Q1 2020 Kawasaki Kisen Kaisha Ltd Earnings Presentation
Tokyo Sep 6, 2019 (Thomson StreetEvents) -- Edited Transcript of Kawasaki Kisen Kaisha Ltd earnings conference call or presentation Wednesday, July 31, 2019 at 10:59:00am GMT
TEXT version of Transcript
* Harusato Nihei
Kawasaki Kisen Kaisha, Ltd. - CFO, Senior Managing Executive Officer & Representative Director
Harusato Nihei, Kawasaki Kisen Kaisha, Ltd. - CFO, Senior Managing Executive Officer & Representative Director 
We will now provide a summary of the financial highlights for the first quarter of fiscal year ending March 31, 2020. We will begin with a summary of the first quarter financial results.
The company posted ordinary income of JPY 2.7 billion and net income of JPY 7.8 billion. This represents achievement of approximately 50% -- 54% of the fiscal year 2019 full year forecast for ordinary income and approximately 70% -- 71% of the full year forecast for net income. We think that the results of the major structural reforms implemented by former President Murakami in fiscal year 2018 are appearing in the current fiscal year and that "K" LINE is off to a good start under the strong leadership of current President Myochin.
However, at this time, we have not changed the full year forecast, taking into consideration U.S.-China trade friction, the situation in the Straits of Hormuz, Brexit, compliance with SOx regulations and other risk factors from the second quarter onward.
Next, we recognize that there are 3 key points regarding the fiscal year 2019 financial results. The first is Ocean Network Express, herein after referred to as ONE. ONE achieved profitability in the first quarter. The second is fundamental reforms and achievement of profitability in the Car Carrier Division. The Car Carrier Division implemented various measures in the previous fiscal year and achieved profitability in the first quarter under the strong leadership of the Division's management team. The third key point is compliance with SOx regulations. Since they will be applied beginning January 1, 2020, we are currently at the preparatory stage, and preparations for compliance are progressing smoothly for the most part. This concludes the summary of financial highlights.
A, financial highlights for first quarter fiscal year 2019. A-1, financial results for first quarter fiscal year 2019. For the first quarter of fiscal year 2019, ordinary income was JPY 2.7 billion, and net income was JPY 7.8 billion. The average yen-dollar exchange rate was JPY 110.73 to the dollar. The yen appreciated as the exchange rate was JPY 110.99 on March 31, 2019, the end of the previous fiscal year, and JPY 107.79 on June 30, the end of the first quarter of the current fiscal year. This means recognition that assets were affected by the appreciation of the yen.
Looking at ordinary income by segment. The Dry Bulk segment posted an ordinary loss of JPY 0.4 billion in the first quarter, while the Energy Resource Transport segment posted ordinary income of JPY 1.8 billion. The Product Logistics segment also posted ordinary income of JPY 1.8 billion, of which the company's equity in earnings of ONE was JPY 0.2 billion. Overall, ordinary income was JPY 2.7 billion, improving by JPY 19.8 billion year-on-year.
The Dry Bulk segment performance declined year-on-year due to the lingering impact of the worsening of market conditions at the beginning of this year despite the improvement in profitability through structural reforms.
Next, earnings increased in the Energy Resource Transport segment due to an increase in mid- and long-term contracts, mainly for thermal coal and LNG carriers and improvement in marketing conditions.
In the Product Logistics segment, Car Carrier Business achieved profitability thanks to the effects of route rationalization and rate restoration efforts implemented since the previous fiscal year. Containership Business achieved profitability thanks to robust demand for services on Asia-North America routes, Latin America routes and routes in Intra-Asia as well as internal improvement efforts such as an additional reduction of service frequency, despite a decline in liftings on Asia-Europe routes at ONE.
Moreover, earnings from "K" LINE's own Containership Business improved substantially due to a decrease in temporary costs incurred in the previous fiscal year and effects of structural reforms in Containership Business implemented in the previous fiscal year.
Next, looking at the key financial indicators, equity capital increased from JPY 103.6 billion at the end of the previous fiscal year to JPY 111.9 billion at the end of the first quarter, and the equity ratio improved from 11% to 12%. This improvement is attributable to several factors as presented on the balance sheet in the financial highlights for first quarter fiscal year 2019: an increase in capital surplus due to the transfer of a portion of the company's shares in domestic harbor transportation subsidiaries to Kamigumi Co., Ltd.; an increase in retained earnings due to the recording of JPY 7.8 billion in net income; a decrease in net unrealized holding gain on investments in securities; a decrease in deferred gain on hedges; and a substantial decrease in translation adjustments due to the impact of yen appreciation. All these factors resulted in a total increase of JPY 8.3 billion in shareholders' equity.
By the way, as stated at the bottom of the page, the company has obtained a subordinated loan in the amount of JPY 45 billion during the current fiscal year and obtained subordinated loans totaling JPY 75 billion, including existing loans in the amount of JPY 30 billion. These loans have received 50% equity credit from a rating agency. And when this was taken into account, the 12% equity ratio is considered equivalent to 16%.
The balance of cash and deposits decreased by approximately JPY 20 billion from JPY 143.2 billion on March 31, 2019, to JPY 120.8 billion on June 30, 2019, as presented on the balance sheet and the financial highlights for first quarter fiscal year 2019. Looking at cash flow-related factors contributing to the decrease, a major cash outflow was payments of more than JPY 50 billion in the current fiscal year for structural reforms implemented in the previous fiscal year. Other outflows were for investments in some vessels and a large portion of the subordinated loan of JPY 45 billion as repayment of a senior loan commitment line, which has enabled the use of borrowing facilities at any time.
Major cash inflows were cash procured during the above-mentioned subordinated loan and cash generated from the transfer of a portion of the company's shares in domestic harbor transportation subsidiaries to Kamigumi Co., Ltd. These factors resulted in a decrease of JPY 20 billion in cash and deposits. However, this poses no problem with respect to the company's cash liquidity since we have a previously established commitment line of JPY 30 billion in addition to the above-mentioned commitment line of JPY 50 billion.
A-2, forecast for first half and full year 2019. The first half and full year forecast remain unchanged. We forecast ordinary income of JPY 5 billion and net income of JPY 11 billion for full year. There is no major change in the exchange rate level from our assumption at the beginning of the fiscal year. A key point here is that the second quarter forecast is for ordinary income of JPY 7.3 billion and net loss of JPY 0.8 billion as we have conservatively factored in an extraordinary loss on liquidation in the second quarter. This is because we are proceeding with liquidation of a container-related company and have conservatively forecast a portion of extraordinary losses at overseas agents and other items. At this time, we have not yet determined a forecast for the interim dividend. Although in the medium-term management plan we recognize that shareholder returns are an important priority, we consider improvement of the financial position an urgent task and are working to improve earnings.
A-3, forecast for first half and full year 2019 by segment. The first half and full year forecast by segment remain largely unchanged. For the Dry Bulk segment, we forecast full year ordinary income of JPY 4.5 billion, an increase of JPY 0.5 billion compared to the forecast announced at the beginning of the fiscal year. Although in the first quarter, business was negatively affected by a market slump, triggered by an accident in an iron ore-producing country that occurred in the second half of fiscal year 2018, demand for iron ore regained strength against the backdrop of a recent increase in crude steel production in China, and market conditions improved substantially. We forecast strong demand in the second quarter as well.
For the Energy Resource Transport segment, we forecast ordinary income of JPY 7 billion as planned. For the Product Logistics segment, we expect equity in earnings of ONE to improve by JPY 23.2 billion year-on-year to JPY 3.1 billion, in line with the initial assumption at the beginning of the fiscal year as a result of expected improvement in operation profit/loss from an additional reduction of service frequency despite causes for concern such as the impact of U.S.-China trade friction and sluggish growth in freight rates on Asia-Europe routes.
Although we forecast results from Containership Business overall to fall short of expectations at the beginning of the fiscal year due to temporary costs incurred in "K" LINE's own containership business, namely adjustment of charter rates and an increase in costs associated with container box leasing, we plan to achieve our forecast announced at the beginning of the fiscal year for the Product Logistics segment overall, thanks mainly to the performance of Logistics Business as well as Car Carrier Business in which we are steadily implementing route rationalization and rate restoration efforts.
The market condition assumptions for the second half, including assumptions for Cape and VLCC are unchanged from the initial assumptions. We have slightly revised the first half assumptions, taking into account the first quarter results.
A-4, latest forecast for fiscal year versus financial results for fiscal year 2018. This waterfall chart shows a comparison of actual ordinary loss for fiscal year 2018 and the ordinary income forecast for fiscal year 2019. There is no major change from the beginning of the fiscal year. We have made a slight downward revision to reflect the previously mentioned partial change, mainly a revision of approximately JPY 1 billion for Containership Business and made an upward revision of roughly the same amount due to an expansion of mid- and long-term contracts in Dry Bulk and Energy Resource Transport Business. Accordingly, there are no major changes to the assumptions in the chart.
A-5, progress of rebuilding portfolio and restoration of financial base. We are steadily securing mid- and long-term contracts in the Dry Bulk segment. For instance, a long-term contract to transport bauxite to Emirates Global Aluminum has commenced. With regard to optimization of market-exposed Panamax and smaller-sized fleets, profitability improvement from structural reforms implemented in the previous fiscal year is appearing as anticipated. Profitability improvement has been achieved in Car Carrier Business. And we believe that the Car Carrier Division has changed into a business unit capable of recording a full year profit for the current fiscal year.
Next, in the Energy Resource Transport segment, we are expanding mid- and long-term contracts mainly for LNG and thermal coal carriers and have won mid- and long-term contracts for LNG carriers with extremely important customers in Japan and overseas. We are also able to add mid- and long-term contracts for thermal coal carriers mainly with electric power companies in Japan.
As indicated by agreement to establish a new joint venture shipping company with Taipower and et cetera, we are steadily taking measures to expand our business even with customers outside Japan. On the other hand, we are proceeding with selection and concentration of market-exposed business with unfavorable risk and return prospects in the future, withdrawing from some business and selling one vessel in the Offshore Support Vessel business at unprofitable KOAS. Profitability improvement from structural reforms is appearing as anticipated in Containership Business, and ONE has achieved profitability.
In Logistics Business as well, we have transferred a portion of the company's shares in domestic harbor transportation subsidiaries and intend to continue to collaborate and further increase synergies with Kamigumi Co., Ltd., and in fact, various projects are taking shape. In our financial foundation revival efforts, we procured JPY 45 billion in funds during April through a subordinated loan.
A-6, compliance with IMO regulations. The third key point for the fiscal year 2019 financial results is compliance with SOx regulations. The company's basic policy is that, first of all, it is important to maintain smooth vessel operations to prevent causing inconvenience to customers, and we will steadily proceed with compliance under a policy of minimizing economic impact. With regard to the use of regulation-compliant fuel oil, we have made considerable progress with advanced procurement and are scheduling trials for usage and fuel switching on a ship-by-ship basis.
We have also formed a global cap response team, and dedicated personnel are proceeding with compliance under this basic policy.
With regard to the increase in fuel costs, we are in the process of discussing a BAF, Bunker Adjustment Factor, benchmark price and calculation method with customers while obtaining their understanding, and such customer understanding has progressed well for the most part. Next, we plan to install SOx scrubbers on approximately 10% of our fleet in fiscal years 2019 and 2020, including retrofitting, and this is also progressing smoothly.
C, Ocean Network Express financial results for fiscal year 2019 first quarter and forecast for fiscal year 2019. ONE achieved profitability in the first quarter, and we believe tremendous improvement has been made. Since we have incorporated realistic earnings in the second quarter forecast, including assumptions concerning future market conditions and cargo movements, we forecast the first half results mostly in line with the initial assumptions made at the beginning of the fiscal year. There is no change in the second half assumptions made at the beginning of the fiscal year since the figures are based on reasonable probability. Although the full year profit forecast has been revised slightly upward, it is nearly unchanged. We are negotiating with customers about the cost burden of the ONE bunker surcharge, OBS, in respect of the fuel oil cost increased due to SOx regulations, and we believe that their understanding has been obtained for the most part.
Fiscal year 2019 first quarter profit was $5 million. As shown in the waterfall chart, the largest factor affecting profit was an increase and improvement in liftings. Although ONE began providing services in fiscal year 2018 in extremely unstable circumstances, liftings improved substantially year-on-year accompanying service stabilization. In addition, we consider a cargo portfolio optimization and a decrease in variable costs due to cost reduction activities to be major factors contributing to earnings improvement.
Figures for liftings, utilization and freight rate indices on major routes are presented on Page 17 of the materials. Liftings on Asia-North America eastbound routes improved by 139,000 TEU year-on-year to 669,000 TEU and utilization improved by 13% to 86%.
Curbing of shipments by some customers and other effects of additional tariffs imposed on China by the U.S. slightly weakened demand. However, reduction of service frequency by 12 sailings, not including the initial assumptions made at the beginning of the fiscal year, contributed to the improvement.
Freight rates for long-term contracts on Asia-North America eastbound routes increased, reflecting the reaching of agreements in line with the initial assumptions. And Asia-North America short-term contract freight rates were strong as well. Liftings on Asia-Europe westbound routes also improved, too. Although utilization improved by 14% year-on-year to 87% since growth in supply exceeded demand due to an increase in supply in the market overall resulting from introduction of a new VLCS, very large containership, on Asia-Europe westbound routes by each alliance, ONE reduced service frequency by 5 sailings. Freight rates on Asia-Europe westbound routes weakened to the prior year level, reflecting the situation of growth in supply exceeding demand.
The full year forecast is presented on Page 18. We have slightly increased profit from the initial assumption of $85 million to $90 million. Although earnings improvement in the first quarter exceeded the initial assumption, we have planned for only a slight increase from the first half initial assumption because of an anticipated decrease in freight rates mainly on Asia-Europe westbound routes. There is no change in the second half forecast.
Page 19 of the materials shows progressive action plans by ONE for profitability improvement. ONE has taken various measures to improve profitability that are gradually producing results. Cargo portfolio optimization is having an improvement effect mainly on Asia-North America routes. Also the improvement effect of product optimization such as launching larger containerships on some routes, vessel allocation efficiency and a review of ports of call, is appearing.
The effects of improvement measures implemented for fuel savings are also appearing. As announced in a news release, it has been decided that Hyundai Merchant Marine will participate in THE Alliance beginning in April 2020, and ONE will aim for further product optimization.
And about the synergy effects we have pointed to since the early days of business integration, we expect to see such effects as planned. ONE has, for the most part, obtained customer understanding about compliance with MARPOL 2020 and SOx regulations. And we assume that they will be able to recover costs associated with regulatory compliance. Finally, we aim to implement transfer of the overseas terminal business early in fiscal year 2019 and are now currently at the stage of intensive negotiation among the 3 parent companies.
B, Division Trends. We will now comment on changes in fleet scale and market exposure for individual segments, as presented beginning on Page 10 of the materials.
Looking first at the Dry Bulk segment, shown on Page 10, fleet size has decreased by 10 vessels from 209 at the end of fiscal year 2018, March 31, 2019, to 199 on June 30. The main reason for the change is a decrease in the number of Panamax and smaller-sized vessels. We have reduced the market exposure of Cape and Panamax and smaller-sized vessels since the beginning of the fiscal year.
Turning now to the Energy Resource Transport segment presented on Page 11, fleet size has not changed in comparison with the end of fiscal year 2018, March 31, 2019. There has been a decrease of 1 VLCC and 1 LPG carrier and an increase of 2 thermal coal carriers. We have substantially reduced the market exposure of LPG carriers and reduce the exposure of thermal coal carriers as well.
Finally, on Page 13, the car carrier fleet has decreased by 5 vessels from 90 at the end of fiscal year 2018 to 85 at the end of the first quarter of fiscal year 2019. This represents a decrease of 8 vessels from the first quarter of fiscal year 2018. As a result, total units carried decreased as well. We consider this an indication of results achieved in the course of implementing various measures.