Ichigo Inc

TSE:2337

Earnings Call Transcript

[Scott Callon, executive]

Hi, everybody. I'm Scott Callon, Chairman of Ichigo. I'm joined today by Dan Morisaku, who is a senior member of our Finance team and the Head of our Global IR. Thank you very much for joining us for the February 2025 Q3 corporate presentation.

Let me start with our world-class weightlifting team, if that's okay. I don't know if you know this, but we do have a world-class weightlifting team. The woman on the left is our employee, Hiromi Miyake, who is the greatest weight lifter in Japanese history. She won a silver medal at the London Olympics, a bronze medal at Rio. She is standing next to Tank Murakami, who was just in the most recent Olympics and took 10th in the world in 102-kilogram class. I just love -- I love the picture. Forgive me for showing it to you. It's one of the things that we do. These are not sponsored external athletes. These are employees of Ichigo, and we're super proud of them and proud of sending Japanese athletes into the world.

Okay. Let's jump into it. Page 6, the Q3 summary. Three things. All-in operating profit was down 7% year-on-year, cash and net income down 12%, cash EPS, down 9% because we've been buying back some stock. That's on stock earnings actually heading up 13% year-on-year. So it's the flow earnings that are down. As you know, we're forecasted to be up in the full year. We expect to have a very strong Q4, and everything is going to be good. We're expanding the REIT pipeline, in particular, hotels, the hotel REIT is doing very, very well. So it's well positioned to acquire.

The office REIT, as you know, we operate it on behalf -- intensively on behalf of the office REIT shareholders. It does the significant value-add work that we also do within the main company, which is this company 2337. And so it is both a buyer and a seller of assets because it sells assets when it's added value and it buys them to create value. So despite that share price being weak, it is also an active acquirer because it has been able to sell assets at very good levels. We're in the midst of an ongoing share buyback, 3.9% of shares outstanding. We've executed about half of that as of the end of December.

The earnings model is durable. We are structurally profitable. We are stock earnings. So our contractually fixed earnings are a run over 200% of our fixed expenses. We show the stock earnings on the right up across all fronts. Sustainable real estate up 16% year-on-year. That's being driven by an incredibly powerful hotel market, in particular, about 32% of our assets right now are office, 25% are hotel. We've got about 20% in resi and 20% in kind of urban, walk-up retail. All asset classes are performing very well, but in particular, hotels are super strong. So that has been a significant driver of earnings this year.

Asset Management is up 12% year-on-year and Clean Energy is up 5%. I'm not going to go into too much detail on all the numbers. I mean they are -- as they are because there's some kind of highlights in terms of broad themes and broad activity and the way we're positioning ourselves in the market. But as I said earlier, all-in OP is down 7% year-to-date, cash EPS is down 9%. We expect both of them to be up double digit in the case of all-in OP and single digit in case of cash EPS when we finish the year in Q4.

It's worth pointing out that the operating profit and recurring profit numbers, which are accounting numbers look spectacularly good. But guys, everybody, we are cash based. We don't pick and choose the numbers that we want to show. We show the numbers that are the most important numbers, and they are all in operating profit and cash EPS. So that's where we are right now.

In terms of the details, Asset Management, you can see an all-in OP is up substantially, 31% year-on-year. Sustainable real estate is down despite, as I just pointed out, that the stock earnings being up 16% year-on-year. So as a result, obviously, if we just do the math on this is because flow activity has been down. We're going to have a bunch of sales in Q4, some of which are already contracted for, and we expect to have a very strong year. Clean Energy is down on an OP basis, but up on a cash earnings basis. It is a business -- one of the things we liked about it, is it generates a significant amount of depreciation allowances for us to effectively shelter our income, so the cash earnings are more important, as you can see those on the all-in gross profit on the right.

We're forecasting record cash earnings on stock earnings growth. And again, it's going to -- it's across the board. All of our -- every segment is -- we expect to generate record earnings on a stock basis this year. You can see there is a significant increase in funding costs. It's like -- I mean it looks pretty big. I mean it's like -- look at the 1.2 to 3% after kind of hanging around at 90 basis points for all those years. But in fact, it's not super material.

We borrow about JPY 200 billion. We've got half of that hedged with hedges that for many, many years were cost us money. And then suddenly, when interest rates went up, they did what they were supposed to do, which is they're now significant earnings generators for us, meaning that we were fully hedged against the increase in interest rates. So half of the portfolio is hedged. And so when you run kind of a 30 basis point increase against JPY 200 billion, that tells you that the additional cost to the firm and financing is about JPY 300 million a year, meaning USD 2 million. I mean this is trivially small.

It's a reminder that a move from 90 basis points to 120 basis points sounds big in terms of the multiple, but in fact, it's only 30 basis points. This is not a material move. We all should be cautious about what the future looks like. I say that because we are. We're in the business of defending kind of your earnings stream and your value. But I would also point out that there's no signs that Japan is something going to have 5% interest rates. So the move that has occurred at this point is not particularly material for us. And if anything, and I've said this before, the most important thing that's happened is because of inflation, which is what is driving up these interest rates. Replacement cost is finally going up. And so it has made -- has 2 elements that push into our business in a very positive way.

One, it means that all of our existing assets finally are growing in value every year because of replacement -- because they move the replacement costs. And two, we have a value-add business. We work not to destroy buildings and rebuild them, which is incredibly wasteful of not only human and environmental resources, but also financial resources. So in an environment where kind of your classic construction company and developers is tearing down buildings and putting them up and they have to pay 100% of building costs, and we generally only put in 5% of building costs, it's a way of saying that construction inflation is a very powerful driver of the economics of our business. So we're in a very good operating environment.

We are selective acquisitions and sales. We always say this, it's always true. I hope that's okay. Again, we need to be smart for you. We have bought at this point, JPY 40 billion worth of assets. When you include contracted assets, it's up to JPY 70 billion. Most of the additional -- of the additional JPY 30 billion that's coming in the fourth quarter, about 2/3 of that is going to be to go owners, so super prime, brand-new residential in Tokyo. We've got about JPY 10 billion that's in hotels coming out of hotel and also in Tokyo in the multi-asset area. Sales are also significant. So we're active buyer and sellers.

As I said earlier, we are able to operate in diverse market environments because we add value. We're not in the business of betting on where the market is going to go. We're in the business of genuinely taking assets, repositioning them, making them better, making them more valuable and on selling them once we have added value to them. So at this point, JPY 42.7 billion of sales, and it goes up to JPY 54 billion, including the contracted presettlement.

This is what it looks like across kind of over time. And we expect this year, as you can see, this is as of Q3, we expect -- at the moment, when you include the contracted presettlement, it's JPY 71 billion for acquisitions, it's JPY 54 billion for sales. We think we end up with probably acquisition stays about that in the fourth quarter, we probably add on another JPY 12 billion or so of sales, and we'll end up -- that's where we end up in the year. So pretty flat in terms of the buy and sell activity.

Owners is a business we started 8 years ago. It's an extraordinary business. You buy assets, you -- and we work with developers. We get assets that are built to our specifications in areas where there are unmet needs. Again, this is kind of super prime Tokyo real estate residential. Holding period is generally under a year, we have a gross margin of generally 10% or more. It's running on an LTV that looks something like 70%. You run the math on that. You've got ROEs that are well over 50%. It's an extraordinarily powerful business. It will continue to grow.

You can see though that we're expecting this year on the forecast to be down from last year. What's happening, and I'll talk about that on the next page also. We pushed out some of our residence token activity. And so actually, we think we'll fall in below this year's forecast for owners of JPY 4.5 billion in terms of OP. As I said, we expect to beat our forecast, so we'll more than cover that elsewhere. Let me turn to the next page, and I'll explain why.

We originally thought we're going to do 4 security tokens. So these are residence tokens. They're secure digital investments on the blockchain backed by hard assets. As you can see the kinds of buildings that we're selling, as I said, really nice assets in nice areas of Tokyo. Instead of doing 2 of these, 2x kind of -- instead of -- I'm sorry, instead of doing 4 of these this year, 4x kind of JPY 10 billion for a JPY 40 billion uplift in our AUM in the security tokens area, instead we did 2. And the 2 of it based a little bit of the market got a little bit dazed and confused around what's happening in the United States and are we going to be safe and is it going to be okay? And Trump won and now everybody is really happy. So it is okay. So really, what's happened is we haven't changed our forecast for AUM for next year. Everything -- we just pushed this stuff out from this year into next year. We're more than able to beat our numbers this year based on our current level of activity outside of the security tokens SD area.

And quite honestly, we have a major new customer who wanted some real size from us in this area. And so we held off some of our transaction activity to be able to service them. Probably in the Q1 or Q2 of next year. So the business is fine. And we will -- we expect to hit our target, although it's not going to happen this year, it's going to happen more fundamentally than next year.

We've done -- continue to work on behalf of our REITs. We put several new assets -- some assets into the hotel REIT. We put 2 assets, and we put 4 assets into the office REIT. That ends up with us having 14% year-on-year growth in AUM. If you add kind of JPY 60 billion, which we think we do next year in the token side, plus kind of whatever activity we have on the REIT side, that implies kind of 15% to 20% to perhaps 25% or more growth in AUM in this business next year also.

Hotels continue to be really, really good after having been terrible beyond belief. This was -- the hotel business is a business that we think has powerful economics. It's driven by 2 things. It's an area where there's genuine growth in Japan. It's -- hotel activity is growing well beyond GDP growth. The inbound activity is enormous. So one, so there is a growth, it is a growing business. It's growing kind of GDP plus in part because we've got Asian inbound that has income levels rise, tourism tends to grow at a GDP-plus basis. Japan is a really nice place and easy to get to and the end is really, very cheap. But it's also the case that we're getting much more inbound activity from the U.S. and Europe. So one reason to be involved in this space is that there's genuine growth there.

But more fundamental, I mean, you can have lots of growth, but if there's tons of supply, it doesn't really matter. You can still have terrible economics in the business. It turns out that hotels are still undersupplied in the quality that people need. These are harder assets to manage operationally. We have a set of capabilities, including a hotel operator that we acquired and we built out that enables us to be advantaged in the space. We have an advantaged dynamic pricing system called PROPERA that enables us to generate higher economics from hotels. So this is a very, very nice business. You can see that the hotel operator called OneFive Hotels, that's the primary driver of the OneFive Hotels operating prepare income went negative in fiscal year '21, '22 and '23, and now it's come roaring back. So the number on the right-hand side, JPY 1.3 billion is just only in the first 3 quarters of the year. So you can see the activities up a bunch.

In fact, as we have on the top of the page, it's grown 90% year-on-year, and we see more growth. Just in the last quarter, the last quarter of this year, we're going to see more growth relative to what we've done year-to-date. This continues to be a very, very powerful place to be active in terms of economics we can drive for you, our shareholders.

This is an example of some of our valid activity, not in the hotel space, but in office. We've generated NOI of plus 81% that was on kind of -- it was actually a fairly substantial [ recap ] CapEx of the building. We generally putting something that looks more like 5% in CapEx to improve buildings. This case, we did 30%. So it was a fair amount. And that 30% spend drove an NOI increase of 81%. External appraisals have doubled asset value. This is over the last 2 years. So it's been enormously successful. We took an old building. The first floor was a warehouse. The top was a penthouse that was really, really, really nice but only lived in by and an individual who was an owner, this is kind of our bread and butter. We could take this and make it into something substantially better with -- and because it's substantially better, you get these powerful economics. To be clear, we are driven by the creation of value, and it's only when we create value do we get these economics. Those economics flow from the value creation that has occurred, and this is a robust example of the activity that we do.

Our problem child, as you know, we're very grateful to -- we have such veteran investors and shareholders. You spent a lot of time with us. As you know, we have a single large office asset. It's on the Tokyo Waterfront. It's spectacular views. It was the original headquarters building for Sojitz, so the huge trading company. So the spec is fantastic on it. The structural engineer is great. As I said, the views are fantastic over the water, Tokyo Bay. And it was on the Olympics side. And so it was all incredibly exciting and totally full. And then COVID came and the Olympics were effectively kind of canceled for all intents and purposes in terms of a viewing event, at least in person, and we had all these departures. And so it was devastating.

And so we spent the last couple of years refilling the asset, reconfiguring it, doing the things that we do. We introduced cafe in the first floor and on the top floor, and we changed the office configurations. We did what we call ready to move in offices. There's a little bit of a Japan thing, but it is enormously expensive in Japan. Tenants are -- have to pay for both the fit-out and the moving back to kind of the original skeleton condition of office when they move in. So it's really, really expensive. And because of rising not only construction costs, but because of the shortage of construction labor, it takes months and months and months. So we have identified a market need, which is like people would rather just move into their offices.

And frankly, there is an environmental element of this because, as you know, we believe deeply in working for a better world and a better earth. Climate change is real. The activity that we have, we want to make sure it's productive for society and the planet. This whole process of kind of building out an office and then effectively tearing it down after 5 years and throwing it away is really not good for anybody. It is super wasteful.

So we have prefitted out offices. Tenants can move in immediately. They don't have to worry about it. They don't have all these costs of setup. They don't have the cost of the strip down. and they pay a premium that's typically up to 50%, and they're happy to pay that premium. Given the total economics of the package, they can move in immediately. They save some time. We do it for them. We can -- we have economies of scale. We're really good at this. So there's some powerful economics to this also. And we've done this at smaller assets, and we've done this now for the first time in a large building, which is Odaiba, and it's going well.

So we're up to 88% under contract. We know we will hit the occupancy in April. We expect to -- our goal actually is to get to 100%. This is a building that is doing really, really well. It was originally a great asset and it was devastated by COVID, and we're bringing it back to where it is and should be, which is a great asset. And the plan is to sell it. So we will -- we're filling this up, and we're going to sell it, and we'll do well for our shareholders.

Clean Energy is kind of just stable. We have ambitions to do more here. As you know, we did an investment in GIGA.GREEN, a German solar operator in part because of solar, of course, and climate change. Climate change is global, not just in Japan and the solar opportunity is also global. We would like to do more in Japan, and we expect to do so. We've got some work going on in green biomass and a nonfit solar power. We also have begun activity in -- and if we get some more details for you, we'll perhaps be able to announce it at the next quarter earnings announcement in battery storage, and we think that will be a really interesting area also for our shareholders. Let's turn to shareholder returns.

As I said earlier, we're in the midst of a buyback, and we think the shares are compelling value. There's a lot of cash flow being generated. The forward outlook looks good. We should be buying our shares. We have a progressive dividend policy and a shareholder return KPI based on DOE, dividend over equity of over 4%. We bump our dividend, we expect to bump our dividend also going forward.

And finally, on returns, we have a unique J. League shareholder program, which is fun for any and all shareholders who care about soccer or football, if you want to pronounce it that way, and we're happy to provide additional value to our shareholders. In terms of our environmental activity, we have gotten to 100% renewable energy in everything that we own and everything that we operate. And of course, that's completely separate from all of our production activity, which you can see on the next page.

So we -- our CO2 reduction results from kind of -- from our solar and wind power production is -- it gives us a result of 4.4x of our CO2 emissions. So we are explicitly climate positive. And as you can see, this is how this trends over time. We've both been reducing our carbon emissions, and we've been growing our carbon CO2 emission reduction activity.

That's what I have. So this is now open to the floor, open mic night as it always is. I'm happy to take anything from everybody. Greg, thank you very much. Go ahead.

[Gregoire Brillaud, analyst]

I have 2 questions, please. One is on hotels. So I see that compared to your H1 results, the RevPAR has increased quite a bit from JPY 12,900 to JPY 14,000, but you've left the full year unchanged for the profit forecast for the stock earnings. Is that kind of all in that's being taken into account? Or should we think that the JPY 6.2 billion is a bit conservative?

[Scott Callon, executive]

Thank you for the question. And so -- and you've given me the opportunity, Greg, thank you to clarify. We have not bumped our forecast this quarter. So yes, the numbers are going to come in higher. You're absolutely right. And as I said, we didn't move the owners forecast, which we think is going to come in lower. So that's a forecast that comes from earlier in the year. We'll come in much higher on hotels and we'll come in lower on owners.

[Gregoire Brillaud, analyst]

Understood. And my second question is regarding the AUM target. So if we think about next year, as you mentioned, the real estate token sales, so that's pushed back a little bit to next year, but you do have a forecast there for next year, which is JPY 100 billion. So I guess just accounting for that for next year, we should be at a minimum of JPY 450 billion. How should we think about how we could grow the hotel and the office AUM for next year?

[Scott Callon, executive]

Yes. I think it's easier for us to understand right now what the security token numbers look like given kind of what our pipeline looks like with our customers on this. And we'll find out together. We're certainly comfortable we end up the year at JPY 450 billion plus. It's probably going to be in a range of JPY 450 billion to JPY 500 billion, but we'll see. That's okay. Go ahead, I'm sorry.

[Gregoire Brillaud, analyst]

Another way to, I guess, to rephrase your question would be you're growing hotels faster than office. Is there -- do you think there are opportunities for fix next year? Or is it still muted from your perspective?

[Scott Callon, executive]

So I mean, we've got on the page that one of the other drivers is we are currently begun marketing our private REIT. And so we'll have to see how much that generates for us. So that one -- and we think that something ends up there. Currently, the -- I mean, the public REIT is not at a level which is accretive for us to do a public offering. And we exist to serve our shareholders. And so we're not going to do dilutive offerings. So at the moment, that activity is primarily as it's been this year, which was we sell fully valued assets and buy new assets that we can add value to. So we're not underwriting next year towards a particular growth in office AUM outside of possibly the private REIT space.

[Gregoire Brillaud, analyst]

Understood. I guess I was asking the question because as you mentioned, I think, several times this year, Scott, the replacement cost is rising, right? So the value of existing building is rising. And I guess I totally agree with that, but it seems that for the real estate market, for the public market, the market doesn't seem to care about that, doesn't seem to agree, which is kind of, I guess, you call it strange, you call it whatever it is. But isn't there a scenario where it would be useful to kind of maybe buy back shares for the REIT to kind of take advantage of this if other people are not seeing the opportunity? Because I guess, yes, in an inflationary environment, I totally agree with you. But when you look at NAV of listed companies or even REITs, the market doesn't seem to care at the moment.

[Scott Callon, executive]

Yes. We think it's a mispricing. So to your point, I completely agree that the office -- I mean, the offices we're seeing rental growth. It's directly linked to the increase in replacement costs. And forgive me because I've said this before, but it's super important. So please allow me to say it again.

People think of Japan classically, the challenge of raising rents is it tends to be an unconstrained supply market. So there's not kind of [ nimby ] here, you get lots of new supply. And -- but that's kind of -- it's only half of the conversation. It's that the new supply is coming in at replacement cost that hasn't changed for 20 years. So literally, somebody can put in a brand-new building or has been able to until a few years ago at the same price as what you did 20 years ago. So you can never raise rents because a brand-new building will be able to offer the same rents.

Now what's happening is literally, there's been a surge, 50%, 60%, 70% increase in construction costs. And so new buildings are coming online and they're coming online at 50% to 60% to 70% higher rents. And so we're able to raise our rents. So the office -- and offices unlike kind of the devastation that occurred in the United States and Europe are full. And so it is a very robust asset class. And so we have been adding to our office portfolio, and we have been selling out of -- off of our balance sheet offices to reflect this increase in value at really good prices. So we will continue to do that.

In the public markets for the office REITs have not recognized that reality. And so we announced -- we had earnings last month for office REIT. We announced that we expect -- you should expect us to focus more on things like buybacks rather than on asset growth because that is what the current market environment calls for us to do in terms of creating the most value for shareholders. So completely agree with you. This is a really interesting opportunity. If the public REITs are underpricing it, then the right thing to do is buy back shares, and you should expect that possibility. I mean, you can't really talk about buybacks, right? But that is certainly something that will be fundamental to our strategy on the office REIT.

Okay. I think we're going to call this a day -- a morning, a day and evening. Thank you so much, everybody. We're really grateful for your time, and we will keep on running forward. Have a good day. Thanks. Bye-bye.

[Statements in English on this transcript were spoken by an interpreter present on the live call.]