IHI Corp

TSE:7013

Earnings Call Transcript 2019-Q2

[Takeshi Yamada, executive]

This is Yamada. Thank you very much for coming to our financial results meeting. I will explain IHI Group's financial results for the second quarter of the fiscal year 2018 based on the PowerPoint presentations disclosed at 3:00 p.m. today.

First, I will explain the summary of financial results for the second quarter. Please turn to Page 4. This slide shows the consolidated results, including orders received in the income statement. Orders received were JPY 649.3 billion, down JPY 65.7 billion year-on-year. In fiscal year 2017, the closing date of the fiscal year for certain overseas consolidated subsidiaries was changed from December 31 to March 31. Although it's not described on the slide, the effect of these changes was an increase of JPY 31.4 billion in the second quarter of the previous fiscal year.

As shown at the top right, the average exchange rate for sales during the second quarter was JPY 109.79 to the U.S. dollar. The yen appreciated JPY 1.35 from JPY 111.14 compared to the previous corresponding period.

As explained on the slide, the effect from financial reporting periods unification was an increase of JPY 57.9 billion in sales and an increase of JPY 1.4 billion in operating profit in the second quarter of the previous fiscal year. Net sales decreased by JPY 73.9 billion to JPY 699.5 billion due to the effect of these changes and to the pullback from the progress of large-scale projects in the Process plants Business in previous corresponding period.

Operating profit increased JPY 10.5 billion to JPY 45.2 billion. While profitability in the Civil aero engines Business declined, it improved in Boilers Business. Also among others, the issue of profitability deterioration in the process plants project underway in North America is being brought under control. Ordinary profit increased JPY 29.5 billion to JPY 49.1 billion due to decrease in nonoperating expenses and increase in share of profit in equity method affiliates. Profit attributable to the owners of parent was JPY 28.4 billion, up JPY 21.5 billion.

Please turn to Page 5 for orders received and order backlog by segment. In Resources, Energy and Environment, orders decreased due to the reverse effect of receiving a large-scale overseas project in the Boilers Business in the same period of last year. In Social Infrastructure and Offshore Facility, orders decreased in the bridges and water gates business. In Industrial System and General-Purpose Machinery business, orders decreased due to the effect of financial reporting periods unification in FY 2017. Excluding this effect, orders received increased in logistics and industrial systems business, Vehicular turbochargers Business, Thermal and surface treatment Business among others. In Aero Engine, Space and Defense, orders increased in the aero engines for Japan Ministry of Defense. Overseas orders received was JPY 294.5 billion, representing 45% of total orders. This ratio declined due to decreased orders in overseas large-scale projects for boilers and others. Order backlog totaled JPY 1,522,300,000,000, down JPY 44.7 billion from previous fiscal year-end.

Please turn to Page 6 for net sales and operating profit by segment. In Resources, Energy and Environment, net sales decreased due to a pullback from the progress of large-scale projects in the Process plants Business in the same period of last year in addition to the effect of the financial reporting periods unification in FY 2017. Operating profit increased significantly as the last year's profitability deterioration issue in the Process plants Business is being brought under control and due to the profitability improvement in Boilers Business. Booking profit in this segment is the first time in 3 years. The last time was in the second quarter of 2015.

In Social Infrastructure and Offshore Facility, net sales increased in the bridges and water gates business, but decreased in the F-LNG and Offshore structures Business and in the Shield systems Business. Operating profit decreased in F-LNG and Offshore structures Business due to a pullback from FY 2017 and in the transport systems business. Net sales in Industrial System and General-Purpose Machinery decreased due to the effect from financial reporting periods unification in FY 2017. Excluding this effect, sales increased in the Thermal and surface treatment Business and in the Vehicular turbochargers Business among others. Operating profit increased due to net sales increase in the Thermal and surface treatment Business and profitability improvement in the parking business, among others, despite the effect of financial reporting periods unification in FY 2017.

Net sales in Aero Engine, Space and Defense increased in Civil aero engines Business.

Operating profit overall decreased mainly due to increased sale of 7 new PW1100G engine despite the cost decrease for handling defects in the Civil aero engines Business. Overseas sales totaled JPY 367.2 billion, representing 52% of total sales.

Please turn to Page 7. This is a breakdown by segment of the JPY 10.5 billion year-on-year increase in operating profit. Change in net sales had a JPY 5.6 billion negative impact overall due to higher sales of the new PW1100G engine that brought down OP in Aero Engine, Space and Defense, despite the positive impact in Industrial System and General-Purpose Machinery. Change in construction profitability had a JPY 19.5 billion positive impact. As I already explained, last year's profitability decline issue in the process plants project now underway in North America is being brought under control. Also in Resources, Energy and Environment, profit expanded significantly due to improved profitability from the Boilers Business. Mainly from these reasons, construction profitability improved.

Negative impact from the change in foreign exchange was JPY 700 million. Change in SG&A, excluding the JPY 6 billion decrease from the impact of financial reporting periods unification in FY 2017, was an increase of JPY 1.2 billion. The negative impact from changing the financial reporting period was JPY 1.4 billion as a relapse from the previous corresponding period.

Please turn to Page 8 for nonoperating income and expenses. Share of profit in equity method affiliates was a profit of JPY 5.1 billion. As for Marine -- as for Japan Marine United Corporation, the profitability of the project is improving, thanks to the yen depreciation, and we were able to secure profits for the quarter. Foreign exchange gains and losses improved by JPY 2 billion and booked a gain of JPY 2.4 billion. Others, which is a net of miscellaneous income and expenses, improved by JPY 12 billion year-on-year. This was a positive rebound from the nonoperating expenses booked during the same period last year, which are listed in the notes.

Please turn to Page 9 for the breakdown of extraordinary income and losses. We made a timely disclosure on September 27 regarding the selling of the small power systems business. Related to this, we booked a gain on sales of subsidiaries and associates of JPY 4.1 billion and also booked impairment losses of JPY 1.5 billion.

Please turn to Page 10 for the consolidated balance sheet. The second quarter-end interest-bearing debt was JPY 364.6 billion, up JPY 42.3 billion compared to the end of last fiscal year. Because of the increase in interest-bearing debt, debt-to-equity ratio was 0.96x, while due to the profit booking of JPY 28.4 billion, equity ratio improved to 21.3%.

Please turn to Page 11 for consolidated cash flows. For this quarter, cash flows from operating activities declined by JPY 45.8 billion compared to the same period last year, due in part to the deterioration in working capital as well as to increases in tax payment and, as a result, was an outflow of JPY 2.7 billion, unfortunately.

For cash flows from investing activities, outflow increased by JPY 34.9 billion compared to the same period last year when proceeds from sale of shares in Westinghouse was booked and was an outflow of JPY 39.6 billion. As a result, free cash flow, which is a sum of cash flows from operating investment activities, amounted to an outflow of JPY 42.3 billion. We will continue, through activities such as shortening cash conversion cycles, to work on enhancing cash generation throughout this fiscal year.

Please turn to Page 12. The numbers shown are actual results for R&D, CapEx and depreciation. CapEx has increased compared to the same period last year as there were investments related to civil aero engines.

Please turn to Page 13. This shows the geographical breakdown of the overseas sales, which I just explained. So please use this as a reference.

Now I'd like to touch upon the full year forecast for fiscal year 2018. Please turn to Page 15. There are no changes to the forecast for orders received, net sales and operating profit. ForEx assumption from the third quarter and onwards are JPY 105 to the U.S. dollar and JPY 130 to the euro, unchanged from our announcement we made previously. For the ForEx sensitivity, this is calculated at JPY 500 million for every JPY 1 movement against the U.S. dollar.

For Pages 16, 17, please allow me to skip these explanations as we have not changed our annual forecast.

And Page 18 and onwards show results and forecasts by segment. Here, I'd like to explain about the gap of operating profit between the second quarter results and the full year forecast.

Firstly, on Page 19, Resources, Energy and Environment. It's the bottom of the left-hand side, you can see operating profit. As you can see from the operating profit for this second quarter, it's JPY 11.5 billion, while the full year forecast is JPY 20 billion. In the first quarter, the gap was large since that quarter was loss-making. But we have narrowed that gap this quarter as we were able to increase profit significantly in the second quarter.

Next, Page 21 is Social Infrastructure and Offshore Facility. The second quarter operating profit was JPY 4 billion, and the full year forecast is JPY 12 billion. It may seem skewed towards the second half, but this is mainly due to the domestic bridge project whose sales booking concentrates at the end of the fiscal year.

Next, Page 23 is Industrial System and General-Purpose Machinery. The second quarter operating profit was JPY 8.1 billion, and the full year forecast is JPY 22 billion. We are basically seeing the same trend as we saw at the last fiscal year.

And lastly, Page 25 is Aero Engine, Space and Defense. The second quarter operating profit was JPY 23.9 billion and the full year forecast is JPY 44 billion. Unfortunately, losses due to increase in sales of the new engine PW1100G is still expected to be booked, but we should be able to settle at around the full year forecast numbers.

Page 27 and onwards are for your later references. This concludes my explanation. Thank you.

[Tsugio Mitsuoka, executive]

Good afternoon. This is Mitsuoka. I would like to explain management review.

Now starting from the Group Management Policies 2016, actually this is the final year of our midterm business plan. It has been 2.5 years already, so first, I would like to touch upon it.

In this midterm business plan of Group Management Policies 2016, we were focused on enhancing earnings foundations. We -- I have been communicating the business to improve the profitability. 6 months ago, in May, in the results meeting, I have explained that against the OP margin target of 7%, our operating profit guidance is JPY 85 billion, and this would only make OP margin of 5.7%. And I made excuse, one was foreign exchange. The yen was assumed at JPY 115 to the U.S. dollar but now it's JPY 105. So there's JPY 10 gap. We have been using the term risk buffer from a year ago. For fiscal year 2017, risks of the projects were not removed and therefore, we implemented risk buffer. But for this fiscal year, as I explained 6 months ago, in fact, I am telling each businesses to stretch the improvements. And therefore, compared to fiscal year 2017, the meaning of the risk buffer is different. And at this stage, we are implementing JPY 11 billion.

Now 6 months have passed. Like Mr. Yamada said, we have not changed the guidance for this fiscal year. The exchange rate in the first half is around JPY 110. So compared to the expectation, yen depreciated by JPY 5. Therefore, you might think that we should make upward revisions to the forecast. But in fact, the aero engine business is struggling a little bit, and therefore, we are not changing our forecast. Frankly speaking, we actually wanted to secure that surplus from the yen's depreciation, but the aero engines business is struggling a bit.

The numbers in the second quarter were described by Mr. Yamada. But if you could deeply read the slide pack, in the Boilers Business, profitability improved. That is written on the slide pack. However, in the full year plan, actually, improvement was expected to come from the maintenance profit throughout the year. However, compared to the plan, that is realized in the first half. And therefore, the numbers in the first quarter and the second quarter looks great. However, there is a maintenance cycle on the part of the clients. And therefore, these great numbers in the first half is the orders brought forward. We are booking these improvements heavier in the first half.

Now talking about the aero engine business, I talked about the foreign exchange, and I also talked about the struggles we are facing. And therefore, for the second quarter and for the full year forecast, we are including the risk buffer as I have explained just now.

Now in order to strengthen earnings foundations, there are 3 ways. One is project implementation, structure, change of business model and also concentration and selection. And I have come up with this slide to talk about the results and the issues.

In terms of the project implementation, I know that we made a lot of problems for the stakeholders, but finally, we are seeing the improvements. However, when we look at the issues we have, we need to enhance our process management in projects. As you can see on the second line, when we are carrying out large-scale projects in overseas, we need to be local, not global. We need to manage the local suppliers and the local laborers, and that is an area we still need to enhance, and we are continuing to address on these issues. And the second point, which is the transformation of business model, every time I talk to you, I always talk about what IHI Group is doing. For example, use of IoT or the new solutions we are working on. Even though we are seeing some achievement, and I would like to touch upon it later on, but still, we have some issues.

When I started Group Management Policies 2016, those issues I saw at the start are still remaining, and that is the equipment supply-oriented business. And this is the unique culture of IHI. And in fact taking 6 months towards the start of the next midterm business plan, we are carrying out many various activities to change ourselves to improve this.

And the third point is about concentration and selection occasions. We have been observing, but through implementation in the business area, we have been focused on injecting resources into priority business and highly profitable business. But actually, the changes to the business climate is happening faster, especially in energy, resources and environment business. And therefore, we need to accelerate our business structural reform.

Going to next page. I would have to talk about the projects that experienced business downswings. I would like to give you the updates. Starting from North American Process plants Business -- project, this is the second construction in E&C. Currently, we have not been able to fully recover from the schedule delay. In terms of the current schedule, the first train, the #1 train and the balance of plant facilities are scheduled to be handed over in the fourth quarter of this fiscal year. In relation to the schedule delay, cost is increasing. However, in many different ways, we will seek to reduce cost. And also we will negotiate with customers and also with the vendors in such a way we are seeking to minimize the losses.

In terms of this project itself, it covers up to #10 train, and the overall handover of the plant is scheduled for the calendar year of 2019. We are now holistically looking at the cost and the schedule of this project.

In terms of this company, IHI E&C International Corporation, because they experienced downswing in 2 projects, today, the Japanese and the non-Japanese are forming a team together to execute the construction. But today, we are assessing position of this company based on business downsizing.

Now in terms of Japan Marine United Corporation, last year, in addition to the SPB tank construction in Aichi, there was also schedule delay in the construction of LNG vessel in Tsu. Therefore, we booked losses from the investment in the equity method affiliate. However, the #1 vessel was handed over to the customer on October 7, and they are now working on the #2 vessel. Finally, it seems that the schedule for the construction of LNG vessel is under control.

2018 second quarter financial results was announced. And like Mr. Yamada explained, they reduced fixed cost, and they accepted orders properly. In addition to that, they were helped by the depreciation of the Japanese yen. And therefore, their second quarter number's very good. However, if the currency goes to JPY 105 to the dollar, this trend is going to be reversed. And if -- but I expect them to secure some profit this fiscal year. And also in terms of mid- to long-term basis, it needs to come up with a structure to compete with China and with Korea. And therefore, involving the shareholders, we are talking about the business structural reform. At the same time for 2018 and for 2019, in order for them to secure profit, various business activities are being taken place.

Next, the business area of Aero Engine, Space and Defense. This is what's written, but mainly, we're talking about the Civil aero engine Business unit. I mentioned this 6 months ago, the PW1100G-JM, we will be shipping a significant amount of this, the number of units. So in order to handle the significant number of units, we were concentrating our efforts here. But in addition to this, ourselves as an OEM party, we have been strengthening our capacity for engine maintenance from last year. We're trying to bolster the capacity. And our Mizuho plant, we have been expanding or enhancing human resources and CapEx in this area. And we have been actually doing this ahead of schedule, this capacity increase. And we have been struggling an awful lot, but we are making -- moving forward in this area.

The next bullet point is on cost reduction activities. If you look on the far right-hand side in very small print, the impact to earnings -- actually, everything, all comes from the early realization of cost reduction. So not just cost reduction in plant but including value engineering, we are working on cost reduction. And also the suppliers, especially the material suppliers, they are responding to our mass production or increased amount of production. And we are trying to reduce -- cost reduction in this front as well. But honestly speaking, we are having a delay against the schedule.

And the third bullet point, we talk about maintenance, again, on the engine maintenance business area. So the capacity, we have expanded that. We had personnel increases in Mizuho plant, and we have made CapEx, and we're ramping up capacity there. But in addition to that, actually, we signed a contract with Saitama Prefecture, and we are going to construct a new plant there. And actually, we are focusing, say, more, on expanding capacity rather than making the maintenance business a profit-generating structures so we'd like to move soon to a profit-generating structure. So this is where we are struggling. And this is the area where we are eating up the positive effect coming from the end depreciation.

The next slide is more on positive news. And actually this fiscal year, directly reporting to me in each of the business areas, there are improvements that I'm trying to push through. And in order to promote this, we have formulated teams. And we are going to have these teams to promote the lean and flexible activities to optimize the group structure. And what's happening in actuality is the SPB tank construction that was made in Aichi Works, this is coming to a close, and this was finished this autumn. And also on the bottom for Resource, Energy and Environment, especially the process plant, given the change in investment climate, and we have these very precious human resources, we are going to allocate these precious human resources to these various areas. So for these, number of people will be reallocated to growth areas, high-profitability areas and areas needing reinforcement. This what we're working on right now.

The next slide is the topic slide. We would like to introduce you the achievements of Soma IHI Green Energy Center. The participants today, if you have the opportunity sometime, I would like you to visit this place. Actually what this is trying to do is energy management. We had an opening ceremony on April 4 in what this place does. So for power, there's a solar power generated or electricity generated by certain sources, and how to balance this from the supplied electricity and to actually balance the demand and supply when it's necessary and to optimize the system, that is the strategy of this place. Be it solar power generation, fuel cell, energy for BCP and also the production of hydrogen, and we have made these facilities. And also we are providing electricity to the sewage treatment plant to provide necessary electricity to where it's needed. And these are the different measures -- ideas that we're taking.

It's not just to optimize energy supply in Soma. But -- and to have power to try to combine a source of power generation and the supply of that.

The following slide, please. This is on IoT. We're updating some topics here. There's a lot of text so if you could read it later on. But in the area of IoT and AI, the progress is extremely rapid. That is what I actually feel. Actually last week, I went to Silicon Valley, and I met with young engineers or CEOs of start-up companies that are most advanced and are at the forefront of the activity. And I had a lot of exciting discussions. And this is just to introduce you what measures that we, as a group, are having in this area.

Now the theme that we have here is more on the construction sites. So it will be the construction that is taking place within our group or our business. But not just for our company, but we could actually go into clients' construction sites, and we could connect things, connect concepts, and we can actually provide solutions, and this slide was to introduce these measures.

And that will end my explanation. Thank you very much.