Ichigo Inc. (2337) Earnings Call Transcript & Summary

Hi, everybody. Thanks so much for joining. I'm Scott Callon, Chairman of Ichigo. I'm joined by Dan Morisaku, who is a senior member of Finance team and the Head of Global IR for us. We are doing something brand new. We just did a Japanese earnings call. We are wearing our suit and our tie for the global call. We decided, we think, to join the globe and recognizing how incredibly hot it is everywhere in the world right now. So forgive us if that's okay. We've gone casual to reflect the fact that we're in the middle of July. So I'm talking off of what's in front of you, which is FY '27/2, the February 2027 Q1 corporate presentation. Let's jump into it. We've got a slightly different format today. We tried to simplify it. Hopefully, that's helpful for you. If you have any feedback, we, of course, welcome it. So please feel free to come back to us on it. So the summary is, look, we're off to a strong start. It's not surprising. The real estate market continues to be very strong. The Japanese market -- real estate market for decades has had a compelling advantage of being very low cost of financing, low interest rates, but with no inflation and therefore, no ability to raise rents. And so what's changed in the most profound and powerful way is that rents are going up. And so it's made real estate a more attractive asset class, and it's flowing through in our business, both because we have a balance sheet in which the value of our assets is going up and second, because what's driving this is inflation, construction inflation in particular. And as you know, our business model, which is value add, is very durable with respect to inflation. We spend very little amount of money on CapEx. And so we are advantaged in the operating environment. And to the extent this is secular that we have inflation in Japan, we're going to be advantaged on a permanent basis. So business profit is up 45% year-on-year, net income up 24%, EPS up 32%. Of course, EPS is growing faster than net income because we think our shares are extraordinarily cheap. I mean they're trading sub 10x P/E, something like 7.4x cash P/E. They're as compelling as they've ever been. We bought about 10% of our shares, more than 10% of shares outstanding in the last 2 years. We think the shares are compelling value for all of our shareholders, and we're putting our money where our mouth is. Cash EPS is up 70% year-on-year. Stock earnings says increase in Ichigo Owners of assets, which is true. But the whole point is stock earnings are relatively stable, so not going to move around very much, up a tiny bit. Earnings go up a bunch on sales of value-added retail asset and a real estate subsidiary, which was primarily office and residential assets. Highlights are we're trying to, and I'll talk about this later, continue to innovate on behalf of our tenants and therefore, for our investors because ultimately, the value of a real estate asset is its ability to serve tenants well and our investors and our shareholders by serving our tenants. So we're doing some stuff with respect to innovating in the office space. We continue to innovate in the hotel space with our hotel brand, THE KNOT, and we completed a JPY 10 billion share buyback, as I said earlier. The bottom of the page shows the full year forecast. We're well on track to meeting it and beating it. Just touched on the key issues there. You should see we're on track for record profits this year again, and we think this is secular. I mean, I think it's our job to have record profits every year. We have your funds as shareholders, we should be deploying those funds in a more powerful way on a consistent basis year after year. So we're on track for another year of record profits. And again, I expect that will continue. Cash earnings are more than 2x accounting earnings because we focus on long-term cash flows. This is not a company that is super focused on doing it on the accounting side that does not have powerful value for shareholders, and we think it's ultimately rooted in generating cash flows for shareholders. There's a bunch of material that I'll go through relatively quickly, and it's meant to give you transparency on how we're running the business, and this will be an example of it. You can see we have a diversified portfolio. The record forecast for this year in business profit has got a number of drivers to it, the most important being SRE, so the sustainable real estate business and Ichigo Owners. I labeled this for the first time we called the section KPIs. It's meant to give you some sense of key performance indicators, not in a narrow sense, but in a broad sense and the things that we focus on to deliver enduring value for you as shareholders. One of them is structural profitability. So a KPI there is we want our stock earnings to be well above our fixed expenses to make us structurally profitable, and we are. So currently running at about 200%, 196% is the kind of the relative fixed earnings, which is stock relative to fixed expenses. You can see on the right side in the upper pie graph, you can see that -- is it a pie? It's a circle. You can see that it's the stock earnings are relatively diversified. And you can also see in Q1 that almost all the flow earnings came out of a sustainable real estate business, and that will change during the course of this year. Stock earnings. So another element of the business is we want to have both stock and flow. The stock earnings is contractual. The flow is also very durable. You can have a business like a convenience store or a supermarket and it's all flow earnings, but every day, you're creating value for your customers and they're coming to the stores. And so by no means is this a situation where the stock earnings are really valuable when the flow earnings are -- should have a low multiple on them. The source of our flow earnings is that we add value to assets in a systematic way and generate value for tenants and therefore, generate value for investors and owners of those assets when we onsell them. We have diversity, and that's another element of our business. We have a portfolio of businesses and it moves around a little bit. It gives us broader diversification. I have to tell you, though, we're not a real estate conglomerate. There's a core element in everything that we do, which is value add, and we express that value add through a number of different asset classes and business models. We have a very strong financial position that expresses itself in a way -- and we work to achieve that, that expresses itself both in us wanting to have overwhelming long-term loans and they currently -- and systematically over time, we managed to be about 90% of our loans being long term. And also, we reduced interest rate risk by hedging our loans. So currently, fixed rate loans are about 56% of the portfolio, a weighted average interest rate of 1.53%. So you can see the interest rate has gone up substantially over the last couple of years, which is to say it's gone off of an incredible low basis from 100 basis points to 153 basis points by -- given that inflation is running at 3% and construction inflation is running between 5% and 10%, this is still extraordinarily low-cost funding in order to take advantage of the market opportunity that is in front of us. Again, we're trying to provide some perspective on the drivers of the business and how they express themselves. This is what the full year forecast looks like. The sustainable real estate business continues to be our major driver. We have significant contributions from owners and from the hotel elements of the business. We'd like to grow clean energy and asset management more. On the right side, you can see the assets. About half of our assets are owned and on balance sheet, overwhelmingly real estate. And as you can see in the bottom of the page, asset management also has a substantial number of assets that we invest and manage on behalf of our investor clients. In terms of acquisition and sale activity, net acquisitions in the first quarter, that is not what the year is going to look like. And to be clear, in a sense, the acquisitions of JPY 34 billion kind of overestimate the actual acquisition activity, which is to say, Ichigo Owners were taking in assets that we had agreed with the developer to buy generally kind of 18 to 24 months ago. So those are not new purchase activity. In the office space, most of this is coming on, and I'll talk about it, the brand new, THE VILLAGE SAPPORO asset, which is a couple of years old soon. In terms of actually brand-new acquisition activity, it's on the order of something that looks really like JPY 3 billion, like tiny. And we expect this year to take down the balance sheet. I've been saying this for a while. We've had stuff coming in. So the balance sheet has been growing and the balance sheet is going down, folks. It's getting smaller. It reflects our view that we want to manage the balance sheet. We want to be capital efficient. There's a lot of risk out in the world right now. It is -- continues to be a phenomenal seller's market. We have ongoing capabilities and value add that we can express in highly capital-efficient ways. We don't need the size of balance sheet, so the balance sheet is going down. So anyway, for the first quarter, we added some balance sheet growth, but that will change from the second quarter on. This is what the time frame. This is what acquisitions and sales look like over time, been some balance sheet growth, but relatively balanced, but we're going to take it down from here. And to give order of magnitude, it's not as if we're going to have the balance sheet in the next kind of 18 months, continues to be very productive, business is productive, but the balance sheet shrinkage is going to occur. So going to the segment earnings, the -- again, we have a portfolio. What's -- and it moves around quite a bit. And you can see asset management is down quite a bit. Hotel is down. Sustainable real estate is up a ton. Clean Energy is up a bit. That results in a totality of being up 45% in terms of business profit in the first quarter. Sorry, I jumped ahead. So on SRE, sustainable real estate. So this is a business where we buy assets and improve them. It's overwhelmingly focused on office and retail, although we had some increased activity in logistics. Not a lot happening on the stock side. As I said earlier, this is stable earnings. The balance sheet is not moving around. So you wouldn't expect it to be moving that much. I think the most important thing to point out is we continue to do very, very well in the leasing activity with our biggest asset, which is Tradepia Odaiba. As you know, that is current in the sale process, we would expect to generate some substantial returns on gains on sale this year. The full earnings up a ton. And look, this is quarter-to-quarter. And so we did less in Q1 last year. We did more in Q1 this year, but we sold an asset in FUKUOKA that we did very well on, and we sold a real estate subsidiary that we also did very well in terms of our activity, which is primarily, as I said earlier, residential and office. We continue to seek to innovate on behalf of tenants. And so one of kind of -- we think it's an insight, but we prefer to think of the world in terms of hypothesis. Don't have a view, have a hypothesis, test it against the reality and evidence as it emerges if it disproves your hypothesis then adjust your hypothesis. And so one of the thoughts that we have is that we work, and this goes back over time, was genuinely a breakthrough in high aesthetic office and in creating communities. But WeWork is shared offices. And most of the world is not working in shared offices or in the office environment, they're in private offices. And yet, there was something very valuable, we think, in having an actual community. And so the village is our office offer that is community-based. And so literally, it's called a village. This is in Japan. So the words we use are in Japanese, but there's a village mayor in each building who is an Ichigo employee who works to support the needs of the village members who are tenants. And we have these offices that have genuine communities in them. And we think that's something that's valuable. We have a hypothesis that all of us yearn for a community. I'm pretty sure a lot of you who are listening to this are in offices where you go up and down elevators and you don't know anybody. And it's -- you don't talk to anybody, you don't want them to talk to you, perhaps, I don't know. But for folks who want to have a genuine community in their office, this is something that we are providing. We think -- again, we think the insight/hypothesis is communities are not just for shared offices, they're actually for private offices. So in order to have a community, of course, you need to have shared spaces. So you have shared lounges, you have shared interest areas, you have cafes, you have all these things where the community get together and we do events, and Meet The Neighbors! is what we're calling these events and which we bring together. And so that's the general framework for the village kind of offer. And specifically, in the Osaka office, we renovated an existing office which we had bought from a single tenant. It was a corporate tenant, which sold -- which is using the building for itself. They moved out. So the entire building became empty, and we actually set it up entirely as ready to move in offices. And the concept there is everything is prefitted. So the tenant doesn't have to worry about kind of anything, move-in costs and move-out costs, which are enormously expensive in Japan. They don't have to figure about trying to get contractors and run contractors in a very difficult environment in terms of getting contract help. We do it all for them. We provide this for them and you get a rent uplift for it because you're creating value. So the leasing is going on at about a 70% premium to what a classic you have to pay for everything yourself and do everything yourself and don't have the flexibility. And so this is -- it's a very powerful offer. So it's not just in the case of VILLAGE OSAKA, it's not just a community offer. It's also a ready to move in office offer for the entire building. We also opened up the VILLAGE SAPPORO this year. In this case, we have -- we work in the first floor. It is the first we work in Hokkaido. So Sapporo, of course, is in the Northern Island of Hokkaido. Again, working with them to develop a community throughout the entire building itself. But this is, again, focused on not just having a cold slab of steel and glass, but an actual genuine community within the building that can interact with each other and support each other and be human beings and community participants together. Hotel business is down in the first quarter. We expect the full year to be up to be up. THE KNOT, which is -- that's our boutique hotel offer. And again, the insight/hypothesis there was that -- and we're now -- we have 6 THE KNOTs, and we'll talk about it a little bit later. We're working on our seventh one. The idea was Japan has super high-class hotels that are really expensive, just like everywhere in the world. They have all these budget hotels. It wasn't something in the category of kind of $100 to $200 per night. That was really -- that was nice. And so we thought there was a gap that could be filled. The KNOTs all share a common characteristic of being very local and also having -- Japanese care about this and people who come to Japan care about this, having outstanding restaurants so you can go there and eat super, super well and also stay there. And so these are really -- and we'll talk a little bit later. But THE KNOT Tokyo and Hiroshima doing very well. We launched and I'll talk about this later, KNOTs in Utsunomiya and Fukuoka. We'll get a full year contribution and things are going fine. You should know that we're incorporating -- we have incorporated no flow earnings in our forecast for this year for hotels. We don't expect to sell any hotels. If that changes, then, of course, we'll get some upside there. RevPAR is down about 10%. It's actually not, we think, the kind of Iran war, the surcharges and all that sort of thing. This is showing up primarily in decreased Chinese arrivals. There's still tensions between Japan and China. Chinese arrivals were just released a few minutes ago, down 50% year-on-year, over 50% year-on-year and also some slowdown associated to the ending of the demand for the Osaka Expo. And so we're seeing -- particularly, we're seeing Osaka and Kyoto being down about 20% year-on-year. Tokyo and Hiroshima, both KNOTs doing well or up 10%, but when you put it all together, you have about 10% drop in RevPAR. These are the 2 THE KNOTs that we just launched. I already -- I spoke to both of them already. Again, you -- it is really more about the -- taking existing assets, improving the aesthetics, the food, the culture of the building, if we can put that and incorporating them in the community, making far better functionality, bringing them to kind of best-in-class across both the hard and soft elements of functionality and customer and guest comfort. So we've got 6 now. We're working on a seventh, which is an Osaka, and this is -- the economics are proving to be very, very powerful. And this is why we want to do more in this space. Ichigo Owners did very little in the quarter. It looks like their flow earnings are up a ton, they are because this is basically 1-year turnover business. And so you sell the assets and then you get new ones. And so the fact that we held off on some Ichigo Owner sales last year and they're going to happen this year meant that our stock earnings, so those are the rental income off these assets went up a whole bunch. But Owners' activity is going to accelerate from the second quarter. And at the heart, Owners is about serving tenants. So we -- it is what we call a fabless model, meaning we do the design, but the development and construction is done by outsourced developers. So it has super high capital efficiency. We've gotten to be really, really good at understanding -- and the target market is prime residential areas in Tokyo, understanding what the requirements are. We have developers build to our specifications, we lease them up and then we turn over in about a year. The fully leased up assets in great locations to investors. And the investors run the gamut from cash-rich individuals and corporations, which was the original concept, but it's turned out that this has become a very institutional market where we do a lot of bulk activity into big institutional investors who want access to this very durable and high return and with now residential rents going up, increasingly higher return asset type. As you know, we've been selling this also into security token space. So this is -- but the whole point is if you're going to make great investment products in real estate because that is one goal. We need to serve the investors who are buying these assets. The first thing you need to do is you need to tenaciously serve tenants. You need to have the best assets for tenants and then that gives you the opportunity to have the best assets for investors. Asset Management business profit is down 51% year-on-year. Actually, we know at this point that flow earnings were down 92% because we had these large flow earnings on performance fees on asset sales in both Ichigo Office REIT, and then we had some fees off of the of private funds last year. But we actually now know that there's been some REIT activity and by our REITs, our listed REITs, and so there will be performance fees coming in. So we now know we're going to -- based on -- and we never put into our flow earning forecast anything because these are decisions being made by the REITs, not by us. But we now know that there's activity that has occurred. We will be getting the fees. And so we will come in. I think it's going to be something like plus JPY 1 billion on cash earnings at this point and plus kind of JPY 0.7 billion on business profits. So we're actually closing in on last year at this point, and we may actually go above it. So these numbers are getting better, and we already have visibility on that. And we have a diversified portfolio, as I said earlier, both kind of asset classes and kind of vehicles. So they run the gamut from listed REITs to private REITs to private funds and our digital token business. Clean Energy is up 15%. Not a lot happened in terms of the portfolio. Stock earnings were up, and that drives business profit up 15%. But this is a business that has not grown to my frustration and to our generalized frustration. And we have spent some time reflecting on that what we needed to do. We try to be savvy and not taking appropriate risk in a pretty dramatically changing operating environment with the end of the FiT, Feed-in Tariff structure that gave enormous structural stability to earnings to kind of a fairly dramatic changing environment. And we don't strap on risk. And these are kind of heavy upfront investments without kind of having high visibility on future earnings. It's one of the strengths of real estate. As you know, you have visibility on earnings. It is one of the strengths of our Clean Energy business, we want to have that also. So the one area that we made a new commitment on that we think qualifies is we have a battery storage business that was just launched that has pretty powerful economics. We're now -- we think the kind of NOI 13%, 14%, something like that. And so this is an area that we have begun to grow and will be a growth driver in this business. I'll just touch briefly on shareholder returns. As I said earlier, we bought back over the last 2 years, over 10% of our shares. We think they're a compelling value, and this has been -- is good and accretive for our shareholders. We have also moved on our dividend. We took the dividend up 35% this year, raising our DOE, dividend on equity, ratio from 4% to 5%. On the sustainability side, global warming is real. It is a fundamental element in our business to address that. We are climate positive. Our CO2 reduction efforts are 9x our CO2 emissions. We are 100% renewable electricity across all of our operations. So we've achieved RE100. We are a double A list company, one of the very few. There are only less than 1% of companies in the world that qualify for that in both climate change and water security. And being sustainable as a company is fundamentally important to us and to all of our stakeholders. At this point, no questions. And so we're going to bring this to a close after another pause, which is hopefully not, there's a question. Okay. So this is why we needed to wait.

Can you hear me?

Yes. Thank you, [ Greg ].

One quick question I have is you mentioned on the battery business, the stationary storage battery business. The extension seems to be mostly after 2031. Obviously, as you understand in Japan, it's become a bit more of a priority. Why not be bigger sooner like 2029 onward as opposed to JPY 14 billion after 2031?

Just to be clear, and we've probably have written that for you. That secondary pipeline is '29 to '31 pipeline. So it's in an earlier process of due diligence to determine its economics and attractiveness. So that is 2029 to 2031.

Understood. And another quick question I would have is regarding the TSE free float. Obviously, you guys have been buying back shares, as you pointed out, which means you are getting it pretty close to the -- I don't know if you're aware of the borderline limit for free float adjusted market cap vis-a-vis the TSE guidelines. You're above that, but things can change. What are you guys thinking about on that front?

So we still have room to buy back shares. So the -- do you know what our exact free float number is right now? I mean we need to have at least a 35% free float. I think we're probably like 45% or high 40s or something like that.

Yes. But the way the TSE calculate is actually different. So maybe I would suggest you get in touch with them because from their rules, you are getting closer to your free float weight is 25% for them.

So we are familiar with the rules. It's just that Scott Callon is -- doesn't have the exact number for me. Is that it? Okay. So Greg, the answer is we're currently at 60%. And so we have 5% more that we could own before we touch it.

But then that means that your -- you have a market cap problem in the sense that if you are giddy on the free float and then your market cap falls, then you're at risk again on with the TSE rules, is my understanding?

Yes, and -- but the market cap level is super low. So that's not the issue. So we need to manage to the free float rule. And so our thinking on this one is we think the shares are very cheap and they're certainly buyable, and we have room to buy more. But at some point, we may have to shift towards bumping the dividend up a bunch, and we'll do that, too. So to the extent that the business doesn't require capital, then we pay it out. And so we have chosen -- and in the past, we have chosen to bump our dividend, but we've been very focused on using the buyback tool to shareholders. And if necessary, we're going to shift the dividend. We're perfectly willing to do that. I mean this business is super productive. We can increase the dividend very substantially without any problem at all. And so the choice to have kept the dividend relatively low and to use buybacks is because we think the shares are super, super cheap. So we may end up in a world where we think the shares are super, super cheap, and we're restricted on our buybacks and so we'll just raise the dividend a whole bunch and see what happens to the shares.

And so if I may, with the last question, Scott. So you mentioned that you might start to shrink the balance sheet a little bit from Q2. But then you're also going to have maybe a big lump of cash coming if the Odaiba building sale closes.

Yes.

So you're going to have a lot of cash.