Kawasaki Heavy Industries Ltd

TSE:7012

Earnings Call Analysis

Company Faces Setback, Optimistic on Recovery

The company's second quarter was marked by a substantial JPY 58 billion loss from operational issues with the PW1100G-JM engine, heavily impacting profits year-on-year and compelling a downward revision of the full-year forecast and halving of the dividend to JPY 40 per share. Nevertheless, orders and revenue slightly increased, with particular growth in the Energy Solution & Marine Engineering segment. The company is dealing with all losses concerning the PW1100G engine, expecting recovery and growth. Despite the notable loss, a profitable outlook remains for fiscal year 2023, with an operating income forecast of JPY 40 billion and net income for owners at JPY 12 billion, aided by expected improved profitability and favorable currency depreciation.

Financial Highlights and Losses from PW1100G Engine Issues

The company experienced a significant profit decrease due to a one-time loss of JPY 58 billion related to the PW1100G-JM engine operational problems, leading to a reduced full-year forecast for FY2023. This also affected dividends, which were adjusted to JPY 40 per share for the full year. Despite these setbacks, management expects recovery and growth in the next fiscal year, indicating confidence in their overall business trajectory.

Segment Performance and Exchange Rate Impact

While the Energy Solution & Marine Engineering segment reported a revenue increase, Aerospace Systems and Precision Machinery & Robot segments struggled with the PW1100G engine issues and sluggish markets, respectively. The exchange rate presented both challenges and gains, with a JPY 7 lower sales weighted average exchange rate year-over-year and a JPY 14.3 billion improvement due to the yen's depreciation against the U.S. dollar.

Struggle with Costs and Changes in Assets and Liabilities

The company faced deteriorating cost of sales ratios and higher sales promotion expenses, affecting profitability. There were increases in inventories consistent with sales expansion and a rise in deferred tax assets due to the PW1100G engine losses. Notably, interest-bearing debt grew due to the business cycle, and the Debt-to-Equity ratio worsened slightly, primarily because of capital reduction from the PW1100G losses.

Improved Operating Cash Flow and Forecasted Profitability

The operating cash flow has improved by JPY 54.5 billion from the previous year, mainly from better receivables collection in the Powersports & Engine segment. Despite issues with the Aero Engine business, the FY2023 outlook includes an operating income of JPY 40 billion and a net income attributable to owners of the parent company of JPY 12 billion, with the positive influence of the yen's depreciation.

Comprehensive Overview of Key Market Segments

The analysis pointed to differing trends across segments, with some experiencing growth in orders and profits, such as the Marine machinery business and improved equity method earnings in China. Others, like the Rolling Stock segment, remained mostly flat in profits despite increased revenues. The Precision Machinery & Robot segment saw lowered expectations due to a sluggish Chinese construction equipment market and a slow recovery in the semiconductor market.

Future Outlook and Focus on Low-Carbon Solutions

The company is concentrating on creating products and services that lead to a low-carbon society, notably through trials of a CO2 capture system that could revolutionize decarbonization efforts. Significant initiatives in hydrogen transportation with the SUISO Frontier underscore an ongoing commitment to carbon neutrality and have garnered international interest.

Advancements in the Powersports & Engine Segment

The company is maintaining previous forecasts for this strong segment, driven by increased demand for motorcycles in Europe and North America, despite some regional declines. The yen's depreciation is offsetting softer demand elsewhere, and forward-looking projects such as the launch of the first hybrid motorcycle highlight innovation and sustainable growth efforts.

Commitment to Shareholders Amid Dividend Forecast Revision

The earnings forecast revision and subsequent adjustments to the dividend have been announced. A decrease to JPY 20 per share for both the first and second half of the year reflects a commitment to a steady dividend payout ratio. The company apologized for the short-term reduction but stressed efforts to enhance profitability and shareholder returns in the future.

Hydrogen Projects and Carbon Neutrality Goals

The company shared updates on hydrogen projects, evincing potential future growth avenues in this sector. This includes a hydrogen power generation project in collaboration with Resonac, advancements in liquefied hydrogen transport, and a goal to significantly reduce CO2 emissions in line with Japan's 2050 carbon neutrality ambition.

Electric and Hybrid Vehicle Developments

The company has introduced its first two electric motorcycles and plans to launch the world's first long-distance capable hybrid motorcycle in 2024. This signals a strategic move towards electrification and sustainable revenue streams within the Powersports industry.

Earnings Call Transcript 2024-Q2

[山本 克也 (やまもと かつや), executive]

My name is Yamamoto. Thank you for your participation. Now I would like to present financial highlights. As announced on the Tokyo Stock Exchange and our website at 11:30 a.m. today, our financial results for the second quarter of fiscal year 2023 were affected by a onetime loss of JPY 58 billion, including replacement costs that will be incurred in the future due to operational problems with the PW1100G-JM engine, resulting in a major decrease in profit year-on-year. Due to this loss, the company has also announced a decrease in its full year forecast for fiscal year 2023 from the previous announcement and the change in its dividend forecast to JPY 40 per share for the full year, with JPY 20 for the first half and JPY 20 for the second half of the year.

As mentioned earlier, we have dealt with all the losses related to the PW1100G to the extent that we could have expected, and the other businesses are generally in line with our expectations. From the next fiscal year, we expect further improvements in all businesses, including the engine business for which the current loss was announced, and we believe that we will return to the growth curve. The above is a brief overview of the project and the details will be explained starting on Page 3.

Page 3. Once again, in the second quarter of fiscal year 2023, the company landed orders of JPY 860.8 billion, revenue of JPY 769.3 billion, a business loss of JPY 32.8 billion, loss before income taxes of JPY 34.4 billion and loss attributable to owners of the parent company of JPY 23.3 billion. As you can see, the sales weighted average exchange rate for the second quarter was approximately JPY 7 lower than that of the same period last year, and the weighted average exchange rate was approximately USD 780 million.

Page 4. The chart below shows the breakdown of orders, revenue and business profit for each segment. As shown in 1, Energy Solution & Marine Engineering reported an increase of JPY 5.4 billion year-on-year due to a significant contribution from the ship and offshore business. On the other hand, as described in 2, revenue and profits declined in Aerospace Systems due to the loss of the PW1100G engine and in Precision Machinery & Robot mainly due to the sluggish Chinese construction equipment market and semiconductor market. As a result of the above, overall revenue increased by JPY 9.5 billion from the same period last year to JPY 769.3 billion, while business income decreased by JPY 63.6 billion to land at a loss of JPY 32.8 billion.

Page 5. See the chart for details. As noted in 1, the loss on the PW1100G engine was recorded as a decrease in revenue from sales, resulting in a deterioration of the cost of sales ratio. The main factors for 2 were cost reductions at the ship joint venture in China and improved profitability due to lower steel prices and a weaker yuan.

Page 6. Next, I will explain the stage profit below the business profit. As shown in 3 above, foreign exchange gains of JPY 3.3 billion were recorded in the second quarter results. While the depreciation of the yen at the end of the period resulted in a year-end valuation gain on foreign currency denominated receivables, the total foreign exchange gain was lower than the first quarter results due to a loss on valuation of hedges as a result of the progress of forward exchange contracts. As a result, income attributable to owners of the parent decreased by JPY 47.1 billion from the same period last year to a loss of JPY 23.3 billion.

Page 7. This section explains the factors that contribute to the increase or decrease in business profit and loss. Compared to the same period last year, the depreciation of the yen against the U.S. dollar resulted in a JPY 14.3 billion improvement. On the other hand, the change in sales composition and other factors resulted in a JPY 10.7 billion decrease in profit, primarily due to lower factory operations in the Precision Machinery & Robot business due to lower demand, mainly in the Chinese market and higher sales promotion expenses in the Powersports & Engine business.

Additionally, some bonus reserves, which were previously recorded in a lump sum at the end of the fiscal year, will be leveled from the first quarter of this fiscal year, and this change in accounting treatment has had the effect of reducing profits by approximately JPY 5 billion year-on-year. Also, a loss was recorded for the PW1100G engine, resulting in a second quarter business loss of JPY 32.8 billion, a JPY 63.6 billion decrease from the same period last year. Please refer to Page 8 for a detailed breakdown by segment.

Page 9. As indicated in 1, the factors behind the change in assets during the second quarter, inventories increased in Energy Solution & Marine engineering, Powersports & Engine and Aerospace Systems in line with sales expansion. On the other hand, deferred tax assets increased as a result of losses related to the PW1100G engine issue, as shown in 2.

Page 10. With regard to the factors that cause changes in liabilities and net assets, as indicated in the 3, interest-bearing debt has increased from the end of the previous period, but this is a normal business cycle. The net D/E ratio was 109%, which is slightly worse than in the same period of the previous year, but this was due to a decrease in capital attributed to losses recorded as a result of the PW1100G issue. In the second half of the fiscal year, we plan to record steady profits, and we will continue efforts not only to improve profitability but also to improve asset efficiency by promoting collection of accounts receivable and controlling inventories in order to return to the 70% to 80% level that we have set as a guideline by the end of the fiscal year.

Page 11. As shown in 1, operating cash flow improved by JPY 54.5 billion from the same period last year, mainly due to progress in collection of receivables in Powersports & Engine in the current second quarter. While cash outflow in the second quarter last year was caused by an increase in advances in Aerospace Systems. In terms of investment cash flow, there was a JPY 12.6 billion increase in cash outflow, resulting in a JPY 41.9 billion improvement in free cash flow compared to the same period last year.

Page 12. We have posted the cash flow trends for the past 10 years for your reference.

Page 13. As for the outlook for fiscal year 2023, as mentioned earlier, despite the loss in the Aero Engine business, we expect to be profitable with operating income of JPY 40 billion and net income attributable to owners of the parent of JPY 12 billion, thanks to improved profitability and the tailwind from the yen's depreciation. For your reference, a graph on Page 39 shows the factors behind the JPY 38 billion change in business profit from the initial forecast of JPY 78 billion to JPY 40 billion.

Although there are some weaknesses in each business since the beginning of the period, with the exception of the PW1100G engine loss of JPY 58 billion, we view this as generally in line with our expectations. Although we have revised our foreign exchange assumption to JPY 140 to the dollar, currently, we plan to incur a foreign exchange loss in financial income loss below business profit in the second half of the fiscal year due to the progress of forward exchange contracts.

Page 14. The breakdown by segment is shown in the chart. Details are explained on the page for each segment.

Page 15. The second quarter results for fiscal year 2023 are shown on the slide. Orders for the full year forecast are expected to increase by JPY 10 billion year-on-year due to a significant increase in orders from the Ministry of Defense despite a decrease of JPY 58 billion due to operational problems related to the PW1100G engine. In terms of business income, although there is an increase due to the change in foreign exchange assumptions losses from the same engine are expected to be significant, resulting in a JPY 48 billion decrease from the same period of the previous year.

Page 16. Please refer to this page for the results of orders and revenue, the number of aircraft sold to Boeing and the number of engines sold in each of the aircraft and engine businesses.

Page 17. This page shows quarterly sales and profit trends.

Page 18. This page describes our understanding of the business environment and order trends in the segment are key measures to achieve our forecast and specific initiatives. Please refer to the supplementary information about the PW1100G engine program for a briefing on the business environment.

Page 19. As shown in the slide for the second quarter results of fiscal year 2023, orders received decreased due to decline in projects for the domestic market, but revenue increased by JPY 25.5 billion year-on-year due to an increase in the delivery of R211 cars for the U.S. market. Profits remained flat year-on-year due to the impact of lower domestic operations despite higher sales. There is no change in the forecast for fiscal year 2023 from the previous announcement.

Page 20. This page shows orders received and revenue from sales in the Japanese, Asian and North American markets, respectively. As for the M9 project for the Long Island railroad in the U.S., delivery of the final cars has been delayed due to a shortage of some parts, but the cars themselves have already been completed. The cost impact of this delay is negligible and has already been factored into the earnings forecast.

Page 21. This page shows quarterly revenue and profit trends for your reference.

Page 22. There has been no change in the business environment and priority measures of the Rolling Stock segment since the previous announcement.

Page 23. The second quarter results for fiscal year 2023 are shown on the slide. As for orders received, although there was an increase in orders for naval ship equipment for the Ministry of Defense, orders decreased due to the absence of orders for a waste treatment facility and 2 LPG ammonia carriers received in the same period of the previous fiscal year. On the other hand, revenue rose due to the energy business and an increase in the construction volume of LPG ammonia carriers and profits rose due to an increase in profit of equity method affiliates in addition to the increase in sales.

We have raised the forecast for orders by JPY 10 billion due to an increase in orders for main engines for naval vessels for the Ministry of Defense, while the forecast for revenue remains unchanged with no major changes. In terms of profit, we have raised the previous forecast by JPY 11 billion due to improved profitability of the Marine machinery business for the Ministry of Defense in addition to improved equity method earnings in China in ship and offshore structure.

Page 24. Please refer to this page for a breakdown of orders, revenues and equity method gains and losses for the Energy, Plant & Marine Machinery and Ship & Offshore businesses.

Page 25. This page shows quarterly revenue and profit trends for your reference.

Page 26. This section describes the business environment and order trends in this segment. There are no major changes in the business environment or order trends. As for priority measures, we will continue to focus on providing products and services that contribute to the realization of a low-carbon and decarbonized society this fiscal year. In particular, we highlight the start of trials for a CO2 capture system using waste heat at Kansai Electric Power Company's Maizuru thermal power plant as an initiative to impact decarbonization solutions. This system uses individual amine absorbers that can recover decarbonization with less energy consumption than conventional methods using liquid amine. This world's first trial has attracted worldwide attention. Please continue to pay attention to our CO2 recovery business.

Page 27. The second quarter results for fiscal year 2023 are shown on the slide. Orders decreased due to a decline in orders for robots for semiconductor manufacturing equipment, robots for general industrial machinery and hydraulic equipment for the construction machinery market in China. Revenue also decreased due to lower sales of hydraulic equipment for construction machinery in China and robots for semiconductor manufacturing equipment. Business profit also decreased due to lower sales and lower utilization. The forecast for orders, revenue and business profit have also been lowered from the previously announced figures in light of the sluggish Chinese construction equipment market and the delayed recovery period of the semiconductor market.

Page 28. This page shows orders, revenue and equity method gains or losses of the Precision Machinery & Robot segments. Please also refer to the following chart for a breakdown of hydraulic equipment sales to the Chinese market and robot sales by field.

Page 29. This page shows quarterly revenue and profit trends for your reference.

Page 30. This section presents the business environment and order trends in this segment. Regarding the business environment, the recovery period of the Chinese construction equipment market is slower than assumed at the time of the previous announcement as is the situation in the semiconductor manufacturing equipment market. However, in light of market conditions, we expect a gradual recovery from the fourth quarter. There are no other major changes from the previous report regarding priority measures and specific initiatives.

Page 31. The second quarter results for fiscal year 2023 are shown on the slide. Compared to the same period last year, revenue increased due to an increase in motorcycles for Europe and 4-wheelers for North America, despite a decrease in motorcycles for Southeast Asia as well as a tailwind from the yen's depreciation. Business profit decreased due to increased sales promotion expenses and upfront investment in R&D and marketing expenses. The outlook for the North American market, our main market, is stronger than we assumed at the beginning of the fiscal year. In addition, the depreciation of the yen will offset the impact of lower demand from motorcycles for Southeast Asia and a temporary drop in demand for general purpose engines due to weather conditions. As such, we have maintained our previous forecast.

Page 32. This page shows revenue of motorcycles in developed countries, motorcycles in emerging countries, 4 wheelers and PWC and general-purpose engines. Please also refer to the table below for information on motorcycle sales by country.

Page 33. This page shows quarterly revenue and profit trends for your reference.

Page 34. Explanation omitted as there have been no major changes in the business environment or priority measures since the last time.

Page 35. With regard to shareholder returns, we have lowered our earnings forecast and in line with our dividend policy of maintaining a medium- to long-term dividend payout ratio of 30%, we have revised downward our first half and second half dividend forecast to JPY 20 each. We deeply apologize to our shareholders and will make every effort to minimize this situation and further increase profits in the second half of the fiscal year. In the next fiscal year, we will focus on restoring the company to its previous growth trajectory and ensuring sufficient shareholder returns.

Page 36. We are pleased to report 3 project topics. The first 2 projects will be hydrogen projects, which we expect to be our future core business. This page describes the diplomatic relations through the operation of the liquefied hydrogen carrier, SUISO Frontier. As on the left of the page, the SUISO Frontier was sent to Saudi Arabia in conjunction with the Middle East visit by Prime Minister Kishida in July of this year. The interior of the ship was observed by Prince Salman, Minister of Energy of Saudi Arabia and Minister of Investment, Falih, who showed a keen interest in our hydrogen transportation technology.

As on the right of the page, the SUISO Frontier was sent to Australia in conjunction with the Australia-Japan Business Partnership meeting held in Australia in October of this year. Australian Minister of Natural Resources, King; and Minister of Economy, Trade and Industry, Nishimura, participated in a tour of the ship. Australian officials who are focusing on exporting liquefied hydrogen as an alternative to conventional fossil fuels expressed a strong interest in the project.

As such, the SUISO Frontier, the world's only liquefied hydrogen carrier currently capable of intercontinental transport has increased the presence of not only the company, but also Japan to other countries around the world in regards to liquefied hydrogen transport technology and progress has been made in specific business negotiations. We will continue to contribute to the early realization of a carbon-neutral society from a global perspective through our world-leading liquefied hydrogen supply chain technology.

Page 37. In relation to the hydrogen business, this page continues to introduce the progress of our efforts in Japan. As shown in the slide, in September of this year, KHI signed an agreement with Kawasaki City in Canada prefecture to strengthen cooperation in anticipation of the establishment of a liquefied hydrogen supply chain centered on the Kawasaki waterfront area. The area will be the site of a liquefied hydrogen receiving station for a commercial liquified hydrogen supply chain verification project, which was selected by NEDO's Green Innovation Fund.

In October of this year, the company signed a memorandum of understanding with Resonac to collaborate on the development of a hydrogen power generation business in the Kawasaki area. Based on the aforementioned commercial liquefied hydrogen supply chain verification project, this MOU provides for the start of a hydrogen power generation project of 100 megawatts or more at the Resonac-Kawasaki plant by around 2030, when the use of liquefied hydrogen originating overseas will become possible in Japan.

The company will participate in this collaboration by providing power generation equipment. We believe that this project is very significant because it will serve as a role model for companies aiming to become carbon neutral and will make a significant contribution to reducing CO2 emissions in Japan. We will continue to contribute to the realization of the government's goal of carbon neutrality by 2050.

Page 38. The last of the project topics will be the Powersports & Engine segment, which has been the main driver of earnings in recent years. Kawasaki's first 2 motorcycle-type EVs, the Z e-1 and Ninja e-1 are now available. In addition to this, in 2024, we plan to launch the world's first hybrid motorcycle that will be able to travel long distances between cities. In this way, we will achieve sustainable growth by providing products that meet the expectations of our customers and by responding to the need to decarbonize our industry while realizing fun to ride, that is unmistakably Kawasaki, even for electric motorcycles.

Page 39. Please refer to the following pages for reference information on capital investment, depreciation and amortization, research and development expenses and the number of employees at the end of the fiscal year. This concludes my explanation.