Dentsu Group Inc

TSE:4324

Earnings Call Transcript 2019-Q2

[Operator]

Good day, everyone, and welcome to today's conference call to discuss Dentsu Inc.'s fiscal year 2019 second quarter earnings announcement. Today's call is being recorded. On today's call, we will only be taking your questions in English, please. At this time, I would like to turn the call over to Mr. Chuya Aoki, Investor Relations of Dentsu Inc. Mr. Aoki, please go ahead.

[Chuya Aoki, executive]

Thank you. This is Chuya Aoki speaking. Thank you for joining us today. Before starting, let me tell you a few things. Firstly, we will be referring to our presentation material titled Earnings Presentation. You can find it on our website. Secondly, let me introduce the host of the call. Joining me today are Mr. Tim Andree, Executive Chairman and CEO of Dentsu Aegis Network, and Executive Officer and Member of the Board, Dentsu Inc.; and Mr. Yushin Soga, CFO and Member of the Board, Dentsu Inc. Finally, we are going to have a Q&A session after 2 presentations from Mr. Yushin Soga and Mr. Tim Andree. The call should take around 1 hour, including the Q&A session. So Yushin, please go ahead.

[Yushin Soga, executive]

Thank you, Chuya. Good morning, and welcome to the call. I'm Yushin Soga, Director and Executive Officer of Dentsu Inc. I will talk us through the first half results.

In the first half, consolidated revenue less cost of sales increased due to contributions of newly consolidated subsidiaries in the Japan business and the international business. The percentage of revenues from digital rose to 48.9% on a consolidated basis. However, the organic growth rate was negative, both in Japan and the international business. Consolidated, minus 1.5%.; Japan business, minus 2.1%; international business, minus 1.0%. Operating margin was 10.0%, 370 basis points lower than prior year. We decided to revise our full year guidance based on the judgment that results in the first half fell short of expectations both in Japan and the international business and that the likelihood of recovering from them in the second half was low. Regarding shareholder returns, we maintained our previously announced JPY 5 dividend increase for FY 2019, leading to a dividend of JPY 95. We also decided to repurchase up to JPY 30 billion of our own shares. That's 4.25% of the total shares issued to demonstrate our confidence in the future growth of the business.

Turning to Page 2. Next, we will discuss consolidated results for the first half of the fiscal year. Revenue less cost of sales posted JPY 449.2 billion. Underlying operating profit was JPY 44.9 billion, and operating margin was 10%. Net loss attributable to owners of the parent for statutory was JPY 1.2 billion, mainly due to an increase in acquisition-related liabilities. Turning to Page 3. The factors behind the change in revenue less cost of sales in the first half year-on-year are as follows: Foreign exchange impact was minus JPY 7.7 billion. M&A contribution was JPY 18 billion. And organic growth was minus JPY 6.7 million. The JPY 18 billion increase from M&A was attributable to JPY 4.2 billion in Japan and JPY 13.8 billion in the international business.

Turning to Page 4. In the Japan business, the organic growth rate of revenue less cost of sales declined. While group companies performed well, the non-consolidated performance of Dentsu was significantly below the previous year's results and our forecast. As a result, operating margin fell 530 basis points to 19.1%.

Turning to Page 5, moving to the international business. A number of key markets had a significant impact on the performance of the region and the international business as a whole. Of these, Australia, which has been struggling due to the loss of major accounts in China, which is undergoing structural reform, are particularly weak. Within the EMEA, U.K. and France recorded negative organic growth. In major markets facing these challenges, we have already taken steps to return to a growth trajectory as quickly as possible by responding to individual issues including leadership changes. In the Americas, data marketing solutions, Merkle, and the media business are both growing well, and new business wins are strong. Operating margin was 230 basis points lower.

Turning to Page 6. I will describe the changes from Q1 for the following items: Financial income increased by JPY 3.6 billion from Q1 to JPY 4.9 billion in the first half due to devaluation of our net debt. Financial costs increased JPY 7.8 billion from Q1 to JPY 20.1 billion for the first half due to an increase in interest expenses and the devaluation loss on put options. Turning to Page 6 (sic) [ 7 ]. We have reviewed our full year guidance based on the results for the first half of the fiscal year and average for the second half. As a result, revenue less cost of sales guidance is lower by 2.7%. Underlying operating profit is down 9.2% from the initial guidance. As a result, the operating margin is now expected to be 14.9% in the current fiscal year. We have pledged to improve operating margins until 2020 after bottoming out in 2018. While 2019 margins are expected to fail, we remain firmly committed to our goal of surpassing the 2018 level of 16.4% in 2020. Turning to Page 8. Now I will look at Japan and the international business separately. In Japan, the main reason for lower guidance was the downward revision of the domestic top line. The first half results were not as high as we expected. However, domestic group companies are expected to continue to perform favorably, and both revenue less cost of sales and operating profits are expected to exceed the previous year's and year's start guidance. The revision lowered Japan business' organic growth rate from 6.1% to 1.4%. In the international business, our revised target for organic growth is positive due to the drive from 2 large markets. In the second half of the fiscal year, earnings are expected to improve due to the cycling out of lost accounts and the onboarding of new clients, particularly in the Americas and EMEA. The operating margin guidance for the international business has been upgraded. We now look for at least 30 basis point improvement versus the previous guidance of 10 basis points. The upgrade is due to strong cost management of central and regional costs. Turning to Page 9. Finally, we discuss shareholder returns. We have revised guidance lower but maintained the previously announced JPY 5 increase to the dividend for FY 2019. We expect to pay a dividend of JPY 95 for 2019. We also announced a share repurchase plan on August 7 of up to JPY 30 billion of circa 4.25% of share capital. We review the share buybacks based on an assessment of funds, business performance and the current share price. The decision to buy back shares is an expectation of management's confidence in future growth. Thank you. I will now hand over to Tim Andree, who will talk you through the strategy presentation.

[Timothy Andree, executive]

Thank you, Yushin. I'm Tim Andree, Executive Chairman and CEO of Dentsu Aegis Network and Executive Officer of Dentsu Inc. I'd like to explain the priority themes for achieving the guidance in the second half of the year and for growth from 2020 onwards. First, I'd like to explain our progress towards growth -- towards the growth targets by 2020, which we introduced in August last year on Slide #1.

This slide shows the midterm guidance we announced in August of 2018. I will explain the progress of each KPI. First, revenue less cost of sales organic growth. We have lowered our forecast for the fiscal -- for the current fiscal year, but we firmly maintain our target of a growth rate of at least 3% over a 3-year CAGR. In Japan, one of our leading indicators, the business momentum index was weak during 2017 and the first half of 2018, but it is recovering and posted significant acceleration in the first half of 2019. Overseas, year-to-date, the level of net new business has seen its best-ever first half performance of $3.4 billion. The pipeline of $7.4 billion is the largest since 2015, with 96% of the pipeline offensive opportunities. Although there is a time lag before results are impacted, these are positive signs, providing the tailwind for the next fiscal year. Secondly, operating margins. Although we guided to a decline in 2019, margins will improve in 2020 versus the 2018 level.

Finally, in terms of shareholder return, as Soga-san mentioned, the buyback of JPY 30 billion announced on Wednesday shows our confidence in the future performance of the business.

Please turn to the next slide. We're approaching a society called After Digital. Real Society will be contained within the Digital Society. In all aspects of life, digital devices are constantly generating data, which instantly transcends all borders, creating new opportunities for Dentsu to drive value for our clients. In Japan, the 2020 Tokyo Olympics and Paralympic Games will be an opportunity to transform Japan society into a world of After Digital. Japan is experiencing social changes at unparalleled speed and scale, and our focus is to make the most of these advantages. Please turn to the next slide. The essence of value-added in the advertising and communications business is to anticipate disruption within society. We believe that our goal is to create solutions for our clients' problems, evolving advertising into innovative solutions that address the disruptions our clients are facing. For example, Dentsu has a track record in expanding into areas such as sports and content with unprecedented success in the industry. Our aim is to become a trusted partner to our clients, solving our clients' business issues, growing together and creating solutions that go beyond advertising. I'd like to share a recent case study. Dentsu's Isobar KFC pocket store in the People's Republic of China is a perfect example of evolving advertising. This won the Gold Lion at the Cannes Festival of Creativity this year. In this campaign, each user opens up a virtual KFC store on a social network. The consumer aims to become the most popular shop in the community by presenting their recommended product lineup to friends on social networking sites. This has a gaming feel, and customers can even order KFC products and receive them in real stores. This is great example of the evolution of advertising, which uses data analytic technology driven by the consumer rather than one-directional approaches from the brands to the consumer. Another solution beyond advertising is seen on the next page. Dentsu has launched a project incorporating a number of Dentsu group companies to address the challenges of digital transformation at a major car manufacturer client. The ISID Group, Dentsu Digital and Dentsu Headquarters work together on an organizational digital transformation project that covers the entire value chain, from product development and design to marketing, sales and data analysis in the customer's business. We achieve this by combining capabilities across the Dentsu Group. Our aim is to provide solutions that go beyond advertising while leveraging the Dentsu Group's traditional strengths. Please turn to the next page. To achieve our goal, not only must the Dentsu Group collaborate and grow, but also we must look to acquire new external skills and expertise. In Japan, we made Septeni Holdings and Equity Method affiliate and made Voyage Group a consolidated subsidiary. Year-to-date, in the international business, we have made 9 new acquisitions, the largest of which is Ugam, strengthening Merkle's data and analytics capability but also providing an offshore capability that allows us to be increasingly competitive and provide margin opportunities. Through these investments, we can significantly increase our capabilities, leverage them across all markets and realize synergies across the group. The Dentsu Group is present in 145 markets. And our 60,000 people could connect across boundaries, creating solutions that go beyond advertising. Value is created through connectivity of our people. We can accelerate the creation of a more flexible and diverse organization through the new holding company structure. The Dentsu head office, which has been responsible for the roles of business management and corporate governance of group companies, will be broken down into functions. This will allow Dentsu to access resources across the global network as well as focusing on growth as a group as a whole. We've already communicated to our employees our intention to evolve into One Dentsu, embracing diversity across the group that will drive innovation.

Next year, the Tokyo Olympic and Paralympic Games will be held and will open opportunities for major changes in the style of viewing and video broadcasting at stadiums. The Dentsu Group with its origin in Japan and strength in the field of sports and content will continue the evolution that's already begun. We've already communicated to our employees our intention to evolve into One Dentsu where all 60,000 diverse employees can connect. We will continue to accelerate our own evolution. Thank you. We look forward to your questions. I look forward to turning the line over to the operator.

[Operator]

[Operator Instructions] Mr. Aoki, there are no questions today. So at this time, I would like to turn the conference call back to you for any additional or closing remarks.

[Chuya Aoki, executive]

Thanks, operator, and thank you very much for everyone for joining us today.

[Operator]

Thank you. That concludes today's conference. Thank you for your participation, and you may now disconnect your lines.