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

This is Noboru Yoshimura, President of Ultrafabrics Holdings. Today, I would like to talk about our 2024 results and revised midterm management plan from 2025 to 2027. First of all, 2024 results, we didn't achieve original plan, except for aviation, and we revised down our 2024 plan after the announcement of second quarter. We ended up with the revised plan. Outside the environment, yen depreciation continued, which is favorable to us. On the other hand, there are some headwinds on EV side and the growth of EV market went down from a growth of 31% in 2023 to growth of 25% in 2024, which lead to our revised 2025 to 2027 midterm plan. When we talk about 25% growth of EV in 2024, except for China, the market in North America growth grew by 9% and the market in Europe went down by 3%. So in those markets, which are our main markets, the growth of EV market slowed down a lot. On the furniture side, U.S. economy remains strong, but high interest rate and trend of work from home hit the commercial real estate market and which also hit our business as well. Next, I would like to talk about result-wise -- sales result by segment. Our original business, contract and health care, we have some challenges in those markets, but our sales in new business such as outdoor -- residential outdoor and hospitality went up by a lot. And overall, contract financial result, our financial sales in 2024 is slightly better than 2023. So our business improved throughout the year. We didn't have a good first half, but the second half was very good. For automotive business, for seat applications, due to the model change of our customer, the sales number went down by about 13%. We have a very good business in aviation in 2024. And especially in 2024, we opened new many accounts. And also our corporate business is very well in 2024. So throughout the year, the business grew by 31.3% in 2024 compared to 2023. In commercial aviation business, this is a repeating business, which grows as the number of customer increases. So the customer coming back to us to retrofitting their planes every 4 to 5 years. So the number of accounts increases, our business in the future will increase as well. In other area, this segment includes RV, marine, truck, apparel and especially RV and marine are hit by high interest rate and apparel is hit by very slow economic situation in Europe. So overall, as a segment, the sales decreased by 22.5%. Next, I would like to talk about the profit and loss. Our sales in 2024 is about JPY 20.3 billion. Our operating profit, JPY 2.8 billion and net income is a little bit higher than JPY 1.6 billion and EBITDA JPY 4.5 billion. So despite the yen depreciation, operating profit went down by about 20%. Regarding our net income, in 2023, our effective tax rate was lower compared to 2024 due to APA advanced price adjustment and net income went down by about 30% due to the increase of tax rate. On cost side, we continue to see raw material cost increase, partly due to the increase of logistic costs in Japan, but the general profit margin improved by 0.8%, mainly due to yen depreciation. Increase of SG&A is mainly result of yen depreciation. Next, I would like to talk about our cash flow. Our operating cash flow is -- we pay less tax in 2024 due to the lower tax rate in 2023. So our overall operating cash flow increased by JPY 713 million to about JPY 3.6 billion. About investment cash flow, investment cash flow is negative of JPY 3.6 billion due to the investment -- sorry, investment cash flow is negative of JPY 2.9 billion, mainly due to the investment to Chiyoda plant. Our financial cash flow was negative of JPY 1.5 billion. There are repayments, we continue to repay our M&A loan, whereas we -- and the new borrowings for Chiyoda investment. And net payment for loan is JPY 647 million, and we paid JPY 715 million for dividend. So altogether, our financial cash flow was negative of about JPY 1.49 billion. Overall cash flow is negative of JPY 721 million and net debt-to-equity ratio stayed at 0.8. Net income was down by 30%, but debt-to-equity ratio stayed at 0.8, which we believe very sound. And with the future cash flow projection, we maintained our dividend at the same amount, JPY 39 for common shares and JPY 85 for preferred. Consequently, dividend payout ratio went up to 44.1%. Next, I would like to talk about who we are today and what -- how we're going to would like to be in 2035, which is 10 years from this year. We are basically -- today, we are basically a global niche company with a premium material and products. And we produce our products in Japan and sell most of them in North America and a big amount is occupied by a big customer. And also, our brand is not well recognized, except for furniture market in North America. We thought about how we would like to be in 2035, then decide what we are going to do in next 3 years. We would like to grow our business 10% per year in next 10 years. To achieve that, we continue to develop, produce and sell high value-added products with high performance, good design and sustainability story. From a regional standpoint, our business is right now concentrated in North America, but we would like to diversify our business to Europe and Asia. We continue to try to achieve operating profit margin of 15% and EBITDA margin of 25%. So what we are going to do to achieve those goals? First of all, our primary focus area for the next stage is Europe. We have operation in Europe, but we would like to expand our business more in Europe and decrease the concentration in North America. Right now, we don't have any business in Asia, except for some existing customers in China, but we would like to expand our -- initiate our business in Asia with -- in the form of joint venture with a partner. We already have competitive products, but we'd like to continue to improve, especially by enhancing our sustainability story. On a product -- on the brand management side, Ultrafabrics brand is not well recognized in Japan, and they are recognized in North America, especially United States, but we'd like to increase our brand recognition outside of North America. Overall profitability will go down or stay below our target for the next 3 years due to various actions for the future growth, including investment in Chiyoda and production out sourcing. Also on the joint venture side, we'd like to -- we are outsourcing our production to our domestic partners, but we would like to expand our production capacity through the form of joint venture with partners overseas. Why we are doing this is that we would like to utilize DKK capacity for high value-added new product in the future. So we need to transfer our existing business to outside of DKK to do that. Again, our numbers in 2024 is well below our original targets. And on the strategy side, there are things are going very well and there are things that are delaying. So this is a very mixed picture. So priorities in next 3 years will be business expansion through joint ventures, further promotion of sustainability, improvement of profitability and European strategy. We put our concrete action plans on the slide, as you can see. And most -- from a regional standpoint, Europe is primary focus. We couldn't do a good job in 2024 and would like to review our strategy for European business, what to do in the next 3 years. Regarding production capacity expansion, our domestic partners are ready for production by the end of 2024, and we are going to set up joint ventures with our overseas partners in 2025 with an SOP target of 2026. On sustainability, construction of our sustainable Chiyoda plant has been completed by December 2024. There are various actions we are taking to reduce CO2 emissions and we'd like to achieve our goal, reduction of GHG emission by 42% in 2030 compared to 2021. To improve profitability, production costs remained relatively high due to the various factors, including a decrease of production volume, but we will try our best to reduce production costs as well as increasing selling price by increasing the value of product, including enhancing the sustainability story. I'd like to talk about our partners in -- for our joint venture. The first one is Simil Cuero in Mexico. They are producing a polyurethane leather right now. And they have already started to supply their products to Ultrafabrics for RV and furniture applications, which is expanding -- it is expanding very well. Except for the products that Simil Cuero is producing right now, we are going to set up a joint venture 50-50, and we are going to have a production plant in Mexico to supply products to -- mainly to North America. And as they are also a PU manufacturer, we would like to codevelop new products with new technology. We will start production in 2026, and we would like to start making profits in 2027. And on the sales and marketing side, Simil Cuero can produce more cost competitive products, and we can do that in our joint venture. So for more cost-conscious customers, we would like to propose a combination of premium DKK products for the area that people often touch and the cost competitive products for other areas to reduce overall cost for our customers. The other one is a joint venture with BMD in India, which we announced in last August. In this joint venture, our ownership will be 45%, which is going to be a minority. We are going to produce products in India. And first, we are going to market them in India, then we'd like to expand that business sales area in other Asian countries. And as you know, Indian automotive market is growing very rapidly. So we can expect very high growth in this market. But production cost in India, we can lower the cost -- production cost in India, including personnel costs. So we will have a very cost competitive products out of India to sell India, in Asia and in the future globally. We will make final decision by the mid of 2025 to see -- to go or no go. And we will -- if we say yes, then we will start producing products in 2026, and we would like to start making profits in 2028. So as you can see in this slide, with those joint ventures in Mexico and India, we will have a very good global coverage. From a management standpoint, we are going to cover the whole world for sales as well as production. So we need to think about how we're going to manage the very wide area for production and sales and marketing. So we are very lucky to have a very, very good partners in Mexico and India. So about sustainability, promotion of sustainability, I would like to explain our Chiyoda plant completed in December of 2024. This is basically replacement of aged Gyoda plant, a part of Gyoda plant, but we renewed the plant with a leading-edge sustainability technology. So what we have here, we have -- we are going to use hydrogen as a source of energy, and we are the second company in Japan to do that. So this is a very leading-edge action. But if we increase the ratio of hydrogen, the cost of hydrogen is probably 7x to 9x of that of natural gas. So we will start with 25% of hydrogen. And then when the price of hydrogen goes down, we will move up to 100%. We also have a water recycling system, and we are going to recycle 60% of water. We have already installed solar panels in Gunma, and we are also going to -- we also installed solar panels in Chiyoda, which reduces 400 tonnes of CO2 emission a year. We are also going to utilize the heat out of our facility in Chiyoda and for the heating, and we would like to use well-water under the ground for the cooling, which is basically the same concept that was used in Olympic Games in Paris. So overall, we invested about JPY 1.6 billion for those facilities and the cost per year will be about JPY 280 million. So we are going to enhance our sustainability story, and we would like to increase the value and the price of our products with this sustainability story. So I would like to talk about the numbers from 2025 to 2027. We are expecting our original business, contract and health care will be coming back in next 3 years. But we have already a relatively high market share, and we have a lot of customers in these applications. So we cannot expect high growth in our furniture business, especially in North America. So we have already started promoting our business in new areas for us like residential outdoor or the business with the [indiscernible] and also hospitality, which can grow higher than our original business. On the automotive side, we have already awarded -- we have already been awarded several EV programs, but our OEM customers pushed out those programs to -- from 6 months to 1 year, which is reflected our revised sales projection. We also reflect some slowdown in the EV market overall, but we believe this is just a delay. There's a future for the EV business, and we are going to catch the growth in EV business in the future by adding new programs. For aviation side, our business has grown a lot in 2023 and 2024. So the number from 2025 to '27 look a little bit conservative. But as I mentioned before, the number of customers has increased significantly during the last 2 to 3 years. Also, we are trying to increase -- further increase our customers. So there is a good chance that we can achieve the higher number than the numbers that we are showing right now. In other applications, 2024 was a very bad year. So we expect the situation will improve. But we don't know by how much. So we're basically expecting the business will go back like numbers in 2022 to 2023 throughout 2025 to 2027. And then the business will go back normal growth. So I would like to talk about our targets for the next 3 years. In 2025, we are targeting at the sales of JPY 22 billion, operating profit of JPY 2.9 billion. Gross profit margin will go down to 49.3% compared to that of 53.3% in 2024. Foreign exchange rate was JPY 151.6 in 2024 on the average and our budget rate for 2025 is JPY 150. So they are not influenced our numbers significantly. With that foreign exchange rate, our gross profit margin went down -- will go down by 4% due to the outsourcing. If we outsource our production, our partner, there's a cost on our partner side and the profit that we are getting by producing by our sales will be on our partner side. So our gross profit -- our sales will go up in 2025, but also the depreciation of Chiyoda Plant will start in 2025. So overall, our gross profit margin will go down significantly. And joint venture both joint ventures will start 2025 and the investment goes fast. So there will be some allocated loss in 2025 and 2026. So we are expecting our operating profit will be better in 2025 than 2024, but operating profit -- our profit before tax will go down. On the effective tax rate, depending on where the profit goes in Japan or in the States, but we are taking a little bit conservative approach with regard to the tax rate, and we are expecting our net income in 2025 will be JPY 1.5 billion. So from a profit standpoint, we expect that 2025 will be challenging, but they will be coming back in 2026 and '27 as the sales goes up, and we expect EBITDA in 2026 will be JPY 5.5 billion compared to JPY 4.5 billion in 2024. ROE is one of our KPIs, but ROE, we expect our ROE in 2027 will be 12.5% in 2027, which is lower than our target of 15% and also lower than our number in 2023. But in 2027, our return of equity will exceed our projected cost of capital. So the difference between the midterm management plan last year and this year, we changed the foreign exchange rate from JPY 140 per dollar to JPY 150. And there are several factors that we are expecting lower sales. We believe that -- we expect that the office market, commercial real estate market in the States will not come back so soon. And we also expect -- as I mentioned, we also expect our EV programs of our OEMs, OEM customers will be delayed and production -- they are expecting production volume will go down. Regarding cash flow. In 2025, we are expecting some increase of operating cash flow, and we are going to have less investment in our facility. We made a lot of investment in 2024, but that investment will decrease in 2025. And on the spending side, we are going to make an investment in joint ventures, which will start 2025. So net debt in 2025, we are expecting our cash flow will stay relatively neutral without increasing borrowings. And in 2026, as in 2027, the operating cash flow will increase and we will repay a lot of loans, but we will have some excess cash flow. And this is because the business will grow without investment because of our strategy of outsourcing and joint ventures. So we are expecting next 3 years, we will spend less money and increase sales, getting more cash flow. And consequently, net debt-to-equity ratio will improve by a lot. As of today, we are not expecting a big capital investment by ourselves. So with this excess cash flow we are expecting, if the plan goes well, the debt-to-equity ratio will go down by significantly. So of course, it is really up to the results each year, but we'd like to consider to including -- consider the increase of dividend as well as share buyback for our shareholders. So next, I would like to talk about what we are thinking about cost of our cost of capital and stock price. Through the discussion with various investors, we believe that our cost of equity is around -- is somewhere between 11% to 12% and WACC at 7% to 8%. And unfortunately, our ROE is below our cost of equity, which is not good, and our ROIC is lower than WACC, which is not good either. So how are we going to improve this current situation? Our PBR is peaked in 2022 and now it's below 1.0. And PBR fall because of the decline of return on equity and decline of PER. And lower ROE is a result of lower net income margin and lower financial leverage. Lower PER is a result of rising cost of equity, which is higher beta and lower expected growth rate. So what we would like to do during next midterm management plan from 2025 to 2027, our -- not really a target, but we expect that our return of equity in 2027 will improve to -- will be 12.3%, which is above cost of equity, but it's still our target of 15%. We choose 15% as a target because 60% of S&P listed companies, their return of equity is above 15%. So we believe that to be considered as one of the excellent companies, our ROE needs to be above 15%. So what we're going to do is there are 3 things. First thing is that lower the manufacturing cost, and we also increase our sales price by adding values to our product through sustainability promotion and by lower the fixed cost ratio by -- through the sales growth. Our target of asset turnover is 0.8 from 0.5 in 2024. Our asset for production equipment will go down through the depreciation and replaced by JV investment. And also, we are applying IFRS so that our intangible asset will amortize through years. So they will go down that will result in higher asset turnover. We are not expecting to add significant asset in next 3 years, except for the investment in joint ventures, which is not significant as absolute numbers. The financial leverage will decrease due to scheduled debt repayment, but we'd like to maintain appropriate debt-to-equity ratio and financial leverage by enhancing our return to our shareholders through the form of dividend and share buybacks. So ratio between operating profit and net income was 58.5% in 2024. We'd like to improve this number to 70% by lowering interest payments through repayment and improved equity method income, which we are going to receive from our joint venture profits. So how we're going to improve our PER. There are 2 things that we need to do. The first one is lower cost of equity. And I think the most important thing is that we promote our understanding of our company to shareholders and investors via very strong communications. We believe we have been doing that, and we have improved that communication, but we don't think that's enough as of today. So the more -- we would like to have more shareholders and investors understand our business well so that they can be a long-term shareholders. And increasing the brand recognition on a global basis also contribute to the stability of stock price, especially when the numbers are not -- do not look great. Other thing that we need to do is to raise our expected growth rate. And we also need to -- we just need to promote the understanding of the nature of our business, but we need to promote the understanding of our growth strategy. So we have to be concrete what we are going to do to achieve 10% of growth on regions, on applications, on product mix. And also, we are going to a growing market like India and Asia and relatively new market or small market for us, which is Europe. So we are going to area that we don't have a big business today so that we can grow our business from a region standpoint. And we have already done this, but we need to have enough capacity to grow the business by 10% next 10 years. But we have already well prepared for that growth through the partnership from a partnership here in Japan and with the joint ventures overseas -- with overseas partners. So this is the end of my presentation. Thank you for your time. Goodbye.