Orix Corp Q2 FY2020 Earnings Call

Good afternoon. I’m Yano of Treasury and Accounting Headquarters. Thank you very much for your attendance at this business performance announcement meeting of our company. Let me now start my presentation on our second quarter business results for the FY 2020 March end period. I hope you can hear me. Now please open Page two of the handout slides. Net income for the quarter was up by 2.6% year-on-year to JPY 159.2 billion, which resulted in an annualized ROE of 10.9%. Please refer to the chart on the right-hand side. Net income tends to fluctuate from quarter to quarter to some extent. However, the result for the single quarter this time was at a higher level at JPY 89.9 billion with an annualized ROE of 12.3%, as compared to JPY 69.2 billion and an annualized ROE of 9.6% in the first quarter. So please turn to the next page. The page shows the breakdown by business segment. Segment profit for the second quarter was up by 3% at JPY 230.4 billion. The trend of the profit over the past five years is shown on the bar chart on the same page. The pale blue expresses the level of gains on sales, while the darker blue expresses the level of segment profits excluding the gains on sales. From the dark blue bar chart, I hope you can see a stable growth achieved over the past five years by the segment profits that exclude gains on sales. Now please refer to the bar chart in a small box on the right-hand side of the same page. Here we compare the result against the first half of last year. The segment profit excluding gains on sales achieved a higher level than the first half of the fiscal year 2019, thanks to contributions made by NXT Capital and Avolon, both of which were new investments in the prior fiscal year. It is our intent and will to continue to steadily grow the segment profit excluding gains on sales going forward. Now gains on sales for the first half was JPY 74.5 billion. This is an increase of JPY 2.5 billion from the first half of last fiscal period of JPY 72 billion. We divested some assets in the Real Estate and Overseas segments, including ORIX Living, the largest contributor to the gains on sales, which we concluded the deal in August of this year. As you may know, we have been proceeding with the sales of our shares of Houlihan Lokey in the United States since its IPO in 2015. I would report to you that we have completed the sales of our entire holding as of July of this year. We will continue to exert our effort to build the portfolio of assets and continue to enhance its value so that we can generate steady and constant gains on sales, although fluctuation may not be avoided from quarter to quarter or from year to year due to the nature of the profit that can be enjoyed from the gains on sales. We at ORIX regard the profit to be a profit that is generated from our day-to-day businesses. Please turn to the next page. The page shows the trend of segment profits as well as segment assets. Segment profits were up by 3% at JPY 230.4 billion. Profits of the Real Estate segment, Investment and Operation segment, as well as the Overseas segment were up, while the profits of other segments were down. Segment assets increased by JPY 435 billion. This includes the impact from leasing accounting standard change by about JPY 200 billion as well as a negative impact from foreign exchange of about JPY 120 billion. If it was not for these impacts, the assets would have increased by about JPY 360 billion. Details of the performance by each and every segment are shown from Page 15 onwards. Allow me to make a few comments about each segment, although it may be very brief. This is going to be Page 17, Corporate Financial Services segment profit was down by JPY 7.6 billion year-on-year at JPY 9.2 billion. The main reason was attributable to a decline in agency fee income from life insurance business for corporate customers. Accounting software and its support business, Yayoi, on the other hand, enjoyed profit increase as a result of an increase in the number of fee-based support memberships as well as the sales of packaged products. Now, Maintenance Leasing segment’s profit was down by JPY 4 billion year-on-year at JPY 16.6 billion. Despite the persisting harsh competitive environment in the auto-related businesses, we managed to maintain the level of revenue in both leasing and maintenance businesses as the prior year. However, in order to further expand the client base, service-level improvement was indispensable, which translated into an increase in SG&A, and for this reason, the profit was down. The negative impact from the change in the accounting standard was JPY 1.3 billion for the Maintenance segment, and JPY 900 million for the Corporate Financial Services segment in the first half. Now let me move on to the next page. Real Estate segment profit was up by JPY 2 billion at JPY 46.2 billion. Large contributions are continuing in this segment that includes the sales of ORIX Living shares in the second quarter. DAIKYO enjoyed a profit growth of JPY 5 billion due to a large number of condominium units being delivered in the second quarter. The next is Page 23, Investment and Operation segment profit, which was up by JPY 3.5 billion at JPY 28.4 billion. Although there was some negative impact from the decrease in the assets for service businesses. In the Investment and Operation unit of the segment, CORNES AG, the new investment in the last year, has started to make profit contributions allowing the unit to trend flat year-on-year. The concession business increased its profit by JPY 3.9 billion; thanks to a rise in the number of tourist visitors to Japan as well as sales of goods. The next segment is the Retail segment. The segment profit was down by JPY 6 billion at JPY 43.2 billion. Profits declined due to the large gains on sales in the last fiscal year as well as a decrease in profit generated from former Hartford Life Insurance. Banking continued to expand mortgage loans for condos for investment, resulting in an increase in financial revenue and income. This is going to be the sixth and last segment, the Overseas segment. The profit of the segment was up by JPY 19.1 billion at JPY 86.9 billion. OCU in the United States increased its profit as a result of growth enjoyed by the asset management business, including NXT Capital. OCE, which is ORIX Corporation Europe, again, an asset management business. Although AUM did expand, fee pressure continued due to a shift in trend from active to passive that resulted in declining profit. The Aircraft and Ship business benefited from incorporating profit from Avolon, a new investment in the prior year, while Asia and Australia increased their profit, the former from gains on sales on investment from the first quarter and the latter from a positive turnaround from a loss incurred from IL&FS in India in the prior quarter. This concludes the performance explanation by segment. Now please go back to Page five of the slide deck. The page shows the trend of employed capital and breakdown of funding over the same period. The funding environment remains favorable, allowing us to enjoy substantial capacity to either borrow from financial institutions or procure from the capital market. We will further effort in diversifying our funding method as well as the markets to tap into while continuing to extend the duration as well as diversifying the timing of maturity. As shown on the chart to the left, long-term debt ratio is now at about 90%. We will continue to be flexible in maintaining the stability of our fund management. Moreover, the employed capital ratio, as of the end of September, was 85%, an improvement from the end of the prior year as a result of buildup of an internal reset. We intend to carefully control the employed capital ratio as well. With regard to financial soundness, Inoue, our CEO, will elaborate a little more in his presentation on the midterm direction later. This concludes my presentation of the second quarter business performance for FY 2020 March end. Thank you for your attention.

I’m Inoue from ORIX. Thank you very much for your attendance once again. So I would like to explain the backdrop to the reasons why we have decided to make some changes to our midterm business plan. As you may recall, back at the time of the business performance announcement in October of 2017, we made the announcement of achieving net profit growth of 4% to 8% during the three years of FY 2019 to 2021, with ROE of more than 11% and the maintenance of credit A rating. However, for the first half of the 2020 March end period, we posted a net profit of JPY 159.2 billion, which is an increase of 2.6%. However, for the following reasons, I would like to report to you that we will be generating only a net profit of JPY 300 billion for the full year of the 2020 fiscal period. While the pretax net profit is forecasted to be at JPY 430 billion, which is an increase of 9% and also a record high, the after-tax profit is expected to be down by 7.3% year-on-year. Since the beginning of this year, macroeconomic slowdown has become more apparent. In addition, there seems to be no end to the China-U.S. trade war, as well as chaotic conditions in Iran and Middle Eastern countries aggravating, along with uncertainty in the EU due to Brexit and increasing geopolitical risks. Despite the IPO market experiencing confusion, there’s still an abundance in terms of liquidity. Therefore, despite the fact that we may start considering making an investment in certain deals, the valuations for each of those deals are way beyond the price that we consider appropriate and adequate, which, in fact, leads us to remain cautiously optimistic. As to the portfolio of ORIX in the United States, Europe, and China, it is well diversified and centered around infrastructure-related investments. We do not have any investment in trade or manufacturing-related areas, which means we are not expecting to be negatively affected by all the aggravating geopolitical risks. However, we recognize the need to adjust our attitude towards investment in light of these macroeconomic conditions. While despite all of this, we are securing a rich pipeline. But to maintain an appropriate and adequate level of valuation, we will need to specialize and focus on development deals, in other words, greenfield investments rather than brownfield ones. However, while greenfield investments allow us better control over the investment amount, they tend to incur costs before achieving positive contributions to business performance. Therefore, we would like to prioritize real estate investment deals such as MICE-IR. Although we have not yet secured approval for our project, we are expecting to incur as much as JPY 5 billion of expenses this year for RFC and RFP, which will continue to increase as we move forward. This is something we cannot avoid in order to win the deal. In the short run, we will incur costs in anticipation of profit or revenue generation, which will put pressure on our P&L. In light of all of this, we feel the need to revise our midterm business plan this year and next. Although we had initially set a target of achieving net profit growth of 4% to 8% starting from 2019 for three years, we would like to reset and come up with a renewed target of achieving JPY 300 billion of net profit by March 2020. While the net profit target for March 2021 will be monitored closely, and rigorous analysis of our business performances will be continued. We intend to announce outcomes at the end of the current fiscal period. As for our target of maintaining a credit rating of A, we want to express our continued commitment to maintaining financial health while maximizing our efforts to keep the credit rating. The reason for this is that we do not want the maintenance of credit A rating to become a factor in influencing investment decisions; please understand that these changes are not merely about maintaining the credit rating. We aim to increase our net income from the current JPY 300 billion level to JPY 400 billion to JPY 500 billion. However, for new investments, we must prioritize projects with upfront costs, which means that in the short term, ROE may fall below 11%. We will still maintain the objective of achieving an ROE of 11%, which speaks to capital efficiency; however, I would like to adjust this to mean we want to achieve ROE of 11% over the mid to long term. In other words, I want you to understand that in the short term, it may drop below 11%. The capital ratio against total assets for the fiscal year ending March 2019 was at 23.8%, and we believe it is time for us to revisit the appropriate capital ratio for ORIX Group as a whole. ORIX Group implements various businesses, and for such a diversified group, the lower limit of capital adequacy ratio should be set at around 23%, which will be the basic assumption for calculating shareholder returns. Of course, future financial turmoil and recession potential should be included in this discussion as factors. This policy is not absolute; however, we believe it is important for us to return surplus capital to our shareholders. For the fiscal year ending March 2020, we will employ whichever payout ratio is higher: 30% or JPY 0.76 per share for the full year, JPY 0.35 for the first half, and JPY 0.41 for the second half. We will also implement share buybacks with a maximum ceiling of JPY 100 billion, executed between November 1, 2019, and May 8, 2020. Through the share buyback, we expect total shareholder return to be about 65%. Furthermore, we will set an upper limit to the treasury stock ratio of 5% against total issued shares. Anything exceeding this ratio would be retired or canceled. Since the global financial crisis, key financial indices have improved greatly. As far as this chart tells you, we do not believe anything should interfere with our A rating. However, unfortunately, some rating agencies have pointed out that there are specific issues—general concerns about the ability to obtain foreign exchange for ORIX, as well as Japanese financial institutions in general. Therefore, this concern may impact ORIX's rating according to ratings agencies. Regardless, our strategy to further improve our financial indices remains unchanged. We intend to manage this company by achieving the right balance between growth and financial health. A total of JPY 1.5 trillion of liquidity consists of, first of all, JPY 500 billion of liquidity based on current assets of ORIX Bank and the Life Insurance company, and the remaining JPY 1 trillion represents current assets for maintaining our single A rating. We believe the validity of our 23.8% shareholder equity ratio should be reassessed, and this is why we have decided to start by conducting share buybacks. On this slide, you can see the projects or assets that have been invested into or sold since April 2018. Although not shown on this list, if you include the sales of real estate, as well as the purchase and sales of aircraft, the total amount is approximately JPY 1.3 trillion each, after implementing new deals and sales. The total capital gain from these five assets shown here is approximately JPY 100 billion. You can see on this slide the list of pipelines of new deals, including developments and the timing of profit contributions from these different deals. From this list, the MICE-IR project is not a confirmed asset yet because we are still preparing for the licensure. RFC and RFP for Osaka Prefecture and Osaka City must be prepared, and we are collaborating with approximately 20 different companies, including MGM Resorts. This project requires upfront expenses, and until we obtain the license, we expect to incur about JPY 10 billion worth of upfront investment. We believe this project will put ORIX on a completely new stage. The promotion of greenfield deals, including this one, is one of the major reasons we want to make revisions to the midterm plan in addition to those external factors. We will continue to execute the deals on the pipeline and launch digital-related business, implement new M&As without fail, and continue to sell projects from the existing portfolio. This is how we intend to increase net income from JPY 300 billion to JPY 400 billion and then to JPY 500 billion. The success or failure of the MICE-IR project will determine whether we will make this announcement and how to formulate the midterm plan beyond March 2021. We appreciate your kind understanding and patience. It all depends on the market and macro environment. But if everything goes smoothly, we believe we can achieve the level of JPY 400 billion by 2025 or 2026, and if we add the sales of assets from the existing portfolio, we may be able to achieve this earlier. Thus, market conditions, profitability of existing portfolios, progress of development projects, pipeline, and financial health all need to be carefully monitored as we move forward. On this graph, you can see the trend of ROE. If we maintain the current pace, ROE will not rise until around March 2025 when development projects start to contribute to profit. We should never purchase anything at an expensive price; we need to carefully examine the purchase price of new initiatives and develop greenfields, promoting new M&As that can contribute short term. We must also promote timely sales of items in our existing portfolio and manage shareholders' returns, including proactive buybacks, employing surplus capital effectively to reach the target ROE. In the short term, ROE may dip below 11%. This is the summary. For the first half of the fiscal year ending March 2020, net income increased by 2.6% to JPY 159.2 billion. ROE was at 10.9%. Our single A rating is still maintained, but, considering the current macro environment and other uncertain external factors, ensuring flexibility is our primary focus. This is why we would like to revise and change our midterm strategic direction for the period ending in March 2021. ROE may fall below 11% short term, but we believe early recovery is possible, and therefore we want to keep an ROE of 11% as our management objective over the mid to long term. ORIX’s financial health is very sound, and we will continue efforts to ensure this; however, the need to maintain our single A rating may interfere with our growth potential. It is not appropriate for us to be constantly aware of the rating whenever executing a new deal. Naturally, maintaining our single A rating is something we strive for, and we believe there is an obligation to return the surplus capital to our shareholders. We would prefer to use capital for new investments to sustain growth, so this policy remains unchanged, but the return of surplus capital is a different matter. This time, we have decided to apply the higher payout ratio of either 30% or JPY 0.76 per share. Additionally, we have announced a share buyback of JPY 100 billion, resulting in a total return of approximately 65%. We will also continue discussions on the lower limit of dividends as well as proactive buybacks for next fiscal year and beyond. That concludes my explanation regarding our midterm strategic direction for ORIX Group.

So the person sitting in the front row.

My name is Watanabe from Daiwa Securities. I have two questions. First of all, this is regarding Page 8, midterm direction and your dividend policy. You are considering setting a minimum payment of dividends, which means that you are not going to incorporate the idea of payout ratio going forward, is that right?

So we have stated that JPY 300 billion of net profit is to be achieved. If we were to set a payout ratio of 30%, it would mean we would experience certain negativity, which is not particularly good. This is why we have come up with the idea of paying the minimum amount of dividends. It seems to be a trend mentioning the word minimum payment of a dividend, and we thought we could not take this for granted. So we will continue to consider whether this is the best policy. But in our case, if you could wait a little while, we will certainly be able to recover our businesses going forward. This is why we do not want to express any kind of negative indicators, even for a single year, and this is something that has to be approved by the Board. Please understand this is not a decision that can be made solely by me.

And my second question is about Page 12 concerning profit growth. Following the best scenario, achieving JPY 300 billion of net profit to reach JPY 500 billion implies an annual growth of 5% to 6%. How committed are you to this target? What would be the base profit and what structure do you envision to generate in terms of the split?

As you can see from this chart and the numbers, there is a declining trend in new investment, including in automotive. We also have to balance both aspects, particularly regarding the divestment and gains on the sales of the existing portfolio, for example, ORIX Living. We may consider exiting certain investments made in the past or maintain them based on their contribution to overall numbers, hence striking the right balance is crucial in this context. I hope you understand my point. Regarding the JPY 400 billion to JPY 500 billion net profit envisioned for the future, we may look for gains on sales, but please understand that we do not have any exceptions here. As explained last time, Rentec, automotive, and areas still have room for growth, including B2B or AI-related segments. If this is the case, automotive profit can also grow simultaneously. Gentleman in the front row, please.

My name is Muraki from SMBC Nikko. After the revision, it seems that your plan is more easily influenced by management decisions, particularly the ROE target on Page 13. Can you provide more specifics about your outlook and the plan itself? For instance, is 11% achievable in the fiscal year ending March 2024?

Let’s refer back a few slides. Unfortunately, this is extensively about greenfield investments, specifically MICE and IR, comprising around JPY 650 billion in expenses until March 2025. While depreciation will occur, profit contributions will only manifest later. This represents a JPY 1.3 trillion investment in total. Given that we started this investment, a large variance is expected. This is why we decided to maintain some flexibility concerning policy. The local community aims to launch the project before the World Expo; however, this timeline is extremely challenging. Coordination efforts are ongoing among three competing companies—Genting, Galaxy, and ourselves. We may know by the first half of next year, at which point future projections might change significantly. Without MICE-IR, the JPY 650 billion expense would not be necessary, which might allow further returns. However, we ask for your patience for about a year. Once this is resolved, we will provide more detailed numbers. Generally, we want to revert to 11% quickly but will operate under the assumption of maintaining 10% for the time being and aim to achieve 12% going forward, which is our policy statement.

Second question. For proactive buybacks next fiscal year and beyond, what triggers these buybacks and how is the amount decided? Would achieving 11% ROE necessarily initiate a buyback? Are you considering the ROE or capital ratio of 23% to trigger this?

Even with our JPY 100 billion buyback, the ROE impact is minimal, about 0.1%. To achieve an ROE of 11%, JPY 1 trillion would be required for buybacks, which is relatively unrealistic. Regularly, JPY 100 million may be allocated for buybacks depending on market conditions. However, share buyback plans require Board approval, so I cannot personally commit to these figures at this venue. It all must be approved by the Board, which consists of six outside directors. We must present our growth strategy and provide balanced explanations to convince them. Thus, I cannot clearly state whether buybacks will occur. We’d like to entertain the next question. The person on the left.

I’m Tsujino from Mitsubishi UFJ Morgan Stanley. My first question regards setting a minimum payment level for dividends?

No. We are considering setting a minimum payment level for dividends.

Regarding the dividend level this year compared to the expected minimum payment, how is it positioned? Have you assumed a decision to ensure it is at least the prior year's level of JPY 0.76? Considering next year's possible minimum payment, does it reflect a trend that might be applied going forward?

At present, we did pay JPY 0.76 last time. We have indicated our net profit goal at JPY 300 billion from a management perspective, independent of shareholders. This is why we feel the need to maintain the minimum payment at JPY 0.76. In the future, minimum payment of JPY 0.76 may not sound appealing. For the time being, we will continue paying JPY 0.76; however, as our payout ratio evolves to around 30%, there will be an interest in achieving a total shareholder return of 65%. Consequently, I would not like to establish a payout ratio around 30%, but more processes will be needed to ensure higher payouts on a total shareholder return basis. Gentlemen in the middle, please.

I am Sato with Mizuho Securities. My first question is regarding MICE-IR. On Page 11, specifically about the JPY 650 billion investment, what are the assumptions for this investment? You mentioned that the total investment is about JPY 1 trillion; does this mean that JPY 300 billion goes elsewhere? So what does this JPY 650 billion cover?

To the local government, we are showing the total cost of JPY 1.3 trillion; ORIX will cover 40%, MGM 40%, and 20% will involve cooperating companies. Bankers are currently looking into extending loans. Typically, this should be a non-recourse loan but differs from Kansai Airport. For MICE-IR, it will be corporate credit until project completion. Until 2025, JPY 650 billion will be on ORIX's balance sheet. Post-completion, this is expected to reduce to JPY 250 billion, with debt dropping to around JPY 300 billion. Presently, according to current accounting standards, this will count as recourse while there is no repayment obligation; it's merely a separate line item.

That's quite clear. My second question pertains to Page 12. Again, regarding gains on sales from the existing portfolio, do you assume selling some assets? As indicated below, asset management and energy and environment are already included. Is that correct?

That’s a challenging question for me to answer. We will certainly consider selling if there's a good offer; however, for now, the asset management business is growing, but fee pressure remains. It's vital to assess whether the asset management business has lasting value; we will evaluate this as we prepare our presentations. Next question, please.

Hello, I’m from Citigroup Securities, my name is Niwa. As you revise the midterm business plan, is this a downward revision of growth prospects? If that is the case, is it due to market pressures or other reasons? In forecasting ahead, if the market forecast is incorrect, might history repeat itself in the future? How do you determine the likelihood of achieving JPY 500 billion in the future?

The investments we've engaged in so far, particularly due to their complex nature, have resulted in substantial due diligence costs. Consequently, in the next two to three years, many of the projects we foresee or engage in will show more upfront costs compared to strategic M&A deals capitalizing on immediate profit. The majority of M&A deals are done on a direct basis, taking a bit longer but allowing for appropriate pricing determinations. Thus, while greenfield projects maintain control over investment amount, they will lead to depreciation costs, which we need to manage appropriately. Please understand that though the JPY 300 billion net profit achievement appears feasible, it may not lead to a repurchase program if executed cautiously. So, these considerations shaped our decisions. Please be reassured we have not scaled back on our targets due to lack of confidence, but have made adjustments given current conditions. In regards to the gray area of investment I mentioned earlier, we are managing multiple projects, more than twenty, outside of Japan. If successful with M&A abroad, it could yield substantial profits; however, high pricing can unnecessarily complicate negotiations.