Kawasaki Heavy Industries Ltd

TSE:7012

Earnings Call Transcript 2019-Q3

[Kenji Tomida, executive]

Good afternoon, ladies and gentlemen. This is Tomida. Thank you for joining us in the financial results briefing for the third quarter of fiscal year 2018 ending in March 2019.

As usual, I will use Page 3, summary of financial results. Overall, financial results for Q3 were in line with our expectations with net sales reaching around 70% of the full year target, which indicates a similar speed of progress as in the previous year.

As for the P&L items, orders received were up JPY 80 billion year-on-year, mainly due to the submarine order received by the Ship & Offshore Structure segment for the Ministry of Defense and the combined cycle power plant order received by the Energy System & Plant Engineering segment for the domestic market.

Net sales were up JPY 2.2 billion, mainly due to the sales growth in the Precision Machinery & Robot and the Motorcycle & Engine segments, which offset the decline in sales to the Ministry of Defense as well as decline in the component parts of commercial aircraft jet engines in the Aerospace Systems segment. Sales for the overseas market also decreased in the Rolling Stock segment.

Operating income was down JPY 7.7 billion despite the improvement in the Ship & Offshore Structure segment, mainly due to the decrease in depreciation of development cost of new engines as well as the provision for loss on construction contracts recorded in the Rolling Stock segment.

Recurring profit was down about JPY 20 billion. On top of the decline in operating income, we have booked a nonoperating expenses of approximately JPY 10 billion due to a provision for the Aerospace Systems segment related to the Trent 1000 engine operation issue as well as a foreign exchange loss of JPY 4.6 billion to reflect the sudden appreciation of the Japanese yen at the end of December.

Net income attributable to owners of parent was down JPY 3.1 billion. This is much smaller decline compared with the decline of about JPY 20 billion in recurring profit. This is due to the absence of the large extraordinary loss recorded last year by the Ship & Offshore Structure segment.

Weighted average exchange rates and the impacts are shown at the bottom of the page. The yen/dollar rate of 111.24 represents the yen's appreciation of JPY 0.07.

Page 4 shows financial results by segment. I will come back to this point later in my presentation.

Page 5 shows details of change in operating profit. Operating profit declined JPY 7.7 billion year-on-year from JPY 44.6 billion to JPY 36.8 billion. Let me explain the factors behind it using the diagram. The absence of provision for loss in LNG vessel construction contracts, which we had last year, increased operating profit by JPY 4 billion.

While the loss incurred in the Rolling Stock segment, which was discussed at the last analyst meeting, decreased operating profit by JPY 8.5 billion as of the end of Q3. The breakdown is JPY 2.5 billion for the Long Island Rail Road M9 base contract, JPY 3 billion for the Washington project and JPY 3 billion for the domestic projects. For the M9 option contract, the order is likely to come during Q4. The loss provision for the order is not included, however, in the JPY 8.5 billion of Q3.

Second, effects of foreign exchange rates due to the yen's appreciation against Asian and other emerging currencies were negative JPY 600 million. Third, change in sales was positive JPY 3.5 billion. The decline due to the decreased sales of the Aerospace Systems and Rolling Stock segments was offset by the sales growth in the Precision Machinery & Robot and Motorcycle & Engine segments.

Fourth, product mix and other factors decreased operating profit by JPY 2 billion. There were positive factors, such as reduced low profitability projects in the Ship & Offshore Structure segment and improved profitability in the energy business. Nevertheless, OP declined due to the lower profitability in the Aerospace Systems segment due to the increase in depreciation of development costs of new commercial aircraft jet engine projects. The lower profitability in the Precision Machinery & Robot segment reduced contribution of semiconductor robots in total sales and the impact of higher steel prices in the Motorcycle & Engine segment.

Lastly, change in selling, general and administrative expense decreased OP by JPY 4.1 billion. This is due to the bad debt provision booked for overseas distributors in the Motorcycle business and increased advertising expense and increased cost in the Precision Machinery & Robot segment to support higher output and increased cost for research and development.

Next, let me take you through nonoperating income and expenses on Page 6. Nonoperating income deteriorated JPY 12.3 billion year-on-year to minus JPY 16.9 billion. Let me give you the major factors behind it.

First, equity in income of unconsolidated subsidiaries and affiliates is down JPY 2 billion due to a decrease in profits of the Chinese joint venture and an increase in losses caused by an increased medical robot development cost.

Next, gain and loss on foreign exchange is down JPY 4.6 billion due to the abrupt yen appreciation in December last year. Next, payments for commercial aircraft jet engines deteriorated by JPY 7.2 billion. There were no payments for contract adjustments this year, however, new payments were incurred out of the contract with Rolls-Royce this year. The net effect was minus JPY 7.2 billion. There was no extraordinary income or loss recorded this year, as I mentioned earlier.

Now let me move on to the details of each segment, starting with the Q3 results of the Aerospace Systems segment. Orders received and the net sales trends were as shown on the slide. Orders and sales decreased due to decrease in aircraft for the Ministry of Defense and the component parts for commercial aircraft despite an increase in component parts of commercial aircraft jet engines.

Operating income decreased JPY 5.3 billion year-on-year due to the increase in depreciation of development cost of new commercial aircraft jet engine projects and other factors.

FY 2018 forecast. Order received is revised up by JPY 10 billion since component parts for commercial aircraft jet engines are expected to increase. Net sales are revised down by JPY 10 billion due to a revision to the progress in construction works for the Ministry of Defense and the decrease in component parts for commercial aircraft jet engines.

On the other hand, operating income is unchanged because we have both positive and negative factors. Although operating income up to Q3 is at a lower level due to jet engine development costs and high volumes of free introductory assistance, or FIA, for engines delivered in the previous year, we believe that we can achieve the guidance because FIA is expected to decrease and after-sale service revenues are expected to increase during Q4.

Please turn to the next page. Page 8 is Energy System & Plant Engineering. Orders received and the net sales trends are as shown on the slide. Order received for CCPP increased for the domestic market. Net sales remained flat due to the increase in construction works for the Energy business, offset by the decrease in construction works of a chemical plant for the overseas market. This chemical plant we are talking about is a gas-to-gasoline plant in Turkmenistan.

Operating income rose JPY 1.9 billion. The decline due to lower sales of the chemical plant mentioned earlier is covered up by the increase in revenue and the profit of the Energy business.

FY 2018 forecast. Both orders and sales projections are kept unchanged, while operating income guidance is revised up by JPY 1 billion to JPY 9 billion on the back of an improvement in the profitability of gas engines and other projects.

Next, Page 9 is Precision Machinery & Robot. I'll discuss the Q3 results first. Orders and net sales were as shown here. They were up year-on-year, driven by the strong performance of hydraulic components, especially for construction machinery. The robots were down slightly year-on-year due to a weaker semiconductor market as well as the impact from the U.S.-China trade conflict.

Operating income remained flat, while profit margin declined year-on-year. This is due to expenses incurred to increase production output, an increase in fixed cost caused by business expansion and the deterioration in robot sales mix, which canceled out the increase in profit due to sales increase.

For full year, orders received, net sales and operating income for the Robot business are revised down by JPY 10 billion, JPY 5 billion and JPY 500 million, respectively, in view of the downturn in the semiconductor market and the impact of the U.S.-China trade friction.

Please turn to Page 10, Ship & Offshore Structure. Orders and sales were as shown here. Orders were up JPY 67.7 billion due to orders for the submarine for the Ministry of Defense, while sales were down JPY 6.9 billion as the increase in LPG carrier was more than offset by the decline in LNG carriers.

Operating income improved around JPY 7.1 billion year-on-year. As shown with the waterfall chart, we did not have the loss disposal for an LNG carrier like we did last year. We had a higher profitability this year compared with the last year, thanks to cost reduction and profitability improvement coming from higher margin ship repair booked for Q3.

For full year, orders are revised down by JPY 20 billion due to the delay in the booking of one LNG carrier into next fiscal year.

Operating income was strong for Q3 at JPY 2.8 billion. But full year guidance is kept unchanged at JPY 1 billion as we expect to book additional provision for a bulk carrier, which is expected to be ordered during Q4. We see lower margin sales because high margin repair service were concentrated during Q3 and booked higher repair-related expenses during Q4.

Let me explain the background behind the bulk carrier order that I mentioned earlier. First, on the macro level, it is clear that demand for gas fuel vessels will continue to expand if you consider the expected reversal of the supply-demand balance of LNG vessels by 2020, driven by an exclusive increase in gas demand worldwide, which is further promoted by regulatory response.

Under such a scenario, following the policy of structure reform, we have been transferring the shipbuilding activities of bulk carriers, tankers and other low added-value vessels to China while focusing on the order-taking activities of gas-related vessels in Japan with relatively higher added value and profitability, for example, LNG, LPG, bunkering and gas-filled vessels. Nevertheless, due to the postponement of some projects, we had a temporarily vacant capacity in the domestic shipyard. To fill the capacity, we have decided to take an order for bulk carrier.

The plans we have announced, however, as part of the structural reform, such as the improvement of domestic shipyard fixed cost and productivity and installation of the dock at a Chinese shipyard, are still on track. And we keep working on achieving an ROIC target of 8% by fiscal year 2020. That was my brief explanation of Ship & Offshore Structure.

Let me now move on to Rolling Stock. First, Q3 results. Orders and sales are as shown here. Sales are down mainly for the North America market. Operating income deteriorated JPY 8.8 billion year-on-year as margin improvement of some projects was more than offset by the JPY 8.5 billion losses recorded.

As explained with the waterfall chart, JPY 2.5 billion was due to additional losses for the M9 base contract, JPY 3 billion is due to Washington Metropolitan Area Transit Authority's wiring repair expenses and JPY 3 billion is due to provision associated with orders in Japan.

For full year forecast, sales were revised down by JPY 10 billion in view of the anticipated delay in delivery and the sales booking of M9 into April this year rather than from the end of the fiscal year. This, however, should not affect the full year earnings because we use a provision.

Let me now give you a supplementary information on the M9 train cars. Our expectation was to receive option orders on top of base orders for 110 train cars during Q3, but the client's internal approval process took longer than expected, and the signing is now scheduled for February. This, however, should not affect the delivery schedule or earnings forecast.

As for the progress on the M9 base contract, the postponement of the delivery was caused by a longer-than-expected testing period by the client reason on above-the-ground facilities. We now expect the delivery to start in April, and the very last option train car is to be delivered during Q3 of 2020.

Last segment is Motorcycle & Engine on Page 12. Net sales were as shown on the slide. It is up JPY 11.3 billion year-on-year due to brisk sales of motorcycles and utility vehicles for developed countries. Operating income was down JPY 3.2 billion year-on-year due to a bad debt provision set aside for overseas distributors, temporary increase in SG&A, higher prices of steel and other materials, and the weakening of emerging country currencies.

For full year, sales guidance is kept unchanged, while OP guidance is revised down by JPY 1 billion due to the revision of some FX rate assumptions, namely from JPY 130 to JPY 124 to the euro and higher prices of steel and other materials triggered by the U.S.-China trade friction.

Next, I'd like to give supplementary explanation on the balance sheet on Page 13. This year, we expect to record the highest net sales in history. Therefore, the production output is on the rise, causing inventory level to rise and the total assets to increase by JPY 216.3 billion from the end of the previous fiscal year.

Trade payables decreased, and interest-bearing debt increased by JPY 265.3 billion from the end of the previous fiscal year, pushing up net D/E ratio to 142.4%. However, an increasing trend of interest-bearing debt from Q1 to Q3 is a normal trend. For instance, net D/E ratio is almost at the same level as last year's 139%.

Let me move on to cash flows on Page 14. Cash flows from operating activities remained almost at the same level as last year due to the decrease in expenditures for overseas projects in the Energy System & Plant segment, despite an increase in working capital affected by an increase in inventories in the Rolling Stock segment.

Cash flows from investing activities remained flat year-on-year at negative JPY 67.4 billion. As a result, free cash flow was almost at the same level as last year at negative JPY 274.8 billion. Although a tough situation is likely to continue through FY 2018 with an increasing working capital caused by higher sales and a continuously high level of CapEx, mainly in the Aerospace Systems segment, we will continue to strive to improve our financial position.

Let me now discuss the full year forecast on Page 15 onwards. FY 2018 forecast has been revised from the end of October guidance to reflect the ongoing U.S.-China trade conflict and the weakening of currencies in Europe, Asia and other emerging countries. The OP guidance is kept unchanged because the increase in the Energy System & Plant Engineering segment is offset by the decrease in the Precision Machinery & Robot and the Motorcycle & Engine segments.

Recurring profit and net income attributable to owners of parent are kept unchanged from the last guidance. Dividend per share is unchanged from the previous guidance at JPY 70 per share. The FX assumption is revised for the euro from JPY 130 to JPY 125, as explained earlier, and unchanged for the U.S. dollar at JPY 110.

Page 16 shows fiscal year 2017 actual performance and fiscal year 2018 forecast by segment. So please refer to it later.

Page 18 shows R&D, CapEx and the number of employees as of the end of fiscal year. These are unchanged from last time.

Page 20 and 21 show the market overview for each business, just for your reference.

With this, I would like to conclude my presentation. Thank you for your kind attention.