Daiwa Securities Group Inc

TSE:8601

Earnings Call Transcript 2019-Q2

[Hidenori Yamaguchi, executive]

Thank you very much for waiting, and thank you for joining the financial reporting meeting for the Second Quarter of Fiscal '18 of Daiwa Securities Group. It's time, so let us begin.

Thank you very much for joining our telephone conference today despite your busy schedules. Today's speaker from Daiwa Securities Group is Executive Managing Director and CFO, Mr. Komatsu. I am the facilitator, IR division, Yamaguchi. Today, we start with the presentation of the second quarter fiscal '18 results and then we will take questions after that. [Operator Instructions]

So let's start.

[Mikita Komatsu, executive]

I am Komatsu of Daiwa Securities Group. Thank you very much for joining our telephone conference despite your busy schedules. I would like to explain our second quarter financial results of fiscal '18 by referring to the material uploaded on our website.

First, please turn to Page 4. This is our consolidated summary. Each percentage change is based on the comparison to the previous quarter. Net operating revenues were JPY 107.8 billion, down by 6.7%. Retail -- revenues in Retail Division decreased influenced by the weaker currencies of emerging countries, which led to shrinkage of bond sales and the decline in distribution amounts from equity underwriting. Revenues in Wholesale Division dropped as well. Global markets expanded net trading income from both equity and FICC, not enough though to compensate for the decline of equity and debt underwritings in Global Investment Banking.

Ordinary income was JPY 20.1 billion, down by 22.1%. Profit attributable to owners of parent was JPY 17.7 billion, down by 4.2%, and annualized ROE was 5.5%. BPS was JPY 801.84, a record high in 27.5 years.

Dividend policy was changed from the current year and the payout ratio is raised to 50% or more. Interim dividend per share is JPY 12, which translated into payout ratio at 53.5%.

Let me now move on to Page 10 for P&L summary. Commission received was JPY 66.2 billion, down by 10.3%. For the breakdown of commission received, please see Page 23. It shows brokerage commission was JPY 14.7 billion, down by 10.9% due to the drop of domestic stock trading volume. Underwriting and secondary offering commission fell to JPY 6.1 billion, down by 45.9% as equity underwriting commission hugely declined. Distribution commission was JPY 7.3 billion, down by 3.7%. Stock investment trust sales expanded, but the rise came from switching transaction between funds. Net trading income grew 1.7% due to solid equity trading, including foreign equities. Net loss on private equity and other securities was posted in association with reevaluation of existing investment. In addition, disposal gain on investment securities held for strategic purpose was reported as extraordinary income.

Next is Page 11 for SG&A. Trading-related expenses remained flat. Advertising and promotion expenses related to sales promotion increased while fee payment decreased. Personnel expenses decreased as earnings-linked bonuses dropped.

Let us turn to Page 13 for overseas operations. Ordinary income totaled JPY 1.2 billion, generating the profits for 10 quarters in a row. All regions delivered profits. Europe made JPY 700 million with a stronger global CB underwriting as well as recovery in revenues from equity and M&A business. In Asia and Oceania, revenues from equity underwriting fell compared to the strong performance in the previous quarter, while wealth management business and the profits from SSI Securities equity method contributed to the profit of JPY 500 million. In Americas, revenues from equity underwriting decreased but income improved with a strong FICC and decreased SG&A.

Now let me move to segment information from Page 14. Retail Division. Retail Division finished with net operating revenues of JPY 47.3 billion, down by 6.5% and ordinary income of JPY 6.7 billion, down by 32.1%. Equity revenues decreased due to a fall in Japanese equity trading volume as well as in sales commission from equity underwriting. Fixed income revenues fell as sales amount of both domestic and foreign bonds declined. Stock investment trust sales increased, mainly due to the increase in switching transaction between funds. Distribution commission for investment trust declined. Other revenues increased from investment advisory and account management fees related to wrap-related business and insurance sales commission.

Please turn to Page 15. This page is on the sales and distribution amount and topics in the second quarter in Retail Division of Daiwa Securities. Contract AUM, or Wrap Account Service, reached a record high at the end of September, which was JPY 2.1627 trillion driven by increase in sales contract amount. Sales amount of stock investment trust increased by offering products that much needs of customer. What sold especially well were our capital protected funds of investment trust, which was the first yen denominated of this kind in Japan in the fund, which mainly invest in FinTech related stocks.

Please turn to Page 16. Let me next explain the results of the Wholesale Division. Starting off with global markets. Net operating revenues were JPY 31.1 billion, up 11% and ordinary income was JPY 8.7 billion or up 50.2%. With regards to equity business, revenues were up, thanks to higher client flow of foreign equities driven by the strong U.S. market and increase in derivatives trading, although Japanese stock trading volume decreased. With regards to the fixed income, FICC revenue increased on the back of recovery of income, mainly from JGB trading by capturing market fluctuation, although income from structured bonds and the foreign bonds decreased due to devaluation of currencies of emerging markets.

Please turn to Page 18. This page is on global investment banking. Net operating revenues were JPY 8.2 billion, down 29.9% and ordinary income was loss of JPY 1.4 billion. In the equity underwriting business, we were able to accumulate results such as multiple CB mandates, including the world's first green CB issued by Sumitomo Forestry and a REIT IPO. In the debt underwriting business, we were a lead manager of Mitsui O.S.K. Lines with their green bond for retail investors, which was the first in Japan as a business corporation in addition to subordinated debt and the Samurai bonds. Revenues from M&A were driven by overseas and cross-border transactions, where DC advisory and the DCS advisory were involved as well as domestic transactions.

Please turn to Page 19. Let me next explain Asset Management Division. Net operating revenues were JPY 12 billion, down 1.4% and ordinary income was JPY 7.3 billion, which was down 1.3%. Daiwa Asset Management average AUM of stock investment trust, excluding ETFs, during the quarter was flat Q-on-Q, although both revenue and income were up Q-on-Q on the back of lower SG&A. With regards to the merger of Daiwa SB Investment and the Sumitomo Mitsui Asset Management Company, Limited, both companies have reached a final agreement and signed a merger contract. In the REIT, real estate asset management business, Daiwa Real Estate Asset Management and Mi-Casa Asset Management, who operates Japan Rental Housing Investments, Inc., merged on October 1.

Please turn to Page 21. Let me explain the results in Investment Division. We posted net operating loss of JPY 1.8 billion and ordinary loss of JPY 2.3 billion due to the loss we posted related to devaluation of the existing investment. This completes my presentation and explanation of the results in the second quarter of FY 2018.

Now we'd like to receive questions.

[Hidenori Yamaguchi, executive]

For this conference call, you can participate by asking questions in English. But for the Q&A session, we are going to receive questions in Japanese first followed by questions in English.

Now please follow the instruction of the operator.

[Operator]

[Operator Instructions] First question comes from Deutsche, Muraki-san.

[Masao Muraki, analyst]

This is Muraki. Well, first of all, about global markets business. Well, you said fixed income in global markets compared to the previous quarter has had a comeback in the present and -- that they mentioned currencies has actually had a drop. Can I get some details on that? And also for the global market as a total, can we get some terms on the perspective just following the most recent reporting from the financial results? The second question is about the Retail Division, especially this time you talked about the bonds and the stock investment trust sales have -- sees weakening of the result. But in this Retail Division result and the performance, how would you evaluate the results of that division with the bond and, mainly, but the bond sales was weakening? So how would you evaluate that result, is my question.

[Mikita Komatsu, executive]

Mr. Muraki, thank you very much for your questions. Let me address your first question first about the global market. Well, JGB in the first quarter was kind of slow. But in the second quarter, it somehow -- with the change of the policies actually have had some positive gains. Wherein the materials, JGB trading made a recovery, but maybe we wrote a bit too strong. But the JGB compared to the previous quarter was better, is what we meant. And for the emerging currency fold, well, for our company, the retail customers had some exposure in Turkish lira or Brazil real, and those bonds have been sold to the retail customers and those currencies have had a large drop. And the evaluation in the bonds that the customers have held was down so that we needed to provide some aftersales care for those customers, the retail customers. And we spent much time. So the FICC activity has not really much that we -- not much as we had expected. So in that regard, as we entered into the third quarter, that aspect of the environment seems to be settling down. So after the month of October, that currency impact seems to be getting a little bit better. When we think about the observation, I think the situation is getting much better compared to the first quarter for JGB. But for the FICC, I have to say that the environment was kind of tough. Now for the retail side, the retail and wholesale actually have had the similar impact, but the customers needed to have an evaluation by themselves. And then unfortunately, we have had an impact of the currency and then the kind of a slowdown on the bond sales. So our observation in that business, we have to say that the business was tough. So the care for the customers, we needed to do whatever we can and we have been focused upon providing the aftersales cares. So instead of selling new products one after another, we wanted to spend more time in providing care for the existing customers with existing products so more time have been spent on the consultation side with existing customers. So in that regard, the third quarter and onwards are going to spend more time on those efforts. And with that, we think we'll be able to spend more time in selling new products as time goes by. Does that answer your questions?

[Masao Muraki, analyst]

Okay. One confirmation, sorry, about that. What then the fixed income -- the incomes, the emerging currency's direction is not -- the impact is not coming from the position, but it's based upon the slowdown in the activity, is that correct?

[Mikita Komatsu, executive]

Yes, that's correct. It's not the position that is caused a big sales slowdown. It's not the real impact coming from the Turkish lira exposure or the Brazil real exposure, it's the trading and the principal itself have had the limited amount of the influence. It's more of the exposure that our customers have had.

[Operator]

Next question is from Mitsubishi UFJ Morgan Stanley, Tsujino-san.

[Natsumu Tsujino, analyst]

For the second quarter, investment commission did not grow that much on a Q-on-Q basis, but sales amount has grown. So you explained the reason why the ratio of products with our low accretion rates increased in its mix, that's the reason. But Bull Bear switching was quite active. But going forward, commission -- high commission products were decreasing the mix and the lower commission products will increase [ of who ] -- at the high level in the total mix, is that the right understanding. Is or that extraordinary trend that you saw in the second quarter? And the second question, foreign equities trading has been increasing -- well, has been increasing. But at the moment, the transaction -- about 50% of that transaction amount is nearby, but most recently U.S. stock market has been decreasing. So how do you assess the impact on your customers? You talked about foreign bonds, impact on customers from foreign bonds, but what is the situation of the impact on your customers from the declining U.S. market or foreign equities in the -- about how to sell foreign equities? So by sales, you recommend foreign equities to them by phase gradually. And probably over time, they have some exposure or the position at the lower book value. So in total, you don't -- they are not in the situation where they have to unwind the total allocation position. So how did you market foreign equities over the past years and what will be the impact on your customers from the declining market in foreign countries?

[Mikita Komatsu, executive]

So Tsujino-san, thank you very much for your questions. To your first question, the commission level or mix of investment trust. Bull Bear switching was quite high, you're right, in the second quarter. And capital protection type fund sold well where the commission is low or lower. So going forward, as I mentioned correctly, in my opinion, this was an extraordinary trend in the second quarter. Going forward, we're not trying to pursue a strategy to sell products with lower commission level. That's quite standard. In the second quarter, Bull Bear switching was quite active and capital protection type fund fold very well where the commission rate is lower in the second quarter.

[Natsumu Tsujino, analyst]

So this is not going to persist?

[Mikita Komatsu, executive]

I think from the third quarter onwards, higher commission level will be achieved, I think. To your second question about the foreign equities. As Tsujino-san mentioned, most of our customers started to construct their portfolio when the price was low. So there are not so many customers who have the portfolio with stocks with only high value. It's not 0, of course, but there are not so many of such customer. Majority of those customers have been buying over time in the market. So I think they have gained the profit. From the positioning, so they are not walking away immediately and they are buying when the market is dropping. So on the total volume, the transaction amount is down from September, but the transaction value has not declined as much as we saw in the foreign bonds in the second quarter. It's not as severe as the bond transaction amount. Investors are thick and investors in equity space are different. So it's quite difficult for the future. But they are not the customers who have ended up with a significant loss in the total portfolio.

[Operator]

Let's move on to the next question, Merrill Lynch Japan, Sasaki-san.

[Futoshi Sasaki, analyst]

This is Merrill Lynch, Sasaki. I have 2 questions. One is on the P&L. You have posted extraordinary gains. In the second quarter, you had the capital gain of about JPY 6 billion coming from the disposal sales -- disposal gain. Well, that's coming from the strategically held stock disposal, all of them, is that correct? That's my question. And if you are going to continuously disposing those strategically held stocks, what is your scope of selling the size of it? That's the first question. Okay, can I ask one -- another question?

[Mikita Komatsu, executive]

Okay, I will answer the first question then. In the second quarter, we disposed from strategically held stocks and we are going to be shrinking that and disposing that on a communal basis. Second quarter, we have had some material impact on that close to about JPY 6 billion in size. That was a disposal gain. But the strategically held stocks at -- most of that, but -- formally, most of them had been the strategically held stocks, but there were some investment we made overseas. And about 10 years ago, we made this investment and this was supported by the good stock market, supported by the good performance of the overseas market and we've decided to have the realization gain. So this was not strategically held stock. Going forward, however, this is not going to be constantly kicking in. So as a policy, we are going to be continuously working from the shrinkage of the strategically held stocks, but we have compressed to some extent already. So we cannot assure that this kind of capital gain to be coming on the cost of base.

[Futoshi Sasaki, analyst]

Okay. My second question is you are talking about the capital production type of the fund. I think that is the fund by Goldman Sachs. With this kind of an approach or the -- a more product lines to be coming in. Is that possible for us to assume that you're going to be having more lineups of the products for the consumers to buy?

[Mikita Komatsu, executive]

Well, this capital production type of the investment trust product is, for the retail market, is very appealing and it was quite preferred. Preferred type of the investment trust products we understand. So JPY 140 billion was what we were able to get through this product sale. So I think that has really made a positive hit among the customers. However, of course, we have to pay attention to the return. Well, when we think about the policy of home saving to investment, we have to pay attention to the return, not only the capital protection. Having said that, when we distributed this, there were some new money that were coming into this product with cash. So they were not all the conversions or the switching from the other kind of a fund product. So in that case, there were some good positive inflows coming into our company that was good.

[Operator]

Next question from JPMorgan, [ Otsuka-san ].

[Unknown Analyst]

My name is [ Otsuka ] from JPMorgan. I have 2 questions. First about Retail Division, this may be the qualitative question. But in October, average -- Nikkei average peaked at the beginning of the month and it has dropped quite significantly this month -- since the beginning of this month. From Mr. Komatsu's perspective, has the mindset of retail investors changed? What is the level of the mindset? It's down so much. So are they eager to buy more? Or are they in the risk of mode and the interest is more towards the capital protection fund to the extent that you can disclose. Could you please explain the sentiment of the retail investors?

[Mikita Komatsu, executive]

Thank you so much for your question. Sentiment of the retail investors from the mid-September to the beginning of October, Nikkei average increased to JPY 24,000. So Nikkei average was quite strong at a very fast pace. But unfortunately, during -- even during that period, retail consumer sentiment was not increased. So it has not increased, so there's no room to decrease. So customer sentiment from the mid of October to now, the market has declined, but sentiment has not really dropped for significantly because it has not increased. There are many retail customers whose cash position is so high. So they are led by position into the retail customers so market is down, so is the account. For example, they are buying Nikkei average products, and the sentiment is actually up a little bit from the bottom, I'd say. That's my impression.

[Unknown Analyst]

My second question is about overseas, Page 13 of the presentation. So let me explain to confirm my understanding is correct. Europe in the first quarter, you lost money. But from the second quarter, you turned it into profitability. So cost base is much lower now. So Asia, Europe, you have accumulated mandates in the second quarter. So I think, you have some mandates, a good level of mandates. Am I right in understanding that these operations are profitable operation now, you can constantly generate profits?

[Mikita Komatsu, executive]

About Europe, originally, we have to break it down into 2. First, securities entity and the second mid-cap M&A advisory entity, DC Advisory. So there are 2 entities. In Q1, just coincidentally, DC Advisory usually generates profits towards the end of the year -- in the second half of the year. So Q1 was not so strong, they lost money. And securities entity, if there was no mandates, profit situation is really tough. So in the second quarter, they had some CB mandates so they turned into profitability because of some CB mandates. So as long as there are some finance mandates, then Europe is in the situation where they can post profit constantly. But going forward, there's a Brexit issue. How would that pan out? So that's uncertain. So to us, the second half of this year, about Europe, we cannot have optimistic view at this point.

[Operator]

[Operator Instructions] Now we will now move on to English questions.

Now let's move on to questions in English. Our first question comes from [ David Louis ].

[Unknown Analyst]

I have several here. Let me go to Page 28 first. On Page 28, as usual, you show the trading value of Japanese equities and also the trading value of the foreign equities. So from the first quarter to the second quarter for the domestic equities, it was down about 12%, that's JPY 2,612 billion to JPY 2,302 billion. And for foreign equities, it increased by about 6% JPY 398 billion to JPY 422 billion. And on Page 25, you show the commission from stocks and others, that's down about 11.8%. So is it possible for you to tell us the change in commissions for domestic equities and for foreign equities? On Page 28, you showed the trading value. And I was wondering what the actual stock commissions were like from the first quarter to the second quarter for domestic equities versus foreign equities. That's my first question.

[Mikita Komatsu, executive]

[ Mr. David ], thank you very much for your question -- your first question. On Page 28 and Page 25, you listed to those 2 pages at the same time by linking. But in case of retail business, especially for the domestic retail business, the transaction volume and the commission itself are kind of related to each other. But for the foreign stocks, in many cases, large portion is not really a brokerage, but it's not really commission-incurred business. Instead of having the commissions, there'll be some gains and losses of the transaction itself that will be directly impacting on our P&L. That is the net trading volume or net trading value. So the negative 11.8% you saw on the Page 25 is about the same as the decline in the domestic stock transaction. So for the foreign stock portion, it's not really materially included in this 11.8% or it does not hit the commission received.

[Unknown Analyst]

It's very clear. Okay, great. On Page 21, there is this investment that you decided to take a provision on, this is for the Investment Division. May I know what really prompted you to take this over JPY 2 billion provision? And what's the original amount of investment versus the provision of over JPY 2 billion right now? So basically 2 questions. What prompted you to make this provision? And how big was the original size of the investment?

[Mikita Komatsu, executive]

Well, thank you for your second question. First of all, the investment amount and the provision itself, this is one investment and we do not really disclose the case-by-case amount. But I have to say that the amount was not that big. The provision, well, as you see, this is really going into the lead so that the provision was made based upon the decision that, first of all, to the amount that we made the investment, the private equity investment company's performance actually aggravated so that we needed to downgrade our evaluation to the adequate level, and that's the reason why we needed to provide for. Well, this is an investment after all. So it's not really the matter of the percentage of that in a smaller amount. It could be quite a big amount. Let's say that the investment originally made at JPY 1 billion could end up with less than, for example, JPY 0.2 billion or something as an example, and this time, it actually materialized that way.

[Unknown Analyst]

My last question, Komatsu-san, is on Page 10. I'm asking about the nonoperating income. If you look at the last 5 quarters, it was JPY 3,831 million last year in the September quarter, and then it was JPY 2,944 million, and then it was -- it rose to JPY 10,111 million, and then it came back down to JPY 3,709 million and it increased to JPY 4,638 million in the September quarter just ended. Can you shed some light on what the major components of nonoperating income was? And why there was such volatility in the fourth quarter of the last fiscal year and now -- and also in the most recent quarter?

[Mikita Komatsu, executive]

We were talking about the nonoperating income on Page 10. The biggest factor is basically the equity method affiliates. The profit comes from this equity method profits. In the first quarter, there was some one-off factor, and we're just looking into the details. [ David-san ], we got that. The fourth quarter of last year, they were obviously weak that we have had as an affiliate. They had one property in Shinjuku, and the part of that was fold. At that time, the price was bigger than our book value. So that's the reason why we were able to post such a big amount for the nonoperating revenue on the fourth quarter of last year. It was about JPY 7 billion in income, if I remember correct. On the nonconsolidated basis, that was not. But basically, on accounting basis, we were able to realize such a big income at that time.

[Unknown Analyst]

Okay. My last question, Komatsu-san, is that earlier on the media call, you were quite optimistic about the second half of the current fiscal year. And you said that the good corporate earnings in Japan as well as some upcoming deals made you feel pretty optimistic on the second half. Can you shed some light on some of these big coming deals? And of course, you don't need to mention specific names, maybe certain sectors that you believe will be more active in the corporate finance wholesale business. And also, why -- second question is why you see strong corporate earnings from Japan in the second half of this year?

[Mikita Komatsu, executive]

Well, for the second half, I was quite optimistic because of some reasons. One is, as I mentioned earlier, that Retail Division is spending a lot of time in the aftersales care, aftersales service for the retail businesses, and that is going to be less and less as time goes on, we hope. And the second is the pipeline. In the second quarter, third quarter and the fourth quarter, the pipelines of ID deals are expected to some extent and that's the reason why we are optimistic about the upswing. And other reason is M&A subsidiary we have. Basically, M&A is normally taking place a lot in the second half. So M&A business, which did not happen a lot in the first half, could happen more and make a recovery in the third quarter and the fourth quarter. That's the reason why I probably sounded quite optimistic for the second half.

[Operator]

As there are no more questions, we now conclude our question-and-answer session.

[Hidenori Yamaguchi, executive]

Now we'd like to close the telephone conference today. But lastly, Mr. Komatsu is going to give you some closing remarks.

[Mikita Komatsu, executive]

The second quarter was not really satisfactory in terms of our income due to continuous low customer activities in spite of our market value towards the end of September, as I explained in the Q&A session.

On the beginning of this month, we continue to see the situation where investors cannot really take any action due to uncertainties and we saw Nikkei average dropped from a touch over JPY 24,000 down to JPY 21,000, also as I mentioned during the Q&A session. In spite of this difficult situation, we think it's important to provide consulting in line with customer needs. This effort ultimately should generate income and enhance corporate value.

Our first half income was unfavorable and ROE was at the low level. However, we can see the progress we are making steadily in figures like BPS, which was the highest in 27.5 years. In addition, our group is implementing various initiatives to provide new values as a hybrid-type comprehensive securities group by integrating traditional securities business with diversified business portfolio to achieve sustainable growth of our group business. In addition, we are strengthening our efforts on multiple growth of SDGs as you can see in the press release in front of you today.

First point is about the green bond issued -- to be issued by our company. Second point is about the establishment of Daiwa Food & Agriculture Co. Ltd., aiming at expanding into agriculture and food business sales. Furthermore, we collaborate with ACA Group, who has the track record of investments in growing Asian companies and investments in business succession of SMEs. We'd like to strive towards social contribution through financial business to realize social value and economic value at the same time from long-term perspective.

I appreciate your continued support to us. Thank you so much.

[Operator]

This completes today's telephone conference call. Thank you so much for your participation today. Thank you so much for participating in spite of your busy schedule. Please hang up your phone now. Thank you so much.