Komatsu Ltd. (6301) Earnings Call Transcript & Summary

Hello, everyone. This is Horikoshi, the CFO. I appear every 3 months, so I don't have much to share that is new. Mr. Hishinuma just mentioned the outlook, but I won't talk about that. And please be reminded that we are announcing the third quarter financial results at the end of January, and we have just started to compile the business plan. So there is not much I can say at the moment. Today, I'd like to talk mainly about my general approach to accounting and finance. Next page, please. This is a look back at Komatsu's performance over the years. Komatsu celebrated its centennial in 2021, and this year is 103 year. Of those 103 years, I have been with Komatsu for 40 years, having joined the company in 1985. As you can see here, there was just 1 year when Komatsu had an operating deficit that was 2001. In terms of net income, there were 2 years when we had a deficit. But in terms of operating profit, it was only in 2001 that we had a deficit. When I joined the company in 1985 or more broadly in 1980s, it was a time when the company was working hard to expand its production bases in places like the U.K. and the U.S. to expand overseas production. By 1990, Komatsu thinking that the construction and mining equipment market was not going to grow anymore, it was working hard toward diversification. I remember very well, being instructed to lower the share of construction equipment to 50%. So we were working hard to expand to other businesses. But in the end, they didn't work out. And in 2001, we ended up with a deficit. At that time, the biggest burden on Komatsu's management was electronics, silicon, polycrystalline silicon. We had a company called Komatsu Electronic Metals, which made a single crystal silicon, and we also had a company in the U.S. called [indiscernible], which made polycrystalline silicon. This was something that cost an extraordinary amount of money. And I still remember well that in the 1990s, the annual capital investment was around JPY 100 billion and around JPY 80 billion of that went to silicon-related projects. I was thinking what kind of company is this? And the result was it didn't work out. And in 2001, we went into the red. From 2001 using the phrase selection and concentration, the company started its organizational transformation to what it is now under the leadership of Mr. Sakane at that time. I remember well that Komatsu Electronic Metals was eventually sold to Sumco and polycrystalline silicon business was sold to Norwegian company. I was in charge of M&A at that time, so I was quite busy slashing and adding entities left and right. I clearly remember about the first 3 machinery that we are discussing today that at the end of 2003 or '04, we bought Paltech and Metso through auctions actually. I remember going to many places doing a lot of due diligence at the time. As you can see from this, sales rapidly increased from 2001. And by 2007, sales had reached JPY 2 trillion. This was the time when the emerging markets led by China were rapidly growing. So we thought that the construction and mining machinery market still has potential, and that's how things evolved. The Lehman shock occurred on September 15, 2008, and this was a really tough time with the yen appreciating to JPY 85 and then to JPY 79 to the dollar. So we closed factories in different places to get through that difficult time. At that time, the profit ratio fell to 4.7%. From there until about 2016, Komatsu continued to record sales of just under JPY 2 trillion in a stable manner. At this point some were thinking, is there no more room for further growth? But in April 2017, as you know, Komatsu acquired Joy Global for approximately JPY 300 billion. And since Joy Global sales were also about JPY 300 billion, our sales jumped to a level exceeding JPY 2.5 trillion. So I think this was a time when we had another business transformation. In 2020, there was a drop due to the COVID pandemic. But after that, sales, especially for mining increased steadily. And for 2 consecutive terms last year and the year before, both sales and profits reached record highs. For this year, we are looking at about the same level as last year. For the second half of the year, we are assuming JPY 140 to the dollar and have this kind of projection. Next page. This is what we explained at our business results briefing, analyzing the sales and profits of the construction, mining and utility equipment business from fiscal '22 to '23 and then '23 to '24. In fiscal 2023, there was an impact from the exchange rate shifting from JPY 134 to JPY 140, and then there was also a significant impact from raising sales prices which increased profit by JPY 130 billion. For the current year, fiscal '24, the exchange rate is assumed to be JPY 147, though I think the yen will actually weaken further. There is that impact and another round of sales price increases this year will lead to higher sales. But as I will explain later, the volume has decreased and the cost of sales and fixed costs have risen considerably. So we expect a profit decrease of JPY 33 billion and a profit ratio of 14.7% for the construction, mining and utility equipment business. Next, please. As you know, from the second half of 2021 around the third quarter, the cost of sales has been rising significantly. And in this graph, the bottom part of the bar shows the increase in cost of sales and fixed costs and the upper part of the bar shows how much we have been able to raise the sales price. The blue line shows the net impact on profit and loss for each quarter and the gray line shows the cumulative profit and loss impact. As you can see, from the third quarter of fiscal 2021, the cost of sales has been rising sharply and the selling price was raised in response, but the net impact was for a long time, negative. I think it was in the fourth quarter of 2022 when finally the net effect turned positive. From then on, we maintained a net positive impact. And looking at the cumulative total, I think we will reach a net positive effect of JPY 26.8 billion in the fourth quarter of this year. The supply chain situation was very tight in 2022 and '23. And with our competitors also raising prices, it was relatively easy to raise sales prices. In this situation, we were able to improve sales prices, but the biggest change was how Komatsu manages P&L. Previously, Komatsu was conducting profit and loss management for each of its roughly 200 group companies, and the main focus was performance management for each individual entity. However, there was fluctuation in transfer prices between group companies and quite a few group company has who use that as an excuse, and we could not assign accountability, so we decided to show the consolidated results for each region. For example, P&L for all products made in the United States, including exports and the P&L of all local subsidiaries that ship to the U.S. are aggregated at the consolidated level. It has become possible to grasp this information, and we are actually showing this at executive officers meeting. For the people in charge of each region, it means that it is shown clearly how much their own regions profits and losses are. So there is a considerable amount of pressure on them, and they aren't able to make excuses. So I think that this is a strong incentive for them to raise their sales prices. Also, the performance-linked compensation for the heads of each region is also particularly linked to the consolidated profits and losses. So I think that this is also quite a big factor. Regarding fixed costs, I think we can show on the next page that the fixed exchange rate assumption is used. From 2017 to 2021, of course, there was inflation, and there were also wage increases, but we absorbed all of this through structural reforms, and we strongly suppressed cost of sales and fixed costs. So if you look at the last 5 years, it's almost flat. From there, Komatsu deliberately increased fixed costs in 2022 and '23 because as you see in the inflation rate above, the rate of wage increases is quite high. Komatsu has 30% of the workforce who are Japanese and 70% are non-Japanese. So the average wage increase for employees is around 9% or 10% every year, although there is a big fuss in Japan, about 5% increase, our growth rate is much higher. And so it was becoming untenable to absorb those increases. And there were also some operational problems caused by keeping fixed costs too low. So from 2022, we raised the fixed cost. Also, it is clear that if we don't direct our resources toward electrification and automation, we would not secure the future growth. So we increased our fixed cost by around JPY 40 billion each year. And over the last 3 years, we have increased our fixed cost by around JPY 120 billion or JPY 110 billion. As to how we measure if this level of fixed cost is appropriate, we look at the marginal profit ratio and the level at which we've which the fixed costs are at in terms of the breakeven point using the marginal profit ratio. At the moment, the breakeven point is around 56% to 57%. And this year, we are aiming to keep the breakeven point below 60%. So we are currently controlling the level of fixed cost to achieve this. Next page. As for efforts to increase corporate value, we are working on how to raise PBR, which is often talked about by the TSE. As you know, the price-to-book ratio is the PE ratio times ROE. And when you factorize the PE ratio, ultimately, it is 1 divided by capital cost minus expected cash flow growth. That is PER. And ROE, which, as you know, can be broken down into 3 components. We are taking measures for each of them, and I would like to explain what we are doing. As for the cost of capital, as you can see below, we have reduced volatility due to increased sales of parts and services. And we have also done share buybacks and the cash flow is as written here. I will go through each of the items again later. Next page, please. Regarding capital cost, as you are probably aware from our explanations at past financial results briefings, our cost of capital is generally considered to be about 8% on a CPM or CPA basis, I forgot. And we aim to maintain the ROE of 10% or more as our management goal. In order to expand the equity spread, we are working on reducing cost of capital. And in order to reduce volatility, we are striving to increase the sales ratio of parts and services. With the sales of parts and services being stable and gross margins being 40% to 50% compared to 20% to 30% for original equipment, increasing the parts and services business will serve to stabilize earnings and reduce capital cost. Also, I have explained the criteria for share buyback several times, so you may already know, but we have 2 mandatory items that need to be met and supplementary criteria such as ROE to measure efficiency, consolidated free cash flow, net cash, the dividend payout ratio as well as the PE ratio. These are the KPIs we view. The criteria has been set so that the Board of Directors can discuss share buybacks thoroughly to avoid unbalanced decisions. The next slide is about expected cash flow growth rates. The expected cash flow growth rate is a component comprising the PE ratio, as mentioned earlier. And it is the most inferior to that of competition according to our internal analysis. Therefore, I believe that it's very important for us to understand how people think about the expected growth rate of cash flow. Engaging in IR activities like we are doing today are also very important for this purpose. The allocation of operating cash flow is shown here. We have been allocating 50% for capital investment, 40% for shareholder return and 20% to prepare for future M&A. As for M&A results, last year, we have acquired ABS, American Battery Solutions in the U.S. And in the past, as you can see here, we have concentrated our M&A activities in the areas of mining equipment and forestry equipment. Komatsu considers M&As as an important means to realize the future vision of our business portfolio. And post acquisitions, we do follow up. Every year, we compare the ROI and WACC of each company to check to see whether the businesses are EVA positive or not. We do this exercise for about 10 years post acquisition. We compare the performance against the plan we had at the time of acquisition. Although this will be mentioned later as well, overall, the M&A deals we have conducted up until now are generally EVA positive. Komatsu is originally a company that has grown through M&A since the 1980s and 1990s and approximately 30% to 40% of our sales are from past M&As. Next page, please. Komatsu has also stated that it strives to be carbon neutral in terms of CO2 emissions by 2030. I mentioned earlier that fixed costs are increasing, but we are allocating them to areas in which we are prioritizing, focusing on R&D. And this is about cash flow. Regarding how we plan increased net income, which was one of the components, although there is no slide on this, Komatsu basically uses the direct cost accounting system, which clarifies the definition of variable costs and fixed costs on a global basis. By consistently applying this system to the entire group, we are able to compare profitability in each region. Because it's unified, it's one reason why global sourcing is possible. Komatsu is a diverse company with people from various nationalities and in various job positions. So we use the simplest possible management method available that is easy to understand. We often use SVM or SVC, standard variable costs or standard variable margins to measure direct cost and fixed costs. It's a very simple, globally unified management method. Please turn to the next page. This page is about the total asset turnover ratio. As I've already mentioned, we started using ROIC as an internal management KPI in 2017. However, ROIC is only a ratio. And this will come up later, but its impact on profits is too large. So when we applied ROIC as a KPI within the company, which turned out to be a mistake, people started to think that as long as profits increased, it didn't matter if inventories and fixed assets increased. This was the mentality held in our group back then. Therefore, we learned that ROIC is not functional as a KPI internally. Of course, it's fine to use ROIC as a way to communicate externally. For example, for companies with a very large portfolio like some other companies, it might be a useful indicator, but we thought that it wouldn't work as an internal management indicator for us. So now we have switched to free cash flow. Regarding free cash flow on the next page, we have reclassified free cash flow a little. So as you can see here, we have broken down cash flow into respective components such as profits, working capital, fixed assets and M&A. For example, in the graph above, the sales growth rates are shown at the top. But when sales are growing, looking at the breakdown of free cash flow at the bottom, the light blue working capital component is negative, meaning that it continues to increase. Then on the right-hand side of the slide are 4 quadrants. We are able to show how companies are performing each quarter. For example, companies may be profitable and may have positive free cash flow, they're fine, but there may be companies that are profitable but have negative free cash flow. This can be identified, and they are plotted on to this chart, and this chart is shared with all of our executive officers and serves well to raise awareness. Also, for monthly reporting, each company gives updates on their free cash flow, which is proof that everyone is highly aware of its importance. Please turn to the next page. Regarding the way we do the reclassification, the left side shows standard cash flow. Cash flow from operating activities and cash flow from investing activities are shown. Each of these items are factorized into profits, working capital, fixed assets and M&A that you could see on the right-hand side. You are able to see where each component is positive or negative. For example, in the case of fixed assets, depreciation cost has a positive impact on cash flow. So it's included in positive cash flow. And the acquisition of fixed assets are treated as a cash out. Next page, please. This page shows the difference between ROIC management and free cash flow management. As we often do with ROIC, when you factorize it, you get the operating margin and investment capital turnover ratio. And then the invested capital turnover period can be further broken down into accounts receivable, inventories, payables, tangible fixed assets and so on. This is done just to show the trends. But in the case of free cash flow, we are able to see the difference between the business plan and actual cash flow. So it's extremely useful in managing the numbers as everyone reports these numbers in their monthly reporting, and we have a grasp on the business. And it also serves to be good pressure. Next page, please. Financial leverage is one of the components of ROA. And this page shows Komatsu's credit ratings from R&I, Moody's and S&P. I mentioned in the very beginning that Komatsu was in the red in 2001. This was when our ratings went down to BBB, which was one step before falling to non-investment grade. Then after, our ratings gradually improved, and now we are steadily maintaining a single A rating. As we often say, S&P and Moody's shares with us the formula that derives our rating. Therefore, we calculate every quarter how much our strong financial strength translates into, whether it be several hundreds of million, billions or trillions. Therefore, one of the criteria for determining dividends and share buybacks is based on calculation of how much borrowing capacity the company can afford to have in terms of its finances. Next page, please. On the left, this page shows the trend of dividends and share buyback. The gray line represents the median of TSE Prime's total shareholder return. We compare this to Komatsu's track record on total shareholder return. And you can see that we have been at least been able to exceed the median TSE companies. The bar graph at the bottom shows Komatsu's dividend per share, which is recently JPY 167 a share. The bar graph below shows the dividends, which used to be as low as JPY 8 or JPY 4, but now it has increased considerably to JPY 167. And the 5 light blue bars indicate the amount of shares -- share buybacks. The past 3 times was JPY 30 billion, respectively. And this year, it's JPY 100 billion. To the right of the chart, you could see retail finance, which people do not pay much attention to, but retail finance is very profitable. As a segment, the operating profit margin is close to 20%. In addition, since there is leverage in the retail finance business, we can benefit from it as assets build up in the retail finance business. This is basically the mechanism by which the price-to-book ratio increases as assets increase in retail finance. We have analyzed that when assets increase, PBR increases ultimately in the retail finance business. Next page, please. This is the last page. As I mentioned earlier, Komatsu follows up on all past acquisitions to see if they are EVA positive. And when you actually look at this chart, you can see that we have been EVA positive and market cap also has been growing in conjunction with these trends. We would like to continue to enhance our corporate value through such efforts in the future. In recent years, we have been conducting impact accounting and other such methods in relation to the SDGs and ESG efforts. For example, we have been estimating how much social value we've created through smart construction or how much social value has been created quantitatively through the AHS business. However, the calculations are still a bit immature for disclosure. So we would like to work out the method of disclosure a bit more going forward. That is all for me. Thank you very much.

Now we'd like to take your questions. Sasaki from UBS Securities Exchange Companies.

I look forward to continue working with you. Based on today's presentation, I'd like to ask Mr. Horikoshi, you mentioned that you are making various efforts toward corporate value creation. But on the other hand, if you look at the share price and its valuation, Caterpillar in the U.S., for example, is trading at a PER of 18 to 20x and Epiroc, a Swedish competitor in mining is also trading at a PER of around 20x. In the case of Komatsu, despite the fact that you are making such efforts based on its fiscal year's plan, your PER is 10x and I think that valuation multiple is considerably discounted compared to other companies and historical levels. From your perspective, based on what you have discussed today, what do you think are the factors that are causing the discount? And conversely, how can the company work to eliminate this discount? Since you have shown us a detailed slide, could you please tell us what you think about the discount in multiples?

I don't have the updated data with me right now. But for example, if you compare with the top company in the U.S., there is a difference of almost 8x in PBR. I think it may be even wider now. If you break it down, the biggest impact is the perception of the expected growth rate of cash flow. This is causing a difference in PBR of more than 3x. Of this 3x difference, about 1 is due to the difference between the U.S. and Japanese deflators. So I think that the remaining 2x is due to how investors perceive the future growth of each company. And so as a result, there is a difference of about 3x to 4x. Then there is financial leverage that accounts for about 2x difference. Then there is a profit ratio, which is also resulting in a difference of about 2x. That is how we analyze the numbers. I think the difference in the markets in which the companies are listed are significant. And I don't think that our medium-term plans and future policies compared to -- I have just said the name out loud, are inferior to be frank with you. However, the fact that there is such a difference means that we may not be communicating well enough to investors and shareholders. And financial leverage is also having an effect.

The next question is from Mr. Maekawa.

Maekawa from Nomura Securities. I have 2 questions. One is about how you have shifted to management focusing on free cash flow? And as you showed us in the sales price, you mentioned that the pressure and incentive for overseas subsidiaries are working very well. But I'd like to know specifically from where changes have started to appear. Also, I think you have multiple overseas subsidiaries. So I wonder are there any differences by business, if you can elaborate on this?

We have all of our companies send us a monthly flash report at the beginning of each month. In these reports, we are told how much sales have been made and how much profit has been generated. Then at the middle of the month, we receive the monthly reports, but previously, it was just PL that was being reported. So we asked them to provide us with all the cash flow data, free cash flow data, and we ask them to explain why the cash is not being generated as projected in the plan and they provide explanations. When presented with numbers, everyone puts a lot of effort into analyzing them. And in terms of raising awareness, we have been able to get across the message that it is not just about accounting profit and that what is important is earning cash. This is particularly true of our sales subsidiaries. Mining is a very large source of our revenue and sales subsidiaries, which are dependent on mining like in South Africa, Australia and Central and South America are all direct sales agents with mining accounting for roughly 70% to 80% of their business. These subsidiaries used to be less concerned about cash flow. Their focus was to avoid missing sales opportunities. So they held a lot of stock to do business. But I feel that, that has changed quite a bit now. However, this year, inventory has ballooned. The thing is when the market fluctuates greatly, the salespeople, the marketing people always have the tendency to say when it is falling, they will say it won't fall that much. And when it is rising, they will say it won't rise that much. We are in a downward phase. So they would say it won't fall that much, and we just have to stick it out a little more to the end. When that happens, production is inevitably pulled higher and inventory piling up continues. In order to resolve this, the production department needs to not take the sales department at its worse and make its own judgment saying there is no way that sales are going to be that high and to maintain what we call negative inventory, and that is what we are doing in terms of production adjustment. In that sense, the mining sector is having a positive effect on cash flow, and that situation has become more pronounced in recent years. We only officially started this year, so it's just starting. However, I think we have fostered a strong awareness for this.

One more thing. You briefly mentioned retail finance saying it has a high profit margin, and there was also the earlier discussion on leverage. So I wonder if you are going to expand this? It could be interpreted as a positive for PER, but I don't think you have talked about this much until now. So could you talk a little about it about retail finance?

Basically, we think of retail finance as a sales tool, and we don't have an intentionally building up retail finance assets. However, until now, we have been taking a very cautious approach to finance, taking no risks at all in extending finance, and that has led to our losing out on deals in Africa and also in the Middle East. So we have shifted from being excessively cautious to taking reasonable risks and extending cross-border financing, and we have really done a lot of those in the past year or 2. In addition to this, we have shifted to looking after our African operations from Europe and the synergy effect of both of these has improved the performance of Africa significantly. Retail finance itself is a business that generally produces stable profits to begin with. After all, we have contracts, so we can take on more risk than banks to a certain extent, and we know how to sell the machines we have repossessed. So we have the collateral and we have the information, and we felt we can take on more risk than we previously thought. As a result, our assets have accumulated.

Now Mr. Ibara, please.

I am Ibara from Morgan Stanley. I have 2 questions. First, you are managing your business using EVA and free cash flow. And from your perspective, are there any business units or companies that still have negative figures and you feel the need to fix them? You've done restructuring in China and revising your approach in Russia. And from the outside, it seems as if no such negative areas remain and basically, everything is well managed. But as CFO, are there any areas that you think need to be fixed? Or is everything basically okay?

If you look at the free cash flow page again, Yes, this page. The bottom left is the most problematic. There, the free cash flow is negative and the profit is negative. There are companies that fall into this category, those that are in emergency situations. Also those in the start-up section, for example, EARTHBRAIN and ABS, which we acquired last year. This was an unorthodox acquisition in that we bought them for the development of human resources. So they are burning cash and loss-making. However, they form an important part of the overall operations, and we don't see them as a profit center. We see it more as a cost center. So those are placed here. Also, EARTHBRAIN still has some start-up elements. So that's also in the bottom left. The other companies sometimes fall into this corner, but not that often. There are emergencies, but not on such a large scale. There are no large-scale problems. For example, at the moment, Europe is in a bad situation. So there are businesses in Europe that are in the red, Cash flow is negative, and they fall to the bottom left for 3 or 4 months. But in cases where companies are experiencing poor earnings, they will be managing their inventory assets quite aggressively, and the reality is that they are rising to the top left.

Do you look at this and make decisions about what to do with the region or whether to withdraw from the business?

No, we don't.

Secondly, in terms of acquisitions, from the CFO's point of view, regarding Komatsu's current M&A, I'm sure you face various conditions such as credit ratings. But what is the maximum M&A potential? You may not be going after large acquisitions in the first place. But from a financial point of view, how much capacity do you think you have?

If it's just debt financing alone, it may be in the trillions. If equity finance is included, of course, the figure will be as high as possible. Well, maybe not JPY 1 trillion, but that may be a bit of an exaggeration.

In that sense, it seems that there is no bottleneck when it comes to your capacity. And I'm sure that there's many opportunities for JPY 1 trillion.

That's correct.

And regarding acquisitions, actually, when you do share buybacks, your company puts importance on credit ratings. It's a minimum requirement. But for acquisitions, you also can account for future growth, right?

The difference between share buybacks and acquisitions is that whether the EBITDA of the given company is included or not, you could take the hurdle higher for M&As, but with share buybacks, that's not the case. The numerator doesn't increase. So that makes the hurdle lower.

Next is Mr. Fukuhara.

This is Fukuhara from Jefferies Securities. I have 2 questions. The first one regarding your view on cost of capital. Earlier, you mentioned that in order to further lower WACC, you need to lower the volatility of earnings. One option is to increase borrowings. If you were to increase borrowings, what will happen to the allocation of cash flow, which you mentioned earlier is 40% for shareholder return and 50% for investment. Will this change in the future? For example, by increasing the allocation to shareholder return and reducing investment or rather allocating more to M&A. What are your thoughts on cash allocation if borrowings were to increase?

Well the ratio I just mentioned is roughly the same as it has been for the past 10 years approximately. With the current business structure we have, this ratio does not change that much. The bottom part of that slide, if you can go back to that slide. Yes, this one. Here, we state preparation for future M&A. In essence, it's about repayment of debt. There is a possibility that this part can change. The reason is because there is no point in improving the financial position any further. In terms of preparation for future M&A, we were accounting for a fairly large-scale M&A. And therefore, we thought if that was the case, we should have a relatively conservative balance sheet in preparation for such an eventuality. However, looking at past trends, if we need to, we can combine equity finance, and there are many options of financing. So there has been a gradual shift toward the view that there is no need to be overly conservative in this area.

Understood. Secondly, I would like to ask you about the upcoming midterm plan. Of course, I'm sure it's difficult to comment on it right now, but I would like you to share your thoughts. What are the core businesses and concepts that you expect will drive your next midterm plan? What are you planning to share with us?

Well, I am not the person in charge of this project. So I think I should refrain from speaking about it too much, but I think continuity is important. I do not think that there will be a major change from the midterm plan that is currently underway. So I think the new plan will have a high degree of continuity. Because of time constraints, we would like to take one last question.

Okay. Mr. McDonald, please.

I have a question about your M&A of ABS. I believe your company paid about approximately JPY 40 billion. It's basically a start-up company with almost no sales or profit contribution. The other day, the Nikkei reported that you are planning to increase the production capacity of batteries by about 4x and that you're planning to make investments worth JPY 10 billion going forward. To be honest, one thing I'm curious about is there was a company called Northvolt that went bankrupt in Europe. And I'm not that familiar with the ABS business, but I was wondering what the difference is between Northvolt and ABS. And if there are any common risks like Northvolt for ABS, can you tell me a bit about it?

I'm not familiar with Northvolt. So I don't really -- I can't really make a comparison per se. But as I've mentioned earlier, we do not view ABS as a profit center in the first place. We have no intention or plans to make batteries or cells, to be honest, but we used to have no expertise in battery packs modules or battery control systems, and that's why we acquired ABS to incorporate their expertise. So there is no such thing as bankruptcy. We don't view the business that way.

Isn't ABS quite dependent on the automobile segment?

The business is not profitable at the moment. And regarding whether the business is highly dependent on automobiles, the business is more exposed to buses. So it has been focused on rather niche areas up until now. So we don't have the scale to make large profits from large sales or to incur large costs. It's not a business that may shake the foundation of Komatsu. Therefore, for example, even if they generated no sales, we would not see this as problematic.

It's not listed here, but for Proterra your company, invested into them previously, right?

Proterra, no, we have not made any investments into them. We have not invested to begin with into Proterra. We just partnered with them, and we were just buying batteries from them, but we have not invested into them. So the fact that they went bankrupt is not a problem at all. I think Volvo just bought them. So they went bankrupt and Volvo bought them. That's right. So it's irrelevant to us.

But then the relationship was terminated with them?

I would not go so far as to say that the relationship has been completely terminated.

As there seems to be no other questions, this concludes the first session, the CFO session. Thank you very much, Mr. Horikoshi. Thank you very much.

Hello, everyone. My name is Umeda, and I am the President of the Forest and Agriculture Business division. I have been in my current position since April last year. And before that, as I will explain later, I was the President of Komatsu Forest, which is located in Umea in Northern Sweden and is the core company in our Forest Machine business. Please turn to the next page. Today, I will be explaining Komatsu's Forest Machine business from a sustainability viewpoint. This is the table of contents. The contents I will be covering today are: first, I will explain the contribution of decarbonization, environmental protection for forest and working population in the forestry industry, such as the issue of manpower and the environment surrounding forestry machinery, such as occupational accidents and social issues. Next, I will explain the forestry operations, the logging methods commonly used around the world and the main types of forestry machinery used in planting and felling as well as an introduction to the current state of the machinery market, the trends in the market. Thirdly, I will talk about the history of Komatsu's forestry machine business today, current focus points and the transition in sales levels. Fourthly, I will talk about the key activities we are currently focusing on and will be focusing on in the future. And fifth, I will explain the future sales outlook for the forestry business. Please turn to the next page. Next, please. As you know, forest absorbs CO2 and holds it. When used as timber, it is possible to store carbon for long periods of time. Also, when wood products, wood materials are used as an alternative to fossil fuel-derived plastics and other materials, the CO2 generated when making materials based on fossil fuels can be suppressed. In this way, force themselves are set to be the most low-cost way of removing and absorbing CO2 from the atmosphere. Generally speaking, trees absorb CO2 as they grow, but it is said that the level of absorption saturate at some point. Normally, it is said that the absorption capacity of trees saturates after about 15 years, although this may vary depending on the reason. In this sense, cutting down trees is not necessarily a bad thing. And as shown in the picture in the bottom right-hand corner of the page, we believe that a circular forestry cycle, the repeated process of harvesting, utilizing, planting and growing contributes to the realization of a decarbonized society by making it sustainable and sustainable use of forest resources. With this in mind, Komatsu is committed to contributing to the realization of a recycling-oriented forestry industry through its forest machine business along with our customers. Please go to the next page. Forest are located close to the foundations of our lives and their functions are closely related to human life. In the second part of the 15th conference of the parties to the Convention on Biological Diversity, COP15, the Kunming-Montreal Biodiversity Framework was adopted, which resolve to restore biodiversity by 2030, a nature positive resolution. Forest, as you can see written at the top on the right, also have functions such as water resource storage, so they play an important role in the management of water resources, water management and water source management. Recently, wildfires have been occurring all over the world and wildfires themselves cause serious damage to residents and forest resources. In other words, we believe the high-quality forest management through controlling such issues have become a social requirement. As you can see in the middle of the right-hand side, the EUDR regulations for Europe, which were scheduled to be applied from December 30 of this year, require that regulated commercial products for the European market as written at the bottom, are not produced on land subject to deforestation. We believe it will be good to think about these things together with machinery. In addition, the value of wood certified by FSC and other organizations increases. From this perspective, the importance of appropriate forest management and solutions is increasing day by day. This is the same direction for not only products and wood products, but also carbon credits. Please go to the next page. The degree of mechanization of forestry operations differs from region to region, but I think that the issues of securing labor and dealing with labor shortages and ensuring safety and security in forestry operations are common challenges globally. The graph at the bottom left shows the challenge of securing labor in Japan and the United States. And as you can see, both countries are experiencing a steady decline in the number of forestry workers. Not only in Japan and the U.S., but also in countries like Brazil and Indonesia, where the pulp industry is very strong, forestry operations are carried out in very remote areas, and it is said that it is becoming very difficult to bring workers to the forested sites far from urban areas. The photos in the middle are an example of a series of photos, and these are from Japanese forestry. The first 3 photos are of planting and forest management and the remaining photos are of felling and transportation. At the moment, in all countries, most of the planting and forest management is still done by hand, but logging is becoming increasingly mechanized around the world. Unfortunately, compared to other countries, mechanization in Japanese forestry is not very advanced. The reason for this is that many of the forests have narrow roads and steep slopes, so most of the work is done manually. They use small machines instead of large ones, but using small machines means that more manpower is needed, so they still need people to do the work. Also, as you can see in the middle photos for felling, Japan still relies on chainsaws for a large part of the work. Using chainsaws means that manual felling is the main method and there are issues with safety, such as the risk of being pinned under a tree that has fallen or the risk of the chainsaw flying towards people if the chain breaks. As you can see in the graph on the right, the frequency of work-related accidents in the forestry industry is very high compared to other industries. Komatsu is aiming to create a smart, clean and productive future for forestry sites, just like construction and mining sites. Please go to the next page. We will now look at the market trends for forest machines. Next page. Forestry operations differ from region to region, depending on factors such as the terrain, the time it takes to cut down a particular species of a tree and the intended use of the wood, for example, whether it is to be used for paper pulp or for housing. In addition, the method use will vary depending on the conditions of the labor market, whether or not it is easy to find workers. On the other hand, as shown in the table at the bottom of this page, there are only 2 main types of mechanical harvesting and extracting methods in use around the world. One is CTL. The term CTL method is an abbreviation for cut to length, and this method was developed in the Nordics. The trees are felled at the forest site and bucking and processing, the so-called alignment of length takes place on site. If it is for pulp, the bark is removed at the same time. The wood is then transported to the roadside where a trailer or truck that can travel on public roads is waiting using a machine called a forwarder and then taken to the plant. On the top left of this page, you can see a harvester and forwarder, which are wheeled machines. These 2 machines, which I mentioned briefly earlier, are manufactured by the Swedish company, Komatsu Forest. Specialized machines like these harvesters and forwarders are used. In some areas, they use harvesters based on hydraulic excavators as shown in the photo below. This is mainly used in the pulp industry in places like Brazil and Indonesia. The other method is called the FTL method, which stands for full tree length developed in North America. It involves using a vehicle called a feller buncher to specifically cut down trees from the roots. After the trees have been felled using the feller buncher, they are transported to the side of the forest road in the original length using machines such as log rollers and skidders. They are then taken to a relatively wide area by the side of the forest road where branching is done using specialized machines such as processors and knuckle boom loaders. FTL is mainly applied in North America and although dependent on the conditions of the lumber mill, the long length of the tree is kept as is and transported for processing. The machines used in this type of method are the feller benches and skidders shown in the top right. The feller benches shown here are crawler type, but there are also wheeled types as well. In addition, various types of vehicles are used in each process. We provide various types of vehicles that have been especially designed or customized to meet the needs of each process as shown in the middle of the page. Next page, please. Next, I will explain the forest machine market. Naturally, as the world's population, especially in the middle class increases, the demand for paper and lumber will steadily increase. And for this reason, mechanization of forestry will become an absolute necessity. We are anticipating an average annual increase in demand of 2.3%. But as I mentioned earlier, although the population is increasing, the number of people employed in forestry is expected to decrease. This is true regardless of region in the U.S. and other developed countries, but also in tropical regions where pulp is produced, the number of people working in forestry is decreasing. And as the number of people in forestry declines, mechanization is becoming an absolute necessity. As you can see in the graph in the lower middle of the page, North America and Europe have already reached a relatively high level of mechanization, but Asia, especially is lagging behind. There are still areas where felling is done mainly, so we anticipate the rate of mechanization in these areas will continue to rise in line with the shortage of labor. This will provide a tailwind for machinery demand. As I explained earlier, tree plantation, forest cultivation and the preparatory work for tree plantations where the ground is prepared and weeding are still often done manually by hand. Nevertheless, the area of forest plantations is increasing year-by-year. Another thing is, as I mentioned earlier, there are cases where the purpose to harvest trees is to produce wood or pulp. But in addition, carbon credits are increasing all the time. There is an increase in the number of plantations for carbon credits rather than for the purpose of cutting down trees. Unfortunately, at the moment, there are very few machines for plantation and cultivation, but we expect to see a rapid increase in the future. Please go to the next page. Now I will explain the outline of the forest machine business and sales. Next page, please. As mentioned earlier, as shown in the top photo, the forestry cycle is a cyclical business that follows the flow of land preparation, planting, weeding, forest surveys, thinning, felling and processing, extracting and transport and then returning to land preparation again. The very bottom line, the bottom section shows the history of M&A in Komatsu's Forest machine business. In 2004, Komatsu acquired the Swedish forest machine company that was selling under the Valmet brand at the time, which is now Komatsu Forest. After that, in 2012, a Swedish company making attachments for CTL harvesters for felling and bucking, Log Max was acquired. In 2018, Quadco, a company that makes attachments for FTL harvesters, which cut trees down from the roots was acquired. The operation of forest machinery is extremely complex and difficult for operators. And we believe that training using simulators is key to supporting our customers. In 2018, we also acquired a Swedish company called ORYX Simulations. In 2019, we acquired a company called TimberPro who manufactures vehicles for FTL method, and we are using their technologies to contribute to safety in felling and the improvement of efficiency in transportation and so on. I think that mechanization will continue to progress in this field, so we will continue to expand our business. However, when trying to expand the forest machinery business, it is not enough to focus on just the felling and transportation part. As I mentioned earlier, it is important to consider how to reduce the amount of manual labor required in the land preparation and forest survey stages of the process. The important thing is to solve labor shortage issues. In other words, we are aiming to mechanize this part and avoid manual labor. Two years ago, as you can see in the bottom right, we acquired a Swedish company called Bracke Forest that manufactures attachments for tree planting and tree tending equipment. They also manufacture some towing equipment. By acquiring this company, Komatsu can be leading the way in mechanization in the tree planting and tree tendering sectors. In the area of forest surveys, and there are various companies doing this, but for forest machine companies and forestry companies, it is a task that requires a lot of manpower. They go into the forest and observe the growth of the trees, for example, and measure the diameter, the length and the height of the trees and take samples. Based on these activities, they can tell how much the forest has grown and what is the time to fell trees. While managing the forest, they compile and implement felling plans. And this is a very labor-intensive job. We can offer satellite technology and remote sensing technology using drones to help with this. Another thing we can do is to make sure that the trees are planted properly. After planting, it depends on the climate and season, but it is necessary to confirm that they are watered properly in the weeks that follow and also have to check to see if the samplings are dead or not. The reason for this is that it's too late to plant trees after other trees have grown. So people are walking around in such places and looking for dead samplings. If they find such samplings, they have to replenish them. In such areas, we can use AI to judge which samplings are dead and so on. We are currently conducting R&D to provide solutions in areas such as visualizations amount of forest inventory, felling and reforestation. Through these activities, we aim to support sustainable forest management and to contribute to the realization of a decarbonized society. Next page, please. The graph on the left shows Komatsu's sales in the forest machine business and the dark blue line shows the sales of the current Komatsu Forest, which was acquired in 2004. It has been 20 years since then, but sales have grown by 3.4x. As I mentioned earlier, Komatsu Forest is now the core company in the forestry business. The upper right-hand side shows the demand for and sales volume of wheeled purpose-built machines, and we have a market share of around 25%. The lower right-hand side shows the market for crawler feller buncher for the FDL method in North America as well as market share and sales volume. Recently, the FDL market has been affected by the high interest rates in the United States and the strong dollar. That has had an impact on housing starts. It's a little more subdued than it was before. The fact that lumber exports are down has also had some impact. And currently, it's in a difficult situation. However, as far as crawler feller bunchers are concerned, we are maintaining a 20% market share. That said, in the category of FTL, we are lacking in other product lineups. We feel that there is room for growth here, and we are working to fill this gap by expanding our product lineup and trying to expand our business. Please go to the next page. As for the fourth item, I will explain the key activities in our growth strategy. Please go to the next slide. As in the construction machinery and mining equipment sectors, we are also expanding our forest machinery business, both on the machine and the solutions side. And this is a common policy of Komatsu. First of all, for the CTL business, we are working on strengthening our production capacity for machines to lay the foundations for growth. Three years ago, Komatsu opened its first new plant in Europe, and it has now started operations. This is the first carbon-neutral plant in Europe, and it has laid the foundation for business expansion and will support our advancement into new markets. So as for the Japanese market, it is shown here on the slide, and I have already talked about this in another slide, but unfortunately, at the moment, mechanization in the Japanese market is not as advanced as in other countries. The area of forest in Japan is actually quite large. And in terms of the area, it is about the same as that of Sweden, a leading forest country in the Nordic area. However, according to the FAO, United Nations Food and Agriculture Organization, it is said that the production of industrial use logs in Japan is only 1/3 of that compared to Sweden. I think the difference is due to the level of mechanization. But all of that is not applicable to all deforested areas. In Japan, the Nordic-style real machine CTL method is already being used in some customers who are operating and using parallel imports. Komatsu is considering introducing the real-based Nordic style as a trial next year. Apart from that, we are expanding our markets in Asia, South America and Japan, et cetera, as shown here. In particular, the paper and pulp industry is currently making large-scale investments in South America, mainly in Brazil and the surrounding areas such as Paraguay. In order to promote sales in South America, we are trying to expand our business in terms of both sales channels and products. As you can see on the right, there are 2 photos. This is a concept vehicle that has been developed among Komatsu Forest and 8 other forestry companies in the Nordic area. This is a high-speed crawler-type forwarder that carries timber, which has a significantly reduced impact on the soil. The key point is to reduce the impact on the ground without reducing productivity while the maintaining current performance of the real-type vehicles in practical use. Particularly in the Nordic countries such as Sweden and Finland, due to the impact of global warming, although we are not currently doing business in Russia, the same is true here. But generally speaking, in these areas where there is tight or frozen soil, when it becomes loose due to the warmth in the summer, the ground becomes completely soft and large vehicles cannot enter the area, is a bottleneck. In many areas, the period for filling is limited to winter. But not only because of global warming, but also because of the [ ruts ] that are being made, there is also an impact on biodiversity. There is a significant impact on trees being knocked over because of roots being drove on and damaged by the tires. We are hoping that introducing low ground pressure vehicles in places like this will be a game changer for forestry in Nordic areas in the future. Furthermore, as well as construction machinery and mining equipment, we are also working on the concept of hybrid electric and battery electric vehicles as well as automation. Another important point is the expansion of the aftermarket, including services. What is the ratio of the aftermarket business to Komatsu parts sale? For mining equipment, we say that the aftermarket accounts for around 50% of the total sales of construction and mining equipment. But unfortunately, for forestry equipment, even for Komatsu Forest, it is only around 25%. We are currently considering the strategies to expand this. This is just one example, but the photo in the bottom left is called a drop box. It's like parts depot. Forests are vast. And from the time the felling begins until the time it is finished, it is over quite quickly. So the operators have to move around the forest as they work. The provision of parts has a huge impact on how the machine can be operated without stopping. The allocation of parts is key. If we were to set up a lot of service points, there would be problems with the profitability. So the key to the aftermarket business is how we can deliver the parts that the customer has ordered and deliver them precisely where they need it and at the right time. In case of this drop box, can put the parts in here according to the customer's order and then the customers can pick them up. And there are some considerations such as invoicing at the time of customer pickup. But we are also working in ways to make it more convenient for customers and considering a way to be able to do things while thinking about the customer, such as developing a parts supplies transaction point. Another thing that we are working on are remote services. As forests are located in very remote locations, we use ICT to connect the car and the operator who provide repair support remotely. We are now placing more emphasis on the provision of those services, including training the operators. Please go to the next page. Next is the activities of the FTL business. As shown above, we doubled the production capacity of the TimberPro Shawano plant last year in the same way as the CTL Umea factory mentioned earlier. In the FTL business, we were talking about the coverage of a product lineup, but there is a huge gap. And at the moment, you don't have any vehicles such as skidders, wheel feller bunchers, and knuckle boom loaders that move around in a relatively wide area in the forest that's close to the road after felling the trees in the forest. We're currently developing a product called skidders, and it is almost ready to be released on the market. So the biggest challenge for us is to expand the coverage of our product line up as quickly as possible. There are some differences from the FTL business. But as you can see in the bottom left, there are construction material-based harvester machines. And in the bottom right we've planters and mulchers. Mulchers are machines that can be used to clear undergrowth or remove unnecessary trees. It is important to develop and introduce these attachments that meet the market needs. In particular, in Brazil we have many opportunities in the plantations because there are machines needed for silviculture and mechanization is progressing rapidly. Mechanization has only just started, and we are in early stages of development with new functions and new challenges emerging all the time. But it is very important to develop ourselves while the market is just starting. Please -- next slide, please. Activities in solution provision are shown in the picture on the left of this page. This shows the entire process circular forestry that I mentioned earlier. Komatsu Forest has been working on the CTL project, which provides solutions based on a common data standard in the Nordic countries for felling and transportation. We have been providing solutions with collaborations with forestry companies or sawmills who buys timbers. This is shown on the lower right, Smart Forestry. Solutions are provided on a subscription base, such as fleet management, production planning and on-site management. In addition to this, we are promoting the visualization of forest inventory, felling progress, tree planting and forest management using remote advanced technology. In the future, as we feel this alone is not sufficient, we will also be working on things shown on the left-hand side, fire management, water source management and pest control and biodiversity management, et cetera, in order to meet social needs. Within this context, we are currently considering how to provide information as a platform. In the future, we think that something like a digital twin of the forest will be necessary. And we are currently considering how to integrate machines and solutions to achieve what we are aiming for. Another thing is that there are parts of the forest where the communication environment is not sufficient. For instance, if it's mining, the operating area is very limited. So it would be easy to build a communication network there but forest land is vast, and there are many dead zones. So there is a lot of work necessary to establish a communication solution. Please go to the next page. Lastly, the sales forecast and target for the forest machine business. We expect to achieve roughly 1.5x the sales of FY 2021 by FY 2024. But if you exclude the impact of exchange rates, the forecast is slightly less than 1.5x. Komatsu, as you all know, has positioned the forestry machinery business as the growth business that is SDGs-related and contributes to decarbonization and is positioned as the third pillar. In addition to the growth in sales due to the increased demand in the future, the expansion of priority activities such as FTL and growth in areas such as [ afforestation ], growth in business combining machine and solutions and activities that do not stop the customer operation, which is the same as mining, are very important. So we will strengthen the aftermarket business where growth opportunities can be expected. Currently, we have only been able to capture around 25% of the total market and aim to further improve sales. Next page, please. This is a concept vehicle for the crawler-type forwarder I mentioned earlier. The crawler on the bottom is a bogie structure and it can go up and down on any surface, just like a wheel type. And it can generate speed, the same as wheel type. It is currently at a concept stage and is under development. Thank you for listening. This concludes my presentation.

Now we would like to take questions. Mr. Fukuhara, please.

My name is Sho Fukuhara from Jefferies Securities. I have a question of your approach to M&A in relation to the future growth of your forestry business. Up until now, you have been buying machinery and attachments. But will you continue to look for companies with the same characteristics in the future? Or will you look for companies also in different genres, such as ABS? Or will you look for companies that can increase the service ratio in the future? Can you clarify your approach to M&A, please?

Thank you for your question. Regarding acquisitions, it is not that we have to make acquisitions. And as I mentioned earlier, there are also parts of FTL that we develop ourselves and in some areas we think it is necessary to grow organically. However, we are also always thinking about M&A while we are doing our business. Of course, M&A of hardware is necessary, but there are also untapped markets. I think plantation, I mentioned earlier, is exactly that kind of field. If we are going to pioneer something that does not exist now, I think that a simple M&A will probably not be enough. Komatsu has an embedded corporate DNA that requires us to be on-site and took -- look closely at things on-site. But in that sense, we may need a company akin to a startup, and we think that we need to carefully consider timing as well. I hope that answers your question.

If I may just confirm, Slide 12 shows the trend in sales over the past few years. From FY '19 to FY '21, Komatsu Forest sales did not increase for about 3 years. But in FY '22 and FY '23, they saw an increase. What was the reason for this?

I think I mentioned earlier about the launch of a new plan, but there were a few problems with the start-up of the new site. And another thing that was very difficult was that semiconductor stop coming in, and the supply chain was in a state of considerable confusion. So we could not get hold of the parts. And this was not just a problem for Komatsu Forest vehicles, but also for the vehicles of our competitors. And there was a part of the market where the timing of the market was determined by the amount that the manufacturers could produce.

Mr. Sasaki, please.

I'm Sasaki from UBS Securities. There are 2 things I would like to talk about, one, is the concept of FTL. I think it was a few years ago that Mr. Hara-san was a speaker at a briefing on the forest machine business and I think he gave a presentation at that time about the challenges of developing FTL. From that time, FTL has been difficult to develop. And it may be impolite to say that it is still challenging. Is it correct to understand that it is a different machine so it is difficult to build and that is why it has taken time? If I understand correctly, the development has progressed considerably. So can we understand that it will expand in the future? Could you please confirm your approach. This is the first point.

Yes, we are trying to expand FTL. I think that was probably 3 years ago. But at that time, we were considering both M&A and organic growth. M&A is a difficult thing to do. You have a counterparty and there are some things that can't be done easily. So while we are considering M&A, we are also thinking about including organic growth, and we are also considering developing our own products. In this context, I mentioned earlier, we have been developing the skidder for some time now, and we also need to elevate the range of products we have because business is not attainable if we do not. There is also an environment where customers want to deal with a single OEM rather than dealing with various OEMs. So if we do not increase our product lineup, it will be quite difficult to expand our business. So in that sense, our current priority is to enhance our offerings.

That's very clear. My second question is, although there was a sales chart, at the moment there may be no disclosure for the forestry business profit margin. But how should we understand the current state? In particular, how does it compare to the company average? And you also mentioned that you'll be raising aftersales service in the future. And if so, will the profit margin also go up? Is this interpretation accurate? Could you explain about the profit margin?

The profit margin is not particularly low compared to the construction machinery business. However, we are at a point where we need to make investments now. For example, investing in people to rapidly develop products. So again, in that sense, it is possible that there will be a temporary decline. However, if we do not make these investments, we will not be able to grow, so this must be done.

Then is it correct to understand that the profit margin will increase in the future when the product lineup is complete and sales increases along with aftersales services increases?

Yes, that's right.

I understand very well.

Mr. Maekawa, please go ahead.

My name is Maekawa from Nomura Securities. I'm sorry to ask a basic question. But you have said that the forestry industry is a third pillar, but the construction machinery industry is roughly around JPY 2 trillion at the moment. So I think to aim for JPY 2 trillion at one go may be challenging. From the current level of just under JPY 150 billion, how much do you think sales will expand at what pace? As you said earlier, you're going to expand your product lineup and also there are markets that are not related to afforestation. Well, there are large companies that are in the industry, but maybe achieving your target by buying these companies will not be your point. Can you give us some quantitative direction of how you want to develop this business going forward?