Itochu Corp

TSE:8001

Earnings Call Transcript 2019-Q2

[Yoshihisa Suzuki, executive]

Ladies and gentlemen, I am Yoshihisa Suzuki, COO, President in ITOCHU Corporation. Thank you very much for joining us. Fiscal 2019 Q2 results were finalized and announced on November 2. As a result of the steady growth of net profit, especially in non-resources sector, which is our strength, consolidated net profit increased JPY 15.5 billion year-on-year to JPY 258 billion, achieving the highest number 2 years in a row. We are thoroughly pursuing "Earn, Cut, and Prevent" to further enhance profit base, which is not influenced by the resource prices. Profit and losses of the group companies that support our consolidated results renewed the highest record 3 years in a row and the percentage of profitable group companies steadily improved from 81% last year to 86%.

Operating cash flow and core operating cash flow were record high numbers. Our ability to generate cash is being enhanced. In this first half, revaluation gains on the conversion of FamilyMart UNY Holdings into the consolidated subsidiary and impairment loss related to CITIC Limited investment were recognized. As we announced on October 1, we made upward revision to fiscal 2019 consolidated net profit forecast from JPY 450 billion at the beginning of the fiscal year to JPY 500 billion, up JPY 50 billion. JPY 500 billion is the second highest in the history of general trading companies.

After the announcement of new medium-term management plan in May, we made a promise to review our shareholders' return in the medium- to long-term at the appropriate timing. Based on the dialogue with the shareholders and analysts and also analyzing our profitability as well as cash flow, we have decided that we will gradually increase the dividend payout ratio and also share buyback of about 100 million shares as a medium- to long-term policy.

As for the reinvented business, we need to quickly evolve and change conventional business models. Each employee needs to become truly aware of the need of reform. We are promoting to build the business models that match customer values. The details will be explained to you later, and that's all I wanted to say. And now Mr. Hachimura, our CFO, will explain the details of fiscal '19 second quarter results as well as fiscal '19 forecasts.

[Tsuyoshi Hachimura, executive]

Thank you. I'm Tsuyoshi Hachimura, CFO. Thank you very much for joining us today. This time, before the business results briefing meeting, last Friday evening, we had the net conference to announce the business results as far as upward revision and extraordinary items. If you go to the corporate website, you will be able to hear the audio as well as see the notes. And the documents are available from the website. I'd like to today focus on the key points of the first half business results, and also I would like to explain the content of the revisions that we announced on the 1st of October and then explain the details of the FamilyMart UNY revaluation gain as well as impairment loss of CITIC Limited.

Let me start with overview of the first half results. Please turn to Page 2. As you can see, we achieved a record high net profit of JPY 258 billion towards the annual target of JPY 500 billion, which will be the highest record in the 3 years in a row, the progress rate has been 52%. Now the core profit is JPY 244 billion and core operating cash flow is JPY 210 billion. Those are also record high 3 years in a row.

Turning to Page 3. In all segments, except for Machinery, profits increased year-on-year. Major drivers are General Products & Realty, including the pulp related as well as logistic facility development projects and also ICT & Financial Business, including the consumer finance business in Japan and abroad and Energy. So business results were strong. But in each segment, we achieved almost highest profit level. But unfortunately, there were 2 businesses, which underperformed. One is that of Yanase. In the first half, it was minus JPY 400 million, and the annual forecast has been revised from JPY 4.7 billion to JPY 2.6 billion. In the first half, there was a higher-than-optimum inventory level and therefore the adjustments were made, which led to the lower new car sales and lower profitability of used cars. At the end of September, the inventory level has gone back to the optimum level. So we expect a turnaround in the second half. Another is Dole business. The full year forecast is unchanged. But in the first half, in the packaged food business, price was weak globally. Therefore, there was a negative figure year-on-year. But as for the full year, we are likely to achieve the target of JPY 10.5 billion. So those are the 2 negative factors.

Now turning to Page 6, concerning the balance sheet. At the end of September, the FamilyMart UNY was converted into the consolidated subsidiary. So there was a positive impact. For the first time, total assets exceeded JPY 10 trillion. Out of that, the impact of FamilyMart UNY is JPY 1.6 trillion. Shareholders' equity achieved JPY 2.9 trillion, which is record high. And so with the higher or bigger balance sheet, the ratio is slightly lower. But toward the end of fiscal year, we will make the adjustments so that they will be in the range of our budget. We are looking for efficiency rather than the size. So as you see on this page, the ROE is quite high. And toward the end of the fiscal year, we expect this to be around 17.6%.

Page 5 is cash flow. Same as profit and loss, cash flow from operating activities were JPY 167.5 billion, core operating cash flow was JPY 210 billion, both of them were record high numbers.

As for the full year forecast, Page 4. The revised forecast of JPY 500 billion was announced on the 1st of October. So this is going to be the record high in 3 years in a row. The breakdown of this is that JPY 10 billion in Metals & Minerals, including iron ore and coal; JPY 10 billion in Energy & Chemicals. And at the beginning of the year, there was a buffer and the others, the minus JPY 30 billion was removed and JPY 50 billion therefore was the upward revision. If you look at each segment, there are strengths and weaknesses. And Metal business still has some buffer, but as for Machinery, the record high number of JPY 63 billion is at our target for this fiscal year. But at the beginning of the year, there was a lower number from Yanase, so this is a challenging target. Each segment, if we -- they achieved the targets, that would lead to the highest level of the profit.

Page 7 shows the major indicators. The changes that we made is that the yen/dollar foreign exchange rate was changed from JPY 105 to JPY 110 to the dollar. Brent crude oil was changed from $55 to $70 per barrel, and also the metal resources related numbers were reviewed, and also sensitivity number was lowered.

Going back to Page 6, this is the balance sheet forecast. As a result of yen's depreciation impact and also the policy of the capital that is related to the sale of the UNY business of the FamilyMart UNY, the total assets are likely to increase and interest-bearing debt is likely to increase slightly.

Page 5 is the cash flow. Based on the upward revision of the profit and loss, we changed or improved the comments of core free cash flow and cash flow from operating activities.

So excluding the extraordinary items, the core profit was quite strong. And after understanding that, this time under the extraordinary gains and losses, on Page 8, I'd like to explain the revaluation gain of the FamilyMart UNY and the impairment loss of CITIC Limited's investment. So our assumption is how we can keep the financial health and to deal with the situation in a conservative manner. And based on that assumption, we closed the business results. So if you look at this in the chronological order, the first was the FamilyMart UNY conversion to the subsidiary, which is one of the core businesses in our medium-term management plan. And as it was changed to the subsidiary, we needed revaluation, and we knew that there was a big gain from this, but based on that, we made a TOB offer. As for CITIC, when we closed the fiscal '18 business results and also in August, as we announced the Q1 results, we tested the impairment, and we did not see any signs for impairment. But this time, we recognized the impairment loss. So once again to avoid any misunderstanding, the CITIC was not first. And as for the CITIC investments, there are different reviews about this investment, however, the business performance of CITIC itself is very strong. So we are trying to take this conservatively, that is to preempt the future concerns. So it does not mean that this was something that we had to do or forced to do. Also there were some views about the impact from the U.S. China trade friction on the share price of CITIC. But actually, there are no direct link to the CITIC share price from the U.S. China trade friction.

So let me further explain about the FamilyMart UNY situation. So we knew that there was a huge gain from the revaluation, and we tried to discuss what would be the best fair value, we have had discussion on this. Our TOB offer was JPY 11,000 per share. And as for the appropriateness of this level, we looked at the market price method as well as comparable peer company analysis and DCF method. And based on that, we came up with this JPY 11,000 offer with the premium. Early January, the share price was at the JPY 7,000 level and in March, it increased to JPY 8,000 level. And before the TOB announcement, it went up to JPY 9,000. And we announced TOB on the 19th of April and the share price went up to JPY 10,000. So actually during the TOB of 17th of July to 16th of August, it went up to JPY 11,000 or JPY 12,000 at the high levels. Of course, the high share price and the high PER means that there is a high expected growth for this company. So we appreciated that. But when there is a TOB, there is usually a control premium added. And after the control premium is -- has subsided, for some time we need to wait until this share price stabilizes to come up with a fair value. We listened to the KPMG opinion, tried to come up with a fair value of the share. After the TOB, early September, the share price was JPY 9,600, and then after the end of September, with our capital policies, share price also continued to rise. But with our strong business results, as I mentioned, this type of extraordinary gain is something that we cannot maintain in the medium to long term. We do not want to have a high level of goodwill. Therefore, ultimately, we closed the middle of JPY 9,000 level. So as a result, there was a gain from this JPY 141.2 billion.

Now turning to the impairment loss of CITIC. Now the business results of the CITIC has been solid. Aside from the impairment loss last week, there was a CITIC results announcement, which was very strong. And at the beginning of the fiscal year, we expect a JPY 60 billion equity in earnings. Now, excluding the impairment loss, this expectation is JPY 63 billion. It is a fact that the share price has been at the low level, but when we made the investment, we made the investment below the net asset price. Our acquisition price was HKD 13.8 per share. But at that time, the net asset-based share price was HKD 17.37. They do not disclose quarterly numbers. So based on the June 2018 level, if you're making a comparison, 3 years ago, the net asset was $17 per share, but now it's HKD 19.5 per share. So this investment was not for capital gain, but we can say that the net asset value has increased by 12%.

So the problem or the challenge is that, their share price is not coming up, their asset value is increasing, and their business performance has been good. But unfortunately, the synergy between the 2 companies was not so sufficient, but this is something that we have to look at in the medium to long term. Now 58% of the CITIC shares are held by Chinese government. Therefore, liquidity is low. And the percentage of the financial business is 80% to 90%. So in Hong Kong market, the financial-related shares are likely to be discounted. Their share price has been moving in the range of $11 to $12 per share. And in this quarter, the price has been rising, but it has not come out of the range. And as I mentioned, their business performance has been solid. So as we considered equity pickup, the undistributed retained earning book value is increasing. That is to say the speed of increasing book value and the speed of increasing share price, when there is a difference between the 2, that means that there is more likelihood for the future impairment loss. At the end of last year and also at the end of first quarter, in addition to the share price, we have to look at the recoverability as well as the future potential and the future economic situation in China. But we judged that there are no signs for the impairment at that time.

In each quarter, equity pickup was recognized, and in Q2, we saw the book value and the share price, the difference between the 2 widening. And despite the fact that the Chinese government is taking measures to deal with economic situation of China, we believe that the speed of CITIC share price increasing is not going to be fast. And we listened to the third-party opinions about the forecast of the CITIC share price as well as the Hong Kong market and Chinese economy from the think tank and investment bank. And based on that, we had discussion with auditing firm, and we have decided that it is reasonable to consider the fair value of lower than $13.8 per share. And as a result of that, we recognized JPY 143.3 billion impairment loss.