Q2 2020 IHI Corp Earnings Presentation
Tokyo Nov 2, 2019 (Thomson StreetEvents) -- Edited Transcript of IHI Corp earnings conference call or presentation Friday, November 1, 2019 at 10:59:00am GMT
TEXT version of Transcript
* Takeshi Yamada
IHI Corporation - Senior Executive Officer, Executive VP & Director
* Tsugio Mitsuoka
IHI Corporation - President, CEO & Director
Takeshi Yamada, IHI Corporation - Senior Executive Officer, Executive VP & Director 
[Interpreted] This is Yamada, in charge of finance and accounting of IHI Group. I will explain IHI Group's financial results for the first half of the fiscal year 2019 based on the PowerPoint presentation materials disclosed at 3:00 p.m. today. This page shows the contents of the presentation today.
Please turn to Page 4. This slide shows consolidated results, including orders received and the income statement. Orders received were JPY 616 billion, down JPY 33.3 billion year-on-year. As shown at the top right, the average exchange rate for sales in the quarter was JPY 108.87 to the U.S. dollar, which was almost the same level as JPY 109.79 of the previous corresponding period. Net sales decreased by JPY 104.5 billion to JPY 594.9 billion. Operating profit was JPY 10.5 billion, down JPY 34.6 billion year-on-year, mainly due to lower sales. Ordinary profit decreased by a bigger degree of JPY 45.5 billion, down to JPY 3.5 billion due to deterioration of share of profit and loss of equity method affiliates and foreign exchange gains and losses. Profit attributable to owners of parent was a loss of JPY 4.8 billion, down JPY 33.2 billion.
Please turn to Page 5 for orders received and order backlog by segment. In Resources, Energy and Environment, orders increased year-on-year, mainly as a result of receiving an order for a boiler plant in Vietnam. In Social Infrastructure and Offshore Facility, orders received increased year-on-year due to new orders for automotive people mover projects in Japan. In Industrial System and General Purpose Machinery, despite the increase in the transport machines business, orders received declined due to the decrease in the vehicular turbochargers business and the thermal and surface treatment business which were mainly impacted by economic slowdown in China. In Aero Engine, Space and Defense, orders received decreased year-on-year in the aero engines and the Rocket Systems and Space Utilization Systems business, among others.
Overseas orders received was JPY 296 billion, representing 48% of total orders. The ratio of overseas orders increased due to receiving a large-scale order for a boiler project overseas despite the decrease in the vehicle turbochargers and the Civil Aero engines businesses.
Order backlog totaled JPY 1,487.7 billion, an increase of JPY 9.5 billion from the end of the previous fiscal year.
Please turn to Page 6 for net sales and operating profit by segment. In Resources, Energy and Environment, net sales decreased due to a delay in project progress in the boilers business and the reverse effect of the progress of large-scale projects in the plants business in FY 2018. Operating profit decreased due to profitability deterioration in some projects.
We, at the IHI Group, are striving to enhance the level of risk management, and cost increase factors identified in that process have been factored in the result. This was also a reason for a decline in profit. In Social Infrastructure and Offshore Facility, sales increased in the Bridges and Water Gates business. Operating profit increased in the Bridges and Water Gates business and the Transport Systems business. Sales in Industrial System and General Purpose Machinery decreased due to lower sales in the vehicular turbochargers business, mainly in Europe and China and also due to the impact from the transfer of the small power systems business. Decline in operating profit was mainly due to lower sales in the vehicular turbochargers business. Sales in Aero Engine, Space and Defense decreased in the Aero Engines for Japan Ministry of Defense and the Civil Aero Engines business. Operating profit decreased as a result of temporary decline in operating rate associated with resumption of the maintenance business in the Civil Aero engines as well as additional program costs. Overseas sales totaled JPY 293.8 billion, representing 49% of total sales.
Please turn to Page 7. This is a breakdown by segment of the JPY 34.6 billion year-on-year decline in operating profit. Change in net sales had a JPY 23 billion negative impact due to a decrease in regular inspection and repair work in the boilers business in Resources, Energy and Environment; decline in sales of the vehicular turbochargers business in China; and in Europe, of Industrial System and General Purpose Machinery as well as lower operating rate of the maintenance business in the Civil Aero Engines of Aero Engine, Space and Defense. Change in construction profitability had a JPY 13.6 billion negative impact. In Resources, Energy and Environment, profitability worsened in some projects as a result of reviewing the estimated cost in light of enhancement of risk management. In Aero Engine, Space and Defense, operating profit decreased due to additional program costs.
Change in foreign exchange hardly had any impact. A change in SG&A had a positive impact of JPY 2.3 billion in total as a result of the fixed cost reductions, mainly in Resources, Energy and Environment and Industrial System and General Purpose Machinery.
Please turn to Page 8 for nonoperating income and expenses. Net interest expenses worsened by JPY 0.7 billion year-on-year. Share of profit and loss in equity method affiliates decreased by JPY 7.5 billion to a loss of JPY 2.4 billion. This is attributable to a profit decline of Japan Marine United due to foreign exchange fluctuations, among other factors. Foreign exchange gains and losses deteriorated by JPY 3.5 billion. Others, which is a net of miscellaneous income and expenses, improved by JPY 0.8 billion.
Please turn to Page 9 for extraordinary income and losses. A total of JPY 5.6 billion extraordinary income was recorded, which is comprised of JPY 4.5 billion gain on sales of noncurrent assets through a partial sale of nonbuildings and structures of headquarters representative office in IT and JPY 1.1 billion gain on insurance claims for typhoon damage last year. Extraordinary losses of JPY 5.6 billion was booked, including JPY 5.5 billion losses on valuation of investment securities.
Please turn to Page 10. Here is the balance sheet. As of September 30, interest-bearing liabilities was JPY 411.1 billion, up JPY 56.4 billion from the end of the last fiscal year -- from end of last fiscal year. The ratio 1.12x, equity ratio 20.1%.
We please move on to Page 11, consolidated cash flows. Cash flows from operating activities was negative JPY 32.8 billion, a decrease of JPY 30.1 billion compared to the same period of the previous year. Major reason for the negative cash flow was the increase in inventory in the Aero Engine, Space and Defense segment, but the negative number should get smaller as situation of the Civil Aero engine maintenance business normalizes in the future. Cash flow from investing activities was negative JPY 39.6 billion, almost no change from the previous year. Free cash flow, combining cash flows generated by operating and investment activities, was negative JPY 72.4 billion.
Please turn to Page 12. On the upper half of this page, you'll see the actual results of R&D, CapEx and depreciation and amortization. R&D expense was roughly the same as the previous year. CapEx increased by JPY 11.9 billion year-on-year. This was mainly because of the new plant for civil aero engine maintenance we are currently constructing in Tsurugashima.
Lower half of this page shows overseas sales by region breakdown of the overseas sales figure we had on Page 6. Over sales -- overseas sales, in total, declined from the previous year, affected by sales decline in vehicular turbocharger business and civil aero engine business.
Next, let us walk you through the forecasts of the consolidated results for fiscal '19. Please turn to Page 14. As separately disclosed today, we have revised our forecasts. Orders received will be JPY 1.4 trillion, which is JPY 50 billion lower than the previous forecast. Net sales, JPY 1.4 trillion, no change from the previous forecast. But operating profit now we are expecting JPY 65 billion; ordinary profit, JPY 43 billion; profit attributable to owners of parent, JPY 20 billion. Each of the 3 items, now we are expecting JPY 15 billion lower than the previous forecast.
Exchange rate assumptions for Q3 onwards are USD 1:JPY 105, and EUR 1:JPY 120. Foreign exchange rate sensitivity for U.S. dollar, JPY 1 move will have JPY 500 million impact on our business.
Please move on to Page 15, orders received forecast by segment. Orders received in Industrial System and Generative Purpose Machine segment, we are now expecting JPY 30 billion less than the previous year, mainly because vehicular turbocharger sales in China is likely to be smaller. Orders received in aerospace -- aero engine space and defense is now expected to be JPY 20 billion lower. The major factor is the less orders we are now expecting to take in the Civil Aero and Engine Maintenance business.
Please turn to Page 16. Here, Resources, Energy and Environment. Net sales will be JPY 10 billion higher than the previous forecast, thanks to higher net sales coming from overseas projects. Social Infrastructure and Offshore Facility, no change in the forecast. Industrial System and General Purpose Machinery, mainly because our vehicular turbocharger business has been negatively affected by sluggish auto sales in China and in other countries, net sales is likely to be JPY 30 billion lower than the previous forecast. Aero Engine, Space and Defense, mainly due to lower-than-expected sales in Civil Aero Engine business, we have downwardly revised the forecast by JPY 20 billion.
Please turn to the next page for the reasons of the revisions. On this page, you will see the factors for our operating profit revisions and the size of impact of each factor by segment, comparing the latest forecast with the forecast we had in May.
Research, Energy and Environment has been downwardly revised by JPY 5 billion. Contract fee increased regular inspection, maintenance work, we are still expecting to post profit coming from this business during the second half, but it is likely to be difficult to recover the JPY 5 billion additional costs we incurred in Q2. Therefore, we've made the revision. Social Infrastructure and Offshore Facility, no change. Industrial System and General Purpose Machinery, due to less sales in vehicular turbocharger, we have downwardly revised our forecast by JPY 8 billion. Aero Engine, Space and Defense. Civil Aero Engine Maintenance business situation has been normalizing, but recovery in operation has been taking longer time than expected. Therefore, we are now expecting JPY 6 billion decrease in our sales. Also, for this reason, out of the JPY 6 billion buffer we've been provisioning for potential business fluctuation, we have reversed JPY 4 billion.
From Page 18 onward, we have financial results by segment, which I have already covered in my presentation. So let me skip the details, but let me make some additional comments.
Please turn to Page 19, Resources, Energy and Environment. The business performance and the forecast we have here. Especially, please pay attention to the operating profit at the bottom. Up till Q2, the operating loss was JPY 7.2 billion, but this year's full year forecast is JPY 13 billion, which means we have JPY 20 billion gap, which is the size of the operating profit we need to generate during the coming 6 months.
Talking about the probability. First of all, boiler regular inspection and maintenance and aftersales for Power Systems. And in nuclear power, there's no new installation, but maybe we do have aftersales. And the orders we have on our hand is JPY 20 billion equivalent, and this will convert into actual sales during the second half. Moreover, this is something I explained when we announced Q1 results, but the deteriorating profitability we experienced in Q1, now we are making effort to improve the profitability. For example, we are making effort to increase the charge for the contract business and also lowering the fixed costs. So we are working on initiatives to improve the profitability, and we are likely to achieve the results during the second half. That's why, somehow, we would like to achieve the full year forecast.
This concludes my presentation.
Tsugio Mitsuoka, IHI Corporation - President, CEO & Director 
Good afternoon. This is Mitsuoka. I will explain about the management overview. Please turn to the next page.
This is what I will be explaining today. I will add explanation and comments to the management review presentation material. Originally, the group management policies 2019, a new medium-term business policy was started 6 months ago. And 6 months after announcing the policy, we have revised the forecast for the first half of this fiscal year. So I would like to explain how this revision will have an impact on the medium-term plan. Even though we also explained in the Q&A session in the earnings briefing for the first quarter, I would like to once again explain this year's forecast against the actual results of fiscal year 2018. This year's forecast assumes concentration of orders and order backlog in the second half of the year.
We had seen decline in our performance more than expected in the first half, and we have already started taking measures. And based on our assessment, probability of achieving the guidance, we have decided to make revisions to this year's forecast.
As Executive Vice President, Yamada mentioned, in Resources, Energy and Environment, we have many high-margin projects carried over from the first half. And based on the original work schedule, in the second quarter and the third quarter -- fourth quarter, we have planned to build up profits. So I would like to mention here as an outline that we will be generating profits in the third quarter and the fourth quarter against the new and revised forecast.
As for the group management policies 2019, we have seen dramatic changes in the business environment as well as technologies. So far, business units have been managing business, but with a view to responding flexibly to changes and to do business with a long-term perspective and reorganize business, if necessary, we formulated the 3-year group management policies 2019.
So I would like to explain what kind of recoveries we are making going forward. This page shows a cascade chart showing a difference of operating profit from the initial forecast against the revised forecast by business area. I will explain 3 business segments where we made revisions to operating profit. We will not make further revision to the forecast.
First, Resource, Energy and Environment introduced the business area system in the fiscal year 2017 to start to leverage our resources better and more flexibly. We aimed at total optimization rather than sticking to each business unit. And actually, many of our staff members changed their responsibilities and were transferred to other units last year. And such efforts have translated to increased sales of higher-margin aftersales businesses. And this fiscal year, for instance, in the plants business, we integrated organizations, namely, IHI plant and IPC. And also in the Power Systems business, we integrated organizations.
Conventionally, corporate was not necessarily involved in screening or checking the contents of works for smaller projects on a business area basis. And this time around, we checked whether improvements, recovery -- replanning can be realized and achieved or not. And this review led us to revising the full year guidance.
Going forward, as we are now able to draw on experts with third-party stances, organization-wise, so we will leverage such important resources so that business area from the quotation stage will check whether a potential project can actually be taken. And if it can be taken, we will and we have adjusted our system so that we can work on front-loading to prevent downside thoroughly to achieve the plan in the third and the fourth quarters.
Next, I would like to talk about the turbocharger business. As the Executive Vice President Yamada explained, demand trend in China has changed dramatically. That had a huge impact on the unit sales of the first half. That also influenced parts supply from Japan, and therefore, we revised the forecast.
As the situation in Europe is not written in the measures section on the slide, so let me explain verbally now. As we have been explaining in individual interviews from a few years ago, we have continued to struggle with our turbochargers business in Europe, and we implemented large-scale structural reforms, and we are starting to see results in capturing orders for the future. But the business size has shrunk in Europe. You are able to see how the turbochargers business had trended by region in the appendices of the financial results material.
From the beginning of this fiscal year, we had anticipated a huge decline in business in Europe, and therefore, we have undertaken a radical structural reform as we assume the unit sales to decline by 30% on a year-on-year basis. But after closing the first and the second quarter, the demand decreased additional 20% from the forecast. Therefore, we have pushed ahead with additional structural reforms given the downward trend in Europe. As a result, operating profit is in line with the original forecast.
So this is what the situation is in Europe for your reference. And as you can see at the measures section on this slide, we are cutting costs by deploying a global production system. That much was unit sales. We might see further changes in the business environment. However, the demand in China in the second half of the year is forecast to recover. Even though colors are different by model or a carmaker, by firmly assessing the situation, we would like to ensure recovery in the second half.
At the bottom of the slide, there are descriptions on the impact from electric vehicles. Let me add a few comments. As I just explained, we have been implementing structural reforms in Europe. Globally, our sales in the aftermarket is small. With a view to strengthening our aftersales, we are headhunting professionals to accelerate aftersales business expansion.
In summary, for the vehicular turbochargers business for the next 3 years, demand decreased in the first half of this year, which will recover, but it will still be lower than our initial expectation. Therefore, we are accelerating our efforts in reorganizing our production system to match the reduced scale of business. We will steadily work on achieving the revised plan going forward.
I would like to reconfirm here that we will make recovery to achieve the operating profit target that we set in the group management policies 2019.
Number three is the initiatives for civil aero engine business. As Yamada mentioned earlier, aero industry is an industry where many things can happen. Having that said, the largest reason for the revision we have made this time is the fact we have not been able to fully recover from the situation following the quality issue.
We have already resumed providing civil engine maintenance service from May and have started shipping overhauled engine from July.
Talking about the measures. I'd like to give you a rough image on what is happening in the field now. Our staff, especially staff in charge of inspection, are still being very, very cautious. If a 100-inspection process is required for an inspection, they are still conducting 200 processes, meaning they are still being too cautious. We need to bring down this level from 200 to, say, 200, if not 100, because staff may not feel comfortable if bringing down to 100. So keep 20 as a buffer, and we'd like to achieve 120 as early as possible. This is what we mean by saying rationalizing and optimizing work processes.
Now many engineers are actually working on-site at our Mizuho plant to make decisions to rationalize and optimize the work processes. Although we have downwardly revised our forecast for fiscal '19, we are determined to bring the aero engine and aero-related businesses back to the levels the business should achieve. And we will continuously strive to achieve the numerical targets we have set. We will make our best effort to recover from the current situation as early as possible.
This concludes the how to recover from the downward revision situation part.
Page 9, progress under group management policies 2019. The policies are the policies we set to bring the company up to the next level. This page shows the current progress we are making under the policies. Our people, including ourselves and engineers, are very good at developing valuable products. They're very good at providing the right solution, right products which meets the customers' needs. But as I mentioned at the beginning, society and the environment surrounding the customers have been changing. How are we going to catch up with the situation? Our people are visiting customers in person. They observe what's going on. They hear customer voices directly, then they generate ideas and convert them into new businesses.
Energy business. We are aiming to decrease our customers' carbon dioxide emission by 50% by 2035. We are currently providing solutions to make it happen. For our overseas business, we used to send people on a business trip basis to conduct hearing or have discussions with our customers, but now, for our target markets, we are now stationing general manager-level people on a longer-term basis to have communication with our customers. This is something we're working on right now.
If I give you one specific example. There's a customer which is located in a market where renewable energy use has been increasing dramatically, but to keep a good balance, or in other words, to adjust the total level of power generation they also keep using existing facilities. They are a having difficult time to adjust the burden, and they wanted to somehow improve the performance of the facility when it is not -- when it is operating out of spec. As a result of visiting the field and having direct and frequent communications with the customer, we could take orders of feasible study.
Next is social infrastructure. Recently, Japan has been experiencing major disasters, one after another. So we believe this business is quite an important business. As a whole, IHI Group, we are working on initiatives to make further contribution in the areas, including disaster prevention, disaster mitigation and building national resilience against -- for disasters. This business, we do not have something like a catalog because when it comes to infrastructure, each region has their own infrastructure. Also, the level of engineers and other people working in the field they have in the region are different. So for each project, we are conducting hearings, having discussions and making the right proposals for the region. Especially bridge maintenance, repair and preventional maintenance are the areas we are likely to have stronger demand in the future.
We also know that number of workforce in the field is likely to keep decreasing by 20% within the coming decade. Root cause is the lower birth rate and aging society. How we can help customers under such circumstance is another area we are focusing on.
Industrial machinery. Until recently, we've been providing aftermarket services in various areas nationwide, but only in Japan. Our exposure in overseas markets was 0. So we are going to develop aftersales network in overseas from now onward. Like what we are doing with our energy business, we will send relatively senior people to strengthen the business and capture demand by getting involved in the field. Therefore, we are going to expand the business. So far, too early to achieve visible results, but within the coming 3 years, we'd like to achieve visible results by improving the business portfolio mix.
Lastly, I'd like to touch upon quality assurance, which is very, very important. Following the inadequate practices we had in our engine business, we've been strengthening our quality assurance system. This was a comment I also made 6 months ago. Now on a group-wide basis, we are working on large-scale initiatives. We've been holding quality and compliance training, both in Japan and in overseas. We completed all the training sessions by the end of September in Japan. And total number of employees participating in the training was 24,000, which means 85% of those who we are expecting to participate actually did.
In addition to conduct survey on site, we are conducting follow-up survey as well to secure and enhance our quality and compliance. We will keep repeating this process in the future to never forget the lesson we have learned. With a mindset of 0 tolerance, we will never accept any compromise.
Below shows the structure we are currently developing. Please take a look at the right-hand chart. Before we had instructions. Our instructions were made following the change of command. And actual work related to Q&A, quality assurance, have been left to the field.
Talking about risk management. Similar to what we are working on with quality and assurance, which I have explained on the previous page, we have identified risk management as one of the themes we need to focus on with top-down approach, which I also mentioned 6 months ago. To build a strong structure to hand over the compliance, quality assurance and business operation risk-related issues, we are developing a 3-layer structure, meaning 3-layer defense lines, like we are doing with our quality assurance business. And we are now generating ideas to build a new structure. We are making a new start.
This concludes my presentation. For your reference, on Page 12, we are sharing the targets under group management policies 2019. As a whole group, we are aiming to achieve 8% OP margin in fiscal '21. No change with our plan to keep improving the business portfolio mix in a steady manner. Unfortunately, we had to revise our fiscal '19 forecast, but we'd like to keep proceeding by working on the initiatives I mentioned today.
We appreciate your continued support. Thank you very much.
[Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]