Orix Corp Q4 FY2020 Earnings Call

So thank you all very much for your participation in the business performance announcement meeting for FY 2020 March end for ORIX. Thank you very much indeed. I'm going to be the emcee for this meeting from Corporate Planning Department, and my name is Kohei Uehara. I look forward to your cooperation in advance. As for the presentation material, you'll be able to refer to it on the screen, but at the same time, you'll be able to download it whenever necessary. So please make sure that you can see the slides. As for the schedule for today, we start with the presentation from Mr. Yano, Head of Treasury and Accounting Headquarters, followed by Mr. Inoue, CEO and Representative President – Director President. And after the presentation of the two executives, we will entertain questions. We are scheduled to conclude the session at 16:00. Because this meeting will be conducted online, there could perhaps be a possibility of you not being able to hear us well, but please do excuse us. As for the questions, after the presentation by CEO, Mr. Inoue, on the screen please write out your questions and send them on the template questionnaire form. I'm sorry for this, but in the interest of time, we would like you to limit your questions to just one question. Now, if we don't have enough time to entertain all your questions, we will send back the response through the secretary later on.

Good afternoon. I am Yano, from Treasury and Accounting Headquarters. Thank you very much for your attendance in spite of the busy schedule to this business performance announcement meeting of our company. Let me share with you the actual results for the FY 2020 March end period. Please open Page 2 of the handout slides. The page shows the net income and ROE for the full year. So, the harsh economic environment due to COVID-19 affected us in Q4. However, our net income was at ¥302.7 billion. This is lower than the prior year, but we managed to achieve our target of ¥300 billion. ROE was kept at double digits at 10.3%. There was a reversal of deferred tax liability associated with the conversion of DAIKYO to a 100% subsidiary in the third quarter. The reduction of corporate tax by ¥27 billion contributed positively to the after-tax profit. As a result, although net income declined by 6.5% year-on-year, pre-tax segment profits grew by 4.1%. Now, please turn to the next page. The page shows the breakdown by business segment. Segment profit for the year was at ¥417.7 billion. Let me explain further by breaking down the profit into base profit versus investment gains. Until the third quarter, we referred to the dark blue part of the bar chart as segment profits that exclude gains on sales. To facilitate your understanding, we started to describe this as base profits from the fourth quarter. The base profit was down 5.5% year-on-year at ¥277.9 billion. Decline in profit in corporate financial services and others, as well as a negative impact from COVID-19, which will be shared later, affected us; however, steady positive contributions were enjoyed from NXT Capital and Avolon investments we made in FY 2019. Now investment gains grew strongly by 30.3% from ¥107.3 billion to ¥139.8 billion. Gains on sales of PE investment both in Japan and overseas were posted while a rebalance of business portfolio such as ORIX Living, Houlihan Lokey, a department for ESG data collection, analysis, and evaluation at RobecoSAM was done at the right timing. Now, please refer to the chart at the bottom of the slide. The bar chart shows the trend of segment profits for the first five years. Investment profits, the pale blue part, may fluctuate due to changing environments. However, as a result of strategic capital allocation and timely exit, we have been successful in maintaining the level at around ¥130 billion on average, which we believe is a proven track record of ORIX. As for the base profits, which is the blue part of the chart, it constitutes 70% of the segment profits for the fiscal year and displays steady growth over the past five years. Now, please turn to the next slide that shows segment highlights. This is page 4, segment highlights. As shown on the chart on the left, segment profits from investment and operations as well as overseas grew, while profits from all four other segments decreased.

This is Inoue speaking. I'll start my presentation from Slide number 6. I'm sorry to repeat what has already been presented. But just as has been announced yesterday, for 2020 March end, pretax net income at JPY 412.6 billion, in fact, was an increase of 4.3%. However, our net income was down by 6.5% year-on-year at JPY 302.7 billion. That was the result. ROE was at 10.3%, which is lower than 11%. However, just as announced last time, we remain unchanged in setting our target of achieving ROE above 11% and we will continue to exert our efforts in that regard. Now due to market fluctuation, multiple credit rating agencies have changed their outlook to negative for ORIX. But the credit rating of A is maintained. For the FY 2020 March end, a dividend payment has been scheduled. Per share of JPY 76 is to be paid; first half JPY 35, second half JPY 41. Therefore, the payout ratio will be 32% for the year. Just as we announced last year, a maximum of JPY 100 billion share repurchase program was executed. Let me report the details on the share repurchase program. From November 1, 2019, through to May 8, 2020, was the exercising period. 34 million shares have been repurchased at the price of JPY 55.8 billion total. The average share price was JPY 1,638. Shares outstanding of ORIX, in fact, compared to the treasury stock is 5.8%, therefore 11 million shares in excess of 5% will be canceled or have been canceled. Unfortunately, from February this year, the COVID-19 pandemic outbreak resulted in the sharp decline in the share price. Therefore, the shares repurchased may not have provided enough benefit to the shareholders. This is our understanding. The initial target for the share repurchase to the maximum extent of JPY 100 billion was not fully exercised this time. As to the extension of the exercising period for the program or renewed program for the repurchase is not planned because we need to prioritize securing liquidity at this point in time. We want to continue to monitor the development of the COVID-19 pandemic and the recovery of the macroeconomic conditions before we decide whether to proceed or not. As of October last year, we mentioned our mid-term direction. However, we do not know how long this COVID-19 pandemic is going to last and how much time will be required before the macroeconomic conditions recover. Therefore, there is no alignment and no harmony among different countries regarding this issue. Under such circumstances, we have decided to refrain from disclosing any short-term direction as well as a mid-term direction because we find the disclosure to be associated with much difficulty. As has been stated, for 2021 March end, the major challenge for us will be securing liquidity. The battle with COVID-19 is very much dependent on timing. It will have a major impact on ORIX's business performance. However, from a financial standpoint, our long-term debt ratio remains high, and we have ample liquidity. The finance as well as the operating cash flow of the ORIX Group will have a limited impact from COVID-19. Please refer to page 8. As of 2021 March end, cash on hand verification has been concluded. Although we have carried out the verification within a limited scope, we have concluded that the magnitude of the impact given to various different businesses varies from sector to sector, but we will maintain operations other than, of course, the operation of the facilities. Assuming the worst-case scenario and ¥500 billion worth of new investments and loan extensions is to be executed, we can still secure ¥600 billion of cash. We remain unchanged in upholding the basic policy of prioritizing liquidity for now. For this year, while funding stress will be considered in a conservative manner by controlling the new investment and loan extension, we should be able to secure enough liquidity. However, to raise the level of accuracy from a mid-term perspective, once we start to see the end of the battle against COVID-19, bringing our business back to its usual speed will be our priority. However, we anticipate it will take a certain amount of time. Now for the Real Estate segment, facility operations inclusive of hotels and inns are unfortunately closed. Therefore, the revenue generation from this total segment asset of ¥118 billion is not to be expected for the time being, because of the incurrence of HR costs as well as depreciation costs before we start to see the recovery in inbound tourist demand, profit contribution will remain negative. For rentable properties, requests for rent reductions have been received, and we are responding on a case-by-case basis. As for the concession business centered around Kansai Airport, for four years until March 2020, in total investment of ¥20 billion, we were able to receive a dividend income of ¥19.1 billion. However, we assume that this dividend income will be zero for the coming New Year, and that there will be no contribution made to the overall profit generation. The accumulated amount of equity method income is ¥50.4 billion, including ¥3.1 billion of interest income from ¥12 billion of shareholders' loans. So the concession remaining period is as long as 39 years. Even if we were to incur losses for a single year, we will be able to recover back the business. For aircraft leasing business, for FY 2020 March end, segment lease segment asset was ¥555.3 billion with segment profit being ¥44.6 billion. Many airlines have forwarded requests for deferral of the leasing fee. We are responding to the requests on a case-by-case basis. Before we can start to see the full recovery in terms of the distribution of goods and people, I think the airline industry will remain sluggish, but ORIX has longstanding experience and knowledge starting from 1990 as a result of experience in Gulf War, SARS, 9/11, GFC. Based on my experience, I predict that it may take more than a year before we can recover from the COVID-19 pandemic crisis. According to a newspaper article, it could be extended until 2024, but I think it will take more than a year to get through this crisis. More than 50% of our investments are indeed in intangible assets. Thus, we foresee the downside risk to be limited. In the asset management segment, ORIX Europe or former Robeco, in December 2019 AUM was €287 billion, but by the end of March 2020, unfortunately, it downsized to €233 billion. But from April, we started to see some recovery in the amount of AUM. We need to monitor developments in Europe closely. Regarding the COVID-19 impact on other segments, it is not zero. In the finance department, we have been getting requests for lease fee deferral; thus, some negative impact must be taken into account. There are many uncertainties at the moment. For this reason, we will refrain from disclosing any details regarding midterm plans for now. Once we start to see how things will settle with the COVID-19 pandemic, we would like to take this opportunity to explain in a little more detail. Moving on to page 10, we analyzed the timeline for how long it will take to return to normal business and estimated the impact on ORIX Group's consolidated net profits. Considering the global situation and Japan's state of emergency, we do not believe the outbreak will cease during Q1 or Q2. However, with our tentative scenario, if by the end of Q3 things start gradually returning to normality, our estimates are that our group net profit will dip to a range of ¥200 billion to ¥180 billion. If the impact were to prolong for one year, our net profit will drop to possibly ¥120 billion to ¥80 billion. These numbers assume that we do not make any new investments or divest any assets during the given duration. Please understand that these estimates are for reference only. Currently, we have many new investments in our pipeline and will conduct physical due diligence in India, Europe, and the Middle East, but we cannot allocate manpower to do due diligence. So once COVID-19 subsides, we will mobilize our team. Unfortunately, we cannot forecast when COVID-19 will settle or when people can be mobilized. Depending on the timeline, these numbers will see an uptake. Our basic approach is that the spread of COVID-19 impacts us tentatively, but thereafter the market will turn for the better. This trend will be an opportunity for ORIX to further accelerate growth. Worldwide M&A entry prices, including key investments, have increased and we believe prices will begin to adjust. After COVID-19 is contained, we will be agile to not miss opportunities and are preparing ourselves for that timing. As of last October, we announced our mid-term direction of ¥400 billion and ¥500 billion. This remains unchanged, and we plan to redraw our timelines. Regarding the new mid-term business plan incorporating this mid-term direction, we request that you wait until we see the COVID-19 impact mitigate. Our basic policy for the MICE-IR project remains unchanged. However, we do need to validate the impact of COVID-19. We must secure ample liquidity to endure prolonged facility closures. How the new way of life and social distancing will impact us, and whether operating an IR facility will be possible under such concepts still need careful consideration. We will closely monitor the reopening of Las Vegas. For Osaka IR, the MGM-ORIX consortium is the only operator participating in the RFP process. However, since the state of emergency continues, the government has yet to disclose the IR basic policy. There remains uncertainty around future processes, but we understand that the Osaka City government will issue its own stance. We are, however, undergoing necessary considerations and analyses and will reflect these findings in future proposals.

So we'd like to start the Q&A now and entertain your questions. If you have any questions, please enter them on this form. The first question we received is from Nomura Securities, Mr. Sakamaki.

On page 5, regarding the decline of energy price, what kind of exposures does ORIX hold in the energy space?

ORIX USA has exposure to energy-related portfolios. Some requests for rescheduling have been made, but at the moment, it is not subject to impairment as of now. The portfolio size is about tens of billions of yen, so we do not foresee any major negative impact.

So from Goldman Sachs Securities, a question from Mr. Nakamura.

Regarding the increase of the risk for advance provision, by applying CECL for the first quarter 2021 March onwards, how do you see the risk increasing for the cost of provision from the second quarter and later?

From the first quarter, yes, we will apply this new model CECL, and we are currently collecting the information. The total amount of provision as of March end is just less than JPY 60 billion. We assume the amount will increase, but there won't be a major negative impact on P&L. For the second quarter and later, this is going to be my personal opinion, but I wonder if we should reflect our view. For the first quarter, the whole life will be reflected. From the second quarter, we cannot foresee increasing the subject, so that is what we foresee at the moment. Regarding the second question from Mr. Nakamura again, this is regarding the aircraft leasing business. There have been no changes in terms of the cash flow generation from the lease income from aircraft; therefore, the risk for impairment is limited.

Well, how do you see the downside risk from ORIX Avolon in the next one to two years?

There have been some requests for deferral. Three months of deferral of the leasing fee has been received from airline companies. The deferral for the principal part will be accepted, but at the moment we are negotiating to continue receiving the leasing portion of the interest income. Virgin Atlantic, Avianca, and others have also filed for Chapter 11. Whether our aircraft will continue to be used by these airlines is yet to be known. However, we are conducting negotiations right now. Even in light of this potential Chapter 11 filing, if they continue to use our aircraft through leasing, it will be calculated on an hourly basis and we must closely monitor developments. According to AVITAS from the appraisal company, the aircraft valuation has not decreased as of now. Considering the maturity timeline, there may be about a 20% risk of impairment. We think that the maximum risk could go up to 25%. If it were to continue until 2024, there could potentially be an impairment risk in the future. This is our current perspective.

We have a question from Mizuho Securities, Sato-san.

As listed on page nine, MICE-IR which is a major investment for the future, the prerequisite for the investments has changed dramatically. If nothing is done, the demand capital cost will rise within the capital markets. In terms of portfolio rebalancing, have you changed your policy or thinking pre-corona and post-corona?

To be quite honest, the MICE-IR project is in conjunction with MGM, and MGM themselves have closed their facilities in Las Vegas. We need to closely monitor their actions and question whether MICE-IR investment will be a good investment for ORIX. I cannot say anything solid at this moment, but in terms of the bidding timing, nothing has been announced so far, though we can assume a dramatic delay. For the next few months, we will validate the situation and re-evaluate whether it is a positive investment for ORIX. We do have approximately 5,000 room accommodations for hotels. We have some new projects, but the impact of COVID-19 has made our operational outlook more rigid. Additionally, the mid to small-sized hotel accommodations may present an opportunity for acquisitions too. However, there is uncertainty as to when inbound travel will resume. We plan to rebalance our real estate portfolio; though we expect to continue rebalancing, we will do so cautiously. Our JPY 12 trillion total asset rebalancing effort is ongoing, driven by the goal of enhancing or improving ROA and ROE.

From Citigroup Securities, this question is from Mr. Niwa.

What will be the subject for acquisition? Will it change concerning the criteria? Could you elaborate on the menu that appears on Page 12? It seems your recent investments have focused on infrastructure, but as a result of COVID-19, the diversification of investment was insufficient. Also, public company stock prices tend to be high globally; will valuations remain too high for you to perform acquisitions?

Regarding our focus on infrastructure investments, we have been making investments mainly in photovoltaic solar power infrastructure in Japan. Fortunately or unfortunately, with regard to solar power, we have not seen requests for rescheduling, so we do not foresee any major issues because the payments will be made by the national government or the EPCOs. In the United States, we consider investing in infrastructure-related service provision related to PE. We find this area safe for investment since state and federal governments are involved with credit extension. We do not foresee any major issues in this segment. Concerning entry prices, we expect continued increases; however, we do see some sectors beginning to experience declines in entry pricing. For Japanese real estate, with many working from home, we foresee a potential decline in pricing for office buildings, but in prime locations, this may not be the case. We foresee prices for warehouses and logistics-related facilities to increase rather than decrease. We have more than ten assets. If we see overheating in pricing, we may dispose of some assets; otherwise, we will only consider new investments that are of high quality. For overseas investments, we cannot quantitatively judge whether valuations are too high or low; we will base our decisions on valuation. But I believe we will likely start seeing clearer trends from September of this year. We will look for deals that yield an IRR of over 15% with exit considerations in mind, and if we find suitable deals that meet these criteria, we may proceed with new investments. Otherwise, we will focus on existing assets.

From Daiwa Securities Watanabe, we have two questions.

On DPS on Page 10 your estimates and your payout ratio of 50%. Given that, if we consider the prerequisites then the normality of this year at JPY 76 seems a good figure. Last year, you considered the minimum line for the dividend, but do you have resistance to a decrease in dividend? What are the conditions for you to deem that the coronavirus or COVID-19 has been contained?

The JPY 35 interim and 50% payout ratio and JPY 76 are equivalent to maintaining this level as we did last year. After-tax profits need to be around JPY 190 billion; that will be the bottom line for the full year net income. I believe we can reach that threshold. However, some of our activities interdepend upon others, hence, this figure. While we do resist decreasing our dividend, it may become a possibility considering circumstances. Our approach will be to ensure that we avoid that possibility and sustain the JPY 76 mark, which means a payout ratio of 50% is reasonable. However, if the COVID-19 impact persists longer than expected then liquidity must take precedence. This might result in a lower dividend. I know I’m being somewhat repetitive, but that's our approach and intent. Now, regarding the second question, your definition or conditions to deem COVID-19 contained, here in Japan, we are progressing toward containment, but PCR testing is limited at this moment. We might not have many patients or perhaps, with BCG shots, the Japanese might be more immune to the virus than we know. Recently, if travelers from China could provide a proof of being negative, then we could welcome them. If we are confident that containment is at hand and if people start moving, inbound traffic would increase, and our operational business would increase; the same goes for the aircraft business. Whether we can revert to what we were before corona could take some time. Here, to contain the virus means to minimize the spread and occurrences, but we cannot only judge based upon Japanese numbers. The U.S. faces a situation that is quite dire. What happens in the southern hemisphere and Africa continent affected by the virus as well remains unknown. Hence, we cannot confidently project what direction this will take. I am not an expert in this field, and I'll refrain from making solid comments, but containing numbers and observing a dramatic decrease while stopping secondary cases will be one of the conditions.

From SMBC Nikko Securities, a question from Muraki-san.

The net profit forecast is JPY 180 billion to JPY 200 billion, and there might be a reduction to JPY 80 billion to JPY 120 billion. What will be the prerequisites for base profit as well as investment gain? Also, what would be the amount of losses drawn from aircraft leasing business and concessions? Finally, how do you foresee an investment opportunity from here on?

The PE fund remains highly competitive, and interventions from the government and central bank are expected. The simulation for the net profit at JPY 180 billion to JPY 200 billion assumes no new investments or divestments. Therefore, there will be an impact of ¥20 billion to ¥30 billion from the aircraft leasing business, and the concession may be adversely affected by around ¥20 billion to ¥30 billion. In the case of equity income method, losses will not directly reflect in the P&L, yet revenue could drop to zero potentially. Thus, we anticipate about a JPY 10 billion drop in income. Considering personnel costs and depreciation charges, we estimate overall negative impacts to be between ¥20 billion to ¥25 billion. When it comes to investments, some opportunities may emerge for rehabilitation and restructuring investments. There could perhaps be openings utilizing ORIX services available. Non-performing loan investments may also start to increase, but we must keep in mind relations with regional banks. We do not intend to issue uncollateralized bonds but explore projects or potentially investing through municipal government bonds. Additionally, there might be possibilities of acquisition or disposal in real estate. We aim to adhere to our direction and criteria as we undergo this.

From Mitsubishi UFJ Morgan Stanley Securities, Tsujino-san has a question.

You explained the payout ratio and considering prerequisites then the net income between ¥180 billion and ¥200 billion. If you go below that, then may I understand that the dividend will be lower than last year?

Yes, that will be the worst-case scenario, but we will do our best to prevent that. Around Q2, we believe we will have a clearer outlook on what will happen. At that point, we will evaluate the fiscal 2021 March outcome. Whether to execute the 50% payout ratio or adjust accordingly will be considered then. Unfortunately, if we experience zero revenue in the second half, it may lead us to go below last year's level, but we aim to avoid that.

In real estate, the pretax profit indicated a ¥2 billion impact. Regarding the real estate service profit for operational business, was the profit quarter-on-quarter okay but year-on-year it dropped by ¥10 billion? How did you absorb that through expense reduction?

This is Yano speaking, and I will respond to the second question. Regarding the operational business, Tsujino-san, which numbers you are referencing are unclear. However, we sold some of the service business. The operational business is prone to seasonality; typically, Q4 is the worst. The numbers I relayed for this quarter are estimates from comparisons. So, there will be slight discrepancies from the actual statements. In our operations, we include hotels, inns, seminar facilities, and aquariums, which are what we referred to.

We have a question from Mr. Tom Grew of Alma Capital.

Is it the case that 50% is the maximum you will pay this year? Is there a possibility of no H2 dividend if things become very bad?

That's right. That is our worst-case scenario. However, I will try to avoid this worst-case scenario. I will aim to maintain around ¥180 billion net income. It is dependent upon coronavirus issues. Therefore, this is the 50% I declare today, and maybe when we announce the half-year results, if this worst-case scenario transpires, there’s a chance that it could be revised.

From JPMorgan Securities, Otsuka-san has a question.

On page 10 regarding net income, if the range was ¥200 billion, in comparison to the ¥300 billion for 2020 March period, which business is seeing a decline?

The operational businesses, particularly aircraft leasing and the concession, are seeing declines.

From SMBC Nikko Securities, this is a question from Takayu-san.

Being affected by COVID-19, will you focus significantly on maintaining the current credit rating?

S&P, Moody's, and Fitch disregarded the numbers we've announced and have automatically changed the outlook to negative. While we have not experienced any negative impacts on liquidity, our outlook is on a negative watch. Regarding credit rating maintenance, I mentioned back in October that our effort is to maintain our A rating. We are not adamant about it and may allow the rating to go slightly lower, but this remains our target.

It is time for us to conclude this session. I would like to close the Q&A opportunity for now. The presentation this time was conducted online. Please excuse us if you faced any difficulty in hearing. I would like to conclude the business performance announcement session for 2020 March for ORIX. Thank you all very much for your participation despite your manifold duties.