Ichigo Inc. (2337) Earnings Call Transcript & Summary

Hi, everybody. This is Scott Callon. Thank you so much for joining today. I'm in a room with my Japanese colleagues wearing a mask. So hopefully you can still understand me despite the mask. Joining us on the call are Tet Fujita, our Lead Independent Director; and Dan Morisaku, our Senior Manager and Finance and our Head of Global IR. I'm working off of our FY 21/2. So February '21 fiscal year corporate presentation, that's on the website. Let's go at it. Starting with page 8. It was a relatively light quarter. That's a little bit because of COVID impact, but -- and -- but discounting that, it's primarily because we have stock earnings, we can see on the page, and then we have variability on our full earnings. So Q2 was a little light. Q3, we're bigger. We've already announced, we did a large transaction of residential sales that will be contributing in Q3. You can see that we continue to, despite this overwhelming, unprecedented, incredibly difficult pandemic that we're all suffering together globally, the earnings model is very durable. We run at significantly higher levels of stock earnings. So there's a kind of effectively fixed earnings above our fixed expenses despite the kind of the chaos that's out there. We describe our stock earnings as robust. We hope you can forgive the term robust. We don't think these numbers are particularly strong and they don't, at all, speak to what ongoing normalized earnings look like. There's a fall-off in Sustainable Real Estate that's overwhelmingly coming from decrease in hotel income. So our hotels have a combination of fixed rents and variable rents -- there are no variable rents. I mean -- so that's what you experience in this kind of environment. Asset Management is down a little bit. Clean Energy, which is completely indifferent to what's happening in the world, is growing very nicely. I'll turn to -- you see, we announced a share buyback. To be very direct about it, we would have announced the share buyback in Q1 where the stock would have been cheaper than it was today. Because we are sitting right in front of this large real estate transaction, we were actually insiders and weren't able to do a share buyback at the time. So we are now announcing a transaction today. I'm going to go relatively quickly through the COVID impacts, and I'll just -- I'll take questions from you to the extent that you have them during Q&A. But Page 9 shows kind of the 3 key segments: Asset Management, Sustainable Real Estate and Clean Energy. Asset Management has had some impact, primarily, again, in hotels, we get Asset Management fees that are linked to NOI of the hotels. The -- if you see the disclosure that's coming out of Ichigo Hotel REIT, RevPAR is down about 70% year-on-year. So for Ichigo Hotel also, you have fixed rents coming in at the hotels, but no variable rents. Sustainable Real Estate has had a little bit of recovery in the hotel rental income, which is great, but it's still just absolutely an utterly terrible operating environment, and we'll have to see COVID come to an end and people feel comfortable traveling again before that changes. The primary impact on earnings is Sustainable Real Estate or is -- and you can see at the very bottom, we break out between impacts and leasing and investment sales and acquisitions, there's been almost a complete halt in transactions in office, hotel and retail. That's primarily because buyer and sellers have different views as to what the appropriate pricing is. So spreads have blown out. It's residential that continues to be very, very active, and that's for obvious reasons. Residential -- Japan has done a very good job of projecting people's incomes, residential assets are fully performing. And so when there's uncertainty what's going on, at the moment in terms of economics for hotel and retail and then certainly in the future as to what work-from-home means for office, those become transaction markets that are very hard to operate in. And residential, on the other hand, it's just very secure. So we've been being big in residential. Turn to Page 10. In terms of our COVID response, it's primarily spending a lot of time with our tenants. And using this as an opportunity to work with our tenants to acquire, quite honestly, data about tenants and what their needs are, what their economics are. This has been an unprecedented opportunity to sit down. We've really, really sit down with every single tenant and gone through their situation. We are there to be supportive. We take a long-view on what it is to be a Sustainable Real Estate owner. It's still obviously traumatic and difficult out there. We will be accommodative. We think there should be accommodation done for our tenants in terms of pushing out kind of rental payment deferrals or partial decreases in the rents in order to help them kind of get through this period. But in return for that, we do ask for a systematic understanding of what the financial situation is, what our own ground economics look like. And so it has created, we think, a transformational opportunity for us to understand our tenant's business better. Offices and hotels are in a very different situation. Just to touch a little bit on offices, we think we have a differentiated view from what the market seems to be thinking about offices. We have done extensive -- I said -- as I said, we've spoken with every single office tenant. We've also done tenant surveys to all of our tenants to understand what's going on with them in the office environment. The market seems to think that work-from-home is going to damage office demand, and it could well. I mean, it certainly could well, both in Japan and globally. What's differentiated in our case is that our offices are: one, very, very well-priced relative to competition. You can see the average rent is about JPY 16,000 per tsubo. So Tokyo, kind of big offices and -- we're in primaries also, but bigger offices will typically be something that looks more like high 20s to JPY 40,000 as kind of a category. So we're literally kind of half those rents. And so what we think the market may be getting wrong, is that we see opportunities for -- to take tenants, and we are experiencing that in our leasing activity. I should say that we have about 200 office tenants right now. We have had 4 ask for some sort of rental accommodation. Rent accommodation meaning kind of can we pay you less or can we pay you later. And we have had 2 -- I think its 2, lease cancellations. So I'm telling you, what we're seeing on the ground with our tenants and what they've expressed to us in our meetings with them and going forward is not that there's going to be this kind of massively weakening in demand. The other thing that we're seeing is we are picking up tenants who are downsizing the space. And to be clear, we specialize in small, mid-sized offices. And the advantage of small and mid-sized offices are better value for money, and in many cases, to address an important need, typically 1 tenant per floor. So one of the things we're getting in our tenant survey is also as we really don't like being with a whole bunch of other tenants in the building. And we want you, as Ichigo, to interact with all the other tenants instead of rules and guidelines so everyone should be wearing masks in the hallways and all sort of things. But it has pushed up demand for isolated office spaces, and we're getting some advantage from them. On the hotel side, it's really become clear that us, we acquired Hakata Hotels, a hotel operator. I think it was early last year. It's clearly advantageous for us to have our own hotel operator. We have picked up 3 operation -- operator contracts on 3 hotels, 2 on our own balance sheet at ICH and 1 at Ichigo Hotel REIT, just related to COVID. So one of the things that we think we ought to deliver to you is we don't think these, our earnings at all right now, look like what normalized earnings look like. But at least take advantage of the current situation to invest for earnings growth in the future. We're getting a lot of inquiries about do we want to takeover operator contracts. We're picking and choosing, and we think we're taking on situations, which are going to be very positive, going forward. Page 11 shows you some of the things that we're doing to try to help our tenants in terms of infection countermeasures. That includes, on the bottom, providing free Wi-Fi at all of our residential assets to help kind of not infection in the buildings themselves, but kind of decrease the amount of activity that is going on within the society to decrease infection spread. I should also tell you that as a company, we were effectively, even 10 months ago, 100% in the office for all intents and purposes, and maybe 90% to 95% at the office were, at this point, operating kind of about 15% to 20%. So we've gone made a massive and dramatic transition to being operated remotely, which is great for BCP purposes, and it's great for kind of flexibility and the ability to do things, all things everywhere. So that transition has worked pretty well. Page 12 shows you the grim numbers, and they are grim. I mean, we don't -- we have about 1/4 of our assets in hotels. We have 1/4 of our assets in retail, which we designed to be Amazon-Proof by focusing on services and experiences. And those 2 groups have been impacted, particularly the hotels. So we're -- you're going to see a big drop-off in earnings. We do think this is one-off. But the grim reality is that OP is down 64% year-on-year and net income is down 68%, EPS is down 67%, stock is down 36% and the flow earnings is down 68%. On Page 13, we show the segment earnings details. Again, I already touched on the Asset Management is down, primarily on Ichigo Hotel, Asset Management fees that we have a link to, in almost all cases, very stable NOI. We run our hotels hard and with very high levels of occupancy. They're not resorts. They're not kind of economically sensitive. We built our hotel portfolio, which is very kind of centrally located, low-cost in terms of the basic offer, plus THE KNOT hotels, our new boutique hotels that have kind of massive outperformers. But -- and so in the Asset Management space, which a hotel is -- again, doesn't have THE KNOT Boutique Hotels, but has these kind of everyday value hotels. The economics are generally extremely durable. They're not now. I mean, this is kind of stuff that has fallen through the floor. On Sustainable Real Estate, the stock earnings are primarily a decrease in hotel income. In actuality, the resale impact has proven to be relatively limited. That's both -- it's primarily because we have a mix of both Amazon-Proof Retail in terms of kind of its restaurants and kind of experiential things and the dense offices and all those things. It's also because we have -- within the retail sector -- as much as Amazon has done very well under COVID, so the suburban outlets. And the suburbs are doing very well because people are not commuting in. Shopping centers, kind of every day kind of shopping. Supermarket, this sort of thing is doing very, very well. Drug stores are doing very, very well. So retail is actually proving to be relatively defensive. The floor earnings, I already touched on, there's very little activity in sales and acquisitions other than residential. We've been very active in residential. And in Clean Energy, that's growing nicely year-on-year. We've had 6 plants online since last year. And I'm sorry, on an earlier page, we wrote that its fiscal year '19 to half -- H1, it's on Page 8. That should have been fiscal year '20. So over the last year, we brought on 6 new plants. Pages 15, 16, 17 and 18 go through kind of elements of the business model. And we've touched on this before. It's a combination of stock and flow earnings on Page 15. Page 16 shows kind of effectively an earnings bank that we build over time. Our accounting earnings significantly understate our economic earnings. Page 17 shows you how -- kind of speaking to Page 16 where we show these unrealized gains. Page 17 shows you how much more we actually generate in terms of actual gains when we sell assets. As you can see, the biggest thing that's noted on Page 17 is a very, very big drop-off in our sales activity, and that's a choice we made. I mean, we can sell office assets, we could sell hotel assets, retail. But we don't think the pricing makes sense, and so we're not involved in doing so right now. And the reason why you see a little bit of a drop-off in terms of the multiple relative to -- or more, in terms of a multiple of what we're getting relative to, our accounting -- appraisal value-based on realized gains because we're overwhelmingly involved with Ichigo Owners. In terms of our sale activity, Ichigo Owners is a little lower-margin business. Anyway, that's going very much according to plan. Page 18, again, points to an essential element of the business model. We're not accrual-based company. We generate a significant amount of cash, over only more than what our net income reports. Page 19 shows there's really been no change under COVID in terms of how we finance ourselves. We finance very, very long-term at extraordinary low rates, and that will continue. Turning to Page 27 (sic) [ 20 ] shows our acquisition and sale activity in the first half. The most important thing to understand is this is overwhelmingly it's been involved Ichigo Owners. So to remind you, Ichigo Owners is a business we set up 3 years ago. It is -- all along, we focused on very quick value-add. And the business model involves a less than 1 year hold if we buy residential assets at a discount in prime Tokyo areas from developers. So -- and generally, we buy them kind of 18 to -- 18 months to kind of 1.5 years and 2.5 years in advance. They come in, they're in a great area, and we lease them up. We sell them on to whoever wants to buy a fully leased up residential asset in a really good part of Tokyo. Demand for that has been overwhelming. So that's the one part of the market that is transacting very, very heavily, and we're very involved in it. We -- so we bought actually the same amount, 13 assets, JPY 10 billion in the end for Ichigo Owners, so 46% of our total transactions. And we sold 13 assets at JPY 16.6 billion, so 81% of our total. That does not include the additional owners activity I told you when I report in Q3. The one exception that looks like we've been doing more in hotels, and that was us bringing online THE KNOT SAPPORO and THE KNOT HIROSHIMA. So we now have 4 of THE KNOTs. This is a boutique hotel that offers extraordinary value for money. The issue with Japanese hotels is you kind of have the high-end net cost, $400 to $500 a night. You have the low-end, which costs $60 to $80 a night. But if somebody wants to stay at a really nice hotel for $150 a night, there's not nearly as much an offer. So we have a KNOT in Tokyo. We have a KNOT in Yokohama. We brought on 2 of them. Truth of the matter is just they're earning, no returns. So we do need to see travel come back for these to be productive, and we're very, very confident that we will be. So the acquisitions, as you see, JPY 8.7 billion hotels, that's primarily THE KNOT SAPPORO and THE KNOT HIROSHIMA. Page 22 shows where we are with the -- our 3 listed vehicles, the 2 TSE REITs, Ichigo Office and Ichigo Hotel and our YieldCo Ichigo Green infrastructure. I think, probably the most important thing that's new on the page is for Ichigo Hotel. We are using Hakata Hotel as our operator for now. 3 hotels, again, we had 2 of them last year, and we picked another one this year. Page 23 shows what's happening with our Clean Energy business, which is growing really nicely. 6 new plants over the last year. 4 of those would be year-to-date. We have 3 more coming online this year. So we have another kind of or nearly 50% -- 46% growth embedded in our current pipeline for the Clean Energy business. Page 24 shows you our first wind power plant that's coming online in December. It's 4 wind turbines in Yamagata in Northern Japan. To give you some sense of the economics on this, total investment, about JPY 3.6 billion. So at JPY 100 to $1, $36 million. The NOI pre-depreciation is 12%. Post-depreciation is 8%. This continues to be -- Clean Energy continues to be a very kind of good business with super normal returns, and we expect to continue to get bigger in it. 25 talks about the buyback. Again, as I pointed out earlier, we would have done one in Q1, if we could. But unfortunately, we were restricted because we had information. And look, I mean, at today's earnings, the multiple looks relatively high. Of course, it does because earnings are plunged. We feel very, very comfortable, one, that our NAV is solid. We're basically buying it around NAV right now, even with a stressed view of what assets are worth under COVID or under post-COVID; and two, we'll fully expect earnings to come back in a very significant way. And so we think the stock is very cheap. Finally, on Page 26, we do have a J.League Shareholder Program that's been remarkably successful. We have 66,000 shareholders involved, not only at this company, but at the 2 REITs and the YieldCo. Unfortunately, that's moved primarily to -- there has been some limited J.League match activity. There's been J.League match activity with limited kind of fan participation, given the way that their J.League guys have been organizing that we haven't been able to send out tickets to our shareholders as we would normally do. So we've been substituting things like sending people autographed merchandise, like jersey and things like that, having online events, et cetera. But this is something that, of course, when the J.League comes back full force, our shareholders will able to fully enjoy again. So that's what I have in terms of the presentation. I'm happy to take any questions or any feedback at any time. Again, thank you so much for joining the call today. And to reiterate, we have not just me, but also Ted Fujita, our Lead Independent Director; and Dan Morisaku from Finance to take questions also.

[Operator Instructions] Greg, we have you. Thank you very much for joining. Go for it.

One quick confirmation on hotels. As you mentioned, so in Q1, you guys bought 2 hotels for JPY 4.76 billion. And the tally at H1 is 3 hotels for JPY 8.7 billion. So if I understood you correctly, the additional hotel was THE KNOT Hiroshima, is that correct?

It was one of THE KNOTs.

Greg, it was Hiroshima.

Okay. And can I give a sense for kind of a normalized NOI yield would be on such a purchase in kind of pre-COVID?

That's a good question. I mean the 10% plus, I mean, these have been very successful, and so we'll have to see. We're rolling out in Sapporo and Hiroshima, we'll have to see if the impact is slightly different, but yes, definitely 10% plus.

Okay. Great. And another quick follow-up on hotels again. So last time on the first quarter call, you were still quite cautious regarding kind of reentering hotels as an asset class. But as you just alluded now, it seems that you guys are kind of starting to look at whether there are opportunities. So can we consider that you would be in opportunistic acquisition mode at the right price going into kind of Q3 or Q4, which is when I expect some of the inventory might come out?

Yes. I mean, look, this is tricky. I mean, so what we've been doing is we've been taking on operator contracts so that you've got less kind of -- you don't have asset risk on that. And we're taking them on conditions that we think are very -- that reflects kind of at least a year of difficulty. And so they're safe, very little downside and you get the ongoing, upside going forward. In terms of buying hotel assets, it depends on what's priced. I mean, there, at some point, we will be post-COVID via vaccine or treatment regime or people just getting tired and decide they want to go in the world again, and everyone's wearing mask as they do in Japan. And so we are underwriting to at least another year of this is going to be really, really hard. And if the numbers work on that basis, and then kind of a gradual recovery. If you underwrite to that and it's attractive, we're definitely there. And the reality is that, I think you're absolutely right, kind of Q3, Q4 is beginning -- people are beginning to run out of runway. Less well capitalized people in leisure and entertainment are finally having to kind of give up. And so there likely are going to be opportunities, and we will look at them very carefully. The other thing I would add is, and I think we've done -- and I own this, so apologies to all of you. I think, we've probably done a poor job of explaining to the market our Propera AI revenue management system. One of the things that's happened is because of COVID, so that optimizes the ability to drive higher returns from hotels, and it's proving to be very powerful. It's the kind of single platform business that we have, in other words, kind of IT driven with the ability to kind of become the market standard and generate huge economics over time. One of the things that happened with COVID is because, quite honestly, one of the things you do is you go to operate -- you should use -- prepare and the like, yes, we're not really -- think we should, and now less there's thing going, do we have to and things are just fine now. COVID has been a wonderful opportunity to market if because the hotel operators are really, really desperate. It's -- the result of that is we get kind of more people in the system. You get kind of this flywheel. You're having more data and the ability to kind of push along the algorithm and optimization ahead of other people. So we do think that Propera is proving to be a significant interest in hotel space, and will allow us to take assets. And generally, you're getting kind of upticks to 20% to 40% NOI that other people can't generate. So hotels continue to be very, very interesting to us.

Understood. And one more question, if I may, on Sustainable Energy, which it was Suga administration, there seems to be a push towards more renewable or I would say, an acceleration of that trend. I mean, isn't that an opportunity for you to accelerate acquisition of kind of third-party sites to get bigger with the Ichigo Green?

Yes. I mean, look, we -- I like your thinking. I mean, I also -- I always want to be incredibly direct. The truth of the matter is that kind of sites that are wandering around kind of that aren't -- haven't been built on, tend to be kind of -- have terrible economics. And there's a reason that they continue to be kind of a strange plot of land with poor sunlight. So the key question is, how do we get bigger in this space. We are involved in looking at kind of not just greenfield, but kind of taking our existing sites. The thing that I think is the most obvious brand-new area for growth, and I've talked about this before, we continue to progress our sustainable biomass activities. So by sustainable biomass, reality is that biomass is not actually good for the world. It's proven to be kind of -- its net 0 carbon over time, but you destroy the planet in the first 50 years. And then kind of at the end, when you finally regrow the trees, you end up kind of completing the carbon cycle. But we're building out a process that's involved in a work with local communities and local governments, where we take forests that have not been properly maintained and you prune the forest. And by pruning the force, you actually preserves the forest's ability to live and create oxygen. And so it's actually truly sustainable biomass. That's the thing that's kind of the most obvious as a brand-new activity. It does deal with a significant environmental problem. It does address the desires of regional areas where the forests mostly are to try to generate employment. It is something that the Suga administration is very interested in. So that's kind of -- we will continue to work on what we can continue to do in solar and wind, but a brand-new potential growth there is going to be the sustainable biomass. Richard, thank you very much, [indiscernible].

Scott, thanks for your explanation on the earnings. Just one, coming back to the hotel. So yes, how have the go to campaigns affected the hotel operations so far? And yes, is it measurable? And have you also taken this into account when discussing -- yes, your hotel acquisition plans? And also taking on these hotel operator contracts, are they like loss-making in the first year or may you please expand a little bit on that?

So look, go to has been helpful for the hotel industry. It's been primarily helpful for operators, and we care about operators. So kind of the grim reality is that the operators are paying no variable rents to us. They have been paying, for the most part, fixed rents. And in certain cases, they are under water on the fixed front. And so what go to has been primarily done has been able to sustain the finances of operators who are in deep distress. But they really have not -- apologies, Richard, they really haven't changed our economics in the hotel business. We're still waiting for -- again, our disclosed data on -- and our own balance sheet hotels look very, very similar. I mean, the RevPAR are down 70% year-on-year. It's just devastating. In terms of the operating contracts, yes. I mean, it could be a minor amount of negatives on the first year, but nothing material. We're not going to wear it out. So we're pretty confident that in the near term, these are kind of breakeven-ish in the long-term, but they generate good upside for us. [Operator Instructions] Greg, thank you. You're always welcome.

Sorry, just a quick follow-up, if there is no one else. Yes, just to follow-on the hotels, my follow-up question was, have you been approached by banks who have potentially asset to offload? And also, separately, have you had interest from third-party for -- to who would like you to kind of spearhead a recovery fund? Or is it still -- would it still be just your principal money, so to speak?

So the answer is no and yes. No, the banks haven't come to us yet. I mean, to the banks' credit and to the FSA's credit, FSA has been very good on, do not pull lines on functioning hotel operations. And so the few cases where we've had operators kind of give up and go into bankruptcy proceeding this -- because they were not actually functioning pre COVID. And so if that's the case, and you're certainly not functioning post COVID. And so the banks are not kind of bringing assets to us at this point. We'll have to see what happens. And we would be someone that they would come to. I mean, we obviously have capabilities in the hotel space. We made it clear that we're growing our presence in this area. We have strong relationship with the banks. On your second question, yes, we have been approached by a number of parties on do you want to do something together. And we'll make a call on that as to -- the trade-offs are, if you bring in other people's capital, your own Asset Management fee on it, and it definitely will involve a performance fee that could be something that has powerful economics. We generally have gone towards using our own capital first just because we found that we have -- we can have proprietary sourcing. We're very careful about kind of the kinds of places that we go, that we kind of -- we turn all the economics to our shareholders as we're pretty well. But we did something very large. To your point, Greg, we probably -- in hotel space, given uncertainties, we probably will end up sharing risk on that. Full stop, I mean, because we're not going to do something massive given the current uncertainties right now.

Okay. It sounds interesting. And just a totally unrelated question. But the push by Suga-san for digitalization and getting rid of Hong Kong, as you guys know well, the real estate in Japan is very regulated industry in terms of you have to have a physical storefront to close deals, blah blah blah, for -- do you think that could change? I mean, is that something that you think could help see a real kind of real estate tech business, so to speak, kind of take-off?

Yes. I mean -- so -- I'm sorry, ahead.

Yes. No, no, that was -- you understand the gist of my question, I guess.

Yes. I mean, so the Suga administration has actually included real estate explicitly in the framework for digitalization. And so -- I'm sorry, I know you already know this, but it involves the ability to no longer require a physical presence for doing real estate transactions is on the agenda. And look, I mean, that's going to be a productivity driver for the business. Quite honestly, we would benefit from it. We would like that a lot. The requirement for kind of physical presence and kind of hand holding and it were -- that is not productive and reflects kind of 19th century best practice, not 21st century best practice. So we would be prepared for that. And look, one of the things that has been a positive for COVID, and we're looking for positives because it's overwhelmingly, in the short term, certainly, from an earnings perspective, COVID has been devastating. Is -- we use it as an opportunity to just put a bunch of time and effort into understanding how we can get higher productivity using information technology. And so there continues to be an ongoing and successful effort to drive higher productivity. And that's primarily about taking processes and making them end-to-end without human interventional. And so I mean, just to use an example, we're robustly automating our financial reporting automation, all the data gathering and everything like that. So that kind of -- you put something in and it shows up for our financial reports. It is not a real estate specific issue, but this has been a good time. You're sitting around, you're not able to do a lot of things that you normally can do. So how are you going to use your time productively? I mean this is a really good way to invest [indiscernible]. It's going to take our cost down. It's going to improve our productivity. In a sense, again, this is something that I got wrong because I don't take full ownership for everything we've done, we should have invested in this more earlier. And so that's also been a powerful lesson, taking some of the firm's resources and doing more on IT should be an ongoing effort. All right. Thank you, everybody. We're grateful for your time. It's a tough time in the world. Take care, be safe. Have a good day.