IHI Corp

TSE:7013

Earnings Call Analysis

IHI Reports Operating Challenges and Strategies

IHI Group's FY23 Q2 faced operational headwinds, posting JPY 480.2 billion in revenue with special factors included but registered an operating loss of JPY 157 billion due to one-time losses, such as additional inspections for the PW1100G engine and litigation settlements. Excluding these factors, revenue was JPY 639 billion with an operating profit of JPY 16 billion. The civil aero engine business is growing, albeit with a hefty increase in maintenance frequency expected due to production issues. To adapt, IHI is focusing on improving cash flow through capital enhancements, even as supply chain instability increases inventory needs. Overall, management is taking measures to counter the decrease in operating profit, mainly affected by R&D and labor cost increases, tallying to JPY 8.2 billion. Despite challenges, investor confidence is shown by maintaining the dividend payout at JPY 100 per share, with no change in the full-year forecast.

Overview and Impact of Special Factors

IHI Group's second quarter of Fiscal Year 2023 was marked by the announcement of significant one-time losses related to the PW1100G engine additional inspection plan and a North American process plant litigation settlement. These one-time losses impacted the reported operating profit, which was stated at a negative JPY 157 billion. Despite these setbacks, the civil aero engine business is observed to be on a growth trajectory attributable to solid demand in aircraft, with hopes to see strengthened profitability by the end of the fiscal year.

Financial Results Excluding Special Factors

Setting aside the one-time losses, the orders received and revenue for the company were JPY 640 billion and JPY 639 billion, respectively, with an operating profit of JPY 16 billion. Noticeably, the foreign exchange rate has experienced a depreciation of approximately JPY 9 compared to the same quarter in the previous fiscal year, which has had varied effects on financial results.

Segment Performance and Foreign Exchange Impact

Sector-wise, the Aero Engine and Defense business saw an increase in orders of JPY 29.5 billion. However, operating profit declined across all reportable segments, with foreign exchange changes resulting in a profit of JPY 5.6 billion, centered on civil aero engines. Conversely, increases in R&D and labor costs led to an JPY 8.2 billion decrease in SG&A, showcasing the dual-edged nature of foreign exchange movements on the business.

Balance Sheet and Cash Flow Considerations

The company's total assets rose by JPY 111.3 billion, to JPY 2,053.3 billion, due in part to investments in securing parts for the civil aero engine amidst supply chain instability. Operating cash flow reflected an excess of JPY 81.4 billion, influenced by inventory spending for civil aero engine and the effects of the PW1100G engine additional inspection program. The forecasted cash flow remains in line with numbers previously disclosed on October 25, with a strategic focus on investment prioritization and working capital improvement.

Management Review and Operational Focus

Management expressed serious commitment toward addressing the recent losses and emphasized a forward-looking approach to solidify the Aero Engine business as a key growth area, despite the one-time powder metallurgy issue. The focus remains on increasing production, strengthening maintenance capacities, and ensuring future profitability within the segment. Additionally, the defense budget increase was seen as an opportunity for IHI to prepare for production scaling in defense engines and related spare parts.

Future Initiatives and Growth Prospects

Looking forward, IHI anticipates a 3% annual growth in aero engines and stresses the importance of production efficiency. With ongoing large-scale projects coming to completion, the company anticipates improved profitability and growth, particularly in areas like gas turbine power generation, nuclear energy, and social infrastructure. Moreover, emphasis is placed on life cycle business expansion and process gas compressor business due to their high growth potential. Despite the significant one-time losses, the management asserts that these do not alter the company's growth trajectory, with continued commitment to shareholder dividends and strategic resource allocation for future initiatives.

Earnings Call Transcript 2024-Q2

[Yasuaki Fukumoto, executive]

I am Fukumoto from Financial and Accounting Division. The outline of the IHI Group Fiscal year 2023 second quarter financial results were disclosed at 3:00 p.m. today. I will explain using the PowerPoint.

And this slide shows the context of what I'll be presenting. Page 4, please. This page gives the highlights of our financial results. FY '23, second quarter IHI Group's financial results. As disclosed on October 25, the impact of the shift PW1100G engine, additional inspection plan and North America process plant, litigation segment have been posted as a onetime lost.

The PW1100G engine, Civil aero engines businesses are still growing, thanks to the solid increase in aircraft demand. And as for the aftermarket costs this fiscal year due to the increase of the profit is not growing as expected, but there is steady increase of price demand and sales.

The material cost price increase has been reflected in various areas, we have added on to the sales price and strengthened our profitability and cost structure, and we hope to see the results further by the end of this fiscal year.

Now in regards to the cash flow, the Civil aero engine business, though we are continuing to see instability in the supply chain, we will secure the inventory for the sake of production increase. This will be given priority. At the same time, we'll accelerate capital and working capital improvements to secure cash. The details are given on the next page.

Page 5, please. This gives the orders received and the income statement. The impact of PW1100G engine, additional inspection program and North America's process plant litigation settlement impacts have been posted as onetime loss. As a result of the orders received was JPY 480.2 billion revenue, JPY 470.3 billion and operating profit and negative JPY 157 billion. On the right-hand side, we give the impact amount of these special factors, plus the numbers excluding these special factors.

Looking at the orders received, excluding special factors, it is JPY 640 billion, and revenue is JPY 639 billion, operating profit is JPY 16 billion. As for the foreign exchange rate, as shown at the bottom, the -- for this quarter, the average is U.S. dollar JPY 140.62, about JPY 9 depreciation from the same quarter last fiscal year.

Please turn to Page 6. On this page, we talk about the onetime loss that we have posted. They shipped PW1100G engines, additional inspection program and IHI, E&C and North American process plant litigation settlement, we talk about the impact amount and the details. As for the details, it has already been explained on October 25 and remains unchanged.

Please turn to Page 7. This talks about the orders received and order backlog by segment. As a result of the litigation settlement, the impacts are seen in the resource, energy environment sector, PW1100G engine, additional inspection programs impact is seen in the Aero Engine, Space, Defense sector. They have led to a drop in the orders received for this quarter.

And as for the orders, excluding special factors, it's given on the next page. On the right-hand side, for your reference, we gave the backlog as of the end of September. This does not -- is not impacted by the special factors and it has increased from the end of last fiscal year by JPY 21.6 billion, totaling JPY 1,321.1 billion.

And next page, we give us a reference the orders received breakdown, excluding special factors. Company-wide, the orders received was the same as the same quarter last year, but we see that for the resources, energy, environment, because last fiscal year, there was the large Southeast Asia gas-fired power plant construction. This has impacted us in this fiscal plus the absence of nuclear power restart deals. As a result, we see a drop in JPY 34.5 billion. Meanwhile, the Aero Engine and Defense business has seen an increase in orders to totaling JPY 29.5 billion.

Next, Page 9, this talks about the revenue and operating profit by segment. The reference is given, excluding special factors on the next page. So I will explain these on the next page.

Please turn to Page 10. And this gives the revenue and operating profit by segment, excluding the special factors. First, revenue. In the social infrastructure, it is slightly below the same quarter last fiscal year. In other sectors, we are seeing a steady increase in revenue. But meanwhile, the operating profit regretfully in all reportable segments there it is drop. And in social infrastructure, we'll continue to see operating deficit. As for the analysis of change in operating profit, that will be given on this next page.

So let me just talk about the changes in revenue. Beginning with revenue, energy and environment. There was a drop in the nuclear power plant construction volume. But in Southeast Asia, there was a progress in the large-scale power plant construction and increase in carbon solution lifecycle business. As a result, revenue has increased. Industrial System and General Machinery, this is driven by the vehicular turbocharger. And Aero Engine, Space, Defense revenue increase, and this is driven by civil aero engine PW1100G and other main engine units increase.

Please take a look at Page 11. This is the analysis of change in operating portfolio according to segment. And PW1100G, the effect from that and also the effect from the settlement of litigation is treated as separate items. The impact of the revenue changes, and because of the decline in the project for the nuclear power and also the civil aero engine is in the early stage of the mass reduction about the main engine units and the aftermarket-related charges. So as a whole, JPY 12.2 billion decline, and effect from construction profitability was JPY 1.6 billion in negative.

And bridges and water gate, so the recording of the necessary costs in advance had an effect, and this is still continuing. And we try to recover towards the year-end. The change in foreign exchange is resulting in JPY 5.6 billion profit, centering on civil aero engines. And change in SG&A due to R&D and labor cost increase resulted in JPY 8.2 billion decrease. And as for the other changes, is due to the backlash for the recorded in the same period of last year.

And on the next page is explanation about the financial profit and loss. And as for the civil aero engine and the vehicular turbocharger, please take a look at the reference.

Take a look at Page 12. This is about the breakdown of the financial profit and loss. As stated, the foreign exchange had fluctuated from the beginning to the year end. So the decline in the profit is JPY 7.6 billion. And because yen depreciation fluctuation was smaller, so the profit of the ForEx is smaller. And equity method investment loss is JPY 1.7 billion in surplus because the Japan Marine United has improved from deficit to surplus.

Take a look at Page 13, and this is the consolidated financial statements. And total assets is JPY 111.3 billion increase and became JPY 2,053.3 billion, and this is due to the civil aero engine. The supply chain is very unstable so that we needed to have securing of the parts and the inventory has decreased -- increased. And the refund liabilities about in the middle of the table is impacted by the PW1100G engine additional inspection program.

And then the outstanding interest-bearing debt, which is right below that, due to the increase in working capital, centering on short-term funding became JPY 644.7 billion. And the capital decreased by JPY 130.5 billion to be JPY 325.7 billion, and debt equity ratio resulted in 1.98x and the ratio of equity attributable to owners of parent became 14.5%. So about onetime recording this as impairment of the capital and also very much deterioration of the financial indices.

So as our guideline, we want to have it recovered to fiscal 2022 financial foundation and we would like to have the cash and the profit. And also, we would like to see the improvement by taking the planned measures.

Next, Page 14, and this is a consolidated cash flow statement. The operating cash flow resulted in JPY 81.4 billion in excess because of the spending of the inventory for the civil aero engine and this is the result of the working capital increase as well. And the PW1100G engine, the additional inspection program that the impact on the cash and that we will need to have the cash conversion cycle optimized to have the cash production so that we would be improving the working capital. So investment cash flow is JPY 31.3 billion, and free cash flow is negative JPY 112.8 billion.

And on Page 15, we show the R&D and the capital expenditure and depreciation and the revenue according to regional breakdown.

Next, I turn to forecast of the consolidated results of fiscal year 2023. Please take a look at Page 17. And the forecast including the segment breakdown has not changed from the disclosed on October 25. So PW1100G engine, additional inspection program effect and the North American process plant litigation settlement, those has been taken into account.

And we had disclosed on August 8, and that has been recorded in the prior forecast. And the sensitivity of the ForEx is JPY 41 for the remaining 6 months is JPY 700 million. And the dividend payout, we had set at interim payment JPY 50, including that to JPY 100 per stock.

So we skipped the pages from 18 to 20, and as we take a look at Page 21. As for the forecast of cash flow, we have not changed from the numbers disclosed on October 25. PW1100G engine additional inspection program, the impact on the cash flow is going to remain for the remaining several years to come. So the group management policy 2023, the growth story, explaining that, we like to prioritize investment and also to improve the working capital.

And as for the securing of the financial stability, we want to have the capital acquisition in sweety manner. And we would need to improve the impaired capital and the DE ratio so that we can plan the measures and to have the financial discipline recovered. And as for the slides after this, take a look at it afterwards, please.

And as such, I conclude my explanation. Thank you.

And next presenter, Ide will talk about the management review.

[Hiroshi Ide, executive]

Yes, allow me to present the management review. Well, this time, we had to make a downward revision of our financial results and the fact that we have posted this large onetime loss, we are taking this seriously and trying to address the situation with all our effort.

Now as for the explanation today, I will talk about the impact of additional PW1100G-JM inspection program, group management policies, 2023 initiatives and resource allocations and management objectives. These are 3 points I'll be covering.

Now first about the PW1100G-JM inspection program. Well, we have already explained about this already. And well, I think I'll be repeating what has already been explained before but allow me from my side to once again present to you what has happened. And so I might be repeating what you might have already heard, but please excuse me.

Well, first in regards to issue from 2015 to 2021 in the process of the powder metallurgy metals and production, and there were rare cases which the powder found its way into the product. And we had a study by Pratt & Whitney, and it was concluded that the repeated inspection will be done and also the service line will be shortened. And as a result, we are expecting that the maintenance frequency will be increasing significantly.

Now as for the manufacturing process, our effective measures have already been taken. And therefore, we have not seen the same problem occurring since then. So having said that, in this case, in regards to this case, we think that it is a onetime event, and we will try to look into the additional maintenance and also the additional warranty to customers, totally $70 billion, and including future maintenance, we will be [ sharing ] and posting a onetime loss, 15% the share of our partnership.

Now we have posted this large loss, but above all, together with our program partners, we have to boost our maintenance capacity and also try to alleviate the impact as much as possible. We'll do our best to do so.

And in regards to the maintenance capacity IHI, also will make an all-out group effort to try to meet this requirement. Now in this case, as I said earlier, it is a onetime event and will not be posting an additional losses next fiscal year. But we are not being optimistic about this. We want to work closer with our partner. We recognize the importance of this partnership, and we'll introduce various measures to assure that nothing like this will happen.

Now having learned from this experience IHI in our midterm plan, management plan, is still positioning the Aero Engine business as a growth business. But though rarely happening in the production process, there are such risks as we've just seen this time. And therefore, we have to try to ensure and strengthen our endurance with against such things and so as to improve the profitability of our engine and to improve our production process for aero engines.

Now about the future prospects of aero engines on the next slide, it talks about this, but yes, I'm going forward, we're expecting a 3% or so annual increase in growth. And the side of the PW1100G, we think that the measures to increase production will be key, productivity increase is a must.

As you know, IHI is involved in development and mass production of small to super large engines. The first generation engines listed here are in the investment recovery phase. And the second generation engines, including the PW1100G is in its mass-production investment phase.

PW1100G and others in the narrow body market, they account for 70% of all aircraft, it is a volume zone. PW1100G engine is highly appraised for its performance such as fuel economy. Following this case, the assessment of the PW1100G may change. But in the long run, we believe it is an engine that can gain share, and we also have expectations for the spare parts business.

Now from here, I would like to talk about each of the business segments and give you the outline of each of our business, PW1100G. Excluding this special factor, we still think that IHI businesses will grow and are growing. And this is something that what you ought to understand, and I will try to explain that taking time here.

So I will explain by business segment though briefly. As I've already said, the PW1100G, this increased inspection plus the aero engine, we think that there will be a growing demand. And therefore, it is necessary for us to ensure that we can increase our production and have the facilities in place to do so.

And as I said, IHI Group on the whole will make all our efforts to try to shift our resources more towards the aero engine business. And we will also work to automate and accelerate DX, digital transformation. We believe that these factors will be key.

Also, about the defense budget, the increase in defense budget is something positive for us. We will prepare for the production increase. That's first. But right now when it comes to defense engine, we are seeing increase in spare parts and also missile, we have the fixed solid rocket motor, we believe that these will see an increase in demand.

But whether it will contribute significantly to our financial results, it will be after fiscal year 2026 after our current midterm management plan. And so keeping that in mind, we -- at this point in time, take whatever measures need to be taken. And that was the aero engine, space and defense.

Next, I talk about the resources, energy and environment. And in this segment, as you have been much concerned about, the large plant especially, the coal-fired plant so that this is the last unit in Bangladesh, in Vietnam, a very large projects, but this is towards the end of the life of the power plant. And both of those are being operating smoothly and having a profit.

So in that sense, as you have been very concerned about the downside risk of the big projects, I think that the concern is no longer there. And as Mr. Fukumoto had explained, the Singapore, we have the group Jurong Engineering and gas turbine project and a very large-scale order we have been receiving from Singapore. And about the gas turbine power generation, I think that is going to be the area where growth is going to come. So in that sense, we would want to have the profitability in this area and continue our efforts forward in this area.

And the next pillar is going to come from the life cycle business through the services. And especially the fuel conversion and services there, the project is going to be quite increasing. And as for this, we are going to have the enlargement as the pillar business, and we want to continue to expand in this area.

And the third one is about the nuclear energy. As for the restart with earthquake reinforcement measures in place, we are working with [indiscernible] and we are planning for the restart. As for Fukushima Daiichi nuclear power plant to have the decommissioning of that, we are discussing with TEPCO. So as for the restart and decommissioning, we are planning towards the future as IHI.

And as for SMR, small modular reactor in the 2020s latter part in United States in Romania, the project has been working, and we want to security improve this. And the traditional type Westinghouse AP1000. So those types of reactors, various projects are now moving.

As for IHI strength, the nuclear reactor containment we have in the United States and overseas, a track record and this is going to be after 2025, but we want to have the business expansion and make preparation for that.

Next is about the social infrastructure. And overseas, we have the large-scale bridge Romania, Bangladesh, India and other overseas locations. And this is quite progressing well. And towards the end of the construction. And because of the cost increase, its profitability is squeezed, but we are having the escalation across there with the customers so that the profitability is coming back.

And Asia, Africa, we want to have the ODA or in the Europe and the United States to have the maintenance projects -- undertaking maintenance projects and also new projects and continue to have the large-scale bridge construction that IHI is good at. And here, for the maintenance projects, including the Daiichi bridge replacement in [ Kazakhi ] and the second [ prosper ] bridge in Turkey, we are continuing with the rehabilitation project and expanding the bridge management support system projects.

Next is about the Industrial Systems and General-Purpose Machinery. And this is about the vehicular turbochargers has been steadily recovering. The unit production vehicular turbochargers has to be recovered, but we cannot be overly optimistic about it. And now we are having the new orders from the large orders, but this is continue to lose to decrease in the mid- to long term.

So in the Western countries, such as the Europe and United States, we want to have a plan in place to strengthen our competitiveness. And as for the heat treatment and surface engineering businesses, we are having a good position here in this area. And automobiles were the first ones, but we're having the medical and the also other areas such as semiconductors. So this is a growth area.

And the compressor -- so the industrial compressor is going well. And in domestic markets, a little bit of press, but the semiconductors large scales and also the carbon neutral, EV-related investments and the new investments we are having more of those so that we want to be positive in these areas. But the ammonia hydrogen and other gases, so the process gas compressor business, there is going to be more expansion in this that are expected.

So we want to put more focus in this area. So that area is about the IHI midterm plan 2023 initiative, which we had set as a growth business and the focus area for the investment. And the PW plant -- has affected us, but there has been no change about this 2023 initiative for the resource allocation.

But having said that, the investment priority, we would like to have a close relook and also for the cost reduction, we want to have a company-wide effort for this. And to have securement of the capital, we are going to think about selling of the fixed assets.

We had a big loss this time around, but this is just a onetime loss. And it's not impacting our growth trend so that we have not changed our investment and management objective, and we are going to have a steady -- this division of dividends to our stockholders. So as I have said at the outset, although we have a very big loss that had hit us, but we want to have the recovery from that. It's a company-wide effort.

So as such, I'd like to finish my explanation. Thank you for listening.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]