Dentsu Group Inc. (DEN0.F) Earnings Call Transcript & Summary

Welcome to Dentsu FY 2025 First Half Earnings Call, and thank you for joining us today. My name is Morishima from the Group IR office, and I will be your moderator for the call today. This is a reminder that today's call is being recorded. [Operator Instructions] Today's presentation materials are available on our website. Joining me today are Global CEO, Dentsu, Hiroshi Igarashi; Global COO, Dentsu, Chairman and Acting COO of Dentsu Americas, Giulio Malegori.

Hi, everybody. It's Giulio Malegori here. Thank you.

CEO, Dentsu Japan and Deputy Global COO, Dentsu, Takeshi Sano. Global CFO, Dentsu, Shigeki Endo. They will be responding to your questions after the presentation. Today's agenda will begin with business and strategic update from Hiroshi Igarashi, followed by financial update from Shigeki Endo. The presentation will end with FY 2025 consolidated guidance and dividends by Hiroshi Igarashi. We will invite you to ask questions after the presentations. Mr. Igarashi, please go ahead.

Thank you very much for joining us today for the FY 2025 Q2 earnings call. Let me start with the highlights. In the first half of 2025, organic growth rate was negative 0.2%, slightly below our expectations, owing to the challenging conditions that our international business is facing in all 3 regions, although Japan performed well. Meanwhile, operating margin was 12.0%, exceeding our expectations and the previous year. Efforts to rebuild the business foundation and internal investments are making steady progress, and we have begun to restore profitability and competitive advantage. However, assuming the challenging business environment of our international business to continue, our full year 2025 earnings guidance is revised. Organic growth rate is revised down from the circa 1% to broadly flat, while operating margin guidance of circa 12% will be maintained. In addition, mainly due to the underperformance of our international business, goodwill impairment loss of JPY 86 billion was recorded in the Americas and EMEA. To focus on capital enhancement, I very much regret to say that the interim dividend will be suspended and the forecast of the year-end dividend undetermined. To make fundamental improvements in our international business, early implementation of measures such as comprehensive and strategic partnership will be sought. Now here are the highlights of the second quarter and the recent period. With regard to new clients, we won the Mizkan pitch in Japan, ServiceNow globally, Dollar General in the United States and BMW in EMEA, where we won media pitches. In CXM, we won Arrow Electronics in multiple markets. And in creative, we won Chery Automobile in APAC. In terms of industry recognition, we won 26 Lions at Cannes Lions as well as numerous advertising awards from the One Show and D&AD. We are also enhancing our recognition in the field of sustainability. Next, a business update. In the first half of the year, we began rebuilding our business foundation with the aim to restore profitability in our international business. Our goal is to achieve an operating margin of 16% to 17% in FY 2027 by reducing annual operating costs by around JPY 50 billion. We have now identified opportunities to reduce costs by around JPY 52 billion annually and are moving into the implementation phase. Headcount will be reduced by approximately 3,400 employees, which account for approximately 8% of our international business. This reduction will target headquarters and back offices with the aim of creating a lean corporate structure. It will be carried out so as not to impair our growth potential or competitiveness. The expenditure for rebuilding the business foundation originally planned as onetime cost of around JPY 50 billion in 2025 as an adjustment item will be partially deferred to 2026 or later. But the effects are expected to be realized in 2027 as planned. The onetime cost in 2025 has been revised to JPY 27 billion. In addition, approximately JPY 6 billion will be recorded as a nonadjustment item, resulting in a total impact of JPY 33 billion on the P&L for this fiscal year. Approximately JPY 2.4 billion in costs have been recorded in the first half of 2025. At the same time, strategic internal investment for growth is also important. The midterm management plan announced in February explained about the JPY 45 billion in internal investment over 3 years starting from 2025. Our original plan for 2025 was JPY 20 billion, but we are monitoring usage and results every 3 months and narrowing down investment targets to initiatives that can ensure appropriate return. As a result, we are currently planning to spend approximately JPY 17 billion. We have identified 5 priority areas for internal investment. First, data and technology, investing in products and platforms that seamlessly integrate market research and media planning powered by data. Second, IGS talent. Our specialized talent are delivering integrated solutions. Third, enhancing capabilities, especially in emerging areas such as new media and leveraging AI to connect teams across the entire group. And finally, building a robust delivery operations organization centered on Dentsu Global Services. By steadily implementing these investments in achieving results, we will regain our competitive advantage. Although expenditures will be backloaded to the second half of the year, we have growing confidence in the return on investment and we'll continue to update you on an ongoing basis. Next, I would like to talk about the progress in sports and entertainment. We have been promoting value creation in this field with approximately 1,200 industry insiders and supported nearly 1,300 clients in 21 markets worldwide. Going forward, we will expand globally as a single network by connecting bases in major regions. I would like to introduce 3 specific initiatives. First, we are expanding our sports data service, Dentsu Sports Analytics to the Middle East and North Africa, building on its success in 20 locations worldwide. Second, we have globally expanded our Dentsu Anime Solutions brand to North America, China and Southeast Asia. We will provide integrated business solutions to content owners and optimize IP licensing and marketing strategies with anime content as the core. The overseas launch of Japanese IP and product merchandising will be conducted. Third, as our new business domain, we are promoting the House of Creators initiative supporting creators in partnership with Roblox and have launched ROBMIX as a collaborative business label in partnership with KODANSHA Creators Lab. Now I will hand over to Shigeki to update our financial results.

This is Shigeki. Let me take you through the financial results for the first half of FY 2025. I will start with the key metrics. Organic growth for the first half of the year was a negative 0.2%, which was slightly below our February expectations. For the 3 months of the second quarter, it was negative 0.7%. Maintaining the momentum from the first quarter, the Japan business continued to perform strongly, exceeding our expectations for the first half. However, the international business continued to face challenges with all three regions performing slightly below our expectations. This was due to the continued slower recovery of CXM in the Americas and in some EMEA markets and due to creative performing slightly below expectations, mainly in APAC. As a result, consolidated net revenue of the group decreased 2.1% year-on-year to JPY 562 billion. However, underlying operating profit increased 7.2% year-on-year to JPY 67.5 billion. This was due to the strong performance of Japan, which recorded JPY 9.2 billion increase in underlying operating profit and the international business, partially offsetting the net revenue decline by controlling SG&A expenses, including staff costs with the start of our effort in rebuilding the business foundation. In addition to the controlled SG&A expenses, phasing of internal investments also contributed to this higher-than-expected profit level. Operating margin was 12.0%, 100 basis points higher than the same period last year. Meanwhile, on a statutory basis, we posted an operating loss of JPY 36.5 billion and a net loss of JPY 73.6 billion. This was due to the JPY 86 billion of goodwill impairment loss we recognized in the international business in the second quarter. The JPY 86 billion of goodwill impairment loss is made up of JPY 68.9 billion in the Americas and JPY 17.1 billion in EMEA. There are 3 main factors behind this impairment. Firstly, the impact of downgrading the FY 2025 forecast for the international business. While we included a level of conservatism in this year's full year forecast at the February timing, the deterioration in the international business was worse than expected. Secondly, the impact of reducing the growth rate used in the impairment test for the Americas from FY 2026 onwards, which was in reflection of the downgrade of the FY 2025 guidance. And thirdly, the impact of the U.S. dollar weakening against the British pound. Because some expenses in the Americas are recorded in British pound, the weaker U.S. dollar caused the value of our business in the Americas to decrease. When we recorded impairment in February this year, it was due to the conservative estimate we assumed and used for the growth rates in the impairment test, not only for FY 2025, but also for FY 2026 to FY 2029. However, on this occasion, the impairment was driven by a complex combination of various factors that resulted in the value of goodwill being lowered, including the greater-than-expected deterioration forecasted in international business for FY 2025 vis-a-vis the assumptions made in February, revision of the assumptions used in the impairment test from FY 2026 onwards and the impact of the U.S. dollar weakening against the British pound. Even with the latest impairment, the balance of goodwill still stands at JPY 583.8 billion across the group, mainly in the Americas. Since the goodwill is exposed to external factors, we cannot completely rule out the risk of impairment in the future. However, we remain committed to achieving the revised guidance. I will now explain the results by region for the first half of the year. Japan maintained a strong organic growth rate of over 5% in the 3 months of the second quarter, continuing the momentum of the first quarter to post strong performance for the half year period. However, all international regions recorded negative organic growth. By market, the United States, the United Kingdom, China and Australia reported negative organic growth, while Spain, Poland, Taiwan and Thailand recorded positive organic growth. Japan, the largest region accounting for around 42% of the group's net revenue posted organic growth rate of 5.3% in the first half with both net revenue and underlying operating profit reaching record highs. This was the ninth consecutive quarter of positive growth for Japan and the third consecutive quarter of growing at more than 5%. During the 3 months of the second quarter, Internet Media continued to support the strong performance of the marketing business, driven by business expansion with existing clients and revenue recognition from new clients won through pitches. In fact, Internet Media recorded 6 consecutive quarters of double-digit turnover growth. Furthermore, in addition to BX business transformation domain continue to achieve double-digit growth, DX digital transformation domain also recorded strong growth. Staff costs in Japan increased somewhat as we worked on strengthening our talent base. However, the increase in net revenue was much greater. And as a consequence, we were able to record a strong operating margin of 24.6%, maintaining the momentum from the first quarter. Having said that, this does include one-off effects such as a bonus provision being reduced at a certain subsidiary. The Americas, which accounts for around 28% of the group's net revenue recorded negative organic growth of 3.4% in the first half. Despite improving from negative 5.1% recorded in the first quarter, the 6-month performance was slightly below our expectations. Organic growth rate of CXM in the second quarter recorded a Q-on-Q improvement, showing signs of stabilization. However, continuing uncertainties in the macro and business environment have partially impacted client marketing spend. And as a consequence, CXM recorded a high single-digit negative growth for the first half of the fiscal year. Media continued to remain relatively stable with the half year result more or less being equivalent to what we achieved during the corresponding period last year. Creative recorded a slightly negative growth in the 6-month period. Despite the decline in net revenue, we were able to improve the half year operating margin by 150 basis points year-on-year to 21.7% as a result of controlled SG&A expenses, mainly in staff costs. EMEA half year organic growth rate was negative 2.4%, slightly below our expectations. CXM continued to face challenging business conditions, recording high single-digit negative growth for the 6-month period. Media remained relatively stable with a slightly positive growth and creative recorded a low single-digit negative growth. During the 3 months of the second quarter, CXM continued to struggle in the U.K. and Northern Europe with the U.K. recording high single-digit negative growth. In contrast, Spain and Poland posted mid-single-digit positive growth. Operating margin remained at 4.7% despite controlled SG&A expenses. APAC's half year organic growth rate was negative 8.9%, slightly below our expectations. CXM and Creative struggled during the 6-month period, both registering double-digit negative growth for the period. In contrast, media remained relatively stable. China and Australia faced challenges during the 3 months of the second quarter. A slowdown in creative in China, in particular, due to reduced spending by Japanese clients weighed heavily on the results. Meanwhile, Taiwan and Thailand continued to post solid performances, maintaining the momentum from the first quarter. Despite maintaining control of our SG&A expenses in APAC, we recorded underlying operating loss for the half year period, continuing from the trend of the first quarter. Next, I would like to explain the changes in the group's underlying operating profit from the corresponding period last year. Underlying operating profit for the first half of the fiscal year increased from JPY 63 billion to JPY 67.5 billion. Net revenue increased by JPY 12 billion in Japan. However, decreased by JPY 15.2 billion in the international business. As such, the group recorded JPY 3.3 billion decrease in net revenue. Staff costs increased by JPY 5.1 billion in Japan, mainly due to strengthening of its talent base, but decreased by JPY 8.9 billion in the international business, driven by the Americas and APAC, with a decrease of JPY 1.1 billion in central costs, staff costs for the group as a whole decreased by JPY 4.9 billion. Other operating expenses decreased by JPY 3.6 billion, driven by a review of outsourcing fees and traveling expenses -- travel expenses. That is all for me. And I would like to hand back to Igarashi san to explain our FY 2025 consolidated guidance and dividend outlook.

Thank you, Shigeki. Finally, I would like to explain the revisions to our consolidated guidance. In the second half of the year, we expect our Japan business to continue to see positive growth. In our 3 international business regions, however, while the media business is relatively stable with new client wins, the challenging business environment is expected to continue due to the slower recovery in CXM as well as project losses and budget reductions from existing clients in creative. Furthermore, the uncertain macro environment is expected to continue. Therefore, FY 2025 group organic growth guidance will be revised from circa 1% to broadly flat. Organic growth of circa 3% for Japan will be maintained. The international business, organic growth guidance is revised down from aiming at positive growth to negative circa 2%. On the other hand, operating margin of circa 12% for fiscal 2025 will be maintained, taking into account swift cost control initiatives in response to the business environment and the partial realization of the effects of the rebuilding our business foundation initiative that we have been promoting since the beginning of the year. Reflecting the second quarter goodwill impairment loss of JPY 86 billion and a review of cost for rebuilding our business foundation, we have revised our statutory operating profit guidance from JPY 66 billion to a loss of JPY 3.5 billion and our guidance for net profit attributable to the owners of parent from JPY 10 billion to a net loss of JPY 75.4 billion. Turning to dividends. Today, we announced the recording of a loss on valuation of shares of subsidiaries and associates of Dentsu Group Inc. on a nonconsolidated basis. This valuation loss is only for accounting purposes and does not affect cash. However, as a result of this valuation loss, on a nonconsolidated basis, Dentsu Group Inc.'s retained earnings have decreased significantly. Therefore, it is deeply regrettable that we have decided to suspend the interim dividend for and revise the forecast of the year-end dividend to currently undetermined. Originally, the interim and year-end dividends were expected to be JPY 69.75 each to result in an annual dividend forecast of JPY 139.5 for 2025. Let us announce the year-end dividend forecast once we have decided its appropriate level based on profits from business, the progress of asset sales, which we have been consistently working on and future capital allocation from a medium-term management perspective. We will strive to stabilize dividends as soon as possible from 2026 onwards. The Japan business performed well in the first half of this fiscal year, achieving record high net revenue and underlying operating profit. Organic growth exceeded 5% for 3 consecutive quarters. As a result, group underlying operating profit also increased 7.2% year-on-year, demonstrating solid performance. On the other hand, due to the challenging business environment in the international business, we regret that we have revised down our full year guidance, recorded impairment loss, suspended interim dividend and remain the year-end dividend forecast undetermined. In order to restore our recovery in profitability at an early stage, we will further focus on rebuilding our business foundation and evaluating underperforming businesses. Furthermore, for international business, we will explore and implement strategic alternatives, including comprehensive and strategic partnerships. As we consider more fundamental measures, we will review our current midterm management plan as needed with the aim of achieving sustainable improvements in corporate value to maximize shareholder value. That is all for me. Thank you for your kind attention. I'll hand it back to the moderator.

[Operator Instructions] The first question will be from Abe-san of Daiwa Securities.

This is Abe from Daiwa Securities. I have two questions. One is about dividend. In the past, JPY 139 to be maintained. Basically, the direction was that you will not reduce the dividend level from next fiscal year. But what was your mindset change leading to this revision, your thinking? And dividend payment for this year. So net income, 35% payout ratio on an underlying basis, is that the idea you have in mind? That's my first question on dividend. And my second question, so downward trend, I think, is being expressed in the international business, but including foreign exchange environment, do we still need to expect some downside impact going forward? Your view on that, please?

Mr. Abe, thank you very much for your questions. Two questions. With regards to dividend, that was the first question. So the dividend has been revised down. What is the thinking behind it? Give us some color. And with regards to the dividend payout level, 35% had been the guideline in the past, but is this still maintained? So I will ask Shigeki to respond to this part of the question. And if needed, I would like to also make some supplementary comments. And as for the changes in the external environment, that was the second question. From the second half of the year, as risk, what kind of changes do you expect to anticipate and give us some color in terms of the market environment, the external environment by market. So I would like to give a response to that, but I would like to, first of all, ask Shigeki to respond to the first part of the question.

This is Shigeki speaking. Thank you for your questions. So as I explained, for the reasons, the full year forecast has been revised down for FY '25. That's one reason. And because of that revision, 2026 and beyond growth rate, especially in the Americas, we had to revise that. So those two are the main contributing factors. In terms of value, Americas has had the biggest impact. As of February, we had quite a conservative number in mind and yet impairment has been conducted. And then taking into account further growth beyond 2026, according to the impairment model, at least, for the Americas, there was a need to further revise down. And therefore, in order to seek further growth, we have decided to change the capital allocation in order to ensure stability. And that has led to us cutting a dividend. So in terms of payout ratio, 35% is in our mind.

Yes, this is Igarashi speaking. With regards to payout ratio, stably keeping 35%, this has been our policy in the past. But this time around, with regards to year-end dividend, it is undetermined at this moment. So I would appreciate if you could bear that in mind. Now with regards to risk factors, the second part of your question, for the first half, risks in the external environment basically had little impact. We were not under any kind of pressure from the changes in the external environment. But from the second half onwards, macroeconomic factors had to be factored in as a risk factor, and that was reflected in the guidance. With regards to specific markets, the Americas, I would say, is quite big. For 90 countries, the tariff measures that were announced on the 7th of August in all these respective markets, I expect there will be some impact one way or the other, but risk factor-wise, inflation in the Americas had to be taken into account for the second half of the year. Apart from that, AI across various fields, it's becoming very prevalent. And needs from our clients have become very sophisticated with the advent of AI, and we have been facing the need to address that. And therefore, AI's impact in marketing is -- well, rather than seeing this as a risk, but this is something that we need to address. So that I hope responds to your question. Thank you very much Mr. Abe for your question.

The next question is from Mr. Julien Roch from Barclays.

My question is in the presentation, you say you aim to expedite the implementation of comprehensive and strategic partnership for your international business. What do you mean by that? What are those comprehensive and strategic partnership? Would you be open to selling emerging International with another company?

Thank you very much, Julien, for your question. So what does the comprehensive and strategic partnership means? Does it include the potential sale of our international business? I think that was your question. Well, as we have explained in this earnings announcement, in our midterm management plan, we have been talking about rebuilding of our international business. We have been working on enhancing our competitiveness. Well, for this, we are going to rebuild our business foundation, and we are going to also reevaluate our underperforming business, and we are making a steady progress on this. Now on that basis, and when we look at the current situation, the current structure of the organization or the capital structure of what we have right now, we are not going to take those as a given. And so depending on the environment and the circumstance that we are facing, we need to consider bold effort. So in that regard, we are continuing with the study by retaining external adviser who have expertise knowledge. So if it is to achieve rebuilding of the business in the early timing, there is an option for us to accelerate business rebuilding through partnership with a third party. And in regards to divestiture of the international business, we are not at a stage of being able to give any clear response at this point in time. And I'm not in a state of being able to talk about anything specific right now. But to give you an example of a partnership, in regards to some of the underperforming business, we may accept external capital or what we are considering right now, the corporate function. This could potentially be subject to quite a bold outsourcing. So these are the things that are included in the study right now. At this point in time, nothing has been decided as yet. But once we reach a decision, we intend to make disclosure and communication quickly. So I hope you understand.Thank you very much for that question.

Next question is from Nomura Securities, Mr. Harahata.

I am Harahata from Nomura Securities. I have just one question. About impairment risk going forward. For International business, you will be scrutinizing for the year, and you will decide on the region and the size. But with this impairment, have you been able to conduct the impairment that will be required. Therefore, there will be no impairment required in the future. I would like to hear your views on that.

Mr. Harahata, thank you very much for your question. In terms of impairment risk, what is the view of the management is the question. I will ask Global CFO, Shigeki to respond to this question.

This is Shigeki speaking. Thank you very much for the question. Regarding impairment, in the impairment test, 2025 net revenue growth rate, not only that, but also medium-term gross profit margin and also external factors are also factored in or foreign exchange, among others, are complex -- are involved in a complex manner in the impairment test, and it's discussed with the accounting firm. So 2025 sales growth, revenue growth alone will not determine the outcome. But having said that, the guidance that we've revised this time, it's very critical that we achieve this revised guidance in Q2. And if we do not revise the forecast of impairment risk for next fiscal year, we are not expecting any further impairment losses. But there are other external factors that will have an impact. And therefore, I will not deny the possibility that there could be additional impairment losses.

So the next question is from Mr. Maeda from SMBC Nikko Securities.

This is Maeda from SMBC Nikko Securities. I do have three questions. Is there a limit to the number of questions that I can ask?

You can ask the three questions.

Well, first question is related to the previous person's question. So in regards to thinking going forward. Well, the organic growth rate for this year has been lowered by some 2%. But next fiscal year onwards, the organic growth of the net revenue for international business next year onwards, so what was the number you have set for that in calculating the impairment on this occasion. So that is a hint for us to think in terms of the external environment. So that's the first question. The second question is for the strong performing Japan business. 3 months ago, you were saying that the first quarter was good, but you were saying that there were some uncertainties in the second quarter, indicating some conservatism, but you have achieved strong result as you did in the first quarter in the end. So the background to that. And also the second half of the year onwards, can we expect sustainability of the strong performance for the rest of the year? And next year onwards, can you continue to structurally grow the business in Japan? And the third question is regarding sports and entertainment. Recently, there's been a lot of news flow from your company and feel that you are putting a lot of emphasis in this area. So for this business, the value of this business, how much the earnings will it likely to generate? So when we are forecasting your performance, I think this is going to be a quite important factor. And so I wanted to get some clarity on that. So these are my 3 questions.