Ultrafabrics Holdings Co.,Ltd. (4235) Earnings Call Transcript & Summary

Hi. This is Noboru Yoshimura, President of the Ultrafabrics Holdings. Today, I will report 2023 results and the new midterm management plan for 2024 to 2026. One of the issues that we faced in 2023 is the movement of our stock price. Our stock price of our company has been very volatile in 2023. To avoid excessive volatility, we think it is very important to tell a convincing mid-term and midterm and long-term growth story to the market. In this presentation, I would like to explain our premier product strategy to achieve both growth and profitability, focusing on sustainability as a peer. This is a picture of our product which is wet-base polyurethane leather. I would like to talk about the overall synthetic market and how our business and product is positioned in that market. Materials for interior and furniture, the basic material is fabric. And we have PVC, which is a basic coated products. The price range for PVC is pretty much similar to or a little bit higher than fabric. Polyurethane leather or PU is a lighter and softer than PVC at a higher price point. There are 2 types of polyurethane leather: one is wet and the other one is dry. The one that -- the wet is the one that has a foam layer, which is second from the bottom in the picture, which brings nice hand haptics to the product together with a good design and performance. And it is positioned as the highest price point in the synthetic market. This is -- and this is what we produce and sell in the market. And we produce this product with what we call Takumi Technology, which is a Japanese craftmanship. This is a picture -- diagram of our overall synthetic market. There is a trend from genuine leather to synthetic and also there is a trend from a fabric to coated materials. And those 2 trends is the -- growing the market. In this data, in 2022 -- in 2020, the size of the market is $84 billion or JPY 13 trillion, which will grow to almost JPY 26 trillion in 2031 at a growth rate of 7.2% at per year. The other day, there was article in the Nikkei, which says less and less beef is consumed in developed countries like U.S., Europe and Japan. For example, the article says that USDA reported that the number of beef cattle in U.S. is the lowest in 63 years. So especially in advanced countries, people are moving away from beef and consume less and less beef. Also, United Nation reported that the greenhouse gas emitted by human beings, about 30% of GHG is from -- is food-related gas. And out of that number -- over 3/4 of that number is coming from cows. So with this trend, we believe that people moving away from beef more on more consumes less and less beef, less and less cows and also the genuine leather market will shrink as genuine leather is a byproduct of beef. So this is the overall market trend where I say that it is going to grow. And where we're going to position ourselves in this growing market? This is a kind of simple diagram showing the structure of the market. And as you can see, the price point is low, middle and premium and obviously, the market for low price point products is larger, and that for premium product is getting smaller. And in that low price point category, fabric and PVC is the main products. And in the middle one, dry PU and some part of PVC is there. And in the premium market with PU and some dry PU are included. And we are targeting at this premium category, which basically replace genuine leather market. To be in this premium category, products need to have strong sustainability story, good design and haptics and high performance. I will explain later in detail why sustainability is so important. The first contact of our customer is always a designer -- designers in U.S. and Europe. Those people are very conscious about sustainability, and sustainability is very important for the future. And they tend to avoid using genuine leather and looking for alternatives for genuine leather like textile, fabric, PU and PVC. And they also look for material, which is premium and luxury. And also those clients -- customers request us to show the road map to net zero. Like -- company like Apple requires their suppliers to be carbon neutral in -- by 2030. So we need to be sustainable and make Ultrafabrics as a sustainable brand to be in a premium category. And for the sustainability store, you have to do 2 things. One is we need to have a sustainable products, and we need to have a sustainable production process. So what is the product sustainability? One of the strengths of our products is good hand, haptics, comfort and credibility. This makes product very premium. And what we are trying to do is trying to use sustainable materials for -- to use sustainable materials to produce our products like biomaterial or recycle material. At the same time, our product has a long life to reduce waste. This is the advantage of fabric, which tends to have a shorter life. Also, our material is very light, which contributes to reduce the CO2 emission, especially of EV and aircrafts. So these are the characteristics of our products with why our products are very sustainable. But we developed more sustainable product that the good one is Volar Bio. This is for furniture application. And we co-developed polyurethane resin containing biomaterial with a resin supplier. And we also use biomaterial for backcloth as well. And we get certificate from USDA of their bio-preferred program which requires to -- which requires products to contain more than 25% of biomaterial on a weight basis. Our customers really love this product, although this is very expensive one, but they would like to use this Volar Bio material for their product. Next one is a good example of high performance product. In this product, Atago, this is for our aviation application, by the way. We use our backcloth functions as a fire block, which makes it possible to remove fire block from the seats and reduce the weight of the seat by about a pound, which is a huge number for our aviation customers. Obviously, the lightweight will contribute to the less fuel consumption and CO2 emissions and brings a great sustainability story to our customers. And another advantage of using Atago is that because we can remove fire block from the seat, the structure of the seat is simplified and cost less to our customers. Another example of high performance product is a Coast. This product has been developed for marine application which requires high anti-UV performance and also resistance to water because as you can imagine, the boat is on the sea under the sun and the water is constantly coming in. So -- and after we release this Coast, our outdoor -- residential outdoor customers love this product because there is a limited number of products suited for residential outdoor application and look luxury. One of our customers, Jensen Outdoor uses our product to come up their furniture -- outdoor furniture in that picture, which looks beautiful, and they get Best of Show award in a trade show. So those are the examples of products with sustainability story as well as high performance. And overall, we are -- right now, we have -- for the products for contract furniture, aviation, RV and marine, more than 50% of our products contain more than 50% of bio and recycled materials. By 2030, we are trying to have more than 50% of our overall products to contain more than 50% of recycled or biomaterial, and that's our target. On the process sustainability side, we are now working on building a new plant, Chiyoda Plant, and we are trying to make this Chiyoda Plant as sustainable as possible. Right now, we have solar panels on the roof of warehouse at Gunma and also the roof of Gunma Factory itself. And obviously, we are going to have solar panels on the roof of Chiyoda factory, but that's not the end of the story. We are trying to introduce a facility to recycle water up to 60% at Chiyoda plant. In Japan, not many people care about the usage of water, but that's not the case outside of Japan and water conservation is worldwide issue. And whenever we have visitors from abroad designer or auditor wherever they are, they always ask a question how you going to do with the water that we use, and we say we are going to recycle it. And that is very important from a sustainability standpoint. For example, in apparel industry, some people say that we are going to use cotton because it's bio and sustainable, but some people argue that cotton is not sustainable because we need a lot of water to raise cotton. So this is a kind of compensation. We really need to -- we need to have with our customers who are mainly designers, as I said. We're also going to try to introduce hydrogen boiler in Chiyoda and we start with 20% of energy coming from hydrogen, but at the end of the day, we are trying to use hydrogen for all of our energies used in Chiyoda. We also use the heat of water coming from the underground as a source of heat or cool for the air conditioning system in the plant. Our sustainability target is to reduce greenhouse gas emission by 42% in 2030 compared to the emission in 2021. And this is our science-based targets or SBT, and we are satisfied for that. And we also have a target to reduce the water consumption by 20% in 2025 compared to 2020. And we are trying to control the waste from our production process by less than 3% of our production. We also care about business sustainability and we often talk about 5P: people, product, planet, partner and profit to make our business sustainable and we will continue to do this. With this midterm business strategy and development of innovative products, we could achieve both growth and profitability last 3 years. In 2023, our sales is JPY 21.5 billion and the operating profit margin is 16.8%, and our target is 15% to 20% so we achieved our target. By further promoting current business strategy and development of innovative products, we would like to have Ultrafabrics brand continue to be a choice for the future. And actually, our product is used in the space, and this is the picture of the inside of Virgin Galactic Spaceship. Now I will talk about the details of 2023 results. There is positive outside factors as well as negative outside factors. Obviously, weaker yen contributed to increase our sales and profitability, which is favorable to us. And also logistics disruption occurred after COVID settled down in 2023, which is normalized lead time and customer satisfaction increased. On the negative side, for the same reason because the logistics disruption has been settled, the lead time is normalized and inventory correction on our customer side occurred so that will reduce our sales to our customers, especially second quarter last year. And also the U.S. market, it was really difficult. Overall economy in the U.S. was robust in 2023, but the office market was fairly weak, mainly due to the continuation of work from home and also Fed raised interest rates for several times, which increased interest rate overall that adversely affected the consumption of luxury products like RV or some boats or marine toward the end of 2023. Also, the weaker yen contributed to the increase of sales and the profit part, at the same time, increased our SG&A in the U.S. on the Ultrafabrics side. Our focus in 2023 was, firstly, diversification of business. As I mentioned, we -- on the furniture side, we have been very strong in contract furniture and health care, but both those business segments remained weak throughout 2023. So with new product Coast, we focused on residential outdoor segment, which is not the big business up until 2022 and building a new sales team to increase the business in this segment. From a regional standpoint, our main region is obviously North America, but we expanded our team in Europe so that we can expand our business in Europe. We also strengthened our partnership to increase our production capacity. One initiative that we took in 2023 is one of our partner -- production partners started shipping finished products to our customers, the first achievement in our company's history. And we also look for a partner outside of Japan. And we also tried to utilize production facility or partner as our BCP option, which is very important for our customers. The other initiative we took in 2023 is we started a new warehouse. We have been operating our own warehouse in New York, more than 2 decades, but because the business is expanded and we also expect it's going to expanding. We need flexibility from a capacity standpoint. So we decided to move -- utilize third-party logistics and move our warehouse from New York to California. This achieved other 2 things. One is for most of our customers, this led to the shortening of the lead time and also the new warehouse cost -- saved cost for us. We also -- from a sustainability standpoint, we share our policy about human rights and compliance with our suppliers so that there's -- we could manage any issues with regard to human rights or compliance in our supply chain. I would like to talk about the new Chiyoda Plant again. The total investment is about JPY 5.8 billion and about JPY 3.3 billion will be used for the facility. There are 3 goals in this Chiyoda Plant. This is basically a transfer of old water-related facilities in Gyoda and we renew those facilities and make operation more efficient. The second one is integrate the inspection and package process. Now we inspect and package our products at both Gyoda and Gunma. We integrate -- we will integrate those operations in Chiyoda and make it more, more efficient. And in the current packaging process, actually, operators need to move the goods, which is relatively heavy. So it is very difficult to female operators to do that. But we are going to automate that process so that any operator, male or female, can do this job. And the last one and the most important one is that we are going to make our production process as sustainable as possible and we are going to spend JPY 1.6 billion for this sustainability purpose. Next, I would like to talk about the results of 2023 segment by segment. For furniture, 2022 was a record year for furniture and partly because of that -- together with that, the weakness in office market, the sales is down by 7.1% for furniture. And both contract furniture and health care are down in 2023, whereas we see some pickup in residential outdoor market, which we will continue to be focusing on 2024 and beyond. Automotive was relatively good, increased by about 20%. Again, the material for seat application continued to be strong, but the products for small parts also recovered from the COVID. So they did also well. Aviation was a real shining star for our business in 2023, increased by 48.8%. And our traditional business, our corporate VIP business remained very strong. And at the same time, our new business -- commercial aviation business grew by a lot. And we expect this trend will continue 2024 and 2025, at least. The sales is, with other applications, including RV, marine, apparel and golf groves, as I said, hit by a weak economy in the world overall. And the sales is -- was down by 11.9%. We are not expecting because interest rate is still high, and it is very difficult to expect or project when it is coming down. We are very conservative about the projection for RV and marine business for 2024. And also our main market of our apparel application is in Europe. And we are expecting the European economy remains very weak in 2024. We have a conservative projection for that area, but we are expecting that golf groves application will come back 2024. But the business in other applications was down in 2023 because of a weak economy all over the world, and we expect they are not strongly coming back in 2024. So as a result, again the sales is about JPY 21.5 billion, operating profit of JPY 3,546 million and net profit of about JPY 2.5 billion and EBITDA of JPY 5,186 million. So there -- those numbers are better -- all of those numbers are better than those of 2022. And we are pretty much happy about the gross profit margin of 52.5%, operating profit margin at 16.8% and EBITDA of 24.6%. Obviously, weaker yen contributed a lot to those numbers. And the average foreign exchange rate in 2023 was JPY 140.6 per dollar. One thing I'd like to mention here is that the effective tax rate in 2023 was low, which resulted in the growth of net income by 90.3%. And this is a result of advanced pricing agreement with tax authorities in U.S. and Japan. We did this agreement in 2018 after the merger between Ultrafabrics and DKK to avoid any tax disputes in the future. And the concept of APA is that there is -- the margin -- there's a range of profit for Ultrafabrics and for DKK. Like, let's say, the profit for the whole group is 100. And given the track record of results in the past, tax authorities agree that, this is just an example, say the profit of Ultrafabrics should remain in the range of 40% to 65%, whereas that range for DKK is 35% to 60%. And the range from 2019 to 2021, the split of profit remained in that agreed range so there is no adjustment needed. But from 2022, the foreign exchange market moved a lot towards weaker yen and we ended up out of range, which is basically more profit on DKK side and less profit on U.S. side. So we have to transfer some profit from DKK to Ultrafabrics to go back to the range that we pretty agreed with the tax authorities, and we did this tax adjustment as of the end of last year. So that leads to the lower effective tax rate in 2023 and pushed up net income numbers. So we did some announcement in January with regard to a revision of our 2023 numbers. But after that -- the announcement, there was some adjustments in this APA-related numbers as well as inventory numbers because we moved our warehouse from New York to California so there is some adjustments after that announcement, and we ended up with the numbers that we just -- I just talked and I apologize for that, we created some confusions in the market. So those are the factors that increase or decrease those sales and profit and the cost numbers, but I have already covered most of them, so I don't repeat that. From a balance sheet and cash flow, we spent a lot of money for the Chiyoda Plant -- for building the Chiyoda Plant, as I mentioned, which decreased investment cash flow, and we continue to invest some money for this Chiyoda-related investment. But we also repaid part of margin and acquisition finance so that net-net, our net debt-to-equity went down from 0.9% in 2023 -- 2022 to 0.8% in 2023. About the dividend, we have already announced that we are going to increase dividend to JPY 39 per share for common shares and JPY 85 per share for preferred shares because of the increase of net income as a result of good business performance as well as AP adjustment. And we have been taking that our target payout ratio -- dividend payout ratio is about 30%. So -- and we ended up payout ratio of 30.1%. So this is within our target. Now I'm going to talk about midterm management plan for '23 to '25. Most of the topics that we have already covered and we basically have done what we said we are going to do in 2023 to 2025. And again, we are trying to grow our business by diversifying our application, dividing -- diversifying our region from North America to Europe. And we're also trying to diversify our customer base to avoid excessive concentration to a certain customer. We also set a new goal. This is a kind of change from original 2023 to 2025 midterm plan. And we set a new target for R&D spending. In 2023, we spent 1.2% of our sales for R&D, which is -- which we don't think enough. So we set a new target that we are going to spend 2% of sales in 2025. And we will see some marginal increase of R&D spending in 2024. We also set a target of spending in sustainability-related activities, which we haven't had before. And we are going to spend 1% of our sales for sustainability-related activities. Our budget rate for our new midterm business plan is JPY 140 per dollar, which was JPY 125 per dollar in the previous midterm plan. One thing I would like to mention about new initiatives that we didn't talk in our previous midterm plan and actually, we did -- we started in 2023, is in furniture area. As I mentioned before, we try to expand the application of our products to residential outdoor. And also, we are trying to have a partnership with [indiscernible] whose customers are relatively small, especially in A&D or architect and design segment. And by co-working with [indiscernible], we can expand our customer base to smaller customers especially in A&D area. So this is a new initiative that we didn't talk in the previous midterm plan, but we actually started in 2023. With those initiatives in a new midterm plan, we are expecting the furniture business growing 11.1% on the average from '23 to '26 -- no, for furniture, our target is 13.3% per annum from 2023 to '26. For Aviation, our target is 11.1% per annum and in automotive area, we are expecting the business growth 16.3% per annum during the new midterm plan. I would like to specifically talk about our aviation business because we have -- we clearly have several advantage in this business. The most important one is the lightness of our product, which is basically 1/2 to 2/3 of weight compared to genuine leather or PVC, other coated products, which will contribute to the less fuel consumption and less CO2 emissions of our customers. And we also have very strategic innovative product Atago, which contributes a significant reduction of weight of each seat. And also, we are not selling just products but the solution, which is -- the main one is our main product, which brings comfort to passengers and Atago which contributes to the reduction of weight. And the third one is a very strong product for the, what we call, high-traffic area where people hit or baggage dropped and hit and for those areas, we propose the product with a very solid strength. And once we get the program, especially in the commercial aviation business in a program of a certain airline, they will replace the leather probably once in 4 to 6 years. So this is going to be a continuing business for us. So our goal -- our strategy is in this -- especially in this commercial aviation business is trying to increase the number of airline customers and also a number of programs that we get from those airlines. So now I'd like to talk about -- actual numbers of 2024 to 2026. Our sales target for 2024 is JPY 22.9 billion, JPY 4.1 billion for operating profit and JPY 2.4 billion for net income. ROE, return on equity, was 16.7% in 2023, we go down to 14.5% because we will sell more finished product -- finished goods produced by our partners, which reduces our margin in 2024. And these numbers will grow to 2025 and 2026. And our new target in 3 years in 2026 is JPY 30.7 billion of sales, JPY 5.1 billion of operating profit and JPY 3.2 billion of net income and JPY 7.2 billion of EBITDA. And with those numbers, the return on equity in 2026, we recover to 15.2%, which above our current cost of capital. We got a lot of questions about the sensitivity with regard to foreign exchange. And with a simple math, the impact on operating profit by JPY 1 per dollar is about JPY 60 million. So if yen weakens and goes under JPY 140 -- like JPY 141 per dollar with a simple math, our operating profit will increase by JPY 60 million. But the weaker yen will cause some inflation in Japan, importing cost in importing inflation, that will adversely affect our employees at DKK. So we would like to increase the compensation or salary for DKK people if the yen weakens. And also, if there is any excessive profit by weaker yen, then we would like to spend more money on people and for the future. So we will manage excess profit from weaker yen. And the opposite thing can happen when the yen gets stronger, but with a simple calculation, simple math, JPY 1 per dollar will affect the operating profit by JPY 60 million. So regarding our new midterm plan compared to a previous one, the profit projection won't be change in 2024, but we have a lower number 2025 because of the reduction of certain programs of our customers. On the cash flow side, one thing I would like to mention is that the investment in Chiyoda Plant will be picked out this year. So investment will go down towards 2026 and that will reduce the net debt ratio to -- from 0.8% in 2023 to 0.4% in 2026. Obviously, if there is any new investment opportunity, this number will change, but they are not in our current plan and nothing new happens, our balance sheet will be dramatically improved. And also, as I mentioned, currently, we have a policy of dividend payout ratio of 30%. But when the -- we have -- when we have excess cash, then we may reconsider and revisit this policy to avoid excessive reduction on ROE. So this is the end of my presentation. Thank you for your time, and I hope 2024 will be a good year for our business. Thank you.