Hitachi Zosen Corp

TSE:7004

Earnings Call Transcript 2022-Q3

[Michi Kuwahara, executive]

This is Kuwahara. Thank you very much for joining the financial results meeting of Hitachi Zosen Corporation. As MC introduced, I present the third quarter financial results first, and then the acquisition of Steinmüller will be presented. Please refer to the presentation material entitled as the Financial Results for the Third Quarter FY 2021. Page 4 shows a summary of the third quarter FY 2021 results. Order intake was JPY 547.7 billion, up JPY 217.7 billion year-on-year. Net sales were JPY 288 billion, up JPY 25.5 billion year-on-year, and operating income was JPY 2.5 billion, up JPY 0.2 billion year-on-year. Robust order has been continuing following the second quarter. As for net sales, without any major issues for the project progress, they were progressing smoothly. As a major topic, including this order intake growth, order backlog exceeded JPY 1 trillion. As for the full year forecast for FY 2021, including the strong order, we revised up the order intake by JPY 40 billion to JPY 620 billion. Net sales were revised up JPY 20 billion to JPY 420 billion, and operating income was revised up to JPY 15 billion. Please turn to Page 5. This is the overview of the third quarter results. Order intake, net sales and operating income are as shown before. And let me explain ordinary income here. While operating income was up JPY 0.2 billion, ordinary income was down JPY 0.8 billion year-on-year. Most of the reason for decline is foreign exchange loss in Inova Group. Inova offers multicurrency for orders in EPC business. Located in Switzerland, their payment currency is Swiss franc, while their cost currency is diversified as either euro or British pound. To hedge this foreign exchange risk, the contract with customers provides multicurrency agreement. With the progress of orders, operating cash flow improved and the deposit account in euro and the British pound built up. However, recently due to the appreciation of Swiss franc, variation loss was incurred related to this. In future, when the cost in respective currency is paid, they would have no impact. But in accounting, the variation loss needs to be posted. Discounting this foreign exchange loss, ordering income also improved year-on-year. I'd like you to understand that actually there was no particular deterioration factor. Please turn to Page 6. Order intake, net sales and operating income by segment are shown here. Order intake was driven by Environmental Systems segment, and it increased by JPY 217.7 billion. Net sales in Environmental Systems also increased by JPY 29 billion. Operating income in Environmental Systems improved by JPY 0.8 billion, but Machinery & Infrastructure decreased by JPY 0.8 billion. Let me walk you through the overview. In Environmental Systems, we received large orders in Dubai, in Slough and Westfield in U.K. this year. As for the project progress, the project in Istanbul completed in October, and the project in Rookery, U.K. was completed in January. Under the COVID situation, the delivery in Istanbul, Turkey, in developing country was on schedule without any delay. And in Rookery, U.K., the schedule was moved up by approximately 1 month, and the project was completed. We had learned that lesson in the past incurring large loss. And the project in Rookery, U.K. was the first project where the lesson was applied. I personally regard it as a touchstone project to show how the lesson learned in the past will be effectively applied. So I was very pleased that this Rookery project was completed ahead of the schedule. Net sales increased by JPY 29 billion in the Environmental Systems segment. As I explained earlier, none of the segments were significantly affected by the COVID-19 pandemic. Operating income improved by about JPY 12.8 billion at Inova. But due to the deterioration in the domestic market, the overall improvement was limited only to about JPY 800 million. In the Machinery & Infrastructure segment, order intake increased by JPY 12.6 billion. This was mainly driven by marine diesel engines and the press machines. Net sales decreased by JPY 3.2 billion due to a decrease in press machines and process equipment. The decline in orders in the previous year led to a decrease in net sales this year. Operating income decreased by JPY 800 million in Machinery & Infrastructure. The main factor was the press machine business. There were 2 factors: decrease in sales and deterioration in profitability, which was caused by the absence of high profitability projects the business had up until the third quarter of the previous fiscal year. Please take a look at the next slide. Page 7 shows the order backlog. As I mentioned at the beginning, as one of the key topics, the order backlog as of the end of December exceeded JPY 1 trillion. Included in this order backlog of the Environmental Systems segment are orders for long-term operations of JPY 468.6 billion. Long-term operations tend to generate sales in a piecemeal fashion over a long term, such as 20 years and 35 years as in the case of the Dubai project. If we exclude this JPY 460 billion from the JPY 1 trillion total, the difference is about JPY 560 billion. We can assume that this JPY 560 billion will be converted into net sales next year onward. This is equivalent to about 1.3 years of net sales if we use the same net sales level of JPY 420 billion as in this year, though the progress will depend on each project, as you are all aware. Based on the available figures at hand, however, we have secured about 60% of the sales required for the next fiscal year. Since order intake for the fourth quarter will be also added on top of this, we believe we have a solid visibility into the sales forecast of the next fiscal year. Moving on to Page 8. The slide shows the breakdown of changes in operating income. From the increase from JPY 2.3 billion last year to JPY 2.5 billion this year, we have such factors as improvement in Inova Group, plus JPY 2.8 billion; decrease in highly profitable projects, minus JPY 2 billion; and decrease in the profit of the press machine business, minus JPY 600 million. Regarding the factors such as the decrease in highly profitable projects and the decrease in the profit of the press machine business, the explanation has been given already at the second quarter investor meeting, and please be assured that these factors are basically unchanged since then. Page 9 is the balance sheet, and Page 10 is the consolidated statement of cash flows. There are no particular outliers, so I will skip the detailed explanation. Please refer to Page 12, which is the forecast for fiscal year 2021. As I mentioned at the beginning of the presentation, compared to the November announcement, order intake is revised up by JPY 40 billion, net sales up JPY 20 billion, operating income up JPY 1 billion, ordinary income up JPY 1 billion and net income up JPY 500 million. These are the upward revisions we have made to the full year forecast. Please refer to Slide 13, which shows a segment breakdown. The upward revision of JPY 40 billion in order intake is entirely coming from the Environmental Systems segment. As I mentioned earlier, the order intake in Dubai and Westfield, which include contracts for long-term operations, was a major driver, especially the order intake in Westfield was significant this time around. Net sales were revised up by JPY 20 billion in the Environmental Systems segment. The operating income was revised up by JPY 0.5 billion in the Machinery & Infrastructure segment and another JPY 0.5 billion in the other segment. Considering the performance trend up into the third quarter, we believe that the level of improvement is fully achievable. Financial information is shown on Page 14. I would like to skip the detailed explanation here as well. That was my brief explanation of the third quarter financial results. I would like to reiterate that order intake has been strong, and the sales trend and the construction progress have been going well. As for operating income, there is no major concern at this point in time. Next, using another presentation material, I'd like to present on the acquisition of Steinmüller Babcock Environment. In December, we signed a share purchase agreement, SPA, for this acquisition and made announcement. And we received many voices of concerns for the underperforming business results of the company. I hope this presentation will deepen your understanding on the transaction rationale and the risk of this acquisition. Please turn to Page 2. Outlining of the acquisition is shown here with the information of the company. Steinmüller is renowned brand name in the industry. It was established in 2002 and founded in 1824. It is a company with long historical track record. The picture on the right shows its plant in 1874, though it might be hard to read. Since that time, the company has been well known as a boiler manufacturer. As shown on the left, paid-in capital is EUR 90 million and net assets are minus EUR 15 million, posting excess liabilities. This might be one of the causes for concerns. But below, in the table, under share purchase agreement signed on 9th December 2021, you see 3 bullet points. And the second one is capital injection by the seller to positive equity level. After the SPA signing on December 9, capital was already injected, and the excess liabilities are completely eliminated. And additional cost in projects awarded before the acquisition is guaranteed by the seller under certain conditions. Closing is scheduled to be in early February. Previously, the biggest concern was the competition law, but the approval was already obtained. So shortly, we reach closing. Right bottom chart shows market share. This pie chart shows our market share in Europe in 10 years from 2011 to 2020. In over 36% plus, Steinmüller Babcock, SBE is 7.7%. Through the integration of #1 and #3 company, the company will have a share of over 40%. The #2 company, CNIM, is seriously struggling. And in January, it has filed for bankruptcy act in France. It is comparable to Chapter 11 for reorganization in the U.S. Under such circumstances, the presence of Inova and Steinmüller in European market has further strengthened. Please turn to Page 3. This slide shows the past business performance and major projects. The chart clearly shows the deterioration of business results from 2018, '19 and '20. Measure and cause are described on the right. Accuracy of preorder risk assessment and the ability for large EPC execution and project management were not sufficient. As for measures, the company already reduced orders, and shifted from large EPC project to small-lot project and aftersales services. And through development of project management system, we confirmed that the stable management have been maintained in project awarded since 2018. For the restructuring, the current new CEO joined the company in 2018. Please turn to the left table of status of project. Project in Spain and Lithuania, awarded in 2017, are mainly responsible for large losses in 2018, '19 and '20. Both our EPC and for these large projects, risk assessment and the project management capability were not sufficient. I said before that new CEO joined the company in 2018, and from 2018, from project in Germany-1 and onward, we have not observed major deterioration. And from 2022, only 2 projects of Germany-2 and Finland-2 will keep ongoing. So you can make sure that almost all of those making projects have already peaked out. Ongoing project in Germany and Finland are EP project, with limited scope for boilers and incineration systems, and the contract size is around EUR 50 million to EUR 60 million, which are much smaller in size compared to the large project of Inova.

As for improvement, as shown briefly on the right, deficit is expected to improve significantly in 2021 as large loss-making project come to end. However, net sales will decrease rather than increase from FY 2022 onwards, partly because we reduced the pace of order taking. As a result, we will not be able to fully recover the fixed costs, and we are not getting out of deficit, yet. However, the deficit does not come from construction projects and limited in size. Under such circumstances, we are planning to reduce the number of employees significantly while also monitoring the progress of the project carefully. Compared to the first half of fiscal year 2021, we plan to cut our workforce by more than 20%. Please refer to Page 4. For Hitachi Zosen Inova's business strategy. If you look at the sales composition for fiscal 2019, there are more new projects and less O&M or operations and maintenance services. We will be revising this trend towards FY 2030. By doing so, we aim to achieve a stable profit structure. As shown in the bottom of the slide, we are aiming to achieve a portfolio with 50% EfW, 25% renewable gas, and 25% O&M services. Please see the next page. One of the benefits of the recent acquisition is the geographically complementary relationship. The areas shown in blue and light blue are areas where Inova has market shares of more than 50% and more than 30%, respectively. On the other hand, the areas shown in red and orange are areas where SBE has major market shares. We can see that the 2 companies can impeccably complement each other's geographical coverage. Please notice that in the upper right corner of the slide, you can find a list of entity names. The numbers assigned to each entity correspond to the numbers on the map. This is how we are continuing to organize our O&M service locations, while expanding our service sites, not only in Continental Europe, but also in the U.K., Scandinavia and other countries. Page 6 explains the technological synergy. The middle of the slide shows a cross-sectional view of an EfW plant. The flow of the process goes from left to right. From the left-hand side, the truck, the collected waste, comes in and drops the waste, and the waste is dropped into the incinerator and burnt. In the boiler section, heat recovery takes place, followed by exhaust gas treatment. And finally, the purified air is released into the atmosphere through the stack or the chimney. In between, there is a process of power generation. That's the process flow. The lower panel of the slide shows the current offerings. And in fact, most of the major services that are offered by Inova are in the incinerator or the combustion area. At the bottom of the slide, you can see the cost of each process as a percentage of the total maintenance cost. In fact, the combustion process accounts for only 14% of the total maintenance cost of an EfW or waste incineration power plant. In contrast, the boiler process accounts for 38% of the total maintenance cost. Through the acquisition of SBE, we were able to expand the stock, and in addition, we were able to gain an access to the boiler capacity and capability, which is complementary to what we already have in the maintenance of a plant. We would like to further expand our maintenance business in this manner. On the upper right, you can see 2 pie charts. The one on the left shows Inova's installed base or plants constructed by Inova. 68% of them are already more than 15 years old. On the other hand, more than 74% of the plants built by SBE are more than 15 years old. The reason why Inova has a lower percentage of plants that are more than 15 years old is because it has a larger percentage of plants built in the U.K. that are relatively young. That explains the difference with SBE. What we should be able to read from this is that, again, among the plants built, many of them are already old. We are trying to increase the stock of maintenance opportunities in these aging plants. And so we do so -- technological synergy will help us expand the scope of these opportunities. Finally, please turn to Page 7. This slide shows the sales targets for the O&M services business at Inova. As you can see, the growth from FY 2018 to FY 2021 was barely positive. Looking at FY 2020 and FY 2021 results, it was flat year-over-year. This is attributable, first and foremost, to the impact of COVID-19. The pandemic created a situation where customers could not perform maintenance even if they wanted to. However, in terms of organic growth at the moment, we are already on track to reach CHF 120 million, which is well above CHF 100 million level. However, our goal is to reach CHF 250 million by 2025. As a pathway to this goal, I believe that we will be able to secure JPY 20 million from the services of SBE that we have acquired. In addition, we can expect the contribution of Schmack, which operates a biogas business. Skipping the next one. We can also expect contributions from Dubai, O&M EfW and Westfield O&M EfW. This is because these 2 cases have been already confirmed. The one I have skipped earlier in the middle of the chart is SBE CSH growth and other M&A. This includes synergies from the recent acquisition, and may include further smaller acquisitions that we cannot disclose at this point in time yet. So we have a reasonable visibility into the road map to CHF 250 million at the moment. As I mentioned, with initiatives, such as the establishment of bases in Europe, M&A, EPC plus O&M and the investment in the long-term operation business, as shown at the top, we believe we have identified a solid pathway towards achieving the goal of JPY 25 billion. Thank you very much. This is all I have for today.