Earnings Call: Q2 2019

Oct 31, 2018

UNIDENTIFIED Good afternoon, ladies and gentlemen. I'm responsible for commercial affairs at MHI. My name is Kobuchi. I would like to thank you very much for coming to discuss your busy schedules. Now as usual, I would like to start with a presentation on financial results included in your handout. First and foremost, please turn to the next page. For the 2018, here is the highlight and outline of the results. First and foremost, for the second quarter, compared with the annual guidance, we had a steady progress. Excluding MRJ investments, fundamental business earnings performed steadily. In terms of the orders, the industry and the infrastructure covered up for the decline in power systems, and the overall profit revenue was in line with the usual years. For profits in Aircraft, Defense and Space, because of the Tier one and MRJ issues, there was a slight decline. However, overall, the power and industry covered up for the decline. As for the free cash flow, as you may be aware, for the second and third quarters, we always have a bottom period, but the promotion of cash flow management has been stabilized. Therefore, the decline was limited to a small amount. Compared with the same period last year, we had about JPY 100,000,000,000 yen better number, higher number. Therefore, as I will explain later in my presentation, the annual projection for cash flow has been upgraded from 50,000,000,000 yen to 100,000,000,000 yen So based on that, as of the interim period, the dividend for the interim period is to be 5 yen increase per share to JPY 65 per share. This has been resolved at the Board meeting today. Next, I would like to take you through the summary. As for orders received, we have JPY 1,561,800,000,000.0000 yen This is a decline of about 30,000,000,000 yen Revenue was 1,872,000,000,000.000 yen up 44,000,000,000 yen year on year. As for profit from business activities, the last year's results were translated into the IFRS numbers so that we can ensure a book to apple comparison. So the number is adjusted. This year, the number was 56,700,000,000.0 yen up 37,300,000,000.0 yen Profit attributable to owner Superient was 25,400,000,000.0 yen up 28,400,000,000.0 yen EBITDA was 120,100,000,000.0 yen Free cash flow was negative JPY 75,000,000,000, all exceeding the results for the same period last year. We had an increase in revenue as well as profit. As for MRJ, cash investment as well as the impact on financial results were separated out from the main business. So the fundamental business, excluding MRJ, was JPY 104,000,000,000 in profit from business activities, $724,000,000,000 from profit attributable to owners of Perion, 167,300,000,000.0 for EBITDA and minus 19,800,000,000.0 yen for free cash flow. So we have had steady results for fundamental business. Now I'd like to take you through the segment by segment results. I gave you the outline, but for Power Systems, large sized projects, because of the timing issue, did not perform so well. But for the year, we have more large sized large ticket items in the second half. Therefore, in your forecast, that is the assumption. Up until Q2, we have 150,000,000,000 or 160,000,000,000 yen negative situation to 425,500,000,000.0 yen For Industry and Infrastructure, there was an increase of about 160,000,000,000 yen At last, metalsmachinery market has been showing recovery and the medium product has been performing well. Aircraft, Defense and Space is as you can see on the chart. Next, sales or revenues. Aircraft, Defense and Space, because of the decline in Tier one, is down, but the and industry were up year on year. Next, regarding business profit. First, for the Power System, we have 47,300,000,000.0 yen up 33,100,000,000.0 yen Gas turbine, steam turbine, nuclear power, compressed air, of these major subsegments are up year on year. Having said that, the Aircraft Engine subsegment, because of Trent one thousand, we had to incur some expenses, nearly 10,000,000,000 yen because of the provision put aside, there was a decline. Therefore, this JPY 47,300,000,000.0 includes the provision set aside for Trent one thousand. For Industry and Infrastructure, we had JPY 30,300,000,000.0, up about JPY 6,000,000,000 yen year on year. Aircraft, Defense and Space, because of the Tier one business suffering from the July decline, pro mix change and increase in July. There were some gaps. And also Defense Ministry related booking of revenue for the second half, the booking is concentrated more on the second half and more for this year than usual years. Therefore, for the first half compared with the previous year, there was a decline of about 2,000,000,000 yen So as a result, for the entire company, we had results as shown on the table. As for the balance sheet, the efficiency is something that we are focusing on. So this should help profits for the next fiscal year onwards. Therefore, we are taking proactive measures towards that. For the second quarter, the balance sheet tends to become higher because of the production. However, this year, compared with the last year, there was not so much change for the second quarter because of the cash flow management and the balance sheet efficiency improvement measures. The trade receivables or inventories. Inventory tends to go higher for the interim period, but the conversion to cash for the reduction in trade receivable is as shown here. And because of the increase in cash, there is an increase in total fixed assets sorry, other current assets. As for the equity, the cash flow situation is better than expected. Therefore, the increase in interest bearing debt is not as much as we had expected. For Q2 last year, there was more than 1,000,000,000,000 interest bearing debt, but this time around, it is less than 900,000,000,000 yen This trend, we think, can be maintained throughout the year up until the end of fiscal year. But we have long term and short term CP and so forth for the financing. Next, I'd like to show you the major KPIs. In terms of the equity ratio, as I said in the previous meeting, MRGA assets were written down. Because of that, equity ratio is less than 30% at 27.3%. Because of the improving situation of the management, the equity ratio has not been hurt so much. And equity ratio and debt equity ratio and interest bearing, that is shown on the table, and we are maintaining financial health. I'd like to move on and talk about backlog by segment. The orange portion, which is Power Systems, currently, orders have been challenging. In the second half, there will be big projects. So for the full year, we do believe a certain level of recovery. However, for the first half or the second quarter, we have been seeing a decline. Offsetting this is the green portion, which is industry and infrastructure, I and I, such as metal machinery and medium lot goods. So currently, power system orders is on the decline. Looking at revenue by segment, it is pretty straightforward, so I'm not going to go through the details. For profit, I earlier talked about Power, Sims and Trent 1,000 and the provisions we took. And 47,300,000,000.0 yen is the profit from business activities, which is substantially higher than last fiscal year. Nuclear power and GTCC contributed to the increase. And also Aero Engines, apart from them, the main businesses have been increasing in profit. For Industry and Infrastructure, Metals Machinery increased in sales. It's been improving. And medium lot goods continues to be firm, although it has been a little bit lower than before. For Aircraft, Defense and Space, commercial aircrafts, the pro mix has been changing, so sales has been decreasing. And here we are with the profits. So based on what I've just mentioned, let's look at the forecast for fiscal twenty eighteen. We haven't changed the outlook for orders received, for revenue as well as for the other profit items. We haven't changed our plan. And we are currently broadly in line with our expectations. However, for free cash flow, like I mentioned earlier, at the interim period compared to plan, it's better by approximately 50,000,000,000 yen So for the full year, we believe that will contribute as an improvement, so that is why we revised up the free cash flow outlook. Excluding MRJ investments, the summary is shown on the next page. And broken down into segment, we offer the information as well. So I hope you could take a look at this later. Finally, I'd like to talk about the increased capitalization of Mitsubishi aircraft, which is on Page 17. For Mitsubishi aircraft, current has been focusing on development, and development period has been extended and the level of development cost has been increased. Therefore, at the end of last year, it reached insolvency. For MRJ, we have been taking drastic measures. And TCE obtainment for twenty nineteen, twenty twenty and for the first delivery in 2020. As we work towards this time line, the probability of this happening is becoming higher and higher. So the financial issues that Mitsubishi aircraft has was something that we wanted to resolve at once. Therefore, we decided to do an increase a capital increase that we subscribe to and also go through debt forgiveness to part of the debt. To the existing shareholders, the plan has been proposed to the existing shareholders. And as a result of them understanding our proposal, the capitalization will move forward in line with the initial plan we have in place. With this, the financial issues leading up to commercialization has now been solved for MRJ. As a result, there will be a dilution of shares, and our stake has went up to 86.7% from 64%. But we will be able to resolve the financial issues of MRJ, and we will also be able to progress the technical development so that under the new organization from 2020, when the business enters commercialization, we believe now we have gained more visibility into that happening. That concludes my presentation. Although brief, that was a presentation about our results. Thank you very much. Now next, Mr. Min Nagao, President and CEO, will give presentation on transition to global group management. This is Miyanaga speaking. Thank you very much. In May, we promised you about the change in the organization. We have completed our structure reform already. Therefore, in order to go into the growth stage, what needs to be done was considered at the end of the second quarter, I was going to explain. So I'd like to give you an update and future plans. First and foremost, for structure reform, what is the problem with MHI and what have you been doing is something I'd like to review with you first. First of all, for the structural reform, what made us start the structural reform to begin with? And during the structural reform, what was still necessary? So before we begin this first step in growth, we had those issues. And what are we going to do in 2018 business plan and for the global management structure? Please go to next page. This is the review. For the medium term to long term, there are two issues that we need to tackle on top of what we have already done. First and foremost, this shows you the long term trend. The problem with MHI is based on the conglomerate management. Back in 1960s and '70s, we had a very good conglomerate management in the Japanese market, and we still had the effect in the 1980s. Up until 1985, we had a good performance. Compared with the GDPs of major countries, MHI growth was higher up until then. However, the social infrastructure in Japan became sufficient and the growth speed decelerated since then. And at that time, we had a very high dependency on the Japanese market. And in 1985, our slowdown started. Back in 1980s 1990s, after the collapse of the global economy, Mitsubishi Heavy Industries started its slow period. We struggled with the expansion of exports and other measures, but these initiatives did not result in high performance. There were some effect, however, to the extent that we could grow only up to the GDP level. You can see the GDP growth of Germany. We thought that we should grow as much as the German economy. That was what we thought. If we had grown as much as the German economy and then with the change in portfolios, lineup and other changes, we could have done better. In some time ago, we had 1,300,000,000,000.0 yen and we could quadruple that to 5,000,000,000,000 yen and we would have been in a good shape if we had achieved that goal. It didn't work well. I will explain later. It was because of the conglomerate management. We had a silo and among different BUs, and we tried to do everything on our own. It worked in Japan. However, on a global market, there was a limit to what we could do only working in silos. Therefore, we had a long period of slowdown since then. Before the LIMA shock, at one time, there was some pickup in economy that benefited our company as well, and we thought that we would start to grow again. The gap continued to expand. So we rest assured because of the good economic growth at that time, but we shouldn't have. After the Lima shock, our profit started to be hard. In 2000s, we failed in our initiative to expand exports. And after the Lima shock, when the economy's growth started to slow and then that hurt our company even more. Therefore, after that, we tried to work on the efficiency and the use of resources and the profit loss structure. That's why we started on the initiatives for structural reform and the financial foundation improvements. But after that, we realized that we also had to increase the size of the business. That's why we started to work on M and A activities. So those are the summaries and highlights of our history in this graph. Next page, please. Another point I wanted to talk about is the phases. Back in February, when we had a good growth, there was a good sales of gas turbine and also steel related businesses. So those are the areas we had strength, like compressor, steel, chemical plants. And all these heavy industries have enjoyed good results in these days. However, after that, when we faced with a slowdown, all of these industries were slowing down. And instead, other industries started to grow. Therefore, there was a shift in the industrial structure in between those two decades. For the energy, we are still struggling with the growth with energy related businesses, especially power generation. For compressor, there are oil and gas. There is some growth in downstream. So that was the basic summary of what happened in those two decades. On the next page, these are the initiatives that we have taken. We tried to increase the size of business through M and A. In power business, we established Mitsubishi Power Systems. And because of the size, we had higher efficiency because of the MHPS. And after that, CO2 issue and renewable energy issue changed the situation drastically. We would have had a growth up to more than point 5,000,000,000,000. However, the situation was not that way. We have only JPY 4,000,000,000,000. We wanted to reach JPY 5,000,000,000,000. In that sense, we have a gap of about JPY 500,000,000,000. Another factor is the delay in MRJ development. In 2020s, we should resolve this issue. However, because of this issue, we have about gap in size of the business by about 100,000,000,000 yen Altogether, these two issues caused a gap of 600,000,000,000 yen Now given these situations, the slow growth was because of the conglomerate business, and we have more than 700 products, although we have cut a lot of SKUs and products already. But the number of business units was too many. Now we have the gap between the headquarters and the business units, and all the business units were competing against one another, and then they were maximizing their own profits. And also, we had dependency on the past successful areas, and we tried to do everything on our own rather than using partners and suppliers. There was a limit to what we could do in this silo, and we failed in many of the initiatives, including export expansion as well. We couldn't take a systematic approach in expanding exports. Therefore, we tried to work on the overall optimization, and we changed the business structure and tried to optimize the business for the entire group. And also, we focused on the core businesses because we had too many business areas which tried to optimize by themselves. Therefore, we incorporate the strategic appraisal system for businesses and implemented a thorough cash flow oriented management, which worked pretty well to improve our business to what we have today. And up to JPY 4,000,000,000,000, we were able to grow the business. From less than JPY 3,000,000,000,000, we were able to grow the scale of the business to JPY 4,000,000,000,000. And the old style conglomerate management had some issues, and we have taken some measures against that already wherever we could between 2010 and 2015. But for the further growth, we had to do a little bit more initiatives because in MHI, the in the long history of the company, we have always had this conglomerate business, and we didn't have the competency as the specialized manufacturer. For example, Mitsubishi Electric has been separated 100 ago, and Mitsubishi Automobile was also separated out some time ago. Therefore, for these specialized areas, we have already separated. But what is already still remaining in MHI, we are still having conglomerate business approach. But we thought that we should change the portfolio so that we can be more effective even with the conglomerate management. Therefore, the old style conglomerate management does not work anymore. For the sustainable growth and profitability, we have to have a new style of conglomerate management in order to grow our business further in the next generation. We have to have a good cycle portfolio changes. So that's what we are trying to do with the new style of conglomerate management. So this is the review so far. In the next area, I'd like to talk about the growth strategy, what we are trying to do. So we worked on efficiency, cash flow and other initiatives, and they will continue to work. But next thing we did was financial structure. As you can see at the lower left, the structural change of the thermal power business is something that we have to accomplish. There is no choice. CFO already explained. Nimitsubishi Power Systems, MHPS or MHI, compared with other companies, up until 2021, we had a very thick pipeline. So the profitability up to then is very much stabilized. So we think that we can stabilize the business for 2019 and 2020. And then we can also sustain the business for 2021. We have already taken actions. But after that, we have to do something in order to sustain the orders. Today, we are very busy with other projects. But in the meantime, we have to prepare for the future. In other words, now is the time that we can take actions towards the future business because we have still have time. And to do that, first and foremost, we have to get the MRJ business on track. We have to have a seamless development from development to sales. And also, in order to grow the business further, we have to go into the globalized business in other products as part of the new style conglomerate management. So under conglomerate management, proactive use of management resources is what we would like to do. And we have created better fluidity through major consolidation by having the domain system. And now our people are more have more mobility, but how are you going to allocate the resources? How are you going to set the goals for the businesses? In the past ten years, this is something I've been continuing to think about. But finally, I have reached an answer, which is categorizing the businesses. Another thing is one of the characteristics of MHI is there are domestic business that still remain in Japan that are quite steady in nature. However, they are not expected to grow any further. As a global company, we need to regenerate new businesses, which means that we need to grow the global businesses. So we need to do this intentionally as we manage the businesses. The other way of thinking is that apart from categorizing the businesses, consider the nature of the business. We make investments over the longer term, and we recoup our investments over the longer term as well. And we made to order products, where it's very hard to make products on anticipatory basis. It's not like automobiles where we do the marketing. We are given difficult challenges. We take time to consider it, and then we receive the orders. So if we get the orders and do a good job around it, it is a steady business we're in. However, when the cycles are shorter and when you're trying to make things even and to create a virtuous cycle, the investment return cycle needs to be not just long but also short as well. So made to order products might be extremely steady, but they're very slow. So we might may need to look at a shorter investment cycle of products that are more cyclical in nature. So for the medium lot product business growth, back in the '60s and '70s, this was working really well, and we were performing back then. So when this is combined with good made to order products, we do well, but we have to be able to attempt and do new things. And we are also trying to restructure the thermal business. But when it comes to renewable business, energy and new hardware, when there are no new investments being made over the medium term, you need to focus on the solutions side of things, which is the soft side of things. For example, environmentally considerate products or making modifications so that power efficiency is better is something that you need to do, the bridge the time lines. So and by doing that, we believe that we can shorten the investment return cycle, and that will be higher focus on cash flow management. And we would like to, therefore, make the balance sheet even more efficient by taking these measures. However, we should not look at things on a spot basis. We should look at the entire portfolio and continuously revise and recalibrate our portfolio Because when it comes to business HQ and business offices, we used to have thirteen and ten, respectively. I wouldn't say it's 13 times 10. However, we had about 70 management units as we manage the business. This is very challenging to manage. So we would like to be more portfolio focused and try to categorize the businesses so that we can do things better. So we would like to maintain growth by recalibrating the portfolio and have a better balanced portfolio so that we can ensure stability of business. And also with regards to the strategic business evaluation system, it was good as we went through a selection and concentration process of businesses. However, when it comes to stability as well as growth in engaging in conglomerate management, we also need to think about intra business synergies and also think about not only short term cash flow but long term cash flow to see whether we can strike a balance between the two. We need to think about many things, and we need to try to incorporate that into our business evaluation. If we do a good job on that, overall, we'll be able to shift to a new type of management, which is conglomerate management. And the things in the middle are what we hope to achieve. Moving on to the next page. At the core of my thoughts, at MHI, these are specific details that we have thought internally. But when it comes to defense space, those are regulated industries. Especially when it comes to defense businesses, it's extremely regulated and under the regulations. We have the three principles and so forth that we need to adhere to. However, it is very stable in nature because of that process. It's the three principles on transfer, defense, equipment and technology. And also, security as well as the space business are what we would like to grow steadily at the same time. And this is a business where we have a relationship with the Japanese government as well as The U. S. So the category is very clear cut with regards to what we need to do. The next category is a category where we have factories in Japan. The market is mainly Japan based. It's basically surviving in Japan, but it's not something that we will do overseas, but it's very niche and stable. But in managing these businesses, it's not about global management. But we would like to improve the profitability and make things more efficient as we manage these businesses. And if there is opportunities for global development, we will re categorize these businesses. But in the next two midterm plans, that's probably not going to happen for these businesses. We would rather focus on profitability improvement, and we would like to be thorough with the conventional way of managing things. That's one-two. For one-three, aero engines, for example, this is not something where we could continue to open factories overseas. It's more about making things in Japan and supplying the components for assembly. However, for commercial airplanes, in Vietnam, we do have some production bases there. And maybe there is an opportunity to develop this as a global business. For MRJ's business strategy and the way we should engage in the Tier one business, we'd like to think about these things as we continue to strive to grow the business. So we show the challenges and solutions at the bottom. Now the valuation points are become going to become clearer and clearer. The next part is globally based businesses on the right hand side. Where it says two-two, this is classified as mature and mid tier businesses. For example, metalsmachineries, now we have a JV with Siemens, and we have the majority. But the development, some of it is being done in Japan, some is being done in Austria as well as in The U. S, depending on the nature of our developments. And there is a global production based presence. So the business is quite mature. And we are also trying to reinforce our global human resources and looking for opportunities to grow. So we are trying to develop this business so that it can turn into even more global business. With regards to forklift trucks or logistic equipment, this is a business where we have developed into U. S. And Europe, but the business is not that large in Asia, but there is an opportunity to globalize even further. So we will focus on that. However, opportunity for M and A is declining, it's a matter of alliances and looking for those opportunities for better added value. So by classifying the business, our thoughts and strategies will be clearer. And with regards to developing and expanding, that is two-one. The final one. The last category is large scalereform. These are for mature businesses, core businesses mature and core businesses. At least that was our expectation. But currently, this is our true core business when it comes to revenue and earnings. However, in several years' time, looking at the current order environment, we need to take measures to re leverage the business, meaning if we do some reform efforts, it can continue to be a core business in the future. So CO2 issues, renewable energy, the balance between this business and renewable energies are something that we need to consider and take action against. So this is a business that needs restructuring. So these are the six classifications of our businesses. This is of which we will do management. So we will recalibrate our conglomerate management into them further going forward. And turning the page. Here are some time lines. Under the current midterm plan, we are going to take care of a lot of these items. And in the next midterm plan, we would like to make a deeper dive into each of the items or further develop the strategies we have in place. And so moving on to the next page. For conglomerate management, we're going to be doing this for further growth, but we need to also confirm the status quo. Looking at the previous business head HQ and business office system, what we tried to do was do everything at the parent level. And in Japan, most of our customers were Japan, so we were just thinking about Japan. Back then, as you could see in the dotted line box, out of the 64,000 people, 34,000 people belong to the parent of MHI. And for the domestic group companies, we have quite a lot of them by business unit or business HQ. They have subsidiaries respectively, and we used to have 22,000 people under 198 companies. For overseas. We only had 8,000 people in the past or 105 companies back in March 2008. So each of the companies were small in scale, but as we developed the businesses, we understood that this was no longer possible. So we wanted to accelerate the speed of management by switching over to a business unit management system so that people can be more independent in their management of business. In the business headquarters and business offices, we try to consolidate so that back office management can be more efficient. And with that, the number of employees increased actually in Japan. However, the number of companies decreased. However, in the overseas region, the number of people went up by 3.5 times, which is quite substantial, and the number of companies went up by 2.5x as well. But for the global market, we believe we need it needs to increase even more. But it doesn't mean that we want to increase the number of small companies more and more. It's more about having a good global management or group management as required. So global management and group management needs to be improved, which is what I show here. Turning the page. So what are we going to do for this purpose? So having a group headquarters is one solution so that we could do optimization management as well as have a solid management base and have a common base. By having that, we'll be able to generate synergies and maintain them. And we would like to have a pivotal power at the group headquarters. And when we were growing the businesses, autonomous management vitality is required. And sometimes, we could delegate the authority to the business units and have them be more independent and raise the business value of each of the businesses we're in. But by business, compared to the pure play companies, the power business is quite large for us, but each of the businesses are medium sized. It's only about 400,000,000,000 or 500,000,000,000 yen in size when you look at the size of each of our businesses, which means that they will not be able to survive over a long period of time. So in order to generate synergies, we need to have a common base or common platform and strike a balance. Currently, the domains are functioning quite well. Whether or not it should continue to be that way, I am not sure. But if we could have synergies generated between businesses, that will be great. And in order to manage our businesses better, I would like to have the domains stay in place. And I think the businesses, the business value is going to continue to enhance. And in order to manage the businesses, by we would like to give clear targets to the regional headquarters. And for the oversight on Japan, it goes back to one-two or three, especially for one-one and one-two classifications, as I introduced earlier. In order to make things successful, we need to apply a different point of view from global management as we manage the businesses. So for the Japan oversight functions, The oversight functions are going to be for the Japan region. It's not just going to be support functions. So from asset management, the oversight function is going to be responsible. With regards to being a listed company, overall business of listed companies will be taken care of as well. So Japan is pretty large, so they'll be in charge of the businesses as well as the regions. And for each of the regional companies, they will generate regional synergies that are connected to the global headquarter. And turning to the next page. Based off the concept I explained, in January, from December to January, we will be relocating our office to Marunoji, Tokyo. And during the January, March time frame, we'll be able to organize ourselves into the new management scheme. And from April, we will be under the new management scheme in earnest. But for HQ, a group head office functions, I believe fine tuning will take about two years from now. And also for the HR system, some things are specific to Japan. Some HR policies are specific to global, meaning careers in global careers in Japan and regional careers. We would like to create a new cycle, and we're going to shift over to the new HR scheme. And we'll be preparing during the course of next fiscal year. Currently, we are doing testing individually speaking, but it's going to take more time to brush up the personnel system. For financial, accounting and tax matters, we are working on the promotion of RPA application. But I think this process is going to be fairly quick to implement. So global management group management is something we would like to reinforce. And by doing so, we will be able to pursue growth opportunities. We hope to maintain Japan as a good earnings base and grow the business through our global business opportunities. That is going to be the transformation that we would like to go through under the current midterm plan. And also, MRJ as well as the recalibration of other businesses is going to happen going forward based off the time line I explained earlier. I also talked about other earnings structure and expenses for MRJ. This fiscal year is going to be the peak for MRJ, and development investments are likely to decline going forward, which means the profitability is expected to improve. So I think this is a good time to go through this transition. Of course, we are in turbulent times when you look at the global politics and economic situation. However, from our point of view, if we are able to transition to this kind of management scheme, we believe that we'll be able to become steadier over the medium term. Thank you for your attention.