Long Island and Washington projects from which we incurred losses in the first half. As a consequence, sales is projected to come down by JPY 25 billion. In the third quarter, we're expecting to receive the order of M9 Long Island option contract. In addition to JPY 8.8 billion loss recognized in the second quarter, further loss of about JPY 6 billion from its construction works is being expected. Therefore, the annual forecast has been revised significantly downward by JPY 16.5 billion from previous announcement to operating loss of JPY 14 billion.

Let's move on to Page 12, which is Motorcycle & Engine. Regarding the second quarter results, first of all, year-on-year sales. Motorcycles and utility vehicles for developed countries were strong, increasing the sales by JPY 6 billion. We provisioned for the doubtful account of overseas distributor and there were temporary increase in SG&A as well as slight price hike of steel and other materials. Hence, the operating profit of the segment was down JPY 2.6 billion. And for the annual forecast, due to the revision of exchange rate assumption and the sales plan, annual forecast for both sales and profit have been revised upward.

Now Page 13. Let me go through the balance sheet. We expect to close the year with record-high sales, and production overall is indeed expanding. Therefore, compared to the end of March 2018, total assets increased by JPY 115.5 billion, main driver being the increase in inventories. Meanwhile, since trade receivables decreased, which led to increase in working capital, and interest-bearing debt increased by JPY 155.2 billion, therefore, our net D/E ratio now stands at 119.1%. But every year, we see an increase in interest-bearing debt from first quarter to second quarter. In other words, same trend is being observed. Incidentally, net D/E ratio at the end of September 2017 was 116%, which was in the similar range.

Next, I'd like to touch upon the issue of damage compensation regarding the overseas LNG tank construction project. During the last earnings call on July 31, I explained that we claimed compensation of JPY 40 billion, roughly, which was a part of damages caused by the breach of contract by the subcontractor. This cost was related to subcontracting agreement between us and the subcontractor, which covered the scope of our construction. Now this subcontractor is also a consortium member. We have stepped in on behalf of this subcontractor for the scope that this contractor was responsible for. We claimed these costs as well, and the total amount being claimed now has grown to JPY 48 billion as of end of September. We will continue to take the necessary steps in order to recover the claimed amount. As a footnote, part of the claimed amount is deducted from the estimated overall costs being recorded as other current assets on the balance sheet.

Next, let me cover the cash flows on Page 14. Similar trend is being observed here. Cash flows from operating activities. Although working capital increased due to business expansion, there was an increase in inflow from Ship & Offshore Structure segment and reduction in material and construction costs due to decline in overseas plant construction works. Operating cash flow, as a result, improved by JPY 9.9 billion. Cash flows from investing activities went up JPY 7.2 billion because of payment increase during the term as a part of ongoing significant capital investment mainly in Aerospace Systems. As a result, free cash flow at the end of September was minus JPY 160.9 billion, up JPY 2.6 billion from the same period of last year. In fiscal year 2018, sales increase will entail increasing working capital, and we will also continue to make capital investment mainly in Aerospace Systems. Therefore, challenges will be ahead, but we will keep up with our effort for improvements.

Next, I am on Page 15, summary of fiscal year 2018 forecast. When we compare the current forecast with the forecast announced at the end of July, orders received has been revised upward, driven mainly by Aerospace Systems. But we had no choice but to revise downward the profits, including operating, recurring and net income, as were announced on October 19. ROIC is also expected to go below 8%, which has been our hurdle rate. Going forward, we will strive towards turning around our Rolling Stock business, and company-wide effort will continue so that we can improve and aspire to achieve higher than the current forecast.

Although the forecast has been revised, our plan for the dividend remains the same as announcement in July, which is JPY 70 per share. Whereas for the exchange rate, it has been revised from JPY 107 in July to JPY 110 to the U.S. dollar. Euro remains intact. I've attached some reference materials. Please take a look at them later.

Finally, on Page 18. Due to some changes, I'd like to make supplementary remarks. Within this table, R&D expenses has not changed. However, CapEx has been reduced in line with the effort to improved cash flows. The timing of acquisition has been revisited, and we have decreased both investment amount as well as depreciation costs.

With that note, I'd like to conclude my explanation. Thank you.