Joji Okada – Executive Managing Officer, Chief Financial Officer
Keigo Matsubara – General Manager, Global Controller Division
Kenichi Hori – General Manager, Investor Relations
Mitsui & Company (OTCPK:MITSY) Q3 2012 Earnings Call February 2, 2012 9:00 AM ET
Thank you for attending our earnings call. Today I would like to explain the financial results of the nine-month period ended December 31, 2011 and our full year outlook. Overall the global economy demonstrated a slower rate of recovery, particularly in the advanced economies amid the financial strains in the euro area, the tightening monetary policies of the emerging economies, and the disruptions in the supply chain caused by the natural disasters in Japan and Thailand.
The growth in emerging and developing economies slowed gradually due to tightening of monetary policies and slower demand from the advanced economies. The growth rates are still high and continue to be the key force for the global recovery. With regard to the Chinese economy, although certain economic indicators suggest some moderation, we maintain our view that China will be able to sustain a strong rate of growth as urbanization of inland China as well as growth in consumer spending are expected to continue.
The international commodity prices, including crude oil and metal resources, have declined from their peak due to slow recovery in the advanced economies and the volatile financial markets. In the foreign exchange market, the financial turbulence in Europe and the prolonging monetary easing policy in the U.S. caused the yen to appreciate to the level of 100 yen against the euro and reach its historical high against the U.S. dollar after World War II. I believe that the operating environment surrounding us will become increasingly challenging from now on.
With this in mind, in the short term we will further intensify our monitoring activities of these risks and reinforce our investment discipline. Concurrently, in running our business we will maintain a long-term perspective as well as our basic strategy of building a high quality balanced business portfolio that would enable us to capture the growth of emerging economies.
Please turn to Page 1 of the presentation material on our website. Net income attributable to Mitsui for the nine-month period ended December 31, 2011 was 340.2 billion yen, which was an increase of 64.4 billion yen compared to the corresponding period the previous fiscal year. Net income attributable to Mitsui for the three-month period ended December 31, 2011 was at 113.0 billion yen, an increase of 20.4 billion yen compared to the same period the previous fiscal year. The increase in the prices of commodities such as iron ore, oil and gas, and coal as well as the steady growth in the volume of iron ore and oil and gas have led to a sizeable enhancement in the performance of the mineral and metal resources and energy segments.
All operating segments have posted increases in net income compared to the same period the previous year, with the exception of consumer service and IT and Americas. Notably, foods and retail has shown a remarkable increase. The details of each of the operating segments will be presented by our global controller, Mr. Matsubara later on.
The consumer service and IT segment posted a net loss of 31.2 billion yen for the nine-month period, primarily due to the impairment losses after tax of 33.9 billion yen on listed securities of its IT businesses. The fact that additional impairment losses as well as significant losses at our associated company were recorded in this quarter was rather disappointing. We will elevate our efforts to add tangible value to these investments and at the same time further intensify our periodic review process of the strategic and economic benefits of our holdings.
In the three-month period ended December 31, 2011, a one-time positive impact of approximately 20.0 billion yen was recorded mainly due to a reversal of deferred tax liabilities on undistributed retained earnings of associated companies as a result of a reduction of the Japanese corporate income tax rate. On the other hand, a negative impact was recorded at our associated company due a revision of future taxable income and the setting up of evaluation allowance against deferred tax assets. As the domestic operating environment surrounding our group of companies becomes increasingly challenging, we need to be continuously mindful of the realizability of deferred tax assets.
Next I will talk about our investments and loans during the period. Please turn to Page 2 of the presentation. Our annual plan calls for new investments in loans amounting to about 700 billion yen and asset divestitures and capital redemption of about 120 billion yen. In the nine-month period ended December 2011, we have executed investments in loans in total of 490 billion yen, which is good progress against our annual business plan, and asset divestitures and capital redemption in total of 180 billion yen which is significantly above our plan.
Mineral resources and energy accounted for 170 billion yen of the investment and loan amount, reflecting continued expansions. Lifestyle business accounted for 160 billion yen, including our investment in the hospital network based in Singapore and Malaysia, as well as the full acquisition of Multigrain in Brazil. Infrastructure implemented 80 billion yen mainly for FPSO and the rolling stock leasing business, and global marketing networks carried out 80 billion yen of new investments including the biochemical business with the Dow Chemical Company as well as the acquisition of a logistics company, both in Brazil.
Cash inflow of 180 billion yen was significantly above our plan, and this was achieved through the continued redemption of capital from the Sakhalin-2 project as well as the reinforcement of investment discipline. The idea of continuously improving the business portfolio through the implementation of asset recycling has been fully embraced within the organization. As a result, our net cash expenditure for the nine-month period was 310 billion yen.
As for the full year outlook, we expect to finish broadly in line with our plan in terms of gross expenditure. In mineral resources and energy, we have ongoing investments for expansions as well as new expansions in the Eagleford Shale project. Also, demand for investment in other areas continues to be strong and we have investments under negotiation. As we explained when we announced our second quarter financial results, if the loan to Codelco is executed, it will be in addition to the annual investment and loan plan for this fiscal year. We will continue to actively seek good opportunities that will strengthen our business portfolio.
At the same time as the operating environment becomes increasingly challenging, we will continue to reinforce our investment discipline. We will be selective and try to further improve the quality of our investments. We will also continuously review our business portfolio and actively implement asset recycling where appropriate, and as a result expect to achieve a full-year cash inflow of more than 200 billion yen.
Now please turn to Page 3 of the presentation. Looking at our balance sheet, despite negative factors such as the appreciation of the yen and the decline in the stock market, total assets increased slightly compared with the end of March 2011 due to execution of investment projects and loans as well as an increase in trading activities. The net debt to equity ratio was 0.93 times and we believe that Mitsui’s balance sheet remains strong. This provides us with a stable financial base which supports our active investment activities.
Free cash flow was negative at approximately 170.0 billion yen. Although we were able to realize cash inflow from asset divestitures over and above our plan, cash outflow relating to working capital was approximately 240 billion yen, which increased due to the settlement payment for the Gulf of Mexico oil spill incident as well as increases in trading volume at foods and retail and energy. While bearing in mind the cash requirement for our trading activities, our policy to target positive free cash flow on a sustainable basis remains unchanged. We will continue to capture good opportunities for investment but at the same time we will keep an eye on improving the quality of each investment and maintaining a good balance between offence and defense so that we can strengthen our overall business portfolio.
I would now like you to turn to Page 4 of the presentation. I will now explain our full-year outlook. Our nine-month period results show a net income of 340.2 billion yen, which is overall good progress towards achieving our annual target of 430 billion yen. Although there is some downward pressure due to a decline in prices and the change in pricing method in our iron ore business, as well as the impairment losses on listed securities, there are also positive factors such as oil price increases and a one-time gain related to the reduction of the Japanese corporate income tax rate. Taking all of these factors into consideration, we have decided to maintain our full-year forecast of 430 billion yen.
We believe that we are taking appropriate measures towards the future to strengthen our earnings base, and at the same time to improve the quality of our net income. While the operating environment is becoming increasingly uncertain, we will continue our efforts to achieve our full-year forecast, closely monitoring the operating environment and various markets.
As for dividends, as we announced together with our second quarter financial results, we plan to pay a year-end dividend of 28 yen per share, making our annual dividend 55 yen per share based on the assumption of our annual net income outlook of 430 billion yen.
I would now like to turn this over to our global controller, Mr. Matsubara for the details of our third quarter financial results.
Let us turn to the key line items of the consolidated profit and loss statements for the nine-month period ended December 31, 2011. Please turn to Page 6 of the presentation. The amounts I will refer to on this page are all before tax figures. Gross profit was 677.1 billion yen, an increase of 23.7 billion yen or 4% over the same period the previous year. Mineral and metal resources posted an increase in profit of 20.8 billion yen due to a run-up in iron ore prices which was partially offset by the negative effects of foreign exchange. Foods and retail posted a sharp increase in gross profit by 17.2 billion yen due to an improvement of mark-to-market valuation gains and losses on forward contracts related to coffee as well as contributions coming from Multigrain as we acquired the entire stake, making it our wholly-owned subsidiary. Energy also posted an increase in gross profit by 14.4 billion yen, mainly attributable to higher oil and gas and coal prices.
Operating income was 289.4 billion yen, an increase of 40.8 billion yen or 16% over the same period the previous year, reflecting an increase in gross profit. Equity and earnings of associated companies was 176.3 billion yen, an increase of 4.8 billion yen or 3% over the same period the previous year.
Valepar, the holding company of Vale in Brazil, posted an increase in profit of 20.9 billion yen, mainly driven by a run-up in iron ore prices although it was partially offset by the negative effect of foreign exchange. Robe River Mining Company in Australia also reported an increase due to higher iron ore prices which was partially offset by the negative effect of foreign exchange and a reversal effect of sales price adjustment gains recorded in the same period the previous year. Due to a decline in share prices, impairment losses on investment of 32.3 billion yen in total were recorded in equity and earnings of associated companies, including an additional impairment loss of 3.5 billion yen for TPV Technology that we recorded in the three-month period ended December 31, 2011.
Now I would like to talk about other items which impacted our net income. All amounts are pre-tax figures. Dividend income was 51.4 billion yen, an increase of 11.8 billion yen or 30% from the same period the previous year, which is mainly due to the increased dividend income from LNG projects which were driven by a rise in LNG prices and dividends coming from the Sakhalin-2 project. Gain on sales of securities was 14.6 billion yen, an increase of 9.5 billion yen or 186% from the same period the previous year. A re-measurement gain resulting from the acquisition of the additional stake in Multigrain is included in the amount. As a result, net income attributable to Mitsui was 340.2 billion yen, an increase of 64.4 billion yen or 23% over the same period the previous year.
Let us turn to the performance of our individual operating segments compared with the nine-month net income in the same period the previous year. Please turn to Page 7 of the presentation. The amounts I will refer to on this page are all after-tax figures. Energy posted a net income of 134.0 billion yen, an increase of 39.6 billion yen or 42% over the same period the previous year. Higher oil and gas and coal prices, as well as increases in dividend income from LNG projects, led to a significant increase in net income which was partially offset by the negative effects of foreign exchange. 5.3 billion yen of a one-time positive impact was posted due to the reduction of the Japanese corporate income tax rate, which was mainly attributable to a reversal of deferred tax liabilities on undistributed retained earnings of associated companies.
Mineral and metal resources posted a net income of 160.8 billion yen, an increase of 36.6 billion yen or 29% compared to the same period the previous year. As explained earlier, the main reason is the rise in iron ore prices and an increase in sales volume attributable to additional capacity from the iron ore joint venture with BHP Billiton, while it was partially offset by the negative effects of foreign exchange. As in the case of energy, mineral and metal resources also posted a one-time positive impact of 10.2 billion yen due to the reduction of the income tax rate, mainly attributable to a reversal of deferred tax liabilities on undistributed retained earnings of Valepar.
Foods and retail quadrupled its net income to 16.7 billion yen, a significant increase of 12.7 billion yen compared to the same period the previous year. It was mainly attributable to the improvement of mark-to-market valuation gains and losses on forward contracts related to coffee, the reclassification of Multigrain from associated company to subsidiary, and a favorable soybean yield.
Consumer service and IT posted a net loss of 31.2 billion yen, a decrease of 32.0 billion yen compared to the same period the previous year. Impairment losses on listed IT-related securities of 33.9 billion yen, including TPV Technology and Moshi Moshi Hotline, exceeded the gain on security sales of T-GAIA posted in the three-month period ended June 30, 2011. For the net income of major subsidiaries and associated companies, please refer to pages 13 and 14 of the data book.
Please refer to Page 8, the last page of my presentation. This page shows the breakdown of the change in net income between the nine-month period ended December 31, 2011 and the same period the previous year. The amounts I will refer to on this page are all after-tax figures. I will start with the large items under the one-time reversal effect column. There was a reversal effect of net loss amounting to 19.0 billion yen in the same period the previous year, consisting of long-lived assets impairment losses of 8.0 billion yen and a valuation loss on securities of 6.0 billion yen, mainly attributable to the preferred shares of Valepar.
I will move on to the large items in the divestiture and evaluation profit-loss column where total net profit decreased by 9.0 billion yen in the nine-month period ended December 31, 2011. We recorded a one-time positive impact of approximately 20.0 billion yen due to a reduction of the Japanese corporate income tax rate which triggered a reversal of deferred tax liabilities. Also, we posted a gain of 14.0 billion yen on securities sales, including those of T-GAIA. On the other hand, as we touched on the previous page, we posted a valuation loss on securities of 43.0 billion yen, including a 33.9 billion yen loss on listed IT-related securities.
With regards to market and commodity price factors, while the currency exchange factor such as the appreciation of the Australian dollar and Brazilian real against the U.S. dollar led to a 52.0 billion yen decline in net income, increases in market prices such as iron ore, oil and gas, and coal more than offset this decline and led to an overall increase of 55.0 billion yen in net income compared to the same period the previous year.
With regard to the cost in energy and mineral resources, there was a cost increase of 29.0 billion yen due to increases in energy-related operating costs and depreciation and exploration costs, as well as an increase in royalties in iron ore projects corresponding to rising market prices. Out of the remaining approximately 28.0 billion yen, approximately 11 billion yen can be attributed to increased volumes in mineral resources and energy. On the other hand, there was a decline in net income due to the great east Japan earthquake and a reduction of 3.0 billion yen in reversal of deferred tax liabilities on undistributed retained earnings of associated companies.
That completes my presentation. We would like to thank you for joining us today.
Question and Answer Session
We will now have a question and answer session, which is expected to last 30 minutes.
There are two questions. Firstly, I would like to know more about one-time factors. Earlier you said there was a positive impact of 20 billion yen due to changes in the Japanese taxation system which triggered the reversal of deferred tax liabilities. Could you give me the breakdown by segment, focusing on major items? In addition, aside from the impairment loss on shares of TPV Technology, what other impairment losses were posted or what sort of one-time positive and negative impacts did you see in the third quarter alone?
My second question is about iron ore. You said that conventionally, price-setting methods adopted by Vale was mainly used, but that more recently pricing reflecting current spot reference prices has been increasing. How much impact have you experienced from that? In the chart shown, the column of market commodity prices indicated 45 billion yen in positive impact for iron ore for the nine months this year, but when I calculate it on the basis of average contract prices, it would have been about 60 billion yen increase. Does that mean the net impact was the difference between these two figures? If that’s the case, could we assume that since there was considerable impact in the third quarter, there shouldn’t be much further impact in the fourth quarter.
Thank you for your questions. Of the two questions, the first one will be addressed by Mr. Matsubara, the Global Controller; and I, Hori from IR division, will take up the second question later.
With regard to the change in the tax rate, there were positive impacts of approximately 10 billion yen in mineral and metal resources as explained earlier, about 6 billion in energy, and 3 billion yen in machinery and infrastructure projects respectively. Other than those, in consumer services and IT, a negative impact of about 1 billion yen was posted. Another major item was a positive impact of about 2 billion yen in corporate sections.
To answer your question about the impairment losses recognized in third quarter, if I give you major items, there were impairment loss of 3.5 billion yen on shares of TPV Technology, and loss on preferred shares of Valepar SA of 1.1 billion yen, reflecting the decline due to foreign exchange translation loss in the investment value of the current portion of the shares. The remaining amount of accumulation of items of small value each.
Now let me answer the second part of your question. As you said, in the third quarter the pricing structure of iron ore has been partially modified. Previously the average prices during the three months period starting from four months before was mainly used to determine the prices for the following quarter. But some of the contracts have changed their pricing structure in the third quarter in that prices were now set based on the average of more recent spot prices. Prices applied are the average of the current quarter or average of the delivery month, for instance. Not all the contracts were shifted to this pricing method, but it’s share in the total mixture of prices is increasing.
Although we are not in a position to disclose the fact breakdown, due to this change the contract prices applied in the third quarter were closer to the actual price level in that particular quarter, resulting in the impact on the overall business performance.
Incidentally, Vale closes it’s financial term with a time lag of one quarter, so I hope you can take that fact into account.
In the fourth quarter, this new pricing trend is likely to be continued, leading to more impact by prices of the current quarter reflected in the prices applied. If you focus on a certain period of time extending multiples quarters, however, what is reflected in the business performance is the area under the price curve, so that there may not be that much difference from the previous structure. But looking at prices on a quarterly basis, there may be impacts due to this change.
I have a question on energy. If you subtract the positive impact of 6 billion yen in energy from the reversal of deferred tax liabilities, profits generated were only worth 40 billion yen-plus in the third quarter. Considering the recent trends in energy prices, one would be under the impression that you could be doing better in profits. Is there any other factor involved, such as the volume? Moreover, dividends from LNG projects seem to have decreased on a quarter-on-quarter basis. Are there any particular reasons behind this?
Let me answer your question. Profits in energy have slightly declined in the third quarter compared to the second quarter. The main reason is that the dividend we had received from Sakhalin-2 project in the second quarter, whose exact amount cannot be disclosed, was not paid out in the third quarter.
Did this answer your question?
Yes, thank you. Then my second question is about the net income for this fiscal year. So far, the progress rate is about 79% against your full-year forecast. As we moved into the fourth quarter, are there any particular concerns in the near term on mind other than commodities prices, such as economic performance in Europe or China?
As we move into the fourth quarter, there’s only one quarter left in this fiscal year, and with the progress rate of 79%, only 20% to go to achieve the full-year target. In energy-related businesses, we’re expecting a certain amount of exploration expenses to be incurred. In coal and iron ore businesses, we also consider impacts of cyclones to be a possible uncertain factor. Otherwise, we do not see any major concern in the fourth quarter.
There are two questions. The first one is about dividends. You are committed to a 23% payout ratio in the fiscal year. I would assume you are currently discussing the medium term management plan from the next fiscal year and beyond. Depending on how commodity markets will move, your plan could be affected either in a positive or negative manner. I’m interested to know if you are ready to take a more flexible policy on dividends; in other words, suppose your profits go down – are you willing to change or increase the payout ratio instead of sticking to your commitment of 23%, for instance? Please tell us your long-term policy on dividends.
With regard to the dividends, we’re just about to being our discussions on the medium term management plan that starts in the next fiscal year, so your question is quite a sensitive one. Obviously we would like to emphasize the return to our shareholders as we manage our company.
I see. Thank you. My next question is about your investment approach. I would assume there are many potential deals, especially related to Europe, coming your way recently. I do understand your target investment amount, but if you split the investments into two categories – mineral resources and energy, and known resources – am I correct to understand that in mineral resources and energy, your basis focus in this fiscal year is to expand your existing projects, though this may be again difficult for you to answer since it relates to the next fiscal year and beyond.
On the other hand, in known resources, as you said, the key may be reinforcement of your investment discipline; but you did sustain impairment losses again in the third quarter, so I’m wondering exactly what measures you could take in this regard and which one will be most feasible?
We are rather disappointed about the additional impairment in the past quarter. The ratio of resources-related investments to non-resources investment has been 1:2 so far. The basic intent is to keep free cash flow at breakeven or positive. This time, however, there was an increase in working capital. Excluding that factor, we hope to keep free cash flow in good balance.
As for our plans, we have yet to spell out the next medium term management plan, including profit outlook; but this year against a 430 billion yen full-year net income forecast, investments are expected to come to 700 billion yen, including 200 billion yen from divestiture, and we would probably aim for somewhere close to that level. For resources, the focus will be on expansion of existing projects as well as new acquisitions such as the LNG exploration project in Mozambique where we participate from the exploration stage. It may be that the resources portion would grow. For non-resources, we shall duly capitalize on investments made over the past two years. As for new investments, we will be selective and try to further improve the quality.
I have two questions. First on the Americas, can you explain why third quarter results are down from the second quarter and what the expectations are from now on? The second question is on that negative figure for adjustments and eliminations. I understand it to be a combination of various items, and would you be able to give us a breakdown?
On the Americas, the largest factor was Westport Petroleum whose margins were squeezed as market conditions deteriorated. An additional factor is a reversal effect of the sale of a senior living facility at MBK Real Estate in the second quarter.
For the second question on adjustments and eliminations, that comes from valuation loss on investments recognized in the third quarter.
I also have two questions. Your equity share of coal production in the third quarter was 2.7 million tons, the highest in recent quarters. How is production going right now? As we have been disappointed before, I am wondering if we can this time expect to see the figures shown on Page 16 delivered. Can we really anticipate 9 million tons this fiscal year and 11 million tons in the next?
The other question is about the reported expansion of the phosphorus ore project in Peru. Will it mean more time required before that operation breaks even or realizes its earnings potential in full?
Coal production in the third quarter was indeed good, but for the fourth quarter there is a seasonal pattern of rain or bad weather, and that is factored in. As for volume, we are working hard to come in at the projected level.
On the reported expansion of phosphorus ore project, our basic position is to seek long-tem capacity expansion and therefore we do look at such opportunities. No decision, however, has been made yet beyond the current projected capacity of 3.9 million tons per year. Production is ramping up nicely as we speak. It is currently at a 2.5 million ton per year level. Costs are higher in this initial ramp-up phase but should come down once operation stabilizes. Our primary focus is to make sure the current phase is successful while also duly prepared for expansion over the longer term.
Can you tell us about the outlook for Bussan Auto Finance? Apparently the third quarter was an improvement over the second. Does that mean the worst is over?
Performance declined at Bussan Auto Finance from around 2009 as competition against Honda heated up, and in particular there was over-competition on the financing front, resulting in severely compromised terms. Delinquency rate was high and bad loans had to be written off. But the Company has now switched its focus from quantity to quality to improve its loan portfolio through enhanced screening and collection procedures. As a result, the delinquency rate has improved now and we hope to bring this operation back to profitability on a full-year basis in the fiscal year ending March 2013.
The question is on the impact of lower natural gas prices on Mitsui E&P USA, which has been in the red for a while. What is the status of the Marcellus Shale project? Is there a risk of impairment?
The arrangement with Anadarko is to effectively fund their share of development cost up to $1.4 billion U.S. The development is still in the early phase, so depreciation weighs heavily and therefore losses at this stage had been anticipated. Having said so, the recent decline in natural gas prices has brought down earnings below anticipated levels. We are therefore carefully reviewing plans and at the same time have conducted impairment testing, but so far no impairment is due.
How challenging are current natural gas price levels? Would the operation be unprofitable even without that depreciation?
Once depreciation is over, we expect it to be profitable.
Thank you very much. This brings us to the end of the conference call.