Hitachi Zosen Corp

TSE:7004

Earnings Call Transcript 2022-Q2

[Michi Kuwahara, executive]

Ladies and gentlemen, thank you very much for participating in our financial results briefing today. I am Michi Kuwahara, General Manager of Corporate Planning of HQ. I will walk you through the financial information slides. Please turn to Slide 4. As you can see here, we achieved the highest first half order intake and sales in a decade. Next, Page 5, please. Order intake and net sales are shown here. Based on these results, we have increased our annual order intake forecast from JPY 450 billion to JPY 580 billion.

On the other hand, operating income and ordinary income decreased slightly from the previous year. Although both operating and ordinary incomes were down year-on-year, we are more or less making progress in line with our annual plan. In our business, since the ratio of public sector demand is high, net sales tend to fall in the end of a fiscal year. As a result, the first half is prone to record a loss. Having said that, the first half of FY '21 was no exception, though the level of loss was lower compared to the past.

I would also like to add that we are making progress in structural improvement. Please turn to Page 6. This is a breakdown of order intake by segment. The total order intake was JPY 380.6 billion. With this, we achieved 66% of the annual forecast, which was revised upward this time. The main contributor was the Environment business of Inova, which received orders from projects in Dubai and the U.K. In Dubai, we were awarded not only EPC, but also a 35-year long-term O&M contract.

The uplift in Machinery and Infrastructure was mainly driven by an increase in marine diesel engines, press machines and precision machinery. Next, Slide 7. highlights of the changes in order backlog. The backlog at the end of September was about JPY 970 billion, quite a high level. In Environment, long-term operation projects backlog amounted to about JPY 400 billion. The increase from March is mainly attributable to the long-term O&M contract in Dubai, which will be in effect for 35 years from 2024 after the completion of the facility.

Please note that it, therefore, will not immediately affect our business results for FY '21 or FY '22. Slide 8, please. breakdown of net sales by segment. The increase in sales in Environment is mainly led by Inova. In Machinery and Infrastructure, sales of press machines decreased. Page 9 shows the breakdown of operating income by segment. I will explain about Environment in the next page, but the details of Machinery and Infrastructure will be given in the slide covering small segments. Please turn to Page 10. And this explains the variance. It shows the factors behind the changes in operating income from the previous year.

Firstly, Inova group was up by JPY 2.2 billion. This is due to the completion of unprofitable construction projects and the steady progress of ongoing construction. On the other hand, there was a decrease in the number of highly profitable projects in Environment, especially in water business, such as retrofit works, pushing down the operating income by JPY 1 billion. Furthermore, profit in press machine was down by JPY 600 billion.

This is due to the dip in order intake in FY '20 being halted by the pandemic. The impact is felt in FY '21 sales. Page 11 is the balance sheet, and Page 12 shows cash flows. Please refer to them at your convenience. Pages 14 and onward are the slides on FY 2021 annual forecast. As mentioned at the outset, we made an upward revision of our order intake by JPY 130 billion to JPY 510 billion. There is no change in net sales and operating income. Details on Pages 15 through 17 will be explained in later slides. So I will not go over them now.

Page 18 shows key financial indicators by year. Please refer to it at your convenience. Let me explain details by segment. Please turn to Page 20. Environment segment, Green part at the top of the bar chart shows Inova group. As for the order intake in the second quarter FY 2021, Inova made a substantial contribution of JPY 235.2 billion. For the full year, it is expected to grow to JPY 275 billion. In net sales and operating income, we can see the improvement of Inova business.

Due to the presented factor for operating income change in the second quarter, the decreasing, highly profitable project, Even with the improvement in Inova, we maintained the operating income full year forecast as JPY 10 billion. It was kept unchanged. In this segment, due to the mix change of EPC and retrofit works in Japan, profitability slightly changes by year. However, supported by aftersales operation and maintenance, stable business management has been maintained.

By combining the improvement of Inova with this, we'd like to achieve the future growth of the entire segment. Please turn to Page 21. Machinery and Infrastructure. Orange or pink part at the top of the bar chart shows Infrastructure. As for Infrastructure, against the full year forecast order intake of JPY 32 billion, the result was JPY 10.9 billion, showing slow progress. Tenders mainly for bridges are scheduled in future, and we'd like to catch up promptly.

Next, please turn to Page 44 of supplementary information for breakdown by small segment. Second quarter results of Machinery and Infrastructure business are shown here. Our order intake of marine diesel engine has been steady along with the order intake growth of peer shipbuilding companies. Press machine order intake recovered from the previous year when the business was severely affected by COVID-19. But it's net sales decreased substantially, reflecting the sluggish order intake in the previous year and operating income deteriorated with sales decline.

Process equipment order intake has been most struggling, affected by the global decarbonization trend. This is clearly reflected in its order intake and net sales in the second quarter. However, we plan to receive order for the promising nuclear power project in the second half of this fiscal year. Including this, full year order is expected to be JPY 18 billion. Order intake of precision machinery has been generally robust, partly due to the increasing demand for semiconductor.

In the second quarter, it incurred loss of JPY 0.4 billion, but we expect the recovery with a sales from project scheduled in the second half. For the full year, profit of JPY 0.8 billion is expected. As for the full year forecast on Page 45, we revised operating income of marine diesel engine and press machine this time. In marine diesel engine due to the technical trouble, operating income is revised down by JPY 0.2 billion, incorporating its impact. Press machine continues to post loss but the improvement trend was confirmed, and we revised up operating income by JPY 0.2 billion.

As a result, for the entire segment, operating income forecast remained unchanged. As for the concerns for this segment, there are delayed order in process equipment and Infrastructure and technical trouble in marine diesel engine, but we assume at this moment that their impact will be limited. As all large loss-making project in this segment in the past are cleared, the structure of this entire segment is being improved to the one that can absorb the fluctuation of small segment. With this, I conclude my presentation. As a summary, let me make a brief comment. Because of the substantial improvement in the first quarter, I assume many people had high expectation for the second quarter.

For them, the results might have been disappointing. However, as mentioned at the beginning, in terms of sales and profit, the progress has been in line with the plan. And I'd like to emphasize this point again. Orders have been solid. And based on this, we will achieve further improvement. Thank you for your attention. I would now like President Sadao Mino, to present management and business information.

[Sadao Mino, executive]

I am Sadao Mino. Firstly, I would like to thank our shareholders, investors, analysts and the people from media for your continued support. Since the latter half of last year, the trend towards decarbonization in Japan has been accelerating. Amidst such a backdrop, I feel that the attention and recognition we are getting are heightening. This is yet again, all due to your support. Please accept my heart felt gratitude. Now let's move on to our management and business information slides. Please refer to Page 24, which shows the progress of our mid-term management plan called Forward 22. There are 3 basic policies.

Under the policy to increase the added value of products and services, efforts to promote manpower saving and automation in energy from waste plants have progressed. Big Data and AI have been used in combustion condition prediction system, which enables stable combustion. Furthermore, big data and AI are used to automate and advance the operations of waste cranes, which had required the know-how of seasoned operators in the past.

Details will follow later. Regarding Machinery and Infrastructure business, AI usage is progressing including the AI ultrasonic inspection systems I have explained before. Furthermore, initiatives are renewable energy, such as wind power, hydrogen and methanation are progressing as well. In October, we issued our second green bond of JPY 10 billion. In accordance with the purpose of the green bond, proceeds will be used to fund onshore wind power generation project in Mutsu-Ogawara in Aomori Prefecture, meeting the expectations of our investors.

Regarding portfolio management from this fiscal year, we added the perspective of market sustainability to our evaluation criteria used in appraising our businesses. This should enable us to have a long-term perspective in evaluating our businesses and in considering different initiatives. As to talent development and work start reform, we position the development of people skilled in management in [indiscernible] as an important agenda. Accordingly, we launched various training programs focusing on HR development.

Now on to Pages 26 and 27, which show the details of major orders received in the first half of FY '21. Page 26 is on domestic orders, while Page 27 is on overseas orders. The content has already been announced, so I will not go through them today. Please look at them at your convenience. Page 28, please. This shows the schedule of major projects in Environment business, excluding Inova. In the first half of FY '21, as you can see in the bottom 2 lines of this table, we received orders for projects in Taiwan in August and in India in September.

In the second half of FY '21, we expect to receive orders for several projects in Japan. As you can see, many construction projects are underway in Japan, China, India, Thailand and Taiwan. On to Page 29. This shows Inova's projects. The construction in Istanbul was completed in October. Although the O&M contract is for a year, Inova is currently providing O&M services for the first time. In FY '21, we received orders from Dubai and Skelton Grange in the U.K. For the Dubai project, a 35-year O&M contract was awarded too. This is Inova's third O&M order for energy from waste plants following orders in Istanbul, Turkey and Australia.

Skelton Grange is Inova's 15th order in the U.K. and Ireland. As you can see, many large project constructions are underway at Inova. From here, I will elaborate on the status of Inova. Please look at Page 30. With 2 EPCs, 1 in Dubai and the other in Skelton Grange and the 35-year O&M in Dubai, order backlog of Inova stands at JPY 235.2 billion, a historical record high. In the renewable gas business, which is expected to grow in Europe and the U.S., Inova possesses Kompogas technology, which is dry methane fermentation process.

Inova has an extensive track record mainly in Europe. To expand our product portfolio, we acquired 2 German companies one engaged in the maintenance of wet-type methane fermentation and the other involved in its R&D this past July. With these acquisitions, we are now able to meet a wide range of customer needs. As you know, Inova had struggled in the past, but as shown in this graph, Inova's is performance is recovering steadily as a result of various management reforms. Inova's contribution to our consolidated results has been increasing every year.

In FY '21, Inova is expected to account for about 20% of our total net sales. As the energy from waste market in Japan matures, we intend to develop overseas markets, which are becoming increasingly important in collaboration with Inova, we will leverage on our group's comprehensive capabilities to grow our environment business. Page 31, please. I will explain Inova's medium- to long-term initiatives. In the past, Inova's main markets were in the U.K. and EU. However, in the past few years, countries such as Turkey, Russia, Australia and the UAE decided one after the other to deploy energy from waste plants on a full-fledged scale. In each every market Inova was awarded the project.

As shown in this graph, Inova's market share in EMEA has been around 30%. But last year, thanks to orders in Russia, for instance, Inova's market share rose to nearly 60%. And we expect this trend to continue this fiscal year. When we acquired Inova, its energy from waste business was centered around EPC. This exposed Inova to risks being quite vulnerable to market trends and orders received. Given that we are currently aiming at attaining a well-balanced energy from waste business structure with 50% in EPC, 25% in O&M services and 25% in renewable gas.

In new markets, there are opportunities for Inova to participate in the early stage of projects, which was the case in Australia that opened doors to O&M contract. Likewise, in Dubai, long-term O&M contract was awarded to Inova. In France and Germany, we are expanding our O&M service network in Europe through M&As. At present, we have built a system that enables us to provide services to approximately 70% of energy from waste plants in Europe. To achieve sustainable growth and stable earnings, we are working not only on EPC, but also on the upstream and downstream of the value chain.

We are seeing some tangible results of this group strategy. On to Page 32, update of Environment business, excluding Inova. Firstly, EPC for energy from waste. Domestic market volume for FY '21 is expected to decrease by about 30% against FY '20's market volume. In our business, much order is expected in the second half, so we will put our utmost efforts in receiving those orders. We received order in India last year. And once again, this September, we were awarded the Moshi project, the third for the group in India. The market had been slow to take off since we received our first order in Jabalpur in 2014, but it has finally started to kick off. As for the O&M business, the demand for major retrofit works has run its course to some extent. We will continue to enhance our competitiveness by promoting new high value-added proposals that will lead to solving customers' challenges such as improving efficiency through the use of ICT and saving energy and manpower through the use of AI.

In China, we established a joint venture with a local partner to promote after-sales activities. This entity is poised to capture the O&M demand that will increase in the future. In FY '20, we posted a loss related to the electricity sales business, which is included in O&M, causing some concern among you. We concluded electricity wholesaling contracts with new sales partners, replacing the ones that had been already terminated. In water business, we received an order for the construction of the Koga city sludge recycling facility in May.

On the other hand, highly profitable retrofit works are completed, so profit will be slightly down year-on-year. To differentiate ourselves from competitors, we will strengthen our comprehensive management and make our operational management systems more sophisticated by using AI and ICT. These measures would enhance our proposal capabilities. As for the external environment, COVID-19 material cost increase and tight logistics are concerned, but impact on our Environment business is minor and limited. Please turn to Page 33. Let me explain Machinery and Infrastructure business. On marine diesel engine, please refer to the number of new ship orders.

Number of orders received in Japanese ship company has been growing. And with this, our engine orders in the first half were JPY 12.5 billion, making the steady progress of 64% of the full year budget. But engine price remains tough. We will strengthen after-sales service business further by expanding menu and increasing staff even -- ever than before. We have been working on marine SCO systems to reduce NOx emitted from marine diesel engine during navigation through catalysis since 2009.

Globally, sea areas where NOx regulations compliance is required are expanding. And cumulative orders for our marine SCL systems exceeded 100 units. We'll continue to meet the environmental needs by leveraging our strengths of packaging solution of engine and SCL. As for press machine, affected by COVID-19, demand fell sharply. But as shown in the chart, the demand for large-sized machine where our group is engaged in finally began to show sign of recovery.

Under such circumstances, orders in the first half were JPY 7.7 billion, which was almost half of the full year plan and business negotiations are gradually increasing. Full recovery in demand is taking more time than our initial plan. But the demand in FY 2021 will be close to the level of FY 2019. Regarding press machine, as demand for effective use of existing facilities is increasing, we will focus on O&M services. Please turn to Page 34. As for process equipment, due to decarbonization trend, investment in refining and petrochemicals is declining, and orders and sales have continued to be tough.

Nonspecial products are produced in JV in India, where production cost is lower, and we have been strengthening after-sale service to cater for aftersales needs of aged plant facilities. As for precision machinery, investment by semiconductor production manufacturers has been rising. And in our group also, the orders for vacuum valve have been strong. And as China has been accelerating domestic production of semiconductors, we set up local production and maintenance basis in China in April 2021 to enhance our business. As for Infrastructure, orders of bridge are expected to be the level of usual year, and major orders will be received in the second half.

As for shield machine, as of October 1, we set up the joint venture, Underground Infrastructure Technologies Corporation with Kawasaki Heavy Industries, integrating sales and engineering divisions. By combining a product lineup and know-hows of the 2 companies, we strengthened competitiveness in Japan and overseas. We have high expectation for future synergy and business development and expansion. As for risks by changes in the external environment, risk by material cost increase is concerned.

But in Machinery business, we will continue to work to reduce costs and strive to receive orders at reasonable prices. In Infrastructure business, generally, material cost increase exceeding a certain level is passed on to prices. Finally, I would like to introduce some business topics. Power to gas or PtG business and use of AI and IoT. Please turn to Page 36. I'd like to explain 2 cases our Power to Gas business. Our feasibility study was selected as one of the first green innovation fund projects of NEDO subsidized project. With Yamanashi Prefecture as Secretary, we are working as a member of the consortium, joining hands with private companies, including Toray Industries and the Tokyo Electric Power Holdings.

For 5 years up to 2025, we will design and test for social implementation of PEM-type water electrolyzer for large-scale and modelization to turn renewable energy into hydrogen energy in safe and secure manner. Please turn to Page 37. I will explain feasibility study on high-pressure PEM-type electrolyzer for green ammonia production and supply project in Lao PRD. It was adopted as a commissioned project by NEDO. Lao PDL is a net energy exporting country. They promoted the hydropower generation, and now they have unused renewable energy.

Our project is to focus on this unused renewable energy and propose its effective use and the way for the use. This study aims to develop and commercialize technology to produce green hydrogen, and that will be converted to green ammonia, which has extensive applications. Especially in the case of producing green hydrogen, we will develop and commercialize high-pressure type of water electrolyzer to meet the global needs. In this project, we serve as a representative company, and we are working with Renova.

Please turn to Page 38. I will explain the cases of the use of AI and IoT. In 2019, we received order for energy from waste plant in Rayong Province, Thailand. But due to COVID-19, we were not able to dispatch supervisors. And local staff wearing smart glass shared images of local sites with members in offices and home offices, receiving support and supervision through ICT. This remote supervision contributed to the completion of facility construction in July 2021. Finally, let me explain the energy and labor saving initiatives of waste incineration and power generation plant.

In Japan, future labor shortage due to aging and the declining birth rate is concerned. However, hygienic waste incineration, which is indispensable infrastructure and power generation renewable energy cannot be suspended under any contingencies, even including natural disasters and pandemics. With the cooperation of Clean Authority of Tokyo, using the big data of Suginami Incineration Plant to demonstrate optimal operation of installation plant.

We introduced a waste bunker and crane 3D system with priority input of agitation degree and the next-generation automatic combustion control system using AI technology and AI automatic operation, and we have been operating them. For the safe and stable waste in duration and power generation, sufficient waste agitation to ensure homogeneity before incineration is required.

Usually, automatic combustion control system controls the waste and air supply volume. But in the case when the combustion deteriorates beyond the threshold, which may happen several times or dozens of times a day, manual operation by a skilled operator is required. By using big data, we are able to sustain the stable operation of steam volume and the temperature in furnace for more than 1 month. and the complete automatic operations for over 2 weeks were demonstrated twice.

With these technologies, we will contribute to the realization of more stable finance operation, saving labor, power consumption and service cost. We continue to use AI and IoT in products and services to solve customers' issues and enhance added value. This concludes my presentation. Thank you for your attention. [Statements in English on this transcript were spoken by an interpreter present on the live call.]