Earnings Call Transcript - IX Q2 2021

Operator, Operator

Good evening, everyone. Thank you for participating in the ORIX Corporation conference for the Second Quarter Consolidated Financial Results for the six-month period ending September 30, 2020. Present today are members of the Board of Directors, Executive Director, President and Chief Executive Officer, Mr. Inoue; Senior Managing Executive Director and Head of Treasury and Accounting Headquarters, Mr. Taniguchi; and Executive Officer, Mr. Yano. The materials for this meeting have been made available on our website around 4:00 p.m. today. Please refer to them. Before we get started, we have some requests. The first half of the meeting will be led by Mr. Yano, followed by Mr. Inoue in the second half, and then we will have a Q&A session. We have about an hour for this meeting. Now, let's begin. I will now hand the call over to Mr. Yano. Please proceed.

Hitomaro Yano, Executive Officer, Head of Treasury and Accounting Headquarters

Thank you very much for the introduction. And I'd like to thank all of the participants for the financial results briefing meeting today, despite your busy schedule. Now I'd like to explain our financial results for the second quarter of the financial year ending March 2021. Please refer to Page 2 of the financial results briefing materials on hand. Net income for the first half of the fiscal year ended March 31, 2021, was down by 41% year-on-year to ¥93.8 billion, and the annualized ROE was 6.3%. With the impact of COVID-19 remaining, we revised our strength of diversified business portfolio to secure solid profits for the group as a whole. As compared to the first quarter, the net profit went down by ¥6.2 billion or 12% as a result of a revision of the estimated tax rate. Net income before tax, which was not affected by tax rates, was almost flat, with first quarter at ¥7.6 billion and second quarter at ¥66.5 billion. We booked profits and losses of some companies such as our concession business on a monthly basis. Therefore, in terms of the actual business condition, we believe that we are out of the bottom. So let's move on to the next page, breakdown of segment profit. The income for the segment totaled ¥149.5 billion. We explained basic profit and gain on sales separately here. The base profit was down by 33% year-on-year to ¥112.8 billion. The main reason for the decline in profit by ¥54.6 billion was the impact of the COVID-19 outbreak. The gain on sales was down by 50%, from ¥74.1 billion in the same period of last year to ¥36.8 billion. In the previous fiscal year, there were gains on sales of ORIX saving and Houlihan Lokey in the United States. We were able to realize a certain amount of gain this year as well by selling assets, like logistics facilities and others. Please refer to the next page. The next page shows the impact of COVID-19 on the financial earnings in the second quarter. As compared to the first quarter, the profit in total decreased by ¥3 billion to approximately ¥27 billion. The impact amount for the aircraft leasing business was down in the first quarter, but the impact on the real estate operation business, the car rental business, and ORIX U.S.A. is certainly becoming less. Concessions had a 3-month lag in booking, as mentioned before. And also, as a result of financial market recovery, there was a reversal of liability reserve of ¥5 billion in the first quarter at Hartford Life. Taking this into account, the second quarter can be described as being on a recovery trend. So let us move on to the next page. First is total segment profit. The total segment income was down by 38% from the same period of last year at ¥149.5 billion. Compared to the first quarter, the segments of corporate financial services, maintenance, leasing, real estate, banking, credit, ORIX U.S.A., and ORIX Europe achieved higher profits. In addition, the three segments of environment and energy, insurance, and banking and credit that are least affected by COVID-19 achieved year-on-year profit growth. Detailed information for each segment is presented on Page 15 and onwards. As for the three business divisions of real estate, concession, and aircraft leasing that were mentioned at the time of the full year as well as the first quarter financial results announcement, these businesses are significantly affected by COVID-19 and will be explained in more detail later by Mr. Inoue, the CEO. The first is the corporate financial services and maintenance leasing segment. In Japan, the declaration of state of emergency restricted corporate sales activities, and there was also a slowdown in utilization rates at the technology center. Automobiles were also affected by a decline in demand for rental costs and other factors. However, after lifting the state of emergency, tourism demand recovered, and car rental sales improved significantly, with profits in this division recovering from a loss in the first quarter to a positive profit. Corporate Financial Services commission income recovered significantly in the second quarter due to aggressive sales activities. Next is the real estate division, which is continuing at a constant pace. While DAIKYO is not significantly affected by COVID-19, it remains strong. Hotel and inn operations have reopened and are enjoying a recovery trend. Next is the investment and concession. For private equity, there's been some portfolio turnover from the previous year, but the business of each company is solid, contributing to the profit. Weaker concession performance is due to the 3-month lag in closing the accounts. Moving on to Energy and Environment. The renewables business, including solar, is solid, though there appears to be a reduction in profit compared to the first quarter. This is due to a one-off profit posted in the first quarter for wind power in India. Excluding that, the profit is up compared to the first quarter. Next is Insurance. Although face-to-face sales activities faced restrictions, we utilized non-face-to-face activities such as online and TV shopping to increase the number of policies in force. Again, it seems to be lower profit compared to the first quarter, but this is due to the reversal of profit recognized in the first quarter for Hartford Life. Excluding that, the profit is up compared to the previous quarter. Moving on to banking and credit. Similar to ORIX Life, non-face-to-face sales and online activities helped grow the assets for real estate investment loans. We are adopting to the new lifestyle and maintaining stable profits. Against the first quarter and the previous year, the profit was up. Moving on to aircraft and ships. The aircraft leasing business, which is a mainstay here, worsened due to COVID-19, but we expect future recovery with an increase in demand in domestic lines. Moving on to ORIX U.S.A. Compared to the first quarter, there was a major increase in profit thanks to the appraisals in the first quarter, and PE investment turning into gains as well as smaller credit losses in energy-related companies. It seems as if the profit is much lower than the previous year, but this is due to the gain on sales of Houlihan Lokey posted in the previous year. Next is ORIX Europe. ORIX Europe's AUM hit bottom at the end of March 2020 at ¥233 billion, and it recovered to ¥260 billion at the end of September 2020, more than 10% improvement. Profit was also up compared to the first quarter. Lastly, in Asia and Australia, we recognized impairment due to lower share prices of the deals invested in China. But local operating companies are doing solid business, and excluding the impairment, this is a positive profit growth in the second quarter. Moving on to the next page, regarding segment assets, corporate finance services and maintenance leasing finance assets are decreasing slowly, standing at ¥1.7099 trillion. At the end of the term, this is down 4%. Insurance was ¥1.7104 trillion, up by 8%, thanks to the increase in the number of policies. Banking credit was up by 3%, at ¥2.6766 trillion, thanks to the increase in real estate investment loans. ORIX U.S.A. reduced its assets, focusing on balance sheet business more carefully while emphasizing asset management. In Europe, there's a second wave of COVID-19, and the future is difficult to predict, but we are building profit based on our distributed business portfolio, which is our strength. That's all about segment performance. I would like to move on to Page 7 about the financial soundness. To the left, you can see that the financing right now, despite COVID-19, is solid. We have efficient capacity, both from banking loans as well as capital markets. The long-term debt ratio is above 90%, thanks to assets. When we made the full year announcement in May, we presented the conservative scenario with extensive worsening of operating cash flow, as on-hand liquidity stress test. But in fact, the request for deferral, as well as the late collection, has stayed at a low level, including the aircraft lease business. The collection rate remains high at 95%. To the right, you can see the shareholders' equity employed capital ratio, which is 85% at the end of September 2020, indicating sufficient capital for potential future investments. That concludes my presentation regarding the performance for the first half of our fiscal year ending March 2021. Next, we'd like to invite our CEO, Mr. Inoue, for his presentation.

Makoto Inoue, CEO

Good afternoon. Still affected by the spread of COVID-19, we have to hold this announcement session through the teleconference. I apologize for the inconvenience, but I also ask for your understanding. So let me explain by making use of Page 8. For the first half ending March 2021, the profit before tax was ¥134.2 billion; net profit, ¥93.8 billion; and ROE, fortunately, was at 6.3%. In the second half, the business conditions were pretty mixed among different countries of the world. We cannot foresee the COVID-19 spread ending and still find it difficult to forecast our business ahead. However, we have decided to forecast our net profit to be at ¥190 billion at the end of this fiscal period. If the forecast of ¥190 billion were to be achieved, it would mean a decline of 37.2% of profit as compared to the prior year. At the time of the full year announcement back in May, due to the spread of the COVID-19 virus and the acute slowdown of the global economy associated with the pandemic, we thought that forecasting an impact was not easy. We explained two scenarios: if we could start enjoying the normalization of businesses from the third quarter, our net profit would be in the range of ¥180 billion to ¥200 billion; whereas if the impact persists for a year, it will be in the range of ¥80 billion to ¥120 billion. Although we cannot still see how things will unfold, we should not expect the worst case, which is why we have decided to focus our net profit at ¥190 billion at the end of this year. As for the full year dividend, we are forecasting the amount to be ¥76 or a payout ratio of 50%, whichever is higher. Regarding fundraising, both operating cash flow and financial cash flow remain steady, and we have confirmed no concerns. Therefore, we would like to restart our ¥100 billion shares repurchase program using this unused budget of ¥44.2 billion of our shares repurchase program. We expect to utilize this budget within this year. As for future share repurchases and the payout ratio for the next fiscal period, I would like to announce details along with our strategy going forward at the full year fiscal period announcement. For the first half ending March 2021, manager easing as well as expansion of public spending in various countries is notable. In fact, the major equity market metrics are almost back to pre-COVID levels. Meanwhile, renewable energy, IT-related sectors, and real estate are almost unaffected by COVID-19 and are not experiencing significant price correction. Contrary to the impact of COVID-19, some prices may have increased. However, we cannot be overly optimistic, as the U.S.-China situation is worsening, and with the presidential election being scheduled, there seems to be no concerted efforts from countries globally. Furthermore, the second wave of COVID-19 is affecting Europe, indicating that we should anticipate a continued negative impact for the time being. Nevertheless, we can enjoy the health of our ¥13 trillion assets. Even if the COVID-19 impact remains, segments such as life insurance, banking, and retail will likely experience limited impact. We're beginning to see progress in stabilizing our business. From the second half onwards, we aim to be more aggressive in our investments in areas where we foresee stable sources of revenue and profit generation while contributing positively in all aspects. As for credit ratings, S&P and Moody's have given us single A minus with a negative outlook, while Fitch has assigned us an AA- rating with a stable outlook. Depending on the timing of investments or dispositions, there may be a case where the rating could perhaps downgrade by one notch. However, through M&A activities and the replacement of assets, we aim to continue building a resilient portfolio, which we see as our mission. Of course, we will make no changes to our policy to maintain financial soundness that corresponds with a single A rating over the mid to long term. Assuming that the rating may decrease to BBB, we don't foresee any major impact as we believe it will remain limited, particularly in the context of additional funding capacity and funding costs. Please refer to Page 10. In terms of real estate operating businesses under the state of emergency, we had to close hotels and inns, but all have reopened except for one. The Go To Travel campaign has significantly supported these real estate operating businesses. Occupancy rates are recovering. We have come out of the worst phase. As a matter of fact, the occupancy rates for inns and direct operated hotels went from 9% to 32%, and moreover, in October, they improved to 78%. As for the new logistics facilities development, given the current conditions, we have received considerable inquiries, especially from the Tokyo Metropolitan District. We are proceeding with the development deals totaling ¥100 billion, and our track record in this business is an IRR of around 25%. Thus, we can expect a positive contribution from this area. On negative news, the government announced a commitment to significantly reduce CO2 emissions. We have biomass projects such as the multi-fixed fuel power plant Soma Energy Park, which has a generation capacity of 224,000 kilowatts. For now, METI is looking into decommissioning inefficient coal-fired plants by 2030. While we plan to continue our operations up until 2038, the upcoming decision by METI might necessitate adjustments to our depreciation schedule. In October, we expressed our support for TCFD amidst ongoing climate risk analysis. We will adhere to government policies, rebuilding our strategies focused on CO2 emission reduction. Regarding the concession business, we are seeing signs of slight recovery; however, international passenger numbers might take some time to recover. Conversely, domestic flights are bouncing back, and cargo operations are showing strong trends exceeding last year’s levels. The IR site selection date has been postponed by 9 months, and the review process will begin next year. We will maintain our original plan while rationally analyzing COVID-19 effects. Turning to Page 11, in the aircraft leasing business, 85% of our OAS portfolio consists of narrow-body aircraft with smaller price fluctuations, while the rest includes wide-body planes leased to major flagship carriers. In the first quarter, we granted several lessees deferrals, but nearly all resumed payments after that. In September, several major appraisal companies reevaluated all different models of aircraft, and the results showed that impairment would not be necessary. We own a stake in Avalon, where orders to Boeing and Airbus were reduced from 400 units to 286 units from the end of December 2019 to the end of September 2020, aligning with lower demand for aircraft leasing. All aircraft scheduled for completion and delivery by 2022 are secured. In September, we completed the issuance of 650 million unsecured notes to secure liquidity in line with the improving financing environment. We are maintaining a BBB rating. While we are not overly optimistic about the aircraft leasing business, we see no major concern regarding the valuation of OAS aircraft, and Avalon is responding appropriately to the current situation. The number of travelers within China has returned to pre-COVID levels, and there's a recovery in travelers within Japan as well. These are positive signs. However, it remains difficult to predict how the demand for air travel will evolve, including the timing. ORIX has over 40 years of experience, and we believe we can minimize portfolio-related losses. Aside from our businesses in real estate management, concession, and aircraft leasing, the impact of COVID-19 remains limited, and we believe profit will continue to recover slowly. As of our earnings announcement for the first quarter, we reported an investment pipeline totaling approximately ¥2 trillion, including ¥300 billion for energy and environment, ¥200 billion in asset management, and ¥250 billion in private equity. Some of these projects were dropped after being reviewed, but each deal makes steady progress, and announcements will be made one by one. We are confident that these investments will contribute to our growth. However, for future deals, cost initiatives will need to be recognized upfront; significant intangible fixed assets and goodwill will be recognized as well in anticipation of future growth. The contribution timing will vary, but we expect each investment to take 1 to 2 years to positively contribute. In September 2020, we announced over a 20% investment in Greenko Energy, the largest renewable energy company in India. This deal is moving towards closure, with an investment of approximately USD 980 million. Greenko operates 4.4 gigawatts of renewable energy sites, including solar, wind, and hydro, with over 80 gigawatts in development projects. We view this company as having significant future potential. We are also considering renewable energy investments in Europe and actively pursuing opportunities to acquire asset management companies in infrastructure, renewable energy, real estate, and ESG sectors. Regarding asset management, in September, we announced that we would receive approximately ¥7 billion in AUM from Boston Capital, a U.S. company, bringing our AUM at ORIX U.S.A. to USD 75 billion or ¥7.8 trillion. As for domestic private equity investment, we just announced the acquisition of total shares for APRESIA Systems, reflecting an increase in demand for base stations in 5G systems. In the COVID-19 era, the necessity for information communication is only increasing, and we are increasing our investment in these sectors. While we cannot disclose details of other private equity deals at this moment, approximately ¥300 billion in deals are nearing completion and will be disclosed sequentially. We believe that it will take time to improve ROE, primarily dependent on how soon the COVID-19 situation improves. However, given the current trajectory, we expect to reach cruise speed around the fiscal term ending March 2023. Achieving a return to the 11% ROE based on the existing portfolio will take several years, but we aim to accelerate recovery by making new investments and increasing gains on sales. Additionally, we also aim to improve shareholder returns. We had hoped to share our midterm direction with you, but we have decided it's too soon due to the ongoing COVID-19 developments. We aspire to return to a net income level of ¥300 billion through asset turnover and successful new investments, and I mentioned that we also aim for substantial growth, targeting ¥400 billion and ¥500 billion in the future. While it may take longer than previously discussed, we still believe these figures are achievable. Moving on to Page 14, in October, we announced our support for TCFD, promoting climate-related financial disclosures. We handle business in 34 different countries globally, making it imperative to address climate change and foster sustainable growth. Our focus will remain on identifying and realizing important initiatives, including greenhouse gas emission reductions and enhancing energy efficiency in our assets, as well as promoting environmentally friendly projects. We face unprecedented environmental changes, and adapting to this new environment is crucial. We need to implement many urgent themes, including remote work and the digital shift, including minimizing paper usage in our business. A strong commitment is vital; without these projects, there is no future for ORIX. That's all from me. Thank you very much for your attention.

Operator, Operator

So first, Mr. Watanabe from Daiwa Securities.

Kazuki Watanabe, Analyst

So this is Watanabe from Daiwa Securities. May I ask a question about your strategy regarding capital gains? I understand that you have started to rotate your model for new investments. Can we assume that you're going to post some gains? However, I also understand that there is no impairment from your aircraft leasing businesses. Do you think that the forecast of ¥190 billion incorporates any potential impairment assessment in case there is any from the aircraft leasing?

Unidentified Company Representative, Unidentified

The ¥190 billion forecast does include a minor capital gain, but it is only several billion yen. We will have some dispositions of logistics facilities and some real estate assets, but no significant capital gains included from private equity in Japan either. Many fund investors are focused on acquiring assets. Unfortunately, it seems that while demand was around 60% to 70%, the funds' acquisition amounts have lowered, which is why we have not incorporated any large cash flow gain in this ¥190 billion forecast. Regarding aircraft impairment, while this is complex, we have not been in receipt of grounding or aircraft returns, so leasing is continuing, and we have been receiving the leasing fee. Our current opinion is that there is no necessity for impairment. If there is impairment, it would likely occur after the next fiscal period, and we would need to evaluate before posting any impairment.

Operator, Operator

SMBC Nikko Shoken, Muraki-san.

Masao Muraki, Analyst

Energy policy across various companies may be changing. How does that impact the existing portfolio and future investments by ORIX? You mentioned that for biomass, there could be accelerated depreciation in the existing portfolio. Will that have a financial impact? Regarding renewable energies, what are your expectations considering Japan’s pipeline, the U.S., and the potential for government policy changes?

Unidentified Company Representative, Unidentified

The investment in Soma and Hibikinada adds up to ¥11 billion, with annual profits of around ¥3.7 billion to ¥4 billion. If operational times extend to 2038, the book value will reach zero. This biomass mixed project aligns with government policy, but changes could lead to discontinuation by 2030 resulting in a need to accelerate depreciation which is an estimated ¥20 billion. While many believe the projects can extend to 2038, government assurances are unreliable. Regarding international investments, there are various renewable energy projects, and we are not involved with coal rest assured.

Masao Muraki, Analyst

Thank you.

Operator, Operator

Next is from Goldman Securities, Nakamura-san.

Shinichiro Nakamura, Analyst

I have two questions. Firstly, regarding the share repurchase program, can you clarify the changes made since the full-year financial results announcement? Secondly, when explaining Page 13, you indicated that the pace of recovery in profit generation is slower than expected. Can you provide clarity on this? Regarding the segments recovering faster, are there additional gains anticipated beyond what was discussed?

Unidentified Company Representative, Unidentified

The unused ¥44.2 billion repurchase program reflects the criticism from the investment community. During the Lehman crisis, we faced significant financial difficulties, leading to tight cash management. However, the situation now is more stable, resulting in the decision to move forward with share repurchases. We plan to provide updates on the dividend payouts and repurchase strategies alongside our expectations for profit. Overall, achieving the ¥190 billion profit remains the goal, and we seek to likely restart repurchases with improved investor confidence. Page 13 highlights the recovery, with aircraft and real estate reliant on getting past recent challenges. New investments will take 1 to 2 years for full effects.

Operator, Operator

Morgan Stanley, please proceed with your question.

Unidentified Analyst, Analyst

I have a question regarding Avalon. You're currently recognizing negative profits. Can you explain why this is occurring despite mentioning no impairment? Specifically, if this were to be evaluated under U.S. GAAP, would there be an impairment risk?

Unidentified Company Representative, Unidentified

Avalon's intention to consider switching accounting methods from IFRS to U.S. GAAP has not been finalized. Under IFRS, they may recognize impairment with an allowance for potential recovery. Their perspective of moving towards U.S. GAAP reflects their need to adjust based on market preferences, focusing on a long-term evaluation. Our outlook on Avalon is stable as long as conditions remain unchanged; no substantial lease returns or cancellations are anticipated. In cases of unforeseen returns, we will reassess our entries as needed.

Unidentified Analyst, Analyst

I understand now. Could you provide more detailed feedback?

Operator, Operator

Next question is from Citigroup Securities, Niwa-san.

Koichi Niwa, Analyst

I'd like to inquire about your outlook for Europe. Given the ongoing M&A activity, how do you plan on managing the businesses and goodwill amortization concerns as a result?

Unidentified Company Representative, Unidentified

In terms of Robeco, both acquisition and disposition inquiries are emerging. However, I currently have no strong intent to sell the business as we believe in expanding operations. Our asset management segment is seen as a growth area, although rumors can complicate the sales process. Overall, expanding AUM and achieving higher returns remains critical for our strategy, regardless of potential goodwill scenarios.

Koichi Niwa, Analyst

Thank you for clarifying. Are there concerns regarding goodwill amortization potentially affecting your credit rating?

Unidentified Company Representative, Unidentified

Goodwill is a factor if we decide to hold onto the asset. The valuation of Robeco and the related goodwill is substantial, but further acquisitions will consider tangible and intangible assets to maintain a strong portfolio without deteriorating our standing.

Koki Sato, Analyst

I have a question about share buybacks. The ¥44.2 billion unused program seems to be a result of favorable financing conditions. As you look ahead, what additional factors will you consider? Given the uncertainties posed by COVID-19, the U.S. elections, and European circumstances, which elements must improve for future buybacks?

Unidentified Company Representative, Unidentified

We believe the prior ¥44.2 billion remains as an untouched reserve. In considering future projects, achieving ROE below 6% is critical. Though we can proceed with significant share buybacks, we must also invest in crucial projects and maintain cash flow. Uncertainties arise from changes in local governance and upcoming events like the U.S. presidential election.

Koki Sato, Analyst

Are you indicating that you're not considering halting the share buyback?

Unidentified Company Representative, Unidentified

Correct. We intend to continue with share buybacks as necessary given the situation with a ROE at 6.3%. We aim to address various uncertainties while maintaining these initiatives.

Makoto Inoue, CEO

Thank you for participating. For our next session, we'd prefer a larger venue where we can meet in person as I find it hard to gauge your reactions remotely. Let's hope that COVID-19 won't disrupt further gatherings. Thank you.

Operator, Operator

With this, I would like to conclude today's teleconference. Thank you for your participation today, and you may now disconnect. Thank you.