Nippon Yusen KK

TSE:9101

Earnings Call Transcript 2020-Q3

[Unknown Executive]

Thank you, again, for taking time out of your busy schedules to attend our explanation of the financial results. Without keeping you waiting any longer, I would like to begin with my explanation of the financial results for the third quarter for the fiscal year ending March 31, 2020, using the prepared PowerPoint slides.

Just as an overview or rather as my thinking at the end of the third quarter, I feel that we achieved better-than-expected results in the third quarter. ONE, in the container shipping division as well as the Energy division, Car Transportation division and Dry Bulk division, all achieved better-than-expected results. On the other hand, the Air Cargo and Logistics businesses were unfortunately unable to break out of their slumps.

In the fourth quarter, as I will explain using numbers later, the strong results are expected to continue in the Energy division and the Car Transportation division. Conversely, along with the currently slumping Air Cargo and Logistics businesses, ONE and the Dry Bulk division will likely face difficulty in the fourth quarter. As a result, I feel that at the present time, the results for the fiscal year ending March 31, 2020, will likely be slightly better than the initial forecast. However, it is very difficult to reflect the impact of the current novel coronavirus outbreak, which is already having a major impact on China in the forecast at this time. All of the divisions are, of course, working to gather information, but it has not been incorporated into the forecast.

Please turn to the first page. I will now explain the results. Looking back on the year-to-date through December, although revenues declined compared to the same period last year, recurring profit improved significantly, and a profit was achieved. Revenues declined slightly due to the sale of several terminals and the elimination of the revenues from the Liner business that remained in the financial results last year. Recurring profit, as I will discuss in more detail later, was driven by the higher profits in the Liner and Bulk Shipping businesses.

Concerning extraordinary income and loss. An impairment loss of about JPY 15.7 billion was recorded in the third quarter for NCA's aircraft, spare engines and parts. Of this amount, JPY 9.5 billion was for the aircraft and the remaining JPY 6.2 billion was for the other assets. Of the JPY 15.7 billion total impairment loss, JPY 9.5 billion was for the 8 aircraft operated by the company, that is 7 400F aircraft and the 1 8F aircraft. The remaining JPY 6.2 billion was for the spare engines, parts and software used by the company.

The impairment loss is the result of consideration targeting not just the aircraft but all the assets currently owned by NCA. As a result of this impairment loss, earnings can be expected to improve by JPY 1.5 billion from next year.

Next, we returned 2 costly chartered-in vessels early this year. And this has already been recorded. Also we sold the Kobe office in the first quarter as part of the efforts for asset liquidation. In addition to this, as already announced, we expect a gain of JPY 9.5 billion from the sale of property in East Shinagawa. However, this JPY 9.5 billion gain has not been recorded in the third quarter. In relation to the timing of the transaction, it will be recorded in the fourth quarter.

Looking back on the results in the third quarter from October through December. At ONE, liftings and freight rates in the North America and Europe trade have not increased. As reported in the Nikkei Shimbun today, cargo volumes from Asia to North America have fallen slightly on a calendar year basis. However, through yield management and the Boarding of sailings in accordance with demand, it was possible to provide support for the bottom line by adjusting supply.

At NCA, although it is very unfortunate despite operating all of the aircraft as planned, demand has fallen a greater-than-expected 30% due to the problems between the U.S. and China. This caused a drop in yield and the company faced a very challenging situation. As a result, it was decided to record an impairment loss on NCA's fixed assets, as I mentioned earlier.

Concerning Logistics in relation to the issues facing Air Cargo Transportation I just mentioned due to the trade problems between the U.S. and China and the turmoil in Hong Kong, cargo-handling volumes greatly fell in the forwarding division. This is a relatively large profit source, and the figures were weaker this quarter. Although the profitability of Logistics has improved, the drop in handling volumes in the forwarding division impacted the results.

The Bulk Shipping segment, which drove the results in the third quarter along with ONE, the Dry Bulk division, Energy division and Car Transportation division all exceeded expectations. There was a downturn in the dry bulk market, but as stated in relation to the freight forward agreements during the explanation on the second quarter results, the market was very strong in the second quarter. The voyages under the FFA concluded at that time ended during the third quarter and contributed to big profits. Also we have concluded FFA for the fourth quarter, but this time, as you can see by the recent weak market levels, the FFA are resulting in valuation gains. This is the opposite of what occurred in the second quarter. Given these factors, the results in the Dry Bulk division exceeded expectations in the third quarter.

In the Energy division, steady operations in LNG carriers and offshore business provided stable earnings. And in addition to this, as reported in the news, following the U.S. government sanctions on the Chinese COSCO Dalian tankers, it was unable to operate its 26 VLCCs. This caused the market to soar. We do not have many tankers operating under short-term charters, but we do have some, and we're able to benefit from the soaring tanker market, resulting in better-than-expected results.

In the Car Transportation division, as I will discuss later, the number of cars transported fell slightly. However, vessel allocation was further optimized, and the bottom line was firm. Also I believe the recovery in cargo volumes to some areas in the Middle East also provided a boost.

Shown here are the figures for the third quarter compared to those last year. As I mentioned earlier, revenues have declined slightly during the year-to-date compared to the same period last year. Revenues have declined by about JPY 130 billion due to the reasons I mentioned earlier. Operating income improved JPY 27.9 billion to JPY 32.4 billion from JPY 4.5 billion last year. Recurring profit improved JPY 41.8 billion to JPY 38.4 billion from a loss of JPY 3.3 billion last year. Net income improved JPY 27.4 billion to JPY 18.7 billion from a loss of JPY 8.7 billion last year.

The next page shows a breakdown of how each segment has improved. Shown here is exactly what I stated earlier in my overview. The Liner segment improved by JPY 38.1 billion from a loss of JPY 24.7 billion through the third quarter of last year to a profit of JPY 13.4 billion this year. Looking at the bottom line on a consolidated basis, recurring profit improved in the year-to-date by JPY 41.8 billion to JPY 38.4 billion from a loss of JPY 3.3 billion last year. This improvement is mostly the result of the JPY 38.1 billion improvement in the Liner segment. Regarding the remaining portion, Bulk Shipping, for example, improved JPY 8.2 billion to JPY 34.8 billion this year from JPY 26 billion last year.

As I mentioned earlier, the Energy division and Car Transportation division were the driving factors. The JPY 38 billion improvement in Liner and JPY 8 billion improvement in Bulk Shipping resulted in a total improvement of JPY 46 billion against the improvement in recurring profit figure of JPY 41.8 billion. The slumps in Logistics and Air Cargo dragged the results down, but the improvements in Liner and Bulk Shipping greatly covered those losses. Although the table does not provide much detail concerning the reasons for the improvements, a stronger yen exchange rate and fuel costs had little impact. Overwhelmingly, the improvement resulted from the markets -- or rather sales in the Liner segment and ONE. And in the Bulk Shipping segment, I believe the effects of eliminating some of the businesses were also realized.

I would like, again, to provide an explanation of the full year forecast. As stated already in the overview, profit has greatly improved compared to last year driven mainly by the Liner and Bulk Shipping segments. Operating income has been revised down slightly compared to the previous forecast. This is due to the expected downturns during the fourth quarter in Air Cargo, Logistics and Dry Bulk. In particular, Dry Bulk is expected to experience a severe downturn. On the other hand, nonoperating income greatly improved. This is the result of the increased earnings at the equity method affiliates such as ONE and the FFA in the Dry Bulk division. The FFA appear as nonoperating income and loss, and the valuation gain is expected to be recorded for these agreements. As a result, both recurring profit and net income attributable to owners of the parent company have been revised higher.

Regarding the breakdown, I have already discussed the factors. So to mention the main points, the improvement in the Liner and Bulk Shipping segments will drive profits. And in relation to the issues concerning the regulatory-compliant fuel and SOX regulations, which were a concern for this year, we have crossed over into the new year with all ships continuing to operate smoothly without any major problems. Also fuel procurement is progressing steadily, so this is also not a concern. As a result, recurring profit and net profit in fiscal 2019 have been revised slightly higher compared to the initial forecast.

The only concern is how the novel coronavirus will impact the results, as I mentioned at the start of my explanation. We are still unable to foresee the impact, and it is the only point of concern.

Also we will continue forward with asset liquidation, including the sale of real estate and early termination of costly chartered-in vessels. Presently, we are planning to issue a year-end dividend of JPY 20 per share, as stated in the profit plan, for a full year dividend of JPY 40 per share.

Shown here are the figures in the full year forecast. They are almost the same, but full year revenues will be slightly lower. Operating income will improve JPY 26 billion from JPY 11 billion last year to JPY 37 billion this year. Recurring profit will improve JPY 42 billion from a JPY 2 billion loss last year to a JPY 40 billion profit this year. Net income will improve JPY 73.5 billion from the JPY 44.5 billion loss last year to a JPY 29 billion profit this year. I have already discussed the factors behind this improvement. On the other hand, revenues are expected to fall by about JPY 20 billion compared to the forecast issued at the end of the second quarter. As I mentioned previously, operating income will be lower, while recurring profit and net income have been revised up.

Shown here is the forecast by segment. Much of it repeats what I've already discussed, so I will explain it briefly. Recurring profits will increase in the Liner and Bulk Shipping segments, while they deteriorate in Air Cargo and Logistics. Overall, recurring profit will improve on a consolidated basis by JPY 42 billion from the JPY 2 billion loss last year to a JPY 40 billion profit this year. As shown in the table, the factors in the JPY 42 billion improvement are the JPY 39.4 billion improvement in the Liner segment and the JPY 9.8 billion improvement in the Bulk Shipping segment. In total, recurring profit will improve by about JPY 50 billion, and this will cover the deterioration in Logistics for a final recurring profit of JPY 40 billion.

Shown here is basically the same as the previous page except for the arrows indicating the status of the businesses. Container shipping will be better and terminals will remain unchanged, while all the businesses in Air Cargo and Logistics will trend lower.

Regarding NCA, I have a feeling most of the questions later will be about this, and I will have Senior Managing Corporate Officer, Hiroki Harada, handle all the answers. Last year, as you know, after the discovery of inappropriate maintenance during the first quarter of the previous fiscal year, all the aircraft were temporarily grounded and they were gradually returned to service from the second quarter. Last year, it was impossible to organize the service network and operate all the aircraft. However, from the start of the year -- this year, it has been possible to operate all the aircraft. Despite this, as can be seen in the previous figures, the results have actually worsened slightly compared to last year. Revenues have, of course, increased somewhat as all the aircraft were in operation, but recurring profit was a loss of JPY 17 billion compared to the loss of JPY 16 billion last year when all the fleet was not fully operational. In other words, the results worsened despite operating the entire fleet.

The main reason for this is the overwhelming drop in cargo volumes. As you know, cargo volumes have fallen about 30% compared to last year. As a result, yield and utilization have declined, and this double punch has led to lower earnings. NCA has, of course, taken steps to address the situation. As stated here, various innovations have been implemented. The around-the-world service involving flights to North America, onward to Europe and then back again to Asia has been suspended. Now North America will be handled as North America and Europe will be handled as Europe. Also concerning the Taipei service operated in partnership with Atlas given the recent increases in cargo volumes from Taipei, efforts are being made to increase the number of flights. These efforts have just commenced, so the effects are not yet fully visible. Given the current situation, as a result of reviewing the company's fixed assets, an impairment loss of JPY 15.7 billion was recorded in the third quarter.

Logistics has also faced lower cargo volumes, particularly air freight forwarding. They were 11% lower in the first half and are expected to be 8% lower in the second half for a full year decline of 10%, evidencing the extremely difficult situation. This is in some ways linked to the Air Cargo segment. And until demand returns there, it will be difficult for the businesses to fundamentally recover.

On the other hand, Logistics is a core part of the NYK Group, and various discussions covering both the NCA and Logistics are being held within the company and within the Group. I am unable to present any specific direction at this time. But based on a strong recognition of the problem, we will work to reestablish the businesses.

Although it is not directly connected to this, executive officer personnel changes at the NYK Group were announced today. Toru Kamiyama, who has been Vice President at Yusen Logistics and a Corporate Officer at NYK Line, has been appointed President and Representative Director of Yusen Logistics while still maintaining his position as Corporate Officer. The business will not suddenly improve just because the President has changed, but through this fresh start as well as given the fact that Toru Kamiyama was originally a member of Yusen Air & Sea Service, there are high hopes.

Shown here are the charter market rates. I will start with the easy-to-explain rates. In the tanker market, charter rates for VLCCs were $24,000 last year and are expected to be $44,500 this year. The fourth quarter is still ongoing, so I cannot say with certainty, but as of the end of January, rates are about $20,000 higher than they were last year. Concerning VLGCs, which refers to LPG carriers, rates will be $54,000 this year compared to $18,000 last year. And although we do not have much exposure through ships operated under short-term charters, the rate increase has contributed to the bottom line.

On the other hand, dry bulk charter rates have been up and down, and we expect the charter rates for our capesize bulk carriers to fall considerably in the fourth quarter. They are forecast to be around $9,000, which is considerably higher than where they are now. Rates are currently under $6,000, so our forecast is quite high. Despite this, they are improving somewhat. However, in the Handymax and Handy market, most of our vessels operate under short-term charters, so they are heavily affected by the market fluctuations. Given this, the downturn in the market has had a major impact. In the fourth quarter, for the Capesize and Panamax bulk carriers, we are managing our exposure through FFA and other means. But because there is no FFA market for Handymax and Handy bulk carriers, these vessels are chartered at the prevailing market rates. This is behind our expectations that the fourth quarter will be a somewhat challenging time for dry bulk.

This page covers Car Carriers. As I stated earlier, the Car Transportation division has made a great effort. Despite this, the shipping volume is expected to decline from 3.4 million cars last year to 3.14 million cars this year. In other words, the shipping volume is forecast to decline 8%. On the other hand, as stated here, the bottom line is expected to be firm as a result of the selective cargo acquisition and improved efficiency and fleet allocation.

This ends my explanation of the financial results for the third quarter. Senior Managing Corporate Officer, Hiroki Harada, will now provide an explanation concerning ONE.

[Hiroki Harada, executive]

Moving on, as I do each quarter, I will provide an explanation of the fiscal 2019 3rd quarter financial results and fourth quarter forecast for ONE in line with the prepared materials.

I would like to direct your attention first to Page 16. Shown here is the expected results in the second half and for the full year compared to the previous forecast announced in October. I would like to point out that, as shown in the table, the quarterly profit was $5 million in the first quarter, $121 million in the second quarter and $5 million in the third quarter. ONE has achieved a posttax profit in 3 consecutive quarters for a year-to-date total of $131 million. This result exceeds the initial forecast. The second half was previously forecast to end in a loss of $66 million due to seasonal factors such as the Chinese New Year and the National Day of the People's Republic of China. But the results at the end of the third quarter exceeded the forecast for the second half.

On the other hand, the fourth quarter is now expected to be a loss of $49 million in the current forecast. There are a number of different views about this figure, but the previous full year profit has been increased from $60 million in the previous forecast to $81 million in the current forecast. There are different outlooks for the fourth quarter, but ONE is anticipating a large drop in cargo volumes after the Chinese New Year. However, this figure does not take into consideration the coronavirus. And even at this level, liftings will be much lower in the fourth quarter compared to the previous forecast. The forecast is based on the outlook that demand will fall. So in that sense, the figures can be said to be slightly conservative. However, these figures were determined before the impact of the unforeseen coronavirus. And because there will likely be a slowdown in the production systems and economy in China, this impact will need to be taken into account. However, as I will touch on later, ONE has been good at agilely responding through adjustments to the capacity supply, so they should be able to utilize this capability to overcome any difficulties.

On the other hand, and I will also touch on this later, the current results have overperformed. The reason for the stronger-than-expected results through the third quarter is certainly not derived from the market, increase in cargo demand or higher spot freight rates, rather, ONE's efforts to improve itself are appearing in the figures. For example, as stated here, variable costs have been greatly reduced through the optimization of empty container positioning. Also in relation to bunker fuel, the price of high-sulfur bunker fuel fell at the very end, and this improved the givens. In addition, regulatory-compliant fuels started to be used from December. But the amount of regulatory-compliant fuel consumed in December was limited to half the forecast amount. By micromanaging the remaining capacity of each fuel tanker aboard the container ships, the fuel was efficiently used down to the last drop. And these efforts led to an improvement in the results. From January, the OBS, ONE Bunker Surcharge, is being applied mainly to long-term cargo, and extra bunker costs are being covered.

Moving on to the next page. Here is a waterfall graph that shows the results at ONE do not rely on the market, as I stated earlier. Looking at the full year results, the orange bars are negative factors, and the dark blue bars are positive factors. Compared to the previous forecast, unfortunately, the liftings and freight rates are slightly lower. Looking at the market situation, for example, spot freight rates have risen somewhat before the new fuel regulations. But on the other hand, spot freight rates to America and other destinations still have not reached the market assumptions.

Including these points, freight rates have acted as a negative factor. Also liftings, as I mentioned earlier, have fallen behind the initial assumptions and are expected to be particularly low in the fourth quarter. In other words, liftings is a negative factor compared to the previous forecast. On the other hand, the reduction in variable costs, such as empty positioning costs, loading, discharging, full container handling costs and inland costs has had a major effect.

Also with regard to operation costs, as I mentioned earlier, ONE has exceeded in reducing overall bunker consumption, including regulatory-compliant fuel consumption, by 7% to 10% each month. And I believe this has had a positive impact. As a result, the full year profit forecast has been increased by $21 million to $81 million from the $60 million in the previous forecast.

Please turn to the next page. Page 18 contains a very interesting table. The fact that the results are not derived from the market can be seen in the figures here. It shows a comparison of the eastbound, westbound voyages in the Asia-North America and Asia-Europe trades in fiscal 2018 and fiscal 2019. During the first and second quarters of fiscal 2018, liftings were low due to the tilling problems caused by customers being driven away by insufficient service. However, comparing the third quarter only, there were 746,000 liftings in the North America eastbound trade in fiscal 2018, but only 665,000 liftings in the third quarter of fiscal 2019.

As you are aware, looking from a calendar year basis, cargo volumes in the transpacific trades particularly fell in October through December compared to the same period the last year. ONE was also affected by this, as evidenced by the lower liftings in the Asia-North America eastbound trade compared to the same quarter last year. On the other hand, utilization was maintained at a relatively high level, and I believe this is the result of effective adjustments to the capacity supply.

Similarly, in the Asia-Europe westbound trade, liftings in the 1,000 TEU units were 444, largely unchanged from the 442 in the third quarter of fiscal 2018. The efforts to increase the liftings in the Asia-Europe eastbound trade led to decreased empty positioning cost. So without greatly increasing liftings in the Asia-Europe westbound trade, the bottom line was improved through improvements to the other factors.

On the other hand, regarding freight rates, the indexed freight rates for the outbound voyages only in each trade are shown in the table at the bottom of the page. In the Asia-North America eastbound trade compared to 108 in the third quarter of fiscal 2018, they were 104 this year. Similarly, in the Asia-Europe westbound trade, they were 100 last year and 98 this year. Spot rates significantly rose as a result of last-minute demand in the Europe trade, but they did not reach the forecast levels. I believe ONE's ability to improve the bottom line without growth in the average freight rate index can be seen in the results.

For reference concerning the capacity adjustments, which refers to not offering sailings when they are not necessary, looking at the third quarter of fiscal 2019, 31 sailings in the North America trade equivalent to 13% on a space basis, and 12 sailings in the Europe trade, equivalent to 18% on a space basis, were voided. The National Day of the People's Republic of China occurs during these 3 months in the fall. So there is naturally a slack in the cargo resulting in sailings being voided. I believe voiding sailings has contributed to the large reduction in fixed operation costs.

Please turn to the next page. Shown here is a review of the progress made in the initiatives, including the synergy effects discussed multiple times in the past. As I touched on earlier, for example, in regards to the reduction in empty positioning costs, the largest factor was the complete change at the start of fiscal 2019 from the legacy contracts of the 3 Japanese shipping lines to the best contracts for ONE. By changing the cargo portfolio and making other changes, the contribution margins have been increased, and it has been possible to greatly reduce cost despite freight rates remaining the same. Through this yield management, ONE has achieved the initial target of $190 million in annual savings.

Also the products were rationalized in fiscal 2019, including the start of a pendulum service from Japan to North America and Europe, and sailings were reduced in the Asia trade. Using the vessels freed up from such rationalization, new services have been started. And as a result of optimizing the products, improvement effects of $260 million have been realized.

In regards to the organization, along with enhancing e-commerce and implementing live chat, as stated here, for example, the booking process has been changed from traditional e-mail and telephone bookings to e-bookings, and this has been a great success both in Japan and around the world. Through these efforts, general, administrative costs have been reduced by about $50 million.

Lastly, regarding compliance with the MARPOL regulations, as I discussed earlier, regulatory-compliant fuel consumption was reduced by half in December through micromanagement. Also the company has responded by applying the OBS from January. As a result, the synergy effects from the initiatives being implemented from fiscal 2018 are expected to be about 96% achieved as of the end of fiscal 2019. And efforts will continue towards achieving over 100% of the synergy effects in fiscal 2020.

The next page shows the same full year waterfall graph as the one on the previous page, so I will not provide a detailed explanation. As can be seen in the analysis of the changes in the third quarter, the market did not progress as forecast. However, as a result of yield management and micromanagement to realize the previously mentioned synergies for the spot market in liftings, variable costs fail, and margins increased, and I feel this has had an extremely large effect.

The final page shows the fleet structure. The 3 Japanese shipping lines, who are the major shareholders, are still loaning most of the vessels. And the structure of the fleet is shown in the table here. As a single-point observation, there are basically no changes at the end of December compared to the end of September. This is natural because there have been no changes to the services. The service routes are announced every year in the spring. So once the announcement is made this spring, these figures are likely to change. Looking at the single points, it can be seen that the business is being operated under the same fleet structure and service route structure at the end of the third quarter as the end of the second quarter.

This ends my explanation of the third quarter results and fourth quarter forecast at ONE.

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