Nippon Yusen KK

TSE:9101

Earnings Call Transcript 2020-Q2

[Unknown Executive]

Hello. I will start today by providing an explanation of the situation as of the end of the first half and second quarter of the fiscal year ending March 31, 2020.

Starting with a general overview, depending on the division, there are some differences, but the results are in line with the initial forecast.

In total, I feel the situation is as we anticipated. In particular, the container shipping line ONE, which was a point of great concern last year, showed a rise in line with the forecast in the second quarter. Increasing my feel that it has excelled in recovering so well in the past year. I traveled to Singapore recently, and when talking with executive management there, they have a firm awareness of the issues. I want to ask them to achieve further increases.

On the other hand, at NCA, which was forced to ground its aircraft last year due to the improper handling of maintenance, as I explained, the operational framework has been restored from this year. But unfortunately, the company continues to face the extremely challenging situation of falling freight rates caused by a greater-than-expected drop in airfreight traffic.

Also in Bulk Shipping, I will provide a further explanation later, but despite slightly lower freight volumes, the Car Transportation division achieved extremely solid results through a restoration of the necessary freight rates and elimination of the unprofitable trades.

The Energy division was also extremely firm centered on long-term contracts. The Dry Bulk division, as you know, was extremely volatile with the market falling very far in the spring, followed by a rapid rise in the second quarter. Based on this, we used FFA with the aim of stabilizing earnings. As a result, for the moment, particularly in the first half, we recorded FFA valuation losses and realized losses from the FFA settlement in relation to those FFA, and this was a slight drag on the results. However, we will recover this amount in the second half. And in total, I believe the results are within our forecast range.

Moving on, I will continue my discussion in line with the PowerPoint slides. First, concerning revenues. They are slightly lower, but this is not a major problem, rather, this is due to the disposal by sales of a stevedore company in North America and the conversion of the cruise ship businesses into equity method affiliates, thus, we don't see it as a problem. Concerning recurring profit and loss, as I just mentioned in my overview, we achieved a profit compared to the loss last year, and this was almost totally driven by the Liner Trade.

Concerning extraordinary profit and loss, our real estate refers to the Kobe office and a profit on the sale of the real estate was recorded. Also in Dry Bulk, we decided to return costly chartered-in vessels early. Looking back on the first half, I covered the main points in my general overview, so I will not add anything here.

Please turn to the next page. Here is a summary of the figures from the second quarter. As I mentioned, the revenues declined as a result of the disposal by sales of the terminal and the conversion of the cruise ship businesses into equity method affiliates. And concerning operating income and loss, it increased by over JPY 20 billion from the JPY 4.1 billion loss last year to a JPY 15.8 billion profit this year. Recurring profit was JPY 16 billion, an increase of over JPY 25 billion compared to the JPY 9 billion loss last year. Net income attributable to owners of the parent was a profit of JPY 11.1 billion compared to a loss of JPY 9.7 billion last year. As indicated by these figures, basically our operating situation has improved.

Please turn to the next page. Shown here is a comparison by industrial segment. I am repeating myself, but as you can see, recurring profit on a consolidated basis improved by JPY 25 billion from a loss of JPY 9 billion last year, to a profit of JPY 16 billion this year. This improvement is almost totally accounted for by the Liner Trade. I think it is clear looking at these figures that the Liner division centered on ONE was the largest reason for the improvement in the operating situation in the first half of this year. Concerning the other divisions, for example, NCA was forced to ground its aircraft in the middle of the first quarter last year, and including the huge loss in the second quarter, a loss of about JPY 18 billion was recorded for the year.

Heading into this year, despite the fact that the operational framework was restored as planned from the first quarter, very regrettably, a huge loss of JPY 9.1 billion was recorded in the first half.

Concerning Bulk Shipping, the results declined slightly from JPY 15.8 billion last year to JPY 14.2 billion this year. But this is due to the FFA valuation losses and realized losses from FFA settlement as I mentioned earlier. I will provide more details later. But we will recover this amount in the second half. So it is not a major concern.

Please turn to the next page. Shown here is a waterfall graph of the points I just spoke about. From the loss of JPY 9 billion last year, although there were some negative factors here due to positive factors relating to NYK's Liner business termination costs and the improved earnings at ONE, a profit to JPY 16 billion was ultimately achieved.

Please turn to the next page. This page summarizes the forecast for the full year based on the results in the first half. Basically, improvement in the Liner Trade and Bulk Shipping contributed to the significant increase in profit. And as a result, operating income is basically forecast to be higher compared to the previous forecast. At the same time, the forecast for recurring and net profit remain unchanged.

On the recurring profit level, the Liner Trade has been revised up, while the Air Cargo Transportation segment has been revised down and Logistics has been revised down slightly.

In particular, relating to the Air Cargo Transportation segment mentioned earlier, the air freight forwarding volume is declining, and this is having a minor impact.

Concerning Bulk Shipping, the Energy division and Car Transportation division are basically firm, and they should achieve results in the second half.

In the Dry Bulk division, the market has been strong, but we were unable to build on the results as the effects of the improved market on profits will be limited from having fixed the income from FFA.

However, the FFA valuation loss recorded in the first half will be recovered in the second half. So as you will be able to see later in the figures, the results are basically in line with the initial forecast.

In addition, we intend to continue working towards the early termination and return of chartered-in Dry Bulk vessels and asset liquidation. Given this current situation, it was decided at the Board of Directors' meeting today to issue an interim dividend of JPY 20. A year-end dividend of JPY 20 is also planned, and we intend to maintain the full year dividend forecast of JPY 40.

Please turn to the next page. Shown here is a summary of the full year forecast. Basically, the results will be revenues of JPY 1,680 billion, operating income of JPY 40.5 billion, recurring profit of JPY 37 billion and net profit attributable to owners of the parent company of JPY 26 billion.

The lower revenues are due to the factors I have already discussed. Operating income, recurring profit and net profit attributable to owners of the parent will all be higher.

Please turn to the next page. Here is the full year forecast by Industrial segment. I am mostly repeating myself, but compared to the JPY 2 billion loss last year, a profit of JPY 37 billion is forecast for the full year. This is an improvement of JPY 39 billion. It is mostly attributable to the Liner Trade.

Also, Bulk Shipping is forecast to achieve a profit of JPY 40 billion compared to JPY 33.7 billion last year. The improvement in the Liner Trade and Bulk Shipping has led to the improved profits of JPY 39 billion.

Concerning the remaining parts, comparison with the last year result of the Air Cargo Transportation segment is, honestly speaking, inconsequential. And the Air Cargo Transportation segment continues to face a difficult situation.

Logistics, as I mentioned earlier, has fallen into the red due to a slight drop in handling volumes, but due to the improvement in the Liner Trade and strong results posted by Bulk Shipping, recurring profit improved by JPY 39 billion compared to last year.

Please turn to the next page. In relation to the changes in the full year forecast, this page shows what has changed and how. As shown by the direction of the arrows, within the Liner Trade, the container shipping division remains unchanged from the previous forecast, while the terminals have been slightly better. So the results should be slightly higher.

In the Air Cargo Transportation segment, the previous forecast was not good. Frankly, other than revenues, the remaining items have not changed much from the previous forecast. Although there are some minor ups and downs, the situation is almost unchanged from when the previous forecast was announced at the end of July.

Please turn to the next page. I believe the direction of the Air Cargo Transportation segment is the main point of concern for most of you.

Last year, as stated here, the aircraft were grounded from the middle of the first quarter, and although some of the aircraft were returned to service from the middle of the second half without ever having a complete operational framework, a loss of about JPY 16 billion was recorded for the year. This year, a loss of JPY 9.1 billion was recorded in the first half and a loss of JPY 4.9 billion is forecast for the second half. We believe the freight situation in the second half will not be as terrible as it was in the first half, although there's some hope as the business enters the peak season, heading into the end of 2019, there is no change to the challenging situation. This forecasted loss of JPY 4.9 billion is certainly not a figure we can be optimistic about.

Looking at these figures here, it is not an apple-to-apple comparison with last year. So it is somewhat difficult to give an explanation. But for example, compared to the first quarter, as you can see in the figures for chargeable weight and volume, the freight situation is not good. The figures last year are based on the aircraft being grounded, half from the middle of the first quarter, while the figures for this year are with all the aircraft operating. So the freight situation is quite bad. As you have read in the newspaper, or heard on the news, Air Cargo Transportation volumes have fallen by about 30%. I feel these figures evidence that.

Please turn to the next page. Shown here is an overview of Global Logistics. Concerning freight volumes, they have been slightly affected by the decline in air exports and I think this has appeared in the results. I feel ocean exports have not been affected as much yet. Unfortunately, air exports declined by 11% in the first half and are forecast to fall 6% even in the second half, evidencing the poor freight situation.

As stated here, hard work is being made to achieve profitability through various innovations, such as advancing the structural reforms in logistics and improving profitability in the U.S. and Europe. Unfortunately, the freight situation is definitely not bright.

Please turn to the next page. Shown here is the market situation in dry bulk and tankers. Compared to the previous full year forecast, given the rapid rise in the second quarter, the full year forecast for Capesize bulk carriers was increased from $16,500 to over $20,000. For the Panamax and other Handy, Handymax bulkers, the forecasts are roughly unchanged.

On the other hand, in the tanker market, as you know, due to the U.S. sanctions on Cosco Dalian Tankers, the VLCC market has soared higher. The figure of $47,500 stated here is about $30,000 to $40,000 lower than recent rates. And if this situation of rates around $80,000 continues for some time, there is room for upward improvement in the Tanker division.

In the VLGC market, which refers to LPG carriers, market rates have also been around $80,000. Even with these high rates, although there are not many vessels exposed to the spot market, the market has been moving in much higher rates than this recently. If this situation continues, there should be an uptick in the results.

Recently, I feel that the Dry Bulk division and Energy division will remain rather firm in the second half. In particular, I think the Energy division will hold some nice surprises.

Please turn to the next page. I probably do not need to explain this to you, but I would like to mention briefly about why we have recorded these awkward figures in relation to the FFA. The reason is voyages such as these -- for voyages that start here and end here, the FFA market for the voyage in the previous term was, say, $25,000. We decided that $25,000 was an acceptable rate. So we concluded a forward agreement for the entire voyage at $25,000.

However, the FFA market for the relevant voyage at the end of the term was $28,000. As a result, at the end of the term, for example, at the end of September, this $3,000 difference multiplied by the 30-day voyage becomes an FFA valuation loss of $90,000. In this case, the voyage begins, but the agreement is for $25,000, while the actual market is trending at $30,000. This difference between $30,000 and $25,000, multiplied by the 30-day voyage is $150,000, and this amount is recorded as a realized loss from FFA settlement. However, the vessel was operating at a rate of $30,000 per day. So ultimately, it brings in earnings of $30,000 times 30 days for $900,000. There is a subtle lag in the timing of these events, and it resulted in a number of FFA losses appearing all at the same time in the first half.

Please turn to the next page - sorry, can you please go back to the forecast on Page 9. In Bulk Shipping, the reason first half profit fell from JPY 15.8 billion last year to JPY 14.2 billion this year, is the FFA valuation losses and realized losses from FFA settlement I just discussed.

However, the increase from JPY 17.9 billion last year to JPY 25.7 billion in the second half of this year is the result of realized profits this time. And the voyages involving vessels chartered when the market was high, will be completed. I ask for your understanding in relation to this point.

Please return to the previous page. In the Car Transport division, we carried 3.4 million cars last year. This year, we are forecasting 3.14 million cars, a large drop compared to last year. In the first half, we carried 1.62 million cars against 1.68 million last year. And in the second half, there will be a slightly larger drop from 1.72 million last year to 1.51 million this year. As a result of various hearings held with each manufacturer, we expect a slight drop in cargo volumes in the second half, primarily to America. However, in terms of earnings, as stated here, we are forecasting solid earnings as a result of improved efficiency in fleet allocation and a more selective cargo portfolio.

Please turn to the next page. Shown here is our financial position. It remains basically unchanged from the last time it was announced. However, interest-bearing debt was increased by about JPY 70 billion. This is due to the impact of the new IFRS lease accounting standards at overseas subsidiaries, which had an impact of JPY 77 billion. This amount was added to the interest-bearing debt resulting in the figure here.

Basically, our financial position remains unchanged, when the impact of the IFRS is excluded.

Please turn to the next page. This page is for your reference. It covers the number of vessels in our fleet.

Please turn to the next page. Shown here are the issues in relation to the medium-term management plan. First, in regards to Dry Bulk. As stated here, this figure in blue is the cargo under medium- to long-term contracts carried by medium- to long-term vessels. And this figure in pink is the cargo under short-term contracts carried by medium- to long-term vessels. And this part is the biggest problem. The other figure in gray is short-term cargo carried by short-term vessels. The Dry Bulk division is now aiming to expand the figures here in blue, even a little, and reduce the figure in the middle in pink as much as possible, practically to 0, if we can. It is not yet all as we hope, but the figure in the middle was steadily declining. However, I feel we need to work a little harder to further build on the achievements.

Please turn to the next page. This slide also covers the progress in the medium-term management plan. It details the accumulation of stable freight rate business. Shown there are LNG carriers, shuttle tankers and other vessels under medium- to long-term contracts. The first lane of the Cameron LNG project has finally started operation. And the second and third lane should come online heading into next year. The impact on earnings will still be small this year, but once full-scale operations commence from next year, I believe it will become a fairly large profit source.

Please turn to the next page. This is regarding Digitalization and Green, D&G. We have announced this in a variety of ways already. So I will not go into it in detail. However, concerning the D&G set forth in the medium-term management plan, we have extensively announced the activities, particularly the initiative for cashless ships. A new company has finally been established in Manila and strong efforts are underway directed at launching the business.

Touching on asset liquidation. Concerning the strengthening of group management, we will secure about JPY 10 billion as profit from the sale of vessels and real estate and the sale of fixed assets, which includes the sale of, for example, the Kobe office, I mentioned at the start of my talk today. Also in order to improve the financial situation, we will improve the balance between cash flow from investing and cash flow from operating activities. I intend to move forward while thoroughly managing the figures.

Also, it was officially decided at the Board of Directors' meeting today that we will adopt a consolidated taxation system from fiscal 2020. We will begin preparations from now, and although we, of course, cannot adopt this system in fiscal 2019, assuming earnings based on fiscal 2019, the system should provide benefits of about JPY 2 billion to JPY 3 billion. This includes the wholly owned subsidiaries in Japan, and we estimate, it should generate effects about this large.

The last page concerns the response to SOx regulations. As you know, the use of low sulfur fuel oil will become mandatory from January 1, 2020. In response to this, we are working internally in the form of the IMO 2020 project. We have already secured over 80% of the total fuel oil volume required through March 2020. Centered on Singapore and Japan, we have procured almost all the fuel in advance, while forecasting the fleet allocation plan. Also concerning the installation of SOx scrubbers, installation is complete in a total of 10 vessels, including new buildings and retrofits, and we are planning to install scrubbers in over 70 vessels by 2022. However, concerning the retrofitting, the work is being done at shipyards in China, but there are large delays.

In relation to earnings, the equipment will be depreciated as it is used. So there will be no major costs appearing in any single year. But if our plan is delayed, various problems will occur. For this reason, we have dispatched engineers and are making our best effort to maintain the construction schedule. However, a number of other shipping lines are also using shipyards in China for a large number of vessels. So the reality is China will be unable to respond on time. This carries with it some potential problems.

Concerning LNG fuel. As I have explained before, we are making steady progress one step at a time. The world's first LNG-fueled car carrier was delivered in 2016, and we plan to receive delivery of 5 LNG-fueled car carriers by 2022. The vessels are operated by UECC and the LNG bunkering vessel ENGIE Zeebrugge is supplying the LNG fuel.

In Japan, operation of an LNG bunkering business for car carriers will begin in the Chubu area from 2020. In the Setouchi, Kyushu area, we have conducted a number of studies with Kyushu Electric Power, Saibu Gas and Chugoku Electric Power, and are considering the results with the aim of conversion into businesses in the future.

Regardless, we operate more than 800 vessels. So we are dealing seriously with the problem of the environment, and we'll continue to fully respond to this problem going forward.

This ends my discussion. Next, Senior Managing Corporate Officer, Hiroki Harada, will provide an explanation concerning ONE.

[Hiroki Harada, executive]

I will now briefly provide an overview of the financial results at ONE for the second quarter of fiscal 2019. The details have been summarized in 7 PowerPoint slides. So to begin, please turn to Page 23. It shows an overview of the financial results, along with a simple profit-loss analysis and in comparison with the previous forecast.

As you are aware, the first fiscal year at ONE was a very difficult year, due to the teething problems. But in the first quarter of this year, ONE climbed above water with a $5 million post-tax profit. This was split between the 3 parent companies by 38%, 31% and 31%, based on the equity share.

In the second quarter, as you can see here, a profit of $121 million was achieved, for a total first half profit of $126 million. This roughly achieves the figure forecast in July. However, even though the post-tax profit was achieved, the substance was very different. As you can see here, first, revenue was below the forecast. This means that a post-tax profit was achieved despite lower revenue. The profit-loss analysis has been arranged as a waterfall graph shown at the bottom of the page. And simply stated, revenue was not sufficient. The reason for this was freight rates. In particular, the spot rates in the Asia-North America and Asia-Europe, East/West trades did not rise as expected.

In terms of liftings, the targets were achieved in some of the trades such as Asia-North America. But the Asia-Europe trade and Intra-Asia trade are facing a challenging situation and failed to reach the targets. Typically, July to September is peak season in the containership business. But despite this, there was no noticeable peak this year. And for this reason, revenue failed to reach the target.

On the other hand, the reduction in variable costs that supplement this, which refers to efforts made by ONE itself, particularly cost per TEU, achieved the targets, including the absolute amount. And as a result, it was ultimately possible to reach the profit forecast.

Specifically for the long-term contracts in the Asia-North America trade, the cargo portfolio was optimized from the legacy contracts to the most beneficial contracts for ONE itself. And as a result, the variable costs, for example, feeder costs, truckage and empty positioning costs, were greatly reduced. As a result, it was possible to reduce variable cost much lower than the initial forecast and factors such as this proved very successful.

In regards to operation costs, it is minor, but services were avoided in weeks with no cargo.

In addition, what we call the Sapphire Project was implemented with aims to reduce the consumption of bunker fuel, which makes up the largest part of the operation costs. As a result of these initiatives, the lack of revenue was ultimately able to be covered by cost reductions.

Please turn to Page 24 for a comparison with last year. Compared to last year, as I mentioned earlier, the impact of the teething problems last year appeared in the first and second quarters. So there is not much meaning to comparing with last year. However, I would like to touch on one point. Revenue has grown significantly from last year. This is the largest point compared to last year, and in particular, the teething problems appeared mostly in the first and second quarters.

During the second quarter, in particular, the inability to secure cargo on the return voyages, in the East-West trades was greatly improved, and this significantly improved earnings compared to last year. As you can see, the improvements of over $300 million generated the post-tax profits.

Moving on, regarding the KPI that specifically illustrate this, please turn your attention to Page 25. Shown here are the quarterly trends in the Asia-North America and Asia-Europe trades. Comparing the first half of this year with that of last year, utilization improved 8% in the Asia-North America Eastbound voyage and 9% in the Asia-Europe Westbound voyage.

On the return voyages, utilization improved by 9% and 16%, respectively. This indicates the teething problems have ended and ONE is securing cargo based on a new contract structure.

Looking at average freight rates as shown at the bottom of the page in the Asia-North America trade, including the second quarter, there was a minor peak, and the figures are somewhat better compared to the same period last year. However, in the Asia-Europe trade, unfortunately, average freight rates are unchanged from last year. And in terms of freight rates, it is difficult to see any tailwind at this point in fiscal 2019.

Please turn to Page 26 for the full year forecast for fiscal 2019. The first and second quarter in the first half basically achieved the forecast announced in July, but the third and fourth quarters in the second half are expected to be somewhat challenging. We are looking particularly at the recent Asia-North America and Asia-Europe spot freight rates. It will likely be difficult to achieve the figures announced in July, and the figures here are the result of completely reviewing the forecast. Unfortunately, the full year profit is expected to be only $60 million, $30 million less than the previous forecast. The details are shown in the waterfall graph below.

In terms of revenue, the outlook that revenue will be more challenging compared to the previous forecast has increased. This is stated in the box on the right-hand side.

The short-term market has definitely deteriorated. The starting line in October is always an extremely challenging time for spot freight rates in the East-West trades. And this has been taken into consideration.

On the other hand, in some of the North-South trades or in the newly started services, the volumes are small. So there is not yet much impact. However, there are expectations here. In total, profit will deteriorate by about $30 million. But ONE has presented a business forecast that aims to achieve a solid profit.

Of the last 2 pages, the first deals with the current initiatives. As I mentioned previously, in terms of revenue, because it is a market, based on our assumptions, there are liftings and spot rates involved, and efforts are being made to cover these through various initiatives. The steady progress of these initiatives is stated here. For example, I touched on the securing of long-term cargo in the Asia-North America trade. But in regards to accumulating revenue by optimizing the cargo portfolio, improve yield management, these initiatives have been implemented primarily in the Asia-North America trade and the benefits of those initiatives are appearing.

Concerning the products, as you know, ONE has already optimized the services, including rationalizations, such as the pendulum service involving Japan, and the effects have already started to appear.

Also, the optimization of the organization is still underway, including offshore personnel, and I believe the forecast figures will start to appear. As a result, of the $1,050 million in synergy effects in the second year, 96% are expected to be achieved, and the current business forecast has been based on this.

Also, ONE will fully comply with MARPOL2020. Over 90% of the required low sulfur fuel has been procured. This cost will be passed on to the customer. And we are explaining the need for the shipper to cover the cost as it is out of our control. This explanation has been received positively, and we expect to be able to recover the additional costs from January.

Lastly, considering the overseas terminals business, although it is steadily progressing, there is no final transfer schedule that I can announce to you, and although I cannot make an announcement, discussions remain ongoing with the aim of reaching an agreement this year.

The final Page 28 shows the fleet structure. As shown on the right-hand side and when looking primarily at Asia, ONE has a relatively balanced service structure. However, because it is focused on Asia, this is also a weakness, and when considering the service portfolio going forward, whether or not ONE can be called a global carrier from each region's perspective will become a key point. This will be discussed going forward. Discussions have already begun in the minor trades. And I believe it is an issue that must be considered.

Lastly, considering the fleet structure, the average vessel size remains 7,150 TEUs, completely unchanged from last year. However, compared to fiscal 2018, the vessels are larger in fiscal 2019, although just slightly. The average vessel size in fiscal 2018 was 6,800 TEUs, but it is now 7,150 TEUs.

I believe this enlargement of the vessel size is actually very important when considering the future development of ONE, and I want to view this as one of the KPIs going forward.

This ends my brief explanation of the second quarter financial results at ONE.

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