Kawasaki Kisen Kaisha Ltd

TSE:9107

Earnings Call Transcript 2020-Q2

[Harusato Nihei, executive]

We would like to begin the briefing on "K" LINE's consolidated financial results for the second quarter of the fiscal year ending March 31, 2020. A-1 financial results for second quarter fiscal year 2019.

For the first half of fiscal year 2019, operating revenues totaled JPY 372.4 billion, operating income totaled JPY 11.1 billion, ordinary income totaled JPY 13.4 billion and net income attributable to owners of parent totaled JPY 16.3 billion. Ordinary income improved by JPY 34.7 billion year-on-year and was JPY 3.4 billion higher than the previous forecast. Net income attributable to owners of parent increased JPY 40.9 billion year-on-year and was JPY 9.3 billion above the previous forecast.

The average exchange rate for the first half of the year was JPY 109.18 per U.S. dollar, and the average bunker price was USD 440 per metric ton. At the previous financial results briefing, we explained three key issues for "K" LINE. The first was reducing fleet costs. We have canceled charter contracts for high-cost vessels and taken others measures as structural reforms at the end of the previous fiscal year. The benefits of these measures are beginning to materialize.

The second was our efforts to achieve profitability in Car Carrier business. We have thoroughly rationalized service routes with a view towards prioritizing profitability while working earnestly to achieve rate restoration. These measures are bearing fruit as we establish a structure to ensure steady profitability.

The third issue was the profitability improvement of Ocean Network Express, herein after referred to as ONE. ONE has recovered from an initial period of instability experienced after its establishment and it is striving to recover cargo opportunities lost last year. In fiscal year 2019, ONE began to renew its service contracts based on its marketing policy, and the benefits are beginning to materialize. Although ONE's results still have room for improvement, they were generally in line with our forecast for the first half.

The Dry Bulk segment posted ordinary income of JPY 0.2 billion in the first 6 months, representing a deterioration of JPY 1.9 billion year-on-year and JPY 0.8 billion lower than the previous forecast. Market conditions weakened significantly in the first half of this year and remained sluggish until a recovery in iron ore shipment volumes from Brazil and a resurgence in grain shipments from South America, market conditions continue to recover.

We also succeeded in reducing fleet costs through the previously mentioned structural reforms, and we expect full year results to exceed our initial forecast. The Energy Resource Transport segment was boosted by robust market conditions for oil tankers along with stable income from long-term contracts in LNG carrier and thermal coal carrier businesses. Market conditions surrounding offshore support vessel business have bottomed out and improved to some extent. Additionally, we succeeded in limiting the impact of foreign exchange rate fluctuations through forward contracts. As a result, the Energy Resource Transport segment, as a whole, posted ordinary income of JPY 4.6 billion, an improvement of JPY 3 billion year-on-year and JPY 1.1 billion higher than our previous forecast.

In the Product Logistics segment, looking at ONE's results, although spot freight rates were lower than forecast mainly on Asia, North America and Asia-Europe routes, ONE improved profitability with meticulous operational management, including optimization of its cargo portfolio by managing its service contract renewals for the first time as ONE, reduction in vessel operation costs through route rationalization and reduction in variable costs due to benefits generated from synergies.

"K" Line's equity in ONE's ordinary income amounted to JPY 4.5 billion, which was generally consistent with the initial plan at the start of the year. Containership Business, as a whole, posted ordinary income of JPY 3.6 billion, representing year-on-year growth of JPY 27 billion and JPY 0.5 billion higher than previously forecast.

The improvement reflects the absence of temporary expenses posted immediately after the transfer of business to ONE in the previous fiscal year and an improved profitability as a result of structural reforms taken at the end of fiscal 2018. In businesses other than Containership, within the Product Logistics segment, as mentioned previously, Car Carrier business improved due to successful measures to raise profitability, while logistics business and short sea and coastal business both achieved steady profits. Altogether, these other businesses posted JPY 6.9 billion in ordinary income, a year-on-year improvement of JPY 6.5 billion and JPY 1.9 billion higher than the previous forecast.

The Product Logistics segment, on the whole, combining these other businesses with Containership segment, posted JPY 10.5 billion in ordinary income, an improvement of JPY 33.5 billion year-on-year and JPY 2.4 billion higher than the previous forecast. Regarding net income attributable to owners of parent, we continue to review our business and fleet portfolio. In relation to the portfolio changes, we posted extraordinary income on gain from the sale of assets in the first half, while our loss from liquidation of subsidiaries and affiliates in relation to the integration of Containership Business was lower than our conservative forecast. As a result, net income attributable to owners of parent for the first half was JPY 16.3 billion, JPY 9.3 billion higher than the previous forecast.

In terms of our key financial indicators, our equity capital stood at JPY 115.5 billion, JPY 11.9 billion higher than the end of the previous fiscal year, while interest-bearing liabilities declined JPY 1.2 billion to JPY 549 billion. Our equity ratio improved 2 points from the end of the previous fiscal year to 13%.

A-2, forecasts for fiscal year 2019. Regarding our consolidated forecast for the full year, while there has been some variation in the segment results and forecast for the first half and second half, we have maintained the previous full year forecast for all profit levels from operating income and below. The current full year forecast is operating revenues of JPY 740 billion, operating income of JPY 6 billion, ordinary income of JPY 5 billion and net income attributable to owners of parent of JPY 11 billion. The ordinary income forecast of JPY 5 billion would be a year-on-year improvement of JPY 53.9 billion, while net income attributable to owners of parent of JPY 11 billion would represent a year-on-year improvement of JPY 122.2 billion, assuming an exchange rate of JPY 108 to USD 1 in the second half and a bunker price of USD 531 per metric ton for the second half compared to the previous forecast of USD 677 per metric ton.

This revision reflects the shrinking of price difference between the regulation compliant fuel oil and the high sulfur fuel oil compared to the initial forecast. Regarding the impact of exchange rate and bunker price volatility in the second half, a change of JPY 1 in JPY/U.S. dollar exchange rates will impact operating income by plus or minus JPY 0.23 billion. And a change of USD 10 in bunker fuel prices will impact operating income by plus or minus JPY 0.05 billion.

Regarding net income attributable to owners of parent, as we mentioned earlier, our first half result was higher than forecast. For the second half as well, we expect to record a certain amount of extraordinary income. We are considering multiple deals to sell assets as part of our overall business portfolio restructuring, including the sale of overseas terminals. Regarding these deals, we plan to start with feasible ones where appropriate. Regarding dividend payments, which we greatly regret, it has been decided that no interim dividend will be paid. In keeping with our medium-term management plan, our priority is placed on improvement of financial strength, which we view as a pressing issue, and we are striving to improve our financial results. No decision has yet been made regarding payment of a year-end dividend at this point.

A-3, forecasts for fiscal year 2019 by segment. Regarding individual segments, the Dry Bulk segment posted a year-on-year decline in operating revenues for the first half, due mainly to a significant slump in market conditions at the start of fiscal year 2019, which gave some impact into the first half beginning in April. For the second half, the supply of vessels is expected to decline due to increased off-hire for scrubber installation, mainly among large vessels. With a better supply-demand balance and an improvement in market conditions, the Dry Bulk segment is expected to post higher operating revenues. For the full year, we forecast Dry Bulk operating income of JPY 5 billion, which would be a JPY 0.5 billion year-on-year increase and JPY 0.5 billion improvement over the previous forecast.

For the Energy Resource Transport segment, oil tanker market conditions are strengthening due to U.S. sanctions against Chinese shipping companies in relation to the Iran issue. Additionally, we are generating stable earnings from highly profitable long-term contracts for LNG and thermal coal carriers.

In offshore energy E&P support business, as we previously mentioned, market conditions have bottomed out and are improving, while they are not yet at firm levels. Therefore, for the entire Energy Resource Transport segment, we forecast JPY 9 billion in full year ordinary income, which would be a year-on-year improvement of JPY 6.5 billion and an improvement of JPY 2 billion compared with our previous forecast.

In the Product Logistics segment, ONE's result for the first half were generally consistent with forecasts. For the second half, we have revised assumptions for spot freight rate market conditions based on recent movements stemming from the economic slowdown concerns from the U.S.-China trade friction. Additionally, we expect lower liftings on Asia-North America and Asia-Europe routes due to service frequency reduction in our winter service plan, although ship operation costs will also decline.

For the full year, we expect ONE to generate JPY 2.3 billion in ordinary income, corresponding to "K" LINE's equity, which would be a year-on-year improvement of JPY 22.4 billion and a decline of JPY 0.8 billion compared with the previous forecast. For the entire Containership business, we forecast a significant improvement in ordinary income due to the positive effects of structural reforms and a decline in temporary costs, which were recorded last year. However, ONE's reduction of services will negatively impact cargo volumes at domestic and foreign terminals, and therefore we have revised the forecast for ordinary loss to JPY 13.5 billion, a deterioration of JPY 1.5 billion compared with the previous forecast.

In other businesses in the Product Logistics segment, we are making strong improvements in profitability compared to the same period last year, mainly in Car Carrier and Logistics business, due to previously mentioned comprehensive rationalization of our route network and other profitability enhancement measures. In the second half, however, intra-Europe services will be reduced in response to Brexit, lower cargo volumes to South America due to economic trends in Argentina and temporary expenses for fuel switching costs due to meet SOx regulations.

In Logistics business, some areas of air cargo business are expected to slump. As a result, Product Logistics segment businesses, excluding Containerships, is expected to post ordinary income of JPY 8 billion, JPY 8.4 billion higher than the previous year, but JPY 1 billion lower than our previous forecast. For the entire Product Logistics segment, including Containerships, we forecast an ordinary loss of JPY 5.5 billion, which would be a year-on-year improvement on JPY 43.7 billion but a decline of JPY 2.5 billion compared with our previous forecast.

We forecast consolidated ordinary income of JPY 5 billion for the full year, consistent with the previous forecast. The JPY 2.5 billion deterioration in the Product Logistics segment, including ONE, is expected to be offset by a combined improvement of JPY 2.5 billion in the Energy Resource Transport segment and Dry Bulk segment, we have therefore maintained our previous ordinary income forecast.

A-4, latest forecast for fiscal year 2019 versus financial results for fiscal year 2018. Compared with the JPY 48.9 billion in ordinary loss for fiscal 2018, we forecast ordinary income of JPY 5 billion or an improvement of JPY 53.9 billion.

We forecast an improvement of JPY 35.3 billion in Containership business, which breaks down into an improvement of JPY 24.4 billion at ONE, corresponding to our equity stake, JPY 3.5 billion improvement in "K" LINE's own Containership business, excluding ONE, and JPY 9.4 billion from the effects of structural reforms in fiscal year 2018.

Besides Containership business, we forecast an improvement of JPY 18.6 billion in "K" LINE's own business. This includes JPY 1.6 billion from the effects of structural reforms in the Dry Bulk segment, JPY 2.8 billion from various measures to improve profitability and JPY 5 billion improvement from Car Carrier route rationalization, et cetera.

We previously forecast these improvements to be JPY 5.5 billion, and the current forecast of JPY 5 billion is nearly consistent with this. Furthermore, the stronger market conditions and expansion of mid- long-term contracts in the Dry Bulk and Energy Resource Transport segments is expected to boost income by JPY 7 billion, while exchange rate volatility is expected to lower profitability by JPY 1.5 billion, with other effects expected to increase profitability by JPY 3.7 billion. Overall therefore for "K" LINE's own businesses, we forecast a profitability improvement of JPY 18.6 billion compared with the previous year or JPY 1.5 billion higher than our previous forecast.

A-5, progress of main initiatives for second quarter fiscal year 2019. We continue to transform our portfolio strategy, which began at the end of the previous fiscal year with implementation of our structural reform program. In the Dry Bulk segment, for instance, we continue to expand our stable income business, mainly for our large vessels. In October, we commenced a long-term consecutive voyage contract for JFE Steel Corporation. We have also formed a consecutive voyage contract with Nippon Paper Industries Co., Ltd, as part of our efforts to build up stable contracts.

In the Energy Resources Transport segment, we have also made strides accumulating stable income business, mainly for LNG and thermal coal carriers. In July, we announced the establishment of an ownership and operation joint venture company with Taiwan Power Company and other partners. While in the second quarter, we announced the delivery of thermal coal carriers for Hokuriku Electric Power Company and J-POWER. In terms of reducing the environmental load, we announced in June that we will install the SeaWing automated kite system on a large-sized bulk carrier. This system was researched and developed over the past 2 years in collaboration with Airseas, a spin-off of aircraft manufacturer Airbus. In keeping with "K" LINE Environmental Vision 2050, we are introducing cutting-edge environmental protection technologies to further reduce greenhouse gas emissions.

A-6, compliance with IMO, SOx regulations. Regarding initiatives for the second half of fiscal year 2019, we are making steady progress to meet SOx global cap regulations that take effect in January 2020. We have two main strategies. First, we have launched a global cap project team to meticulously plan the switchover to regulation compliant fuel for more than 300 vessels in our fleet, and they are making progress on a ship-to-ship basis. They are operating based on the policy of ensuring compliance with new regulations while also preventing any stoppage in voyages as a result of the switchover. At the same time, a project team is coordinating with the sales divisions to minimize the economic impact of the switchover.

We have also made progress with advanced procurement of regulation compliant fuel at major ports. And we have nearly completed procurement for our needs, with the exception of some smaller ports. Actual trials of usage have been successfully conducted on multiple types of vessels, including Cape-size vessels and Car Carriers, and we have completed assessment of the performance. We are also taking various measures to minimize the impact of higher fuel costs. Regarding high sulfur fuel oil left over after the switchover, we are planning to dilute this with low sulfur marine gas oil, LSMGO, which has a very low sulfur content. We have already taken such steps as preparing sludge dispersion agents to minimize the amount of leftover fuel.

Further, with regard to increased fuel costs, we are carefully explaining to customers the need for an appropriate increase as a social and environmental costs. We are still in the process of holding discussions with some customers, but overall we are gaining their acceptance of the measures. This has been an intensive effort over the past 2 to 3 months on the part of our sales divisions, and we are just now coming to the end of the process.

C, Ocean Network Express financial results for fiscal year 2019 second quarter and forecast for fiscal year 2019. Turning to ONE's results. After-tax profit for the first half of fiscal year 2019 surged to $121 million, a year-on-year improvement of $313 million as business rebounded from instability experienced after the company was launched last year, both lifting volume and utilization rate improved, while ONE took its own measures for the first time to hike long-term contract rates on Asia-North America and Asia-Europe routes, particularly Asia-North America, optimizing its cargo portfolio and lower operating costs by rationalizing routes.

These combined measures led to the $121 million profit. Revenue grew $146 million year-on-year to $3,109 million. Profitability improved through cargo portfolio optimization, cost reductions from synergy effects and lower variable costs. Asia-North America Eastbound lifting volume grew 12% year-on-year to 773,000 TEU, while utilization on these routes improved 4 points to 94%. Due to additional U.S. tariffs on Chinese goods, some customers refrained from shipping. While there was improvement year-on-year in volume, the result was actually slightly less than the budget target. Asia-Europe westbound lifting volume surged 20% year-on-year to 488,000 TEU while utilization improved 5 points to 95%.

In Europe, various shipping alliances launched newly delivered large-sized vessels causing supply growth to slightly outstrip demand growth. As a result, while lifting volumes surpassed budget target, freight rates were slightly below the target. Regarding lifting volume on both Asia-North America Westbound and Asia-Europe eastbound routes, as shown here, the results improved by about 30%, recovering from the initial instability after business launch. Although first half results were largely consistent with the forecast, as I mentioned earlier, we have revised downward the spot freight rates on Asia-North America and Asia-Europe routes for the second half due to current market trends.

As a result, we currently forecast after-tax loss of $66 million for the second half, a deterioration of $28 million from the previous forecast. For the full year, we forecast ONE's after-tax profit to be $60 million, reflecting the $126 million first half profit and the $66 million loss forecast for the second half. This represents a $30 million downward revision from the previous forecast. "K" LINE's equity equivalent is forecast at $18.6 million profit.

Regarding profitability improvement measures for fiscal year 2019, for the second half of the year, THE Alliance is making progress reducing service frequency. In response to a decline in demand, steps will be taken from November to reduce service frequency on Asia-North America routes for the winter season. For Asia-Europe routes as well, discussions are underway with Hyundai Merchant Marine, which will join THE Alliance in April next year to reduce service frequency.

Additionally, the overhead cost reduction target for the current year is $50 million and steady progress is being made to meet this target. There is no change to our target of $1,050 million in synergy effects with 82% fulfillment in fiscal 2018, 96% fulfillment in fiscal year 2019 and 100% fulfillment in fiscal 2020.

Regarding MARPOL 2020 SOx regulations, we have been told that procurement of necessary volumes of regulation compliant fuel has been completed. As for the increase in transport costs, we are asking customers to bear the higher cost. Customers have a higher consciousness of environmental problems, and they have generally agreed to the ONE Bunker Surcharge, OBS, to cover the cost increase. We have been told that such bunker surcharge has been added to long-term contracts, and the effort to gain customer acceptance is gradually being completed. Thank you for your attention.