Kanadevia Corporation (7004) Earnings Call Transcript & Summary

I'm Kuwahara, President. Thank you very much for participating in the financial results meeting for the second quarter FY 2024. Now I'd like to present the Q2 results. First, we changed the company name. As you are aware of, as of October 1, we changed the company name to Kanadevia. This is a combination of Japanese word kanaderu and Latin word via. With the company name change, we have been intensifying branding activity. TV commercial is shown on the left top, and left bottom is a banner at coliseum stadium. We are intensifying these external public relation activities. White bottom is a photo at the prelaunch event, a company activity 100 days before October 1, and right top is a photo of the company event on October 1. Not only expanding the external recognition, but we also take this as a good opportunity to change the mindset of employees, and the corporate culture reform and intensify the branding activities. Let us move to financial information. Q2 results are shown on this slide. Q2 results are shown in column A. Order intake was JPY 284.8 billion. Net sales were JPY 269.9 billion, Operating income was JPY 3.1 billion, ordering income was JPY 0.6 billion and net income was minus JPY 1.1 billion. Year-on-year comparison is shown here. Orders and net sales were almost in line with the plan. Operating income was also in line, after absorbing the deterioration of Precision Machinery & Infrastructure, which was already reported in Q1, but we posted minus JPY 2.5 billion in nonoperating income, and it was down by JPY 3.3 billion year-on-year. Most of the nonoperating income was a loss on investment by equity method. I refrain from disclosing the specific project name, but it is related to the Power Generation business of offshore wind power. We have been promoting a business development of offshore wind power. But considering the increase in project cost, we discontinued the project. For this, we incurred impairment loss on investment for the special purpose company, and posted a loss of JPY 1.5 billion on investment by equity method. This affected heavily on order income with a decrease of JPY 1.3 billion year-on-year to JPY 0.6 billion, and partially due to a decrease in ordering income, Net profit decreased JPY 1.4 billion to minus JPY 1.1 billion. Next, for the full year forecast in column B. Order intake was revised upward from JPY 620 billion to JPY 680 billion up by JPY 60 billion, considering the current progress of order intake and the probability of the pipeline. Net sales were also revised upward from JPY 570 billion to JPY 590 billion, considering the progress of project. Forecast of operating income and order income remain unchanged. We plan to post an extraordinary income of JPY 2.9 billion in this fiscal year, as shown here. As disclosed on October 23, we had an insurance claim lawsuit over a Shield Machine Project in the United States. Due to the settlement this time, we post JPY 2.9 billion of insurance income in extraordinary income. With this, Net income is revised upward by JPY 2 billion from JPY 16 billion to JPY 18 billion. This slide shows a breakdown of nonoperating income. Gain and loss on investment by equity method is shown as minus JPY 0.8 billion here. And it includes the impairment loss on offshore wind power JPY 1.5 billion as mentioned. Next, consolidated balance sheet. From the end of the previous fiscal year, total liabilities and net assets decreased by approximately JPY 50 billion to JPY 483.2 billion. A pattern of the last few years the increase of accounts receivable at the end of the fiscal year and the recovery in the Q1 and Q2 in the following year continues in this fiscal year as well. This is reflected in the decrease in operating assets. What is prominent in this fiscal year is an increase in tangible and intangible fixed assets and others. They are affected by M&A that was implemented in this June. Shareholders' equity ratio was 33.3%, improved by 2.8 percentage points from the end of the previous fiscal year. Consolidated cash flow statement.operating cash flow in the previous year, JPY 8.2 billion had a special reason behind it. Last year, we abolished the notes payable, and that led to the low operating cash flow. Investing cash flow includes M&A that I mentioned before. and that resulted in an increase of approximately JPY 10 billion year-on-year. Financing cash flow reflects the progress of repayment of bank borrowings and bonds payable with cash generated in operating cash flow. I'll explain segment information from this slide. Orders intake in Q2 decreased JPY 61.9 billion year-on-year. And net sales increased JPY 37.8 billion. In the breakdown, there were both increase and decrease, but basically, the progress was in line. I will explain the changes in operating income and the full year forecast on the following slide. Operating income for the second quarter improved by JPY 2 billion from JPY 1.1 billion in the previous year to JPY 3.1 billion this year. The blue boxes on the right shows the improvement in the environmental business. which totals JPY 5 billion. The pink boxes on the right shows the JPY 2 billion deterioration in the Machinery & Infrastructure and the JPY 1 billion deterioration in Carbon Neutral Solution. The JPY 5 billion improvement in the Environmental segment is broken down into three areas. The first is a JPY 3 billion improvement in the Environmental EPC. The main reason for this is that the cost increase related to biomass power generation that occurred in the previous fiscal year were eliminated in this current year. The JPY 1.7 billion improvement in the Inova Group includes a revenue increase effect from the smooth progress of projects. The deterioration in the Machinery Manufacturer includes the Precision Machinery and infrastructure that I mentioned earlier in the first quarter report. I will explain further about the carbon neutral solution in the slides that follows. This slide shows the overall Environmental business segment. I will explain the breakdown of the segment by separating the Inova Group from the rest of the segment. First, let's look at the group's centered on the main body of Kanadevia, excluding Inova. The key point is to highlight here. are the order intake and sales. Those are progressing as expected. The situation is almost the same as we had expected in the second quarter and the full year forecast. On the other hand, the change in biomass, which I mentioned earlier is reflected here in terms of operating income,the minus JPY 800 million for the second quarter, an improvement of JPY 3.3 billion from the previous term. This is because the impact of biomass has been eliminated. I think you can see the same trend in the full year forecast, the effect of biomass. In addition, we have factored in continuous improvements to our business and we have raised our forecast from the initial JPY 9.2 billion to JPY 10 billion. This slide shows the details I've just mentioned. So please refer to it later. Next, the situation with Inova Group. First of all, with regard to the amount of orders intake, we have increased the forecast for the current period from JPY 279 billion to JPY 49 billion, an increase of JPY 70 billion. Looking at the current status of the pipeline, the probability has increased significantly. We have also raised our forecast due to the effect of foreign exchange rates. With regard to net sales and operating income, we have revised our forecast based on the fact that the project generally progressing smoothly. In addition, the effects of the M&A we carried out this fiscal year are also included in the net sales and operating income. I'd like you to refer to the slide later for breakdown information Machinery & Infrastructure. What I wanted to highlight here is the deterioration in fracture that I mentioned earlier. The deterioration in operating income in the second quarter was JPY 2 billion. With regard to deterioration in the Precision Machinery & Infrastructure business, we believe that we will have measures that we respond to the situation by the end of the second quarter. We expect to be able to recover from the impact of this and our full year forecast is JPY 900 million compared to our initial forecast. This is a decrease of JPY 1.5 billion, and we are forecasting a decrease in profits. Another point to consider in the Machinery & Infrastructure segment is the Precision Machinery businesses order intake. The second bar from the top in the bar graph of order intake from the previous fiscal year, shows the Precision Machinery business and the fact that the orders were sluggish in the previous fiscal year is linked to the deterioration decline in sales. in this current fiscal year. Therefore, I think the major issue for the current year and the next year is whether we can secure orders for the Precision Machinery segment in this current period. I'd like you to refer to the slide for your reference later. Next Carbon Neutral solution. Once again, the key point in this segment is engines. Order intake and the full year forecast for the segment as a whole, we had initially forecasted order intake of JPY 63.5 billion, but this has now been reduced to JPY 10 billion -- by JPY 10 billion to JPY 53.5 billion. This JPY 10 billion is all due to engines. In the wake of recent inappropriate conduct, we are currently limiting our ordering activities for engine units to a very limited extent. And this is one of the reasons why we have reduced our order intake forecast by JPY 10 billion. Also in terms of operating income, we have revised our forecast down from JPY 1.3 billion to JPY 0.8 billion for the segment. This is also basically due to the impact of engine business in light of the recent inappropriate conduct, inspections are taking longer than before. Furthermore, we are also reviewing our process at the same time. But we have factored in such items in the deterioration of the engine business in our current forecast. Please do refer to the breakdown of carbon-neutral solutions later on, too. Now the status of our order backlog. The order backlog at the end of September this year was JPY 1.61 trillion. I think you can see that it is steadily expanding. The lower chart shows a breakdown of this JPY 1.61 trillion by sales recognition year. In the second half of the current fiscal year, we expect to generate about JPY 300 billion to be exact, JPY 297.9 billion out of this order backlog. The next slide shows our key financial figures. I'd like you to refer to that later on. Now I'd like to move on to the management and Business Information section. The first slide shows a breakdown of major orders received in the current period. Inova has received orders for long-term O&M in Abu Dhabi and for a project in Schwandorf Germany. Kanadevia also received orders for a project in Kyrgyzstan and for a project to construct hydraulic gates in Philippines. The next slide shows the details of our main Environmental projects, including the project schedule. The 2 biomass-related projects I mentioned earlier, Tokushima Tsuda, second from the top, and third from the top, Kamisu Biomass, were completed in the previous fiscal year, but there were cost increases. And regarding other biomass projects, we have Fukuyama biomass in the middle of this table. And this is a biomass project that is currently under construction. We are making use of all of experiences and learning we gained from Tokushima and Kamisu and committed product in the construction of this project and at the moment it is progressing smoothly. And from this time, we have all included the detail of the retrofit work. I hope you will refer to these information as well. This is the list of the main projects of the Inova Group. The orders received this period, which I mentioned earlier, Abu Dhabi is at the bottom of the EPC section, and Schwandorf is at the bottom of the retrofit section. Next, I would like to talk about the goals and the progress of the midterm management plan. The top half shows the order intakes, sales and operating income. The target volume for the final year of the midterm plan for FY 2025 are JPY 600 billion in order, JPY 560 billion in sales, and JPY 28 billion in operating income. But as you can see from FY 2023 and 2024, we have already reached these targets in terms of order intake and sales. The bottom half shows the long-term trend in net sales and operating income. And at this point, I would say that we are progressing smoothly toward the Forward '25. Next, I would like to highlight the key points by business. First, let me explain the state of our business, excluding the Inova Group. In this slide, I would like to highlight the status of waste-to-energy EPC market in Japan, as shown on the top left. The order volume for FY 2023 was 2,420 tons, which remained at a very low level. Although it will recover to 2,700 tonnes in FY '24, it is still at a low level. However, we expect it to recover to 4,000 tons and 4,700 tons from next fiscal year onwards. As for the Japanese market for waste-to-energy EPC market, we believe that replacement demand due to the aging will remain solid and expect the market to remain stable for the time being. Next, allow me to talk about the status of the Inova Group's Environmental business. The top half shows information on market share and the market size in the European and the Middle Eastern markets. In 2020, Inova's share shown in dark blue was 58.1%. Since then, it has been around 50% and we have been able to stably secure a very high share. The market volume is shown below pie charts. In 2023, it was 4,714 tons, which is a significant decrease compared to the previous year. However, we that this is a temporary phenomenon. There were no large-scale projects in 2023, the kind of large projects we had in 2020, '21 and 2022. Considering that markets the Middle East, Saudi Arabian and others will be emerging from 2024 onwards, we believe that this market size will be sustainable at a high level. One more thing I would like to touch on the service business on this slide. We have implemented this with the market after sales to service company that I mentioned earlier. In addition we also purchased shares in the French service company EST Industries in which we previously held a 40% stake. As of October 1, we have increased our stake to 60%, and this week, we have made it a consolidated subsidiary. Next is Machinery & Infrastructure business. First, please refer to the chart of order volume in the press machine market. In 2020, demand certainly slumped due to the COVID-19 pandemic. But since then, the market has been stable with orders at JPY 140 billion from 2021 onwards. As a result, our press business has also been relatively stable. The photo on the upper right is on Tangent Kanadevia, which we established in October last year. We are considering responding to the hydraulic gates and ODA projects, which are expected to grow in demand in the Southeast Asian market. Most recently, we have secured a project in Pasig, Marikina in the Philippines. Next is on our Carbon Neutral Solution business. First of all, engine. In this regard, we will devote all our efforts to restoring trust as a way to correct the inappropriate conduct. The top left shows the chart of the Japanese government and offshore wind power installation targets. We are also now focusing on floating offshore, and as shown in the bottom right, we applied for and was selected for the NEDO's floating offshore wind power demonstration project. The photo in the upper right shows our participation in the IG Prefecture project. This slide is reference information for the expansion of O&M business and Inova Group. Please refer to the information on the left for the M&A mentioned in the previous slide. The map on the right shows the service basis of Inova and its service network we have acquired this time. If you look at this, you will understand that regional complementary functions can be realized, and we can pursue such synergy effects. Also, the bottom left shows a list of M&A that has been carried out to expand O&M business. In addition, the bottom right is on the chart showing the expansion of O&M business. The bar graph shows the expansion of sales from O&M businesses and the proportion of O&M businesses in the total market has actually expanded to 29% which shows that business composition is actually improved. The next slide shows a completed approach. On the left is Dubai. This is one of the largest in the world. It was completed in August this year. On the right is a photo of the completed slough project in the U.K. which shows the construction was actually carried out in a very narrow space. Inova was able to complete the project 3 months ahead of the schedule. We have also received orders for long-term management of this project. Finally, I would like to introduce our initiative to realize our circular economy. COP 29 will be held in Baku Azerbaijan from November 11 to 20 this year, and we plan to participate in it. We plan to exhibit at Japan Pavilion of the Ministry of the Environment and to take presentations at the related seminars. In addition, we declared our support for the TNFD in December last year and published our TNFD report in October this year. We consider this our engagement in pioneer initiative in the industry. If you have the opportunity, please refer to the report. On the last page, we have provided a collection of links. So we hope you will use them as reference information. This concludes the explanation of the presentation materials.

First question is from Mr. Noguchi of SBI Securities.

Yes. I'm Noguchi of SBI Securities. First, let me ask about Page 15. I'd like to ask about Environments business overseas, Inova Group's O&M. Environment business and Inova Group is progressing steadily, but when I refer to O&M compared to the initial forecast, order intake and net sales increased, but operating income decreased. I'd like to know the background presumably, I think it was affected by expenses related to M&A or depreciation of goodwill. If that is the case, let me know the one-off cost. And for the next fiscal year, how will the profitability of O&M develop? I'd appreciate it if you can comment on this.

I may need to apologize concerning this question because we revised the allocation SG&A expenses this year. Its allocation for O&M increased this time though previously, it was allocated to EPC and we had optimzation. Therefore, though there's no impact on Inova Group as a whole, there were moves between EPC and O&M. This is related to the M&A that you mentioned along with the series of M&A we conducted. Naturally, G&A expenses expanded. But they were not properly allocated and we revised the allocation. Given the substantial increase in sales this time, we optimized the allocation of the G&A expenses, and that resulted in this number. Going forward, in the next fiscal year onward, the baseline will be the profitability of this year. Of course, we'll strive to improve profitability along with sales growth. But please understand that the baseline is that of this fiscal year.

Second, let me ask about the Marine Engine in Carbon-neutral Solutions business. Regarding the development of this incident, the penalty and expenses will be decided the external investigation committee, but please tell me how I should see going forward? There are two points of questions next year onward. First, it is about the order intake of marine engines. Do you project a decrease or reduction in orders, but as about 30 Japanese engine makers have been doing similar things, I do not think orders decrease are likely to happen. The second question is about the development of our next-generation marine engine for hydrogen and ammonia that you and other peers are involved in. If orders and sales are flat, then is a loss related next-generation engine development going to be expanded to building or will remain mostly unchanged at less than JPY 1 billion, with the incident. How will order intake develop? And though it is not related to incident but tell us about the cost for engine development as much as we can.

Talking about the impact on order intake. I said before that currently, we are controlling order-taking activities for engine. On the other hand, Japanese ship building market continues to be robust. And as shipbuilders have long-term order backlogs, demand for engines are firm. So I think that the expectation for our company do not decline. That said, the investigation into the inappropriate conduct is not complete yet, so we'll control order intake and work on the order backlog firmly first. Having said that, considering the current market environment of shipbuilders, we'd like to normalize operation as soon as possible to meet the expectations. But we'll not able to continue the conventional ways of inspections and processing, so we may not be able to achieve the volume that was expected before. So I don't think the current condition will continue, but I think we need to lower the level of orders from our previous expectations in our business plan. For your second question about the development of the next-generation engine it would be the similar tone. But as our top priority is to take corrective measures against this incident. And this priority will be simply down Therefore, I think the delay of the development schedule is unavoidable, and we'd like to work to improve the situtaion first.

Follow-up question, please. When orders and sales contract, fixed cost burden will be heavier. But we will be able to manage this with reallocation of people in the carbon neutral solution business or within the company? This year, our incurred operating loss of JPY 0.7 billion. But do you think it is unlikely to increase to, say, JPY 2 billion or JPY 3 billion next year onwards? Is the color of my assumption correct?

I'd like to refrain from commenting in terms of color with the specific numbers this time because we have a negotiation with customers regarding future orders. So very sorry, but I'd like to give you colors in other occasions.

We'd like to take questions from analyst first this time. Mr. Taninaka of SMBC Nikko Securities, over to you.

I'd like to ask about the prospects of the engine business. If my calculation is correct, operating income of engine business in the first half was minus JPY 0.7 billion, and the full year forecast is also minus JPY 0.7 billion, with no loss incurred in the second half in your assumption. But listening to you now about the inspection cost and the controlled order intake I felt loss might be posted further. So would you tell us the background to come back to the breakeven?

Your observation for operating income is correct. Q2 results were minus JPY 0.7 billion, and the full year forecast is also minus JPY 0.7 billion, and the full year initial forecast of sales was JPY 27 billion and this time, and it remains at JPY 27 billion with no revision. This is based on the orders already contracted. And sales for this year are based on this, thus, basically, we think we can maintain the sales. Additionally, fortunately, after sales service have been progressing better than the plan now, and that would be the additional boost. In the first half, there was a confusion with the incident. But gradually, it has been calming down. And as of now, we have not revised our full-year forecast of JPY 0.7 billion, but we cannot deny the risk included and concerns regarding this as you were concerned.

As a follow-up question, how should we receive your message of risk included? Do you mean that risk is related to the prospect of inappropriate conduct? Or is it the risk that profit may deteriorate with increased inspection costs despite the increased sales? How should I take it?

I said before that the inspection costs and the process was reviewed. And currently, we are in the process of normalization. It would be good if we can continue this normalization trend. But it is possible that the inspection costs may last longer than our current estimate. It may happen. That is the implication of the risk included in my comment.

Another question is about biomass power generation trouble in Q1, and I think it was under negotiation over who will bear the cost between you or a customer. Would you update this project, please?

This is on Page 24, second from the top, a biomass project in Tsuda, Tokushima. As you said, the table happened and remedial construction is ongoing, and we'll be able to resume operation by the end of December. As for the cost sharing with the customer, we are negotiating it with the customer so let me refrain from making specific comments. Currently, we are talking with the customer.

Now from Mitsubishi UFJ Trust and Banking Corporation, Mr. Shitamuri, please.

This is Shitamuri of Mitsubishi UFJ Trust and Banking Corporation. I have two questions as well. First, I apologize for repeating the same topic but I would like to confirm something about engines. Would the cost of the inspection process review that was carried out this time,be limited to this fiscal year or would the revised approach be continuing in the new fiscal year and beyond so that the company will continue to operate in a higher cost situation? That's what I wanted to confirm. This is my first question, please.

I'm sorry to say that I will not be able to give you a definitive answer. As I mentioned, there's no doubt that the inspection and responses are countermeasures, we are currently carrying out or bringing our businesses back to normal. However, whether this is confirmed or not, that's another matter. When we take an optimistic view, this trend will continue, and we will return to normal operation, then we'll be able to return to normal operations from the next term onwards. But understand that we are not able to say anything definitive about this until we see how things develop for a while longer.

I see, I understand. So this review is not of production lines, and there was a cost incurred by equipment or CapEx or something like that. But rather, you are reviewing the inspection procedures that may take a little longer, correct?

Yes, you're absolutely right.

My second question, you mentioned that you recorded a loss due to the abandonment of the offshore wind power project in the income from equity method affiliates. Will this affect your company's future offshore wind power or wind power initiatives as a whole? Or is this loss just a one-off cost and will not affect your company's future offshore wind power businesses? Will your approach to the business remain unchanged? Could you please tell us about the approach of wind power business in the future based on this project, please?

Our base policy for offshore wind power generation project is to focus on providing basic structures. In that sense, we do not currently envision to proceed with the project itself as a business developer. Therefore, I think we can say that the possibility of such investment losses of going in the future is extremely low. As shown in the slide currently displayed, we are targeting to manufacturer floating offshore facilities, such as shown on this slide. Our target is to manufacture super large floating structures. In addition, we also want to focus on our own technology, the suction bucket for a fixed bottom type. Therefore, our basic policy for the offshore wind power business is to focus on the manufacture of foundation -- basic foundation structures for both the fixed bottom type and the floating type.

I understand. So even if you did not participate in the project, there are no issues, problems with receiving orders for delivery of such equipment, right? Is it correct to understand that there are no need to consider this in conjunction with this project?

That's right. I think one of the reason is that there are very few companies that possess the technology to manufacture these floating structures. In particular, the manufacture of floating structure requires facilities such as large-sized docks. It's quite clear that our company alone does not have the facility or capacity to achieve the government's targets shown on this chart. And on this slide, from this -- for that perspective, I think it's safe to say that if this plan itself is to be realized, the government's plan, the probability of company receiving orders is extremely high.

Then Mr. Noguchi of SBI. Are you raising your hand? Please go ahead.

Thank you very much taking my second round of questions. I also have two more questions. Please forgive me for asking a few rather difficult questions, but the main strength of your Environmental business is doing so well. So I have a question about Machinery & Infrastructure, hydraulic gate business. I think there was an incident in which additional costs were incurred for Japan hydraulic gate construction project in the first quarter. It's rather had timing. In spite of this, your company has taken on another hydraulic gate project in the Philippines in the first half of the year. In other words, while there are increase in the cost on hand from Japan, you are also increasing orders overseas which are probably more difficult. They don't seem to really make things sense. So how should we view this? Also looking at this infrastructure business from a slightly longer-term perspective, I think it's a difficult position in terms of target management system and RIC standards for each project, each region. But how much leeway are you giving to this product at the present? Perhaps you are taking on this project in Philippines because if you do not take on the challenge, you will end up with no trial and no errors. So you are taking on this project with this intention of perhaps making adjustment. Please tell us more about these measures.