Ichigo Inc. (2337) Earnings Call Transcript & Summary

This is Scott Callon, Chairman of Ichigo. Thank you very much for joining our FY '25/2. So February 2025 1st Half Corporate Presentation. I am joined by Ted Fujita, to my right, who is our Lead Independent Director. And then on my left is Dan Morisaku, who is a senior member of our finance team and Head of Global IR for us. So thank you very much for joining. Let's go straight to it. So here is a summary on Page 7. All in OP, down 32% year-on-year. Cash net income down 43%. So these are not numbers that look fantastically good and they're fine. So kind of the business is going very, very well. Stock earnings, you can see, are up 11% year-on-year. We have movements around during the year in terms of when we get a flow earnings and sales will be accelerating in the second half of the year. So despite the numbers looking light and they are light, not a problem at all. We launched -- we'll be launching on October 17. So 7 days from today, our fifth Ichigo Residence token. That's part of where kind of we have some visibility already on what forward earnings look like in the second half of the year. We have announced a buyback of 6 billion shares in terms of the amount, 3.9% of shares outstanding. The background to that is the shares are about as cheap as my memory serves. We're trading at 11x, accounting earnings about let's see, what is it, 8.5x cash earnings. So really, really good value given how strong our business model is, and how productive it is in the current market environment. And going forward. Look, this is not about -- to build huge value over the long term means you have to build in the short term and medium term and long term. But we are focused on the long term, things are outstanding. We think it's very good value for us to be buying our shares at these levels. In terms of RE100, we completed our 100% renewable energy transition during the quarter. So things are on track there. In terms of the general outline of where we are. As you know, we run the firm to be structurally profitable. We need stock earnings to be over double fixed expenses. We're running at 217%. So that's very much on track. Stand-alone real estate, as you can see, the stock earnings are up 15% year-on-year. That's mostly contribution from hotels, which are growing very, very strong. And both in terms of hotel -- [ Reno ] will come to us as the owner and also our Ichigo or 15 hotels with Ichigo owned hotel operator, which is doing very, very well. We've got a small decrease in asset management stock earnings year-on-year. That's because we cut for Ichigo office. Asset management fees for the full year, we expect to be the same as last year, and clean energy is up on us bringing up a large plant online at the end of last year. So we're running right on plan. Here, what the numbers look in terms of breakdown, you don't get to choose the numbers that you like. So even though the accounting numbers look really, really strong. So operating profit, OP, up 25% year-on-year, recurrent profit up 36%. Those are not the right way to look at us. It is the all and OP number where we take -- and we've done this for a while. So I'm sure you're familiar with this, but we take stuff that shows up because of the fixed asset categorization of certain of our assets as extraordinary gains, we put it back into operating earnings because it doesn't matter if we're classifying these assets as current assets or fixed assets, we're doing all this value add work. And so it's a better way to look at it and understand the firm. So as I said earlier, we're going to have flow earnings, so asset sales and the capital gains on them concentrated in the second half. So those numbers are down year-on-year, 30%, relatively significantly, right? We had a very strong first half last year. We have our [ item ] on this year, but on the full year, we expect to be up substantially. And again, our cash earnings are substantially higher than our account earnings because we focus on cash flow through shareholders. This gives you a little bit of a breakdown starting on asset management, Ichigo Hotel and Ichigo Residence tokens are driving growth there, as already pointed out, we had a fee cut, Ichigo Office REIT, which is good for the Ichigo Office REIT shareholders. So that's a positive. It means we have to kind of work harder and do more as a sponsor to the REIT and we're fine with that. Stock earnings, again, the hotels are very, very strong. This is an asset that we're involved in very extensively because it is harder to do. So Ichigo's capabilities in this area are important and it just has a lot of growth to it. It's inbound growth and there is kind of an opportunity to upgrade Japanese hospitality across the board, which we think is a significant value driver. Flow earnings, again, are going to be primarily in the second half. We already have visibility on one, which is our fifth token sale. I've talked about -- and we will touch about it a little later, but we have visibility also on a 6 and seventh token sale. For this year, meaning we haven't announced it, but we expect that to happen. So we're comfortable that we're going to have in terms of full year earnings. We do expect to have a record earnings in terms of stock earnings growth. In fact, we at this point, expect to beat these numbers. And again, hotels, this gives you a little bit of a breakdown. Hotels are a big driver. It's worth pointing out, as you can see at the very bottom, so on the right-hand side, the left -- inside the box, you got the navy blue on the top, and it shows you the breakdown between sustainable real estate, clean energy, asset management and hotel operator in Propera, which is our asset -- our kind of artificial intelligence, AI-driven pricing mechanism for hotels. You can see that for the full year, in '24 -- February '24, we only did 784, and this is primarily our hotel operator, 15. We did 784 in the first half, we did 851. So were up very, very substantially. This is a very high-quality earnings stream. No assets involved. We just manage assets well and get paid for it. Shows what's happening in financing. As you can see, rates have gone up from 0.89%. Our average financing cost has gone up to 1.13%. At some point during this presentation, and hopefully, it's okay. I'll make that point right now we need to talk about what we think is happening is that's a mispricing in our shares and broadly across Japanese real estate. So 1 of the fantastic elements of Japanese real estate investing is that you finance structurally below your cap rate unless you are buying assets at a really bad price with really low cap rates, but you finance terribly. So we financed an average of 1%. We buy assets that typically yield 4% to 5%. We add value to them. It is a fantastic way to make money. When you're funding at 1%, your assets yield, say 5%, unless something goes horribly, horribly wrong, you win. So what's interesting though is our shares have sold off and the broad real estate market has sold off, real estate shares has sold off in the last couple of months on the basis that the BOJ is raising rates. And yes, this is correctly viewed as a negative, as a headwind for us. So we refinance now 20-plus basis points higher. What's not been part of the conversation, which is absolutely fundamentally far more important is that the problem with Japanese real estate investing for decades, everyone understands you finance a very low financing rates for lower cap rates. But the big problem has always been replacement cost doesn't go up. There has been no inflation. And so as an owner of a real estate asset, you want to raise rents, but with replacement costs going up, you have an office building, somebody can build a brand new building next door at the same price that you built it 10 years ago, 20 years ago. You cannot raise rents. And so the most important thing that has happened, the BOJ is raising rates because there's inflation. And to be very clear, construction inflation is much, much higher, like even an order of magnitude higher than generalized inflation. Construction costs were up 50%, 60% over the last several years, largely because of severe labor shortage and this got very hard to get kind of the labor we need to put things up. And the result of that is there has been an other transformation in our ability as real estate owners. We become a normal country in Japan. Every other market, you raise rents year after year. And the reason is because if somebody builds an asset next door to you, they build at a price is 20% higher, 10% higher, 30% higher, 50% higher, and that's the market we're finally. So the most powerful change in Japanese real estate to the last several decades it's not that we've got rates that have gone up a tiny bit. We're now funding about 1%, is that we finally have inflation driving higher replacement costs, driving higher returns organically from our assets over time. That is the powerful driver of the economics of the operating environment for our business in which we embed a very powerful business model. So you can understand why we're buying back our shares. This shows you what we're doing on acquisition and sales. They largely kind of flat against each other. We have -- we are active in office. It's worth pointing out, and I've said this before, the Japanese office market is radically different than, for example, the U.S. or Europe, which is kind of a dumpster fire. Japanese offices are full. We had Miki Shoji data for September for Tokyo Office out today, came in at vacancy at 4.6%. That's down from 6.1% a year ago. The market is getting tighter, our rents are going up a tiny bit, but it's primarily kind of tightness in the market. Japanese people -- well, I mean, Japanese people coming to work. So that's 1 element that's driving demand. But more fundamentally, tenants want more space for the workers. And so the office environment is relatively robust. And I think it's become the case certainly in the last 6 months that global investors that come and understand, that the Japanese office market is robust and is a good place to put money. So the global investors are back in the office and where we're active in the space. In Ichigo Meguro Building. I don't know if it's worth pointing out that this building is 300 yards from my home. So every day, I walk by it, and I see this big kind of you see our upper-hand side, you can see the Ichigo sign in Japanese. The -- this is what we do, and not buy assets 300 yards to my house, it's never happened before and it's not an element of our search for assets. But it is an extraordinarily well-located building, right near Meguro station, right on the Meguro River, which is an incredibly famous cherry blossom viewing location. I don't know, hundreds of thousands of people come, 1 million people come there every year. I mean a lot of people come and they look up and see -- and this building is right on the river. Because of the river, you can see it from very far away. And so we point out that -- I just pointed out that it has kind of a sign of a visibility for us. So it's a nice branding opportunity. It is fundamentally for our tenants, and that's who we serve, also very nice branding opportunity. Anyway, we bought this asset in August of 2022, we spent about 10% of building value on CapEx to make it much, much nicer. Very specifically, we -- there's something called -- it's a small category, and we think it should be a bigger 1 called ready-to-move in offices. So just you know, in Japan, you have to do your own fit out of the office, and you have to take the office back down to original states. So in other words, take out your fit out when you move out of an office, it's incredibly expensive to do both. And so as a result, there is a need, is always unmet that particularly for start-ups to kind of prefit the offices, like put everything in all the fixtures, the tables, the office layout, the glass barriers between the offices, as you can see the pictures. And it just save a ton of money as a tenant by doing that. And so we've done this in multiple occasions. In this case, about 90% of this office has become -- this building has become ready-to-move in offices. It's been explosively successful. We've taken up rents 50%. The -- it's nearly full, and it's going to be full very, very soon. So this is a very powerful offer. And as an example, kind of the value-add work that we do. As I say, very high efficiency, but you're meeting an unmet tenant need, which is how to get in an office without having to spend kind of in certain cases, kind of multiple years of rent. I spoke to it earlier, hotels are a stock earnings growth driver, and that will continue to be the case. We expect to be this full year forecast. I'll turn to Ichigo Owners, which, as you know, is a high quality. And let me talk a little bit on the next page also it offers in prime locations, beautiful, brand-new residential assets. The demand for this among tenants is very, very high. It's a very ongoing, very secure revenue stream, income stream with inflation in Japan, Japanese investors and global investors are looking for access to a high-grade, high-value, durable and growing revenue stream. And so this is a very popular asset category. And as we've written on the first bullet point, the core offer is prime residential assets tailored to tenant and investor needs. There's some volatility in this business. But as you can see, the line is going up, and it will keep on going up. We had a little bit of falloff we're forecasting this year relative to last year, in part because there is significant rental income on these assets before we sell them. This is a high turnover business. We generally buy the assets, lease them up in under a year. And so these are very high-quality assets. We actually spend time with the developer backing out what we want and we have this huge database and think we're very advantaged in understanding what tenant needs are. And so the lease-up activities is very fast. You get it to 90% occupancy, then you sell it. But last year, we actually push back the sales towards the end of the year. So about -- of the JPY 5.4 billion that you see for last year, about JPY 0.5 billion of that is just kind of unusually long holding period during the year. So kind of on a more kind of ongoing basis would have been JPY 4.9 billion This year, it says JPY 4.5 billion. We'll probably beat that. So anyway, we'll look fairly similar to last year. But going forward, this will continue to grow. And again, we started this business 7 years ago. It started at JPY 0.1 billion. We're in a 50-fold over that, what has been in a 7-year period, and we expect to grow this very substantially. And this is our fifth Ichigo Residence token, again, forgive me if I repeat the things I said before, but that's hopefully a better than -- the same things that a couple -- different from what I said before. This is a market which is securitized real estate, digital real estate on the blockchain. It is real and valuable. It's not a belief in golden god like crypto, the dividend yield on this is about 4% for really nice assets, brand new. This is coming out of owners, right? So these are the assets that we do, prime, really nice brand-new assets, residential in Tokyo. The demand for this product is overwhelming. We'll do our fifth one. So we've announced a fifth 1, to date our second this year. We expect to have 2 more that come later in this year or alternatively, if those don't happen, we'll have alternative sources of demand for these. But this is a very productive kind of real estate offering and a very powerful asset management investment for investors, so it continues to grow quite well. This is what the growth curve looks on this. We expect to have JPY 60 billion of assets in Ichigo Residence tokens. This year, we think that pushes up to JPY 100 billion next year. And then this is what overall growth in our asset management business looks like. As you can see recent growth has been driven by Residents tokens and -- meaning kind of we've done entirely residential assets into these tokens. We think this market expands outside of that to hotels and other assets. But for the moment, there are tokens, we've done entirely been residential. And so the growth that has happened in this has been primarily in our asset management business has been in the tokens and the private REIT. Next year, we think we do another JPY 40 billion or so of tokens probably another JPY 20 billion in the private REIT. We expect to be active in the public [ bidding ] part. The hotel REIT, the share price performance is very strong on super power for economics. So the economics that we're driving out of our hotel business are not only for the shareholders of this company 2337, Ichigo Inc, but Ichigo Hotel REIT, 3463, security code is doing very, very well. So there's an ongoing opportunity there. And again, we add value. We do not just buy assets and leave them alone. So we are very active and very productive in growing value within our own balance sheet for our shareholders and also within Ichigo Hotel REIT. So we expect to do -- if we did another JPY 40 billion in that, in the public REITs next year, this year, we pushed up our AUM to JPY 400 billion. Next year, we'll be up to JPY 500 billion. Clean Energy continue to want to grow this business and we see the kind of immediate opportunities in green biomass and nonfit solar power. We announced the buyback. As I said earlier, JPY 6 billion. As you can see, we're upping the tempo of our buybacks. That reflects both super strong cash flows, a stock price, which we don't think reflects fully the extraordinary operating environment and the powerful business model that we're in. We've also been pushing up our dividend more recently. I mean we -- there's ongoing debate internally, do we bump the dividend? Do we buy back shares? Do we invest for growth? Well, the answer is we can do all 3. So particularly our domestic investors who have been good and loyal like the high dividend. So we are -- we have been raising our dividend, we expect to continue to do so. The current dividend yield is about a little bit under 3%. So that's a very nice yield. Let's not forget in Japan, despite rates, the BOJ now no longer being in 0 interest rates, it's at 0.25% interest rate, so 25 basis points. So rates are really low. The long bond trades below 1%, so you can earn a 3% dividend yield on our shares, that should work very well for a lot of investors. We have -- as you know, we are a top sponsor of the J.League. It's an extraordinary branding opportunity for us that has driven a lot of understanding and recognition for Ichigo and we have a shareholder program were distributed tickets from the J.League games to all of our shareholders in all of the entities that we manage. We believe in working to protect the global environment, climate change is real. And as I pointed out earlier, we completed the 100% switch to renewable energy this year. Far more fundamental than that is we are climate positive. We do all of our clean energy, and so this is solar and wind power production activity. We have very substantial CO2 reduction. In fact, it's over 4x higher than our CO2 emissions. And that's the breakdown of how -- over time, as you see, we've both grown. The green bars show the growth in our clean energy production and how it reduces CO2 emissions. And you can see that the shrinking kind of light blue bar, which is our -- the decrease in our CO2 emissions as a result of our cutover to renewable power. So I'm now happy to take questions from anybody. Greg?

This is Greg at Point72. Can you hear me?

Yes, I can. Thank you so much.

Great. I have a few questions, maybe I'll split them into 2 parts. But the first there is -- the first 2 questions would be token REIT or token real estate issuance, I would say, that's obviously going very well. Can you remind us a little bit what kind of fees you guys get on those on an annual basis? And also what's kind of implied cap rate you managed to sell those residential asset? That would be my first question. And then the second question is regarding the borrow cost. As we look at your presentation material, the average maturity has gone up. So I assume you've borrowed more at the long end. Can you give us a sense for what kind of interest rate you are borrowing at for the 10 years or so maturity that you've borrowed that?

Great. Got it. So the fees on the tokens is -- I mean, this kind of can change a little bit. But generally speaking, it looks like something like a 1% upfront and a 50 basis points per year over time. The cap rates look like kind of the low 3s because this is a super high-quality brand new, a Tokyo prime assets. And Greg, your question on borrowing cost is our most recent borrowing costs or...

Yes, because half over half, you've extended the duration of the borrowings. So incremental borrowings, longer iteration, higher cost, I assume, but like how much kind of higher cost?

Yes. Thank you very much. Why don't we show the page from the presentation that shows the borrowing cost? Thank you, Greg. That's -- as always, a very sophisticated question. So Page 14. You can see that our borrowing costs at 1.13% right now, kind of actually, there's hedging activity in there. All in, we're borrowing right now and the most recent is borrowing looks like 1.25%. These are not material moves, not at all. Our borrowing costs have gone up a tiny bit, replacement cost has gone through the roof. It is an extraordinary time, the best time in Japan to be a real estate investor.

Well certainly for the token a high 2%, low 3. That's pretty good for the residential there, yes?

Yes. Yes.

I have 2 more questions. Should I go ahead or back into the queue?

No, go for it.

So yes 2 quick questions. First 1, please an update on the Tradepia building, the vacancy progress? And second, your opinion on the [ raison ] transaction. When this was announced, obviously, I was immediately thinking about you guys. And so wondering if you have any view on that?

So trade PI is going very well. I mean, as you know, that went from a very -- a great asset to a problem asset during COVID and we just keep on punching away and doing what we do. The -- so at this point, we've got occupancy up to 76%. We -- it's heading to kind of -- we think it may actually -- it's certainly going to go to 85%, we think it could well go higher than that during this year. So this asset is very much on track. We've done a bunch of work to reposition it. We've attracted -- we've done things similar to what we did in the Ichigo Meguro building, where we've made it far more attractive. You've got amenities like cafes and things like that. It's actually kind of in the sense of destination building for a lot of start-ups and along Tokyo Bay. The views of Tokyo Bay are fantastic. This was originally [ Sojitsu's ] headquarter building. So it's a great building. We're actually going to take 1 floor and do a ready-to-move-in office there for some start-ups because the demand is so high. So this asset is going very well. And we expect that we will do a sale of this over the next couple of years. Now that it's kind of fully -- kind of be fully stabilized as a really, really nice asset. And then on [ recent ], I mean, any time you see a company bought a 93% premium, that's nice. So it did take out 1 of our peers. It does show very substantially value and that kind of is available in this space. It probably also speaks to the fact that [ Helix ], which is a pretty smart, as you know, the buyer was a big Japanese real estate company, which is a very smart real estate company and a good buyer, so that kind of value. And so it does speak to, we think, pretty directly since the [ Reysim ] is a peer of our, as being kind of Ichigo's peer as being undervalued.

Did it have something to do with the size of the buyback?

No, no. Meaning the 2 are linked with shares are deeply undervalued. You'll see companies like [ Helix ] being opportunistic in using their balance sheet and their ability to fund well to acquire a cheap peer. And in our case, we think our shares are deeply undervalued. So -- and by the way, this buyback is not one-off. As you know, we have been buyers of our own shares and retiring quite a bit of it, and we'll continue to do so. And of course, in the long run, we expect to drive our shares to what we think full value should be. So we're -- by no means are we satisfied with the current share price, but it does create an opportunity behind this year. So a very good luck. Okay. Thank you very much, everybody. We're really grateful for your time. And we'll keep working away to deliver the strong returns you deserve. Have a good day.