Ichigo Inc. (2337) Earnings Call Transcript & Summary

Hello, everybody. Thanks so much for joining. Today, we're doing the Ichigo fiscal year '27-2, so the February 2027 first half corporate presentation. I am joined on my right by Ted Fujita, who is our Lead Independent Director; and on my left by Dan Morisaku, who is a senior member of our Finance team and the Head of Global IFRS. Thank you very much, everybody. Let's jump forward. I've got a mic in my right hand, I've got a clicker in my left. Hopefully, I can make this work. So here's the first half summary. We last had a call in July. Quite honestly, not a lot has changed since then, certainly not in terms of our business and what we do, which is drive profitability for our shareholders by delivering assets that are improved assets for tenants and, therefore, ultimately for investors. So the numbers are pretty straightforward. We're on track for what we're going to achieve this year. First half looks a little light, no any issues at all. So business profit is up 3%, net income down 2%, EPS up 4%. cash EPS up 17%. We like that a lot because we're focused on cash flows and cash to shareholders rather than accounting earnings. Stock earnings down a little bit, flow earnings up. Highlights are kind of we're on track. I mean these are some bullet points, but I think the most important thing to understand is that we're in an operating environment which is extremely paired or matched to our core capabilities. As you know, we are not a real estate company. We focus on sustainable real estate. We're not a company that does raw development where the construction costs have gone through the roof and it's made it very, very difficult for a lot of our peers, and I would call them competitors. And so we take existing assets, we improve them so that the surge in construction costs is actually very beneficial for us in terms of competitive advantage. So things are going well. We've got some -- I'll talk about this later. We got some AM, Asset Management, flow earnings, JPY 1.1 billion on performance fees from our office REIT. Asset acquisition is on track. We announced a JPY 5 billion share buyback today. All shares will be canceled. We announced additional cancellation also of another 3.4% shares. At the bottom, we're on track for having record profits across the board. We expect to have business profit up 21%, net income up 8% and EPS up 13% and ROE 15%, cash ROE 20%. We've raised our dividend this year 35% with a DOE of 5.1%. This effectively gives some more detail on what I just spoke to. Again, we focus on cash earnings. They are at 1.4x our accounting earnings. We are relentlessly focused on delivering value for our shareholders. And ultimately, we think that in terms of -- that happens in terms of cash production. Business profit, we have a diversified portfolio. Certain things go up, certain things go down. We forecast, for a record, we fully expect to hit those numbers this year via some second half contribution. We are structurally profitable. Our stock earnings, meaning kind of the earnings that are relatively fixed through things like contracts such as rental income, power generation contracts, base asset management fees, again, those are contractual, run about 2x our fixed expenses. Our stock earnings ratio, so a percentage of stock versus flow, 56% at this point in time. And again, I'm going to go very quickly through this because this is a material we have updated for today, but there's not a lot of change in the last 3 months. We expect to have a record high on cash earnings. Again, stock earnings, we have actually forecasted down. And so JPY 24.3 billion, which is a record high for us last year. At this point, our -- we have not changed the full year forecast. We could have; we didn't. But at this point, we're projecting ourselves coming at JPY 25 billion on stock earnings for the full year, again, above what was embedded in the forecast of JPY 23.8 billion. So again, we expect to have a record year for stock earnings this year also. We have long-term debt. It's about 90%. It is -- half of it is fixed with average interest rate of 1.7%. There's been some push-down in the average tenor of our borrowings. In general, we borrow for 10 years. We have a business called Ichigo Owners, which has a turnaround of generally about 1 year in terms of from ownership to sale. We borrow there generally for 7 years. What's happened is we've increased our Ichigo Owners business a little bit relative to the total pie. We've also increased, and this is a very good thing, we started issuing bonds, and we're getting an increasing amount of uncollateralized debt, generally, which have terms around 3 years. So that's pushing down the average tenure, but this is some strength rather than weakness. As you can see, rates have gone up, 26 basis points year-to-date, in terms of our average borrowing costs. That has de minimis effect on our earnings, about JPY 800 million. So it's -- and we forecast for it. It's not an issue at all. So the one thing that's going on that is clearly a negative for everybody in the real estate world, and that includes us because we do have borrowings, is that interest rates have gone up. It is overwhelmingly far more important, the other factor, which is that interest rates are going up because inflation has gone up, replacement cost has gone up. The competitors and their ability to compete with us has gone down. And so the ability to organically drive rental growth from our assets is the highest it's ever been. The ability to deploy our value-add capabilities at low cost and add value to our assets is the highest it's ever been. But we should be clear. It's probably, I'm going to use some numbers just so that they're helpful for you, 70%, 80% wind in our back, maybe 10% to 20% wind in our face. The 70%, 80% wind in our back is what I just talked to you about our increased competitiveness in the world of higher inflation and, call it, 10% to 20% wind in our face because of interest rates. So one of them is obviously far more powerful than the other. This is what our business looks like across the board. I'm just going to run forward. Hopefully, we have some things to talk about in question-and-answer. You can see we had net acquisitions year-to-date. Although most of it is Ichigo Owners, which turns over really, really fast. And the standard real estate purchase, most of that was actually a building we brought up in Sapporo, which was very, very [indiscernible] an example of us doing development. We hardly ever do it. So it's like -- it's not quite a once in a lifetime, but very rarely happens. So general activity [indiscernible] the high turnover to Owners going on, and we'll consider -- we expect to have significant sale activity in the second half, some of which was already contracted for, as you can see on this page. So looking on the far right, you can see both acquisitions and sales activity. Again, overwhelmingly, it's in the high turnover to Owners business, which continues to go very, very well. You can see on the right-hand side, there are executed contracts already, and this is how we have some insight already into what our second half profits look like because, of course, purchases don't generate profits, but sales actually generate accounting profits. This is one of the things we've always felt about our business, underestimates the economic value created because accounting profits are only shown when you sell assets you added value to. We continue to have substantial growth in the unrealized gains in our balance sheet. And that doesn't appear in the accounting profits, but it is something that we have insight into. We have right now about JPY 110 billion of stated shareholder equity. The third-party appraisal value of what our unrealized gains is about JPY 76 billion. We're generally selling our assets for over twice what the third-party appraisers think. So that puts us at JPY 152 billion. So in reality, we have overwhelmingly, we have, in fact, kind of 2.5x of shareholder equity relative to our stated accounting shareholder equity. And that's because all the value we've continued to create over time with our value-add activity. Bunch of segments, they move around this portfolio, that's fine. So Asset Management up 60%, Sustainable Real Estate up 38%, Hotel down 57%, Ichigo Owners up 39%, Clean Energy down 17%. So moving double digits. And the net of it is you end up plus 3%. in the full year, we expect to be up over 20%, to 21%. And the remote has failed. SRE, Sustainable Real Estate, business profit is up 38%. Some decrease in stock earnings, although it was higher than forecast because office rents continue to go up. But we had asset sales that are going to push down our stock earnings a little bit. I mean the thing that's incredibly -- I mean, fabulously [indiscernible] I think everybody on this call is familiar with our very big asset, Tradepia Odaiba. Occupancy growth continues to be fantastic. We actually are showing here 99% occupancy. I think the real number is 99.7%. We've rounded it down. So that is an asset that is performing extraordinarily well. We have an average rent in Japan, this is something you know, we use this thing called tsubo as a unit of area. It's 3.3 square meters. But anyway, the average existing rental is about JPY 16,000. We're currently filling at JPY 20,2000. So it gives you about 20% upside. That is an asset, as you also know, that's for sale. So we have a very, what we think, is going to be a very powerful sale process in terms of monetizing this asset and the value that we brought to it on behalf of all our shareholders. Flow earnings up 63% as of the first half. We expect to see a lot more in the second half. This is an example of -- we like to at least, on one slide, every single quarter, show you what we do. Because at heart, we don't bet on red and black. We are not a leveraged play in Japanese real estate. We are a careful -- and we truly are, a careful acquirer of assets that we can add value to and make them better and generate higher value for the tenants and, therefore, higher value in terms of NOI generation for ourselves and ultimately for the owners that we sell to. And so this is an example of an asset we bought 2 years ago. We are increasingly converting into what we call ready-to-move-in offices. Perhaps you know this, but in Japan, living costs are extraordinarily high. It is -- the tenant pays for, the tenant also has to take the asset risk and return it to its reasonable conditions. So exit costs are really, really high. So one of the unmet needs for tenants in Japan is to just make the office ready for them. I mean you do all the fit for them. We are a very large, experienced real estate firm, so another reason, and we do construction, we do engineering, structural engineering. So another issue is that we have both kind of capabilities in doing this and economies of scale that a small tenant will typically not have. And remember, we serve mostly SMEs. So we can actually do this for tenants and command much, much higher rents, and the math works for them. I mean it works fantastically well for them. So this is an example. When we bought the building, we had floor that was empty. So we filled it with 3 ready-to-move-in offices. We've increased the rent. Rental income is up 1.8x to 2.1x. We're forecasting in totality 1.8x NOI, which is -- and will be full. So this is going really well. We're looking for other opportunities in the area. This is -- Hongo is near Tokyo, Tokyo University. And so there's a bunch of start-ups there and a lot of new activity there and a significant demand for this kind of office space, which we're providing. Hotel business profit is down 57% year-on-year. We expect to have no flow earnings in this segment. And so it is expected to be down, and we will deliver on the expectation. Again, we have other segments as a portfolio business. We expect the full year forecast to be down in the segment down 29%, and that's fine. So we will still have record earnings as a totality because we are a totality with different segments and different exposures. RevPAR, I told you there's overwhelmingly a wind in our back. I mean look, hotels have been weak. We should all recognize that. We have RevPAR down 12%. That's 2 things, is continuing effects and we're going to have the kind of the same-store sales effect roll off on this. But as you know, China was coming in massive size in Japan and then there's a diplomatic dispute between China and Japan and Chinese travelers drop off. So we're seeing a drop-off in RevPAR from that, from Chinese inbound. We've also had a drop-off in Osaka and Kyoto from the end of the Osaka World Expo. So RevPAR is down 12% in total based on kind of 20%, 30% drop-off in Osaka and Kyoto. RevPAR for Tokyo, Fukuoka and others are up about 5%. Despite the RevPAR decrease, total room revenue was up 16% because we have new hotel acquisitions and openings. And as you know, we took some hotels offline to make them better, as we do, and brought them online. And so the full contribution from that is going to happen in the second half of the year. Owners business profit up 39% year-on-year. We actually expect it to double. So there will be relatively explosive earnings activity out of Owners in the second half. And at the core of what Owners is, is we serve investors and -- tenants and investors to drive growth. We call this a [ fabulous ] business model. I mean it's slightly different from other Sustainable Real Estate activity, meaning that we contract with developers. We design assets. They build them to our specs. We buy them after they're built. So we don't take the development risk on this. We then lease them up really quickly. But we now have this massive database on what tenant needs are in one area. It's a very high turnover business with very, very high returns and continues to grow well. Asset Management business, BPE business profit up 66% year-on-year. Look, we've talked about this before, we actually -- so we're above what the full year forecast looks like. A big driver of the returns in this business is performance fees on -- and we get performance fees only if we have gains on sale in assets in our listed REITs. We do not control the listed REITs. That is a different governance structure, has different shareholders. We're not about to start the year by saying we forecasted we're going to make these returns on sales in the REITs because they can do this because that is not something that we can actually speak to. So it results in a structurally, forgive me for this but we haven't figured out a better way of handling this, and if you have any ideas on it, we don't forecast in performance fees at the beginning of the year. And so year after year, our REITs work their assets really, really hard. I mean we are ready to go. We have the same value-add activity there. We end up generating these performance fees. And so what happens is we systematically outperform our asset management forecast because these numbers come in. So unsurprisingly, we've had a big return in the first half. We may well have some stuff in the second half. Again, I can't speak to that. So that's coming in above our forecast, is effectively it's going to happen every single year. And we're trying to grow the Asset Management business. It has gotten harder because there -- it's gotten harder in some of the growth -- I mean, in general, real estate share prices -- operating company share prices are down, REIT share prices are down. We care a lot about generating accretive activity for our shareholders. We don't want to do new issuance on the REITs unless it serves their interest. It's gotten harder with rates going up to put out, for example, security tokens at levels that are attractive to investors. So there is an element, as I told you, the 10% to 20% that is a wind in to face with rising interest rates. This is a slightly different issue, the fact that real estate and REIT share prices are low. So this is a little bit -- you can toss this into the same 10% to 20% drag wind in our face as opposed to wind in our back. But we will -- we like the business a lot, has fantastic returns on capital because it really -- it's hardly -- no capital to speak of going into it. We will continue to see how we can innovate in this space to generate ongoing returns. Clean Energy, down a little bit. We forecast it to be down because there were some maintenance -- one-off maintenance activity. We had a lightning strike. That's pretty unusual. Although global warming is real. And you should know that things like floods, of course, are pretty obvious to people. Lightning is also increasing across the world. So that was interesting. We had it covered by insurance. We had mostly covered by insurance. Anyway, this is a business that's basically on track, as expected because it's a really stable business. We're looking at building out battery storage activity and green biomass. This is a business, again, we would like to grow. We completed JPY 5 billion of buyback earlier this year. We announced a JPY 5 billion buyback today. We think the shares are extraordinarily cheap. Of course, it's our job to get the shares to a level higher than extraordinarily cheap. So we'll continue to work on that. But if the shares are cheap, we can deploy capital against them in a way that we think is accretive for shareholders. We think that is the case today by buying the shares in at the current share price, which closed today at JPY 386. Basically, 8x earnings, trading below NAV. When you put it in unrealized gains, we think the shares are very, very attractive. We will have a second consecutive double-digit dividend increase. As you know, we will run out of room at some point in time on buybacks because there are minimum requirements for the free float. We will, therefore, be shifting towards dividends when that happens, and you should continue to expect to see significant ongoing dividend increases. Global warming is real. We think it's -- we need to be responsible and, of course, in a powerful way in generating high returns to our shareholders. But we believe our shareholders join us in recognizing that it is our corporate responsibility to do the right thing for the world, and we are doing so. So we are climate positive. Our CO2 reduction activity is 11x of CO2 emissions. We have 100% of renewable electricity across all -- each of our operations. We are CDP double A List. There's only like something less than 20 basis points of all companies in the world qualify for that. So we are recognized as being best-in-class in our sustainability, and we know that's important to you. It's important to all of us also. Those were, as it were, my prepared remarks. I'm now happy to take any questions or comments from anybody. Thank you so much for your time.

I have a couple of questions. The first one is, as you mentioned, you guys bought 3 offices in the first half. So the amount is a bit large. Should we understand that this is partially asset replacement for the Odaiba building?

No. I don't know if I would describe it as asset replacement. But yes, we think office is really interesting. Having said that, the JPY 11.5 billion of that is the Sapporo building, which is -- which was kind of -- which was development and different. So it really is I should turn to the page where we have this. Can somebody take us to the asset acquisition page? So yes, off the top of my head, it was about JPY 4 billion of kind of office acquisitions. And quite honestly, we'd like to do more. We're finding office to be really, really compelling. There is very robust demand, for offices, corporate profits are high. Corporations continue to compete for talent by giving them better and bigger offices. And the economics of new development have been absolutely crippled. And so it's -- and I've said this before, but people talk about Japan, it's like you can never raise rents and it's because it's an open development market, which is true. But that was only half of the issue was that Japan is very pro-building. It's easy to get approvals to put up new developments of any sort of real estate. But the issue historically has not been that somebody can put up an office next to you. It's that they can put it at the same price because there was no construction inflation if you put up your building 20 years ago. So you can never raise rents. And what's happening now is literally new offices are coming online and they have to have rents 40% and 50% higher. And the numbers don't work. So they're not coming on. And so the supply is being restricted and the ability to provide high-quality, as I say, we improve offices, is a very, very powerful way to deliver value for tenants and therefore, our shareholders. So office, we think, is the most powerful place to be. So I mean the good news is we bought 2 assets. The bad news was it was only JPY 4 billion worth; we'd like to do more. So yes, we expect to sell Odaiba. We will sell it at very good levels. And we'll have a process, which is -- it's a big asset. It's a very big asset. And so we'll have a process that puts some months into it in terms of getting the best price and having a robust competition for it. And we will figure out a way to replace that Odaiba with office assets over time. But it's not so much as Odaiba office replacing as it is office is really attractive. It's money we made and we want to do more there. Does that make sense?

Yes. And then my second question, if I could, is on the target AUM. So given the current situation, should I understand that this is more kind of an aspirational target at this stage? Because it's going to be hard to grow asset to 400 billion in the second half, I guess?

I think that's right. Yes.

And then my last question is the buyback. So as you mentioned, from your point of view, the current share price makes sense to do a buyback. But then you guys were already sailing pretty close to the wind in terms of free flow versus stock. And of course, even outside of that, if you cancel shares and if you buy back and cancel sales, then your liquidity goes down, so which means from a large investor standpoint, it's kind of harder to buy the stock. How are you guys thinking about that as well?

You're on the right topic. There are some trade-offs here, but we think overwhelmingly, it's the right choice to -- if your shares are, we think, extraordinarily discounted to fundamental value to buy them in. You should know that probably at this point, we have about JPY 8 billion worth of buybacks that we could do before we run out of room with the TFC free float. So we should all understand that those are shifting towards dividends, and that's fine. So yes, all the points you raised, I completely agree with. And thank you so much for your extraordinary intelligence always and forever. And that's what we have left on the buyback activity, and we're going to shift to dividend.

I mean I'm sure -- obviously, I'm sure you understand all this, Scott, but I guess one issue with a mid-cap like yours is that the free float itself can also lead to a discount. And so it's a bit chicken and egg. You're buying back shares because the share price is cheap, but then institutional investors will say, well, we can't buy the stock because there isn't enough liquidity and then -- and so the discount doesn't contract [indiscernible].

Yes. I mean, yes. And it's not as if we trade by appointment. We trade every single day. And so I think our -- yes. And we should be thoughtful about this. And we think the buybacks are a good value. We're certainly not going to fit the shares out. And ultimately, we think our -- I mean, we have an opportunity to grow a lot of value. We should demonstrate that and the shares will go up as a result. There are enough kind of small and mid-cap also institutional investors. We have connections with literally tens of thousands of individuals. I'm comfortable that with the right outcomes, that we can move the shares higher and we need to do something on that. It will be interesting to see as we become a far higher dividend payer, how that affects our kind of individual shareholders. My guess is they're going to like a lot, and we'll find that together.

I guess one -- I know you can't comment on that, but one suggestion would be if you have a decent extraordinary gains as a result of the big asset sale in the second half, maybe pay a special dividend as well.

Yes. Yes. We're open to all ideas. Will, thank you very much. We will take you off mute.

Great. Could you explain to me why the tokens are impacted by rising rates? Just sort of -- I just didn't quite get that. You ran through it fairly quickly. That's the first question.

So I mean, the token product is -- it's our -- so these are securitized tokens, so our underlying real estate. And the securities firms who put them together want to have the kind of the highest possible dividend. And so they did -- and so as you know, for our company and for our REITs, we generally hedge to have 50% or as high as 70%, 80% fixed rates. But securities firms didn't want that. So we did this with floating rates. And so what's happened is, as rates have gone up, it's pushed down the dividend and it's pushed it below kind of where the securities firms want to have in terms of selling a yield product. So that's the answer. Rates have gone up, and it is -- and there has been no protection from the rates going up. Now what's happening also is that rents are going up. And so in reality, if you're not totally focused on dividend yield, there's an opportunity -- a capital gain opportunity, which is extraordinary. And we actually liquidated our first security token. The yield that we marketed to the investors was an ongoing 4%. We ended up giving them double that, 8%, in terms of annual return. But this is a market which is currently intermediated by securities firms and they -- and so the math doesn't work for them. So it's kind of going into a pause right now. And we'll have to think together whether or not we restart it. It's something that you go doing something totally different or with the securities firms with the investors, it's not a pure yield play, but something that's yield plus capital gain. But for the moment, as I say, rising rates has impacted the dividend yield on these tokens, and it's below where the securities firms want to sell. Does that make it clear?