Kanadevia Corporation (7004) Earnings Call Transcript & Summary

Good morning. I am the President. Kuwahara is my name. This April, I was appointed President and COO. I ask for your continued support. Now we have already released our financial results last Friday so I believe that you have already had a chance to look through them. I will, therefore, focus on just the main points in my presentation and then fill in the details by answering your questions afterwards. Let me then start with the financial information part. The key points of our fiscal '23 results are shown here. We achieved increases in both net sales and operating income for the sixth consecutive year. Order intake, net sales and operating income were as shown here. Order intake was down 3% year-on-year, but net sales and operating income were up 12.8% and 21.3%, respectively. We were able to exceed targets for the first year of the medium-term management plan. In light of this, we have increased our dividend per share by JPY 5 to JPY 23 for the fiscal year ended March 2024, and plan to pay out JPY 23 for fiscal '24 as well. This slide shows the overview of the results for fiscal '23. I have already mentioned order intake, net sales and operating income. Add to that, ordinary income and net income also increased by JPY 7.8 billion and JPY 3.4 billion, respectively, over the previous year. Since the separation of the shipbuilding business in 2002, we have achieved the highest performance in all categories except for order intake. For your reference, for order intake, last year's JPY 737.5 billion was the historic high after separation of shipbuilding. This slide shows the fiscal '23 results by segment. I will discuss segment information in the part talking about fiscal '24 forecast so I will skip the details here. Let us jump to Page 11. The slide shows the status of order backlog. The order backlog at the end of March 2024 was JPY 1,543.4 billion. Compared to JPY 764.4 billion at the end of March 2021, it has grown by about 4x. The lower part of the graph shows breakdown of order backlog by sales recognition year. It is JPY 407.8 billion in fiscal '24, which is 71.5% of the planned net sales for fiscal '24, which indicates that sales have already been confirmed to a considerable extent. The slide on Page 12 shows the breakdown of changes in operating income. Starting from JPY 20 billion in fiscal '22, Environment AOM, mainly retrofit works and electricity sales, pushed up operating income by JPY 3.8 billion. Inova contributed JPY 2.9 billion, and another JPY 1.4 billion came from the Carbon Neutral Solution business. On the other hand, Environment EPC, Machinery and Infrastructure and others had a negative impact to operating income. Major cause of lower profits in Environment EPC was a significant cost increase for biomass power plants. This slide shows nonoperating income and expense and extraordinary income and loss for fiscal '23. In fiscal '23, nonoperating income was positive JPY 1.3 billion, an increase of JPY 3.5 billion from the previous year. The main factors were gain on investment by equity method and foreign exchange gain. The gains on investment by equity method were a result of performance improvement at equity method holdings such as Naikai Zosen, Steel Plantech and others. Foreign exchange gains improved by JPY 1.4 billion due to yen depreciation. And also at Inova, there was impact of depreciation of the Swiss franc. In fiscal '23, we recorded an extraordinary loss of JPY 1.6 billion. This is mainly due to impairment losses on aging dormitories and other facilities as well as provisions for demolition costs. Page 14 shows the balance sheet. Compared to the previous fiscal year, total assets increased by JPY 53.9 billion. This is an increase of about 11%. But considering that sales have grown by about 13%, I would say that the increase in total assets is commensurate with sales growth. One major development for this fiscal year was the elimination of trade notes in fiscal '23. The impact of this has appeared in the form of a decrease in cash and deposits and a decrease in notes and accounts payable. There's also a similar impact on the cash flow statement. Specifically, cash flow from operating activities has decreased significantly. This is strongly impacted by the elimination of trade notes. The forecast for fiscal '24 is shown on this slide. We are projecting for fiscal year 2024 order intake of JPY 620 billion, net sales of JPY 570 billion, operating income of JPY 26 billion, ordinary income of JPY 22 billion and net income of JPY 16 billion. The slide on Page 17 shows these figures by segment. I'd like to show the key points on this in a later slide as well. I'd like to move on to the breakdown of changes in operating income. This shows the breakdown of the change from JPY 24.3 billion in fiscal '23 to JPY 26 billion in fiscal '24. First, there is an increase of JPY 3.6 billion in Environment EPC. This is due to the fact that the impact of the biomass power plant in fiscal '23 will be gone in fiscal '24 and also due to the increase in profit at the Inova Group. On the other hand, for environment AOM, we expect a JPY 2.2 billion decrease in operating income due to a decrease in highly profitable projects, such as retrofit works. One of the characteristics of this fiscal year is the increase in the fixed costs. We expect an increase of JPY 2.2 billion. As we will explain later, we are reviewing the executive remuneration system and the managerial personnel system. This will result in an increase in labor costs. In addition, as we will change the name of the company in October of this fiscal year, we expect expenses for associated branding activities. And including these expenses, we expect fixed cost to increase by JPY 2.2 billion. Page 23 is financial information. I hope you will take a look at it later on. Page 24 is the return on capital and cost of capital slide. On the left are ROE and cost of equity, and on the right are ROIC and WACC. Regarding ROE on the left, we have assumed a cost of equity in the range of 8% to 9%. We have achieved a steady improvement in ROE since 2019, but unfortunately, in fiscal '24, we expect it to decline to 9.5%. Regarding ROIC and WACC, we have assumed WACC in the range of 6% to 7%. ROIC was 7.4% in fiscal '23, but is expected to decline to 7% in fiscal '24. This is because we plan to increase business investment in line with our growth strategy. And as a result, we expect ROIC to decline to 7%. This slide shows our shareholder return policy. As I mentioned at the outset, we paid a dividend of JPY 23 for fiscal '23 and plan to pay JPY 23 again for fiscal '24. I will now move on to the management and business information. Page 27 shows the major orders received. First for Japan, these are the major orders we received in fiscal 2023. Page 28 shows major orders received globally. Page 29 is a list of major projects in the Environment business. Please note that the list includes only the projects for Hitachi Zosen. I talked about the biomass power plant projects earlier. They appear on the second and third lines on this table, namely Tokushima Tsuda biomass and Kamisu biomass. Both projects were completed and delivered in fiscal '23, so we do not expect any impact from these projects in fiscal '24 onwards. Page 30 lists the major projects in Inova Group's Environment business. The bottom 2, the Walsall and Abu Dhabi as well as the 2 long-term operations; Slough in the center and Earls Gate, where orders received during the last fiscal year. What I would like to draw your attention to is this chart, orange lines are increasing. I think you can see from this that we have been shifting from a business structure that previously were skewed to EPC to a strategy of expanding to O&M after completion. Page 31, the numbers show the status of each business. The top half shows charts and figures of order intake, net sales and operating income. The bottom half explains market topics and highlights. Page 31 shows the Environment Business, excluding Inova. Comments on the overall market for waste-to-energy facilities are given in the first bullet point on the bottom half. The market size will trend in the range of 2,500 to 5,000 tons per year. Naturally, there are some fluctuations from year-to-year. In fiscal '23, the market size was around 2,500 tons, which means it was at a low level. We currently estimate that the market size will be at the 3,000 ton level in fiscal '24. The key point in the upper chart can be seen in the operating income section. The dark green line shows EPC or new construction. It shows that we hit bottom in fiscal '23. And from fiscal '24 onwards, we will be on an improving trend. The construction of biomass plants I mentioned earlier were completed and delivered in fiscal '23, so we expect to move to an improving trend. Page 32 is a slide of the Inova Group. If you look at net sales and operating income, you can see that we are steadily moving in an upward trend. I would also like you to focus on the trend for AOM business shown in light green. If you look at the sales figures for AOM business, it was JPY 11.5 billion in fiscal '20, and now it is JPY 45 billion in fiscal '24, a growth of about 4x. This has led to the AOM businesses increasing contribution to operating income as well. This is the Machinery and Infrastructure business. First, let's look at machinery. The most characteristic is the sales figures. In fiscal year '22, sales were JPY 61.9 billion, but then they declined to JPY 56 billion level in fiscal '24. This mainly reflects the poor order intake of this segment, which is strongly affected by the sluggish semiconductor market. As a result, operating income has fallen from the JPY 3 billion level in fiscal '22 to the JPY 2.2 billion level in fiscal '24. As shown in the lower part of the slide, we expect semiconductor demand to recover during this fiscal year, and the key will be whether we can secure orders. For infrastructure, you can see that we are on a relatively stable trend. This is the Carbon Neutral Solution business. This segment is strongly influenced by the trend of the social system transitioning towards a decarbonized society. On the other hand, this segment is positioned as a growth business in the medium to long term. Please pay attention to the topic notes in the bottom half. For instance, in the case of engines, we received an order for dual fuel test engine for green methanol. In the area of process equipment, we are seeing an emergence of demand for alternative fuels and storage and transportation for CCS. In the area of decarbonization systems, we have signed a memorandum of understanding for the demonstration of the commercialization of methanation. In the area of wind power, institutional support for commercialization of offshore wind such as additional GI Fund project applications and the GX Economic Transition Bonds are starting to materialize. This is a segment in which we need to respond to these developments. Page 35 shows performance targets and basic policies of Forward 25. I will explain the current status of basic policies and the priority measures shown below in the next page and onwards. On Page 36, please refer to the expanding overseas business first. We set our KPI of overseas sales as 40% for 2025, but as the chart below shows, due to the prominent contribution by Inova, we already achieved 45% in 2023. As for O&M/Service shown on the right, we set this KPI as 50% for 2025. The result was 39% in 2023 and it decreased from the previous year. This is because of the prominent growth of Inova EPC business sales shown on the left and O&M service sales proportionately declined. As the bar chart indicates, its gross sales have been increasing steadily. We will continue to sustain this trend in the next fiscal year and onward. Initiatives in promoting structural reform are shown below. As shown in the middle we executed M&As in Canada, Thailand and Italy in 2023. Page 37 shows expansion of overseas businesses. And the pie chart in the upper part show the order market share of waste-to-energy business in EMEA market. Our share in 2018 was 26.6%. But in 2022, share of Inova was 55.3%, and the share of HZI Steinmuller that became a part of our group was 11.1% and we secured over 66% in total. Below the expansion of value chain is illustrated. In FY 2017, we focused on EPC in European market. But now we developed a strategy to cover global market and improve value chain. Specifically, we have a project in Dubai and Abu Dhabi. Page 38 shows the overview of a project in Abu Dhabi that I just mentioned. And methanation demonstration project in Oman that I touched upon in the Carbon Neutral Solution business. Page 39 shows the investment for the creation and expansion of growth businesses. We plan to invest approximately JPY 140 billion in 3 years from FY 2023 to FY 2025 in the Forward 25 plan. In FY 2023, we invested JPY 38.4 billion. Out of JPY 140 billion in 3 years in total, we plan to invest JPY 75 billion in business, and we are currently steadily filling the pipeline of business investment. Next page shows some examples. Project in Germany and Italy shown on this slide are all for biogas or biomethane. REPowerEU shown below is the ambitious road map to strengthen energy security and accelerate the transition to renewable energy. This aims to produce 35 billion cubic meter of biomethane by 2030, which is estimated to be translated into 5,000 new biomethane production facilities. Page 41 shows KPIs in promoting sustainable management and results in FY 2022 and 2023. Activities in human capital and DX are shown below as well. Page 42 shows strengthening human capital. We are implementing personnel system reforms in earnest. We are now promoting a review of the executive remuneration system and review of the managerial personnel system. In the review of the executive remuneration system shown above, we introduced performance-based compensation further and long-term incentives. This concludes my presentation. And we'd like to invite you for your questions and comments. Thank you.

We will now begin the Q&A session. First, Mr. Ito of Mizuho Securities, please.

This is Ito from Mizuho Securities. First question, could you explain your outlook for order intake for this fiscal year especially about the Environment business you are forecasting JPY 470 billion for the Environment business this term. Can you explain how that stacks up? For example, if you break it down by domestic and overseas, what is the pipeline you see? And is this number reasonable as the order intake target for this fiscal year? Or depending on how the pipeline is built up, is there a possibility that it could go higher? Could you explain about that first?

Yes. Thank you for the question. Please show Slide 18. That was a question about order intake. We forecast order intake for fiscal '24 to be JPY 470 billion. Compared to the previous fiscal year, that's a decrease of JPY 88.8 billion. The breakdown is plus JPY 56.2 billion for EPC and minus JPY 145 billion for AOM. Please turn to Page 19. This shows the breakdown of the Environment business into -- excluding Inova and Inova Group. First, in the domestic environment business, we are projecting an increase of JPY 25.4 billion in EPC. In terms of new projects, we expect 3 projects in Japan this fiscal year. In the previous fiscal year, fiscal '23, we had just one project. So that difference is manifested as the JPY 25.4 billion. AOM is forecast to decrease by JPY 71.4 billion, but this is due to most of the retrofit works being completed in the previous fiscal year and there are almost no large-scale projects in this fiscal year. For Inova, we forecast order intake to be JPY 279 billion, down JPY 42.8 billion year-on-year. The breakdown is an increase of JPY 30.8 billion in EPC and a decrease of JPY 73.6 billion in AOM. As I indicated earlier in the major project section, there were 2 EPC orders in fiscal '23. We are planning to receive 3 EPC orders this fiscal year. As for AOM, we expect order intake to fall by JPY 73.6 billion in reaction to our receiving an order for a long-term operation project in the U.K. in fiscal '23. Order intake fluctuate greatly from time to time. Winning or losing a single project can affect the number greatly. So our position is that we have no choice but to be conservative in our estimates. If the best of best case scenario holds, we can expect to see a large increase from this. Depending on the progress we see in the first or the second quarter, we will revise this forecast as necessary. With that, I would like to conclude my response.

My last and second question. I'm looking at Page 40. I want to ask about the biogas investment. I would like to ask you to explain again, if it's okay, how do you assess the level of IRR for your investments in biogas today? Is there a potential for it to become a more profitable business? Or conversely, do you feel that it is lacking if the IRR for a project is falling below 10%? Also, could you please explain about the business investment in biogas for fiscal '24? What would be the approximate size of that investment?

Regarding the IRR level, the 2 projects in Germany are in the upper teens range and the project in Italy is around 8% as shown. For your reference, the U.S. and Swedish projects in the upper rows are in the low teens range. We are in the start-up phase of this new type of business model. So I think it is inevitable that we start in the teens. However, if you ask me, would we be satisfied with a level below 10%? I would say that, of course we would not be, and our target would be to have IRR in the upper teens at a minimum. In any case, we believe that the most important thing during the start-up period is to accumulate a track record of results so we think that there may be a phase in which we will need to prioritize accumulation of projects first even if the IRR is in the low teens or occasionally under 10%. Regarding the plan for fiscal '24 in terms of the level that we have in mind, let me answer this one later.

Okay. That's fine. Understood.

Mr. Ito, was that okay? Now we would like to move on to the next person's question. Mr. Oodaira from Tokai Tokyo Securities, please?

Yes. This is Oodaira of Tokai Tokyo Securities. Can you hear?

Yes, we can.

I have 2 questions. One is about Inova and the other, I want to get your sense about the business portfolio. First, in terms of Inova's earnings environment, on Page 38 of the presentation, you mentioned Abu Dhabi and Oman. And as you expand horizontally, and I'm sorry, this is an unprecise question, but how do you see the opportunity and the threat/risk picture here? Do you see opportunities and threats in the same way as before? Or are you seeing some new opportunities and/or new risks that are emerging? Can you comment on this first, please?

Yes. You asked about the risk or opportunity regarding projects in the Middle East. Thank you for the question. Actually, the project that contributed to Inova's earnings in fiscal 2022 and '23 was Dubai. Dubai progressed as a very profitable project. It was a different model from the U.K. In Dubai, we have a consortium, and we work with local partners with respect to civil engineering. In the past, we experienced huge losses arising from civil engineering work in the U.K. But in the Middle East, we have a scheme where we have a partner to take on the civil engineering risk. In Abu Dhabi, we are also working with partners in the same way. Based on our experience in Dubai and Abu Dhabi, we have accumulated a considerable amount of knowledge and expertise in project execution or are in the process of acquiring that knowledge in the case of Abu Dhabi, which is yet to be started. In terms of opportunities, I think that the demand for waste-to-energy in the Middle East will continue to increase in the future. In Africa, for example, we are already seeing the emergence of such demand in countries such as Morocco. I believe that our track record in the Middle East will contribute to our competitive advantage in those new markets. Also, the methanation project in Oman that is shown on this slide, as you can see at the bottom, this project is a collaboration between Hitachi Zosen, Inova and Osmoflo, our Australian subsidiary. Hitachi Zosen provides the methanation technology, Inova provides project execution and engineering expertise centered around the Middle East and Osmoflo will be in charge of seawater desalination. I think we shall see more of these kind of group-wide collaboration opportunities to emerge in the future.

Second question. Mr. Kuwahara, since you assumed the Presidency recently, I would like to ask you about your thinking on Hitachi Zosen's overall business portfolio. For example, about 10 or 15 years ago, when the earnings environment was extremely tough, investors were telling you to sell this or that or to downsize. In the end, there were some things that you could do, some things you couldn't. This time, while profits have been growing at a respectable rate, you do have some unprofitable and low profit businesses. Forgive me for pointing that out. And I want to ask what you plan to do about them. May we assume that you will continue the approach of keeping those businesses and working to revive their profitability? Or will you aim to improve profitability by, for example, selling them or restructuring them? So I want to confirm how you see this issue of the total business portfolio. This is my second question.

Yes. I have recently been appointed as President. And my own personal view is that one of the critical missions assigned to me is to further accelerate the growth of our overseas business centered on Inova. Another one is to promote the business portfolio that you just mentioned. We prepared slides on return on capital and the like. It is basically ROIC management. For this, we only showed high-level indicators at the company level, but I believe that in the future, we will be asked to disclose ROIC by segment. And I think we will have to oblige. I believe that under this kind of management approach, we also need to improve the balance sheet and portfolio. I would like to leave it at that for today.

Now to the next question. Mr. [ Noguchi of SBI Securities ], please?

I am [ Noguchi of SBI Securities ]. Can you hear me?

Yes, we can.

First question. Let me ask you about the results for the fiscal year that just ended. Could you turn to Slide 6? It is about the order intake. According to the forecast made 3 months ago, in February, order intake for fiscal '23 was supposed to land at JPY 620 billion, but in fact, it ended up more than JPY 90 billion higher at JPY 715.1 billion. I think this is mainly due to better-than-expected results in the Environment business. What was behind this? Did you suddenly receive an unplanned project? It seems that, that is not the case and rather, it was a fiscal '24 project being coming in early, but since the outperformance was quite large. Can you talk about what led to this?

You are asking about the outperformance in order intake. As you can see from the chart, the upswing occurred basically in the Environment business. Please look at Slide 8. As of February, we were forecasting Inova's order intake to be JPY 249 billion, but the final figure came in significantly higher at JPY 321.8 billion. EPC in particular was JPY 156.2 billion, an increase of JPY 40 billion over plan, and AOM was JPY 165.6 billion, an increase of a little less than JPY 30 billion. Foreign exchange impact was certainly a part of this. We believe that foreign exchange factors accounted for about JPY 10-plus billion of the upswing. And then the Abu Dhabi project was finalized at the end of March within the fiscal year. Since we did not know until the very end whether the Abu Dhabi project will be included in this fiscal year, we were a little conservative in our projection. So the Abu Dhabi project contributed significantly to the result for fiscal year 2023. Those I believe, are the major factors.

I understand. Also in the domestic environment business, excluding Inova, was there an order intake outperformance of about JPY 25 billion, mainly from AOM?

Yes. In the domestic environment business this fiscal year, there was an irregular -- or irregular is probably not the right word, a project that we did not anticipate in the budget and that was a large-scale renovation project for the city of Nara. This one project alone brought in about JPY 12 billion in orders, which was outside the budget. In addition to these, I think that some of our conservative forecasts have led to the deviation.

I apologize for my long question. Can you jump to Page 19? The plan for this fiscal year is on the far right, and it shows that AOM order intake will drop by more than JPY 70 billion, from JPY 198.4 billion to JPY 127 billion. You also explained that retrofit works will decrease. But may we assume that excluding Inova, in the best case scenario, there is a possibility that an unexpected project worth tens of billions of yen could come in again? Of course, some things you don't know. But is it correct to assume that the possibility is not 0?

As for the domestic environment business, our main customers are local governments. So basically, there will not be such a big change. I think that last year's project with city of Nara was a special case. The city of Nara itself had not originally planned this project but they encountered frequent problems caused by aging, and the city was forced to place an unplanned order. This is not to say that such cases will not come up, but at this point we do not anticipate any such case. And so I do not think that we can expect much of an upside here.

I understand. Finally, the second question. Could you please show the Carbon Neutral Solution business on Page 21? You plan an increase in net sales of JPY 19.8 billion, about JPY 20 billion, but expect operating income to drop by JPY 500 million. A projection of higher net sales and lower income doesn't sit well with me. Is it just that you are forecasting conservatively? Or is it because some subsidies will be reduced? The nature of this business is upfront investment so I don't really expect profits, but it is a bit worrisome to see sales increase and profit decrease. So please explain this and also give me your outlook for the future.

Yes. Of the JPY 19.8 billion net sales increase in fiscal '24, wind power accounts for JPY 10.2 billion. The bulk of the JPY 15 billion net sales in fiscal '24 for wind power is the Mutsu-Ogawara onshore wind power project. This project will reach its peak in fiscal '24. However, the Mutsu-Ogawara project is a loss generating project. We secured the order accepting that this will generate a loss. Therefore, although net sales will increase for wind power, there will be almost no contribution to profit. On the other hand, the process equipment, there were foreign exchange factors in the previous fiscal year. And also factors such as the elimination of warranty work, which we had had until 2 fiscal years ago. Therefore, in fiscal '23, there was a gain on the reversal of warranty work provision but this special factor will be removed in fiscal '24. And this is why we are forecasting a decrease in operating income. Having said that, process equipment is certainly on a trend of profit growth and this is a segment that benefits from yen depreciation. So I personally expect an improvement here.

Now the next question, Mr. [indiscernible], please?

I am [indiscernible]. Can you hear me?

Yes, we can.

First question. On Page 39, in the Basic Policy 2, creation and expansion of growth businesses, you mentioned that the actual investment for 2023 was JPY 38.4 billion, including JPY 15 billion for business investment and JPY 9.6 billion for CapEx. What is your outlook for the current fiscal year to the extent you can comment? Broadly speaking, how much do you plan to invest for business, CapEx, R&D and DX? Could you share your basic thinking about this?

Regarding capital investment and R&D investment, please refer to Slide 23. The third and the second lines from the bottom show the planned R&D and capital investment. In fiscal '24, we are planning JPY 12 billion for R&D and JPY 13 billion for capital investment. Going back to the previous page. As for business investment, leaving aside whether the plan itself will be realized or not, if we add up the projects that have been accumulated so far, we are looking at a level of over JPY 30 billion. This may also serve as an answer to Mr. Ito's earlier question, but this is a sense of scale with which we are projecting for fiscal '24.

Could you break this down to the extent possible, what is inside the business investment and capital investment?