Mitsui & Co. Ltd. (OTCPK:MITSY) F4Q 2012 Earnings Conference Call May 10, 2012 3:15 AM ET
Unidentified Company Speaker
We thank you for coming today. I would like to talk about the financial results for the year ended March 2012, the medium-term management plan through March 2014, and the outlook for the fiscal year ending March 2013.
Please take a look at slide one of the PowerPoint Presentation. As we look at our operating environment, the global economy is maintaining its moderate rate of growth, although risk levels remain elevated due to the financial turmoil in the euro area and increasing volatility of the oil market affected by higher geopolitical risks. The emerging and developing economies are showing a gradual slowdown in their growth rates, but the growth rates remain fast-paced and they continue to be the key force for global recovery. We believe that China’s growth rate will be sustained, because of its resilient domestic consumption and the investments required for urbanization of the interior regions.
The commodity markets, including crude oil and metal resources, showed recovery after a period of price decline due to the slow recovery in the advanced economies and the volatile financial markets. Geopolitical risks are also increasing and may lead to higher volatility in crude oil prices. As for the foreign exchange market, there is a possibility of the yen strengthening again. We believe extra care was required in monitoring the commodity markets, the foreign exchange markets, and the uneven growth among various regions. We will reinforce our disciplined approach to investment and constantly improve the overall quality and balance of our portfolio, thereby effectively capturing the growth opportunities in the emerging markets and meeting the global demand for our products based on a sound long-term view.
Please turn to page 2 of the presentation. We are pleased to report to you that we have posted net income attributable to Mitsui of ¥434.5 billion for the year ended March 31, 2012, an increase of ¥127.8 billion from ¥306.7 billion for the previous year. We have surpassed the second year target of ¥370 billion of the medium-term management plan through March 2012 by a substantial amount. We can say that we have demonstrated the upside earning potential of our main products. Mineral resources and energy made large contributions due to higher prices of iron ore, coal, oil and gas, while there were units that did not reach their original targets, including information technology, which posted significant impairment losses. There were one-time affects due to the introduction of the Australian Mineral Resource Rent Tax and a reduction of the Japanese corporate income tax rate. Mr. Matsubara, our Global Controller will explain these items later in more detail together with details of the performances of the operating segments.
I will now briefly explain on page three, the progress we have made in investments and loans. During the fiscal year ended March 2012, we implemented investments and loans in the amount of ¥650 billion broadly in line with the original medium-term management plan. In mineral resources and energy, we invested ¥270 billion mainly comprising of expansion projects. We invested ¥180 billion in lifestyle business, including investments in IHH in overseas healthcare business and in Multigrain, a Brazilian grain production and origination business, ¥110 billion in infrastructure businesses, mainly in FPSO and rolling stock for leasing and ¥90 billion in global marketing networks, including the chemical manufacturing joint venture with Dow Chemical. We made strides in new projects with good growth prospects.
On the other hand, we collected ¥210 billion through capital redemption from Sakhalin II and divestiture of assets. This is above our plan and is a result of our efforts to further improve the quality of our portfolio by constant recycling of our assets. As a result, net cash outflow for investment and loans was ¥440 billion. On the other hand, we collected ¥210 billion through capital redemption from Sakhalin II and divestiture of assets. This is above our plan and is a result of our efforts to further improve the quality of our portfolio by constant recycling of our assets. As a result, net cash out flow for investment and loans was ¥440 billion.
Please turn to page four, let's look at our balance sheet and cash flow. Net DER is at 0.81 and indicates that our balance sheet remained strong. We have ample liquidity by maintaining an appropriate level of cash and a stable longer term maturity on our debt and are in a position to implement high-quality investment projects in a dynamic way. Free cash flow was negative by ¥57.2 billion due to investment into growth projects and an increase in working capital.
Please turn to page five. According to our policy of the 23% dividend payout ratio, we planned to pay an annual dividend of ¥55 per share for the year ended March 2012. By excluding the interim dividend of ¥27 per share already paid, the year end dividend will be ¥28 per share.
Please turn to page seven. Now, I would like to review the medium-term management plan originally announced in May 2010. As for the quantitative results, we posted a net income for the year ended March 2011 of ¥306.7 billion inclusive of the loss for the settlement of the oil spill incident in the Gulf of Mexico against the forecast of ¥320 billion. As for the year ended March 2012, we posted a net income of ¥434.5 billion significantly surpassing the original forecast of ¥370 billion with the support of high commodity prices.
ROE for the year was also significantly higher than the target number. Net DER is well within the range planned in the medium-term management plan and we maintain a strong balance sheet that is capable of sustaining continued investments for growth. Through the resolutions regarding the potential liabilities which our subsidiaries had in relation to the oil spill incident in the Gulf of Mexico, as detailed in our public disclosure documents, we now believe that we have substantially decreased the risk of the incident having any material effect on our balance sheet.
Please now turn to page eight. We implemented investments and loans amounting to ¥1.34 trillion, which exceeded the original plan of ¥1.2 trillion. The breakdown is ¥500 billion for mineral resources and energy, ¥190 billion for global marketing networks, ¥300 billion for lifestyle business, and ¥350 billion for infrastructure. Cash inflow through recycling of assets amounted to ¥400 billion as a result of continuous review of our portfolio. Next, I would like to review the key initiatives of the medium-term management plan outlined on page nine.
Please turn to page 10. Initiative one is reinforcement of the earnings space and business engineering capabilities. By expanding our investments and good quality upstream assets in mineral resources and energy, we made great progress in increasing our production equity tonnage and reserves and in securing superior cost advantage. Notable example for the acquisition of unconventional energy resource assets, such as the Marcellus Shale gas project and the Eagle Ford Shale oil and gas project as well as the Mozambique gas project, where we successfully found a substantial scale gas reservoir through exploration. We also made important strides in maintaining and further expanding the production capacity of the existing iron ore projects in Australia.
Please turn to page 11. For the non-resources business areas, we have taken the following initiatives to capitalize on the economic growth of the emerging countries. For the global marketing network area, chemicals invested in the phosphorous or development project in Peru, which Vale had been developing. This unit also formed joint ventures with Dow Chemical for a chlor-alkali project in Texas; in a biopolymer production project in Brazil, developing new businesses in the upstream area of its supply chain. In the areas of steel products, motor vehicles, and construction machinery, we accelerated our business cultivation in the emerging markets. In the lifestyle business area, we made Multigrain AG, a wholly-owned subsidiary based on our strategy to expand our global grain origination network.
We acquired a 30% share in Integrated Healthcare Holdings and positioned it as a business platform for our efforts to expand our healthcare-related business in Asia and other regions. Infrastructure achieved further progress in advancing projects in the area of power generation, water treatment, transportation and port logistics. The units also participated in several deepwater FPSO chartering projects in Brazil. Of the projects that I described, Greenfield projects in the upstream area will require a few years before they reach commercial production status and demonstrate full earnings contribution.
Please turn to page 12. The strategy for environment and energy initiative led to the acquisition of natural gas-fired power stations in Mexico followed by the divestiture of a 30% stake, which was executed in view of stabilization of the business and an early collection of part of the invested capital. Coping with the changing domestic business environment, we merged our liquefied petroleum gas business with that of JX Nippon Oil & Energy and we also reached a basic agreement with Sumitomo Corporation to conduct a detailed examination to integrate the respective domestic fertilizer businesses. We also newly created the domestic business development department, which will assist the business units and setting strategies and promoting domestic businesses under the changing operating environment in connection with the recovery from the Great East Japan earthquake and Japan's possible accession to the Trans-Pacific partnership.
Please turn to page 13. The second initiative is the implementation of global strategy and strategic deployment of human resources. We made meaningful progress in the development of new businesses in BRICs countries, Mexico and Indonesia, which were our regions of focus. In particular, we have seen steady growth in our project base in Mexico, Brazil, and India, while strategic partnerships have been strengthened in Indonesia creating the necessary grounds for new business development. We also focused on new growth frontiers realigning our network in the Central, Eastern Europe, and establishing new offices in Africa.
Please turn to page 14. The third initiative is the evolution of portfolio strategy led by the Portfolio Management Committee. We continued to examine the portfolio strategy of each business unit and monitor their performances. The process enables us to improve the quality of our assets make strategic divestments and allocate our resources in a dynamic manner. It was rather disappointing however that we recorded significant impairment losses in certain assets in the fiscal year ended March 2012. We will reexamine effective ways to add value to our portfolio, reinforce our existing review processes, and promote exiting from certain investments were appropriate.
Let us now turn to our new medium-term management plan. The new medium-term management plan is titled Challenge and Innovation 2014 with the subtitle of creating the future through dynamic evolution. Each business unit shall strive to become a leading company in its respective domain, and taking as a whole, we will aim to become the strongest global business enabler.
Please turn to page 16. First, I wish to explain the quantitative forecasts. Based on our view of the operating environment that I described in detail at the beginning of my presentation, our forecast for the fiscal year ending March 2013 is a net income level of ¥400 billion taking into consideration, the current market situation for the international commodities, since it will take a few years for the Greenfield projects and the upstream areas to fully contribute to earnings. The fiscal year ending March 2013 will be a year dedicated to improving the quality of the portfolio and solidifying our earnings base, assuming that new earnings contributions will be posted from our past investments.
Our forecast for the fiscal year ending March 2014 is a net income level of ¥450 billion. During the new medium-term plan, we will steadily increase the equity production tonnage of our main upstream products and will enhance the profitability of each of our six business areas, which have been newly identified and which I will introduce to you in a short while.
We will constantly review and reconfigure our portfolio through dynamic asset recycling in order to establish a stronger base earnings platform that is capable of capturing significant upside as well. Further, assuming that the initiatives laid out in the new medium-term plan go as planned. In three to five years' time, we (envisage) to a level of net income attributable to Mitsui in the range of ¥500 billion to ¥600 billion, total assets in the range of ¥10 trillion to ¥12 trillion, and ROE in the range of 12% to 15%. I firmly believe that our growth drivers are very strong looking three to five years ahead with the commercializing of significant new potential projects such as the Mozambique LNG project and the full commercialization of the Greenfield projects in the upstream areas of our strategic product lines. We will continuously strengthen the cash earnings base of our company.
Slide 17 describes the newly identified six business areas based on which we will execute our medium-term plan. The previous four business areas are now reconfigured into six business areas. Each area will strategically build up its upstream assets and simultaneously enhance its trading and marketing network in a way that an effective balance between the two activities will be established in the respective product value chain. We have also created a business area called innovation and cross function comprising of three business units, namely IT, financial, and new business and transportation logistics. They are equipped with the necessary resources to develop new businesses for the future, carryout investments for corporate development purposes, and contribute to the entire earnings space by providing various functional capabilities. The six business areas are expected to collaborate among each other to promote new business development.
Slide 18 describes the net income forecast numbers for each of the six business areas during the medium-term plan. The numbers include the corresponding forecasts of the overseas segments providing the global product based earnings forecast numbers. They are illustrated here for your reference.
Page 19 describes our plan for investments and loans for the new medium-term plan according to the six businesses areas. Our plan is to invest ¥1.4 trillion during the two-year period in total and divest assets for a total amount of ¥300 billion in total during the period. As a result, the net cash outflow plan for the period is ¥1.1 trillion. In year one, cash outflow was planned at ¥800 billion. More than half of the gross investments will be implemented in the metals and energy areas. Expansion at existing projects account for the bulk of the amount. Together with investments into selected new projects, we will aim to significantly increase our equity production tonnage and reserves for our key commodities.
We have also included in the plan a certain level of investment in the low-risk medium return type of assets in the machinery and infrastructure area. Lifestyle, chemicals, and innovation and cross function planned to invest ¥500 billion respectively. The amounts are relatively modest for these three areas and they include the follow-on investments in the upstream area that were initiated during the period of the previous medium term plan such as the two joint ventures with Dow Chemical. These three areas will work towards making a steady progress in the projects already in place and demonstrating the potential values of these past investments.
As a result, free cash flow for the first year was expected to be negative. The plan for the second year is to invest ¥600 billion. The amount is an accumulation of expected cash cow investment into high ROI expansion projects in the upstream areas and other projects that are quite likely to materialize. Our basic approach is to constantly recycle assets and to implement investments out of our cash flow, but if and when attractive investment opportunities arise, we will exercise flexibility in this approach.
Slide 20 lists the base strategy and the key initiatives and the new medium-term plan. The base thinking is to build a strong earnings base that provides for sustainable and stable growth. We will differentiate our functional capabilities to enhance the quality of our earnings, create and add new values by accumulating good meaningful work, and create businesses that cater to the demands of the next generation. Through these activities, we will contribute to the global economy while also contributing to the recovery of domestic businesses by creating new industries and markets aiming to be the strongest global business enabler. Next, I will touch upon the five initiatives we have set in order to achieve this basic policy.
Please now turn to page 21. Initiative one is the reinforcement of the earnings base by demonstrating business engineering capabilities. In the areas of metals, energy, chemicals, food, and consumer products, we will aim to expand the respective upstream businesses. These initiatives will include expansion of existing projects, long-term commercialization projects starting from the exploration stage, manufacturing projects of strategic chemical products, grain production and origination projects, and projects related to paper manufacturing from raw materials. The product areas will strengthen their downstream presence, which will contribute to the business development in the respective upstream areas.
In the upstream businesses, it is imperative that both the business and the host country achieved sustainable growth with mutual benefits. Utilizing our various capabilities, we wish to contribute to the growth of the host countries. We also expect that there would be more opportunities, where we can utilize our various capabilities in areas such as the natural gas value chain and in developing multi-faceted business relations with our strategic partners.
Please turn to page 22. We will further strive to capture growth in the emerging economies and global industrial demand by leveraging the global marketing network of our steel products, chemicals, motor vehicles, and construction machinery units. We will also provide industrial solutions to the demands of the emerging economies through infrastructure projects of power generation, water treatment, and energy transportation. Our own collaboration between the food unit and the agricultural chemicals unit and the acceleration of our business development in the field of medical and healthcare are also our key strategic areas. In the new innovation and cross function area, we will elevate our functional capabilities in the finance, logistics, and IT area and strengthen our corporate development activities in an effort to create new businesses for the company.
Please turn to page 23. Initiative two is creating businesses for the next generation. We will deploy our network and functional capabilities in a creative manner and source new leads to business innovation, structure developmental projects, and implement corporate development activities. We will strengthen environmental business and new energy development including renewables utilizing our global network. We will also make value adding contributions to new industries emerging domestically and to the industrial transformation taking place in Japan which encompasses a broader scope of international business collaboration.
The third initiative is the evolution of portfolio strategy. The action plan that we have laid out in order to demonstrate the full potential value of our past investments is a vital part of our medium-term plan and we will execute the action plan with the highest priority. We will be even more selective in our investments and will try to control the potential of downside risk of these investments. We are determined to strengthen our review process of each investment leaving no exceptions and to promote exits whenever it makes sense to do so. As the nucleus of our portfolio strategy, we will further enhance the development of human resources who are capable of managing complex business situations in an international setting.
Please turn to page 24. Initiative four is the acceleration of globalization initiatives. In addition to the present key regions of focus, namely Brazil, Russia, India, China, Mexico, and Indonesia, we are introducing Mozambique and Myanmar for the new medium-term plan and we'll be allocating our business resources to these areas. We will also implement business development in the Frontier regions of Africa as well as Turkey and the Middle East region and aim to capture the growth opportunities in these areas.
We expect leadership from managerial personnel who have been acquiring the necessary experience and skills to develop businesses on an even larger global scale. Initiative five is reinforcement of group management infrastructure. We will continue to further promote improvements in our business operation and achieve a more efficient and effective monitoring and control of various potential risks on a group wide basis. The management will continue to emphasize the message of it hearing to good meaningful work.
Please now turn to page 25. Finally, I would like to briefly explain our shareholder return policy during the new medium-term management plan through March 2014. During the new medium-term plan, we will continue to principally aim for a steady increase in dividends through improvements in corporate performance. Reflecting our sound financial standing is a result of successful implementation of the initiatives of the previous medium-term plan.
We've decided to raise our minimum target dividend payout ratio to 25% of consolidated net income. Therefore, for the year ending March 2013, we currently envisage an annual dividend of ¥55 per share applying the 25% payout ratio on our assumed annual consolidated net income of ¥400 billion.
With that, I would now like to hand this over to Mr. Matsubara, who will provide you with more details including the result of fiscal year ending March 2012.
Nobuko Matsubara – Global Controller
Let me now explain to you in a little more detail. Our results for the year ended March 2012 as well as our new medium-term management plan. Please turn to page 27 of the presentation. I will now explain the performance of our individual operating segments compared with the net income in the corresponding previous year. For the net income of major subsidiaries and associated companies, please refer to pages 14 and 15 of the data book. The amounts I will refer to from now on are all after tax figures.
Energy posted a net income of ¥188.1 billion, an increase of ¥131.5 billion over the corresponding 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. A reversal effect from the settlement of the Gulf of Mexico oil spill incident recorded in the corresponding previous year was also a factor.
Mineral and metal resources posted a net income of ¥201.3 billion, an increase of ¥33.8 billion over the corresponding previous year. Although an impairment loss on goodwill was recorded in the scrap metal recycling business. The rise in iron ore prices and the decline in income taxes contributed to the increase. For the year ended March 31, 2012, there were two factors causing the decline in income taxes. The first factor was the introduction of the Mineral Resource Rent Tax or MRRT in Australia.
The second factor was the reversal of deferred tax liabilities on undistributed retained earnings. Part of this was associated with the distribution of profit. And another part was caused by the reduction of the corporate income tax rate in Japan as applied to the undistributed retained earnings related to Valepar. I would like to say more about the MRRT. As the special measure associated with the introduction of the MRRT, we were given the option to uplift the tax book values of the assets subject to the MRRT that we held as of May 2010 through the market value and appreciated over a maximum of 25 years recognizing such depreciation as tax losses. We plan to apply such uplift. The MRRT is regarded as a kind of corporate income tax and the subject to tax effect accounting.
As such, we recorded deferred tax assets for the difference in the book values for accounting purposes and tax purposes. On the other hand, we apply valuation allowance for the amount we believe to be unrecoverable. For the year ended March 31, 2012, we recorded a decline of income taxes of ¥19 billion mainly related to iron ore operations.
Consumer service and IT posted a net loss of ¥35.5 billion, a decrease of ¥39.4 billion compared to the corresponding previous year. Impairment losses mainly unlisted IT related securities of ¥39.8 billion including TPV technology mostly outlined in the Nihon Unisys with the main reason.
Please turn to page 28 of the presentation. This page shows the breakdown of the change in net income between the year ended March 2012 and the corresponding previous year. I will start with the one-time reversal effect column. There was a net reversal effect of ¥71 billion overall. The substantial part of this amount being the settlement payment with respect to the Gulf of Mexico oil spill incident recorded in the corresponding previous year.
I will move on to the divestiture and the evaluation profit-loss column. There were positive effects due to factors such as the reduction of the Japanese corporate income tax rate and the introduction of the MRRT in Australia. On the other hand, we posted the valuation losses of ¥62 billion in total including a ¥39.8 billion loss unlisted IT related securities. As a result, the net overall effect added up to zero.
With regards to market and commodity prices factors while the currency exchange factors such as the appreciation of the Australian dollar against the U.S. dollar led to a ¥61 billion decline in net income increases in market prices of commodities such as oil and gas and iron ore more than offset this decline. And let to an overall increase of ¥50 billion in net income compared to the corresponding previous year. As for cost in energy and mineral resources, there was a cost increase of ¥33 billion due to increases in energy-related depreciation and exploration costs as well as an increase in royalties and iron ore projects corresponding to the rising market prices. The remaining approximately ¥40 billion includes factors such as increases in volume of mineral resources and the effect from the Great East Japan Earthquake.
Please turn to page 29, net income for the year ending March 2013 is expected to be ¥400 billion. I will now explain the changes for some of the major operating segments in comparison with the year ended March 2012. For mineral and metal resources, the projected net income was ¥135 billion, a decrease of ¥66.3 billion from the previous year. While the tightness in iron ore demand and supply may ease to some extent. We believe that the demand for iron ore in China will continue to be strong.
We do not disclose our iron ore price assumptions, but we’ve assumed that a certain level of iron ore price will continue throughout the year taking into account the current market price. For energy, the projection of net income is ¥140 billion, a decline of ¥48.1 billion from the previous year. While our assumption for the JCC crude oil price is US$110 per barrel, we have assumed a lower price level than the previous year for coal considering the current market movement in the demand and supply outlook.
For innovation and cross function, which is a newly established operating segment, we projected net income of ¥9 billion, an increase of ¥41.2 billion from the previous year, which is due to the reversal effect from the impairment losses recorded in the previous year. As for all others adjustments and illuminations, we project a positive net income mainly due to the change in headquarters cost allocation system from partial allocation to full allocation to the business unit starting from the year ending March 2013. This change was introduced in order to better reflect the cost structure of our company in making various business decisions.
Please now turn to page 30. This page shows the breakdown of the change in net income between the year ended March 2012 and the year ending March 2013. I will start with a one-time reversal effect column. As I explained earlier, the net overall effect for the divestiture and the valuation profit-loss for the year ended March 2012 added up to zero. Therefore, we do not project any reversal effects from the previous year.
With regards to market and commodity prices factors, while we expect a positive impact of ¥14 billion due to increases in the crude oil price due to the reduction in prices of other commodities such as iron ore and coal. We expected net overall negative impact of ¥45 billion. As for cost and energy and mineral resources, we assume increases in depreciation costs mainly in our shale gas operations as well as increases in exploration costs in Mozambique etcetera.
The remaining approximately ¥31 billion includes factors such as increases in volume of mineral resources and energy as well as recoveries in net income and other operating segments, mainly in machinery and infrastructure and chemicals. Finally, please turn to page 31, as for the year ending March 2014 we forecast a net income of ¥450 billion. We expected growth in net income as our previous investment should start to bear fruit towards the end of our new medium-term management plan. That completes my presentation.
Now, we would like to open the floor for questions.
(Operator Instructions) Are there any questions?
I have two questions about your plan for the current fiscal year and one on your policy behind the medium-term management plan. Firstly as Mr. Matsubara, Global Controller explained the net income in the energy segment is forecasted to drop from the ¥188.1 billion for fiscal year 2011 by ¥48.1 billion to ¥140 billion in fiscal year 2012 with price factor in oil and gas being plus ¥14 billion and coal being minus ¥19 billion. You (verbally) explained earlier that the exploration costs for Mozambique, is incorporated in the March 2013 plan. Is this cost big enough to account for expected drop in net income or are there any other major expenses to be incurred.
You can ask all the questions. My second question is a bit too detailed. So, you could take it offline and come back to me later. You said there will be a change in the headquarters cost allocation system leading to a turnaround of loss of ¥42.8 billion in adjustments and eliminations in fiscal 2011 to profit of ¥10 billion in fiscal 2012. In terms of this year-on-year change by segment, this will become the second largest following mineral and metal resources. Could you please give us a breakdown of its impact my segment. Thirdly, President Iijima said that it would take some time for non-resources segments to realize returns.
Looking at the company's past medium-term management plans, one can say that in mineral resources and energy, you have owned quality assets such as those in Brazil and Mozambique allowing you to benefit in terms of prices and volumes. Contrary in non-resources segments, you have suffered negative growth affected by market fluctuations. At the risk of sounding like a novice, I would like to ask given that while you have acquired core upstream assets in emerging countries with strong connections with your governments, you have failed to capture the opportunities and development industrialization or expanded consumption in downstream areas in those economies. What makes you believe you will be able to do so in this particular medium-term management plan.
Unidentified Company Speaker
Thank you for your questions. Let me as Head of IR answer the first and second questions and our President answer the third.
Unidentified Company Speaker
With regard to the actual results in fiscal year 2011 and forecast for fiscal year 2012 in energy, let me give you ballpark numbers that I have at hand, which I believe we'll answer your question. To explain the gap of ¥48 billion as the factors with one-time effects, firstly, there is a change in Japanese succession system last year resulting in a ¥5 billion in negative impact for this fiscal year. Another ¥6 billion due to the change in internal cost allocation and ¥5 billion more in divestiture of listed shares is expected.
All of these add up to about ¥16 billion in negative impact due to one-time effects. With regard to factors other than one-time reversal effects, an increment of ¥7 billion will come from increase in volume. In terms of prices, oil and gas will benefit by about ¥14 billion. Price of coal are falling. The number indicated in the breakdown on year-on-year change is for the entire company. So if ¥13 billion is subtracted to get the number for the energy segment alone that will give us a net positive impact of ¥1 billion.
The impact from foreign exchange rates will be about negative ¥3 billion. In terms of exploration costs because of new projects including the one in Mozambique that will be a negative impact of ¥6 billion. In oil and gas projects including shale gas in North America due to increased depreciation cost that will be a negative impact of ¥14 billion.
Trading in oil performed quite well last fiscal year, which is expected to be difficult to be duplicated this fiscal year, leading to a slight decrease in the forecast. Furthermore, dividends to be received likely to decline from some projects. These and some other factors will together amount to ¥17 billion on the negative side on top of the previously mentioned figures.
In other words, operational factors, which are not one-time effects will account for a decline of ¥30 billion plus and we have come up with the forecasting energy in fiscal year 2012 by adding our forecast numbers at this moment.
Now, let me turn to your second question, I will share with you, how much additional burden that will be on each segment due to the cost allocation change from headquarters. Iron and steel products ¥1 billion, mineral and metal resources about ¥8 billion, machinery and infrastructure slightly less than ¥5 billion, chemicals almost ¥3 billion, energy ¥6 billion as I said earlier, lifestyle slightly less than ¥5 billion, and innovation and cross function slightly less than ¥3 billion. That's all.
Unidentified Company Speaker
To answer your third question as to the gap between upstream mineral resources and energy and known resources in terms of realizing returns. If we look back on the business environment since 2000, we have seen inflation upstream and deflation downstream leading to a consistent outperformance in mineral resources and energy segments. Moreover, our known resources segments have sustained significant amount of impairment losses especially on listed shares. And this is mainly because we have conducted a considerable amount of strategic investments and listed shares of business partners.
Back then, as the known resources businesses being so in realizing returns, if I take an example of chemical segment the chlor-alkali project with Dow Chemical where construction is scheduled to be completed by the end of 2013. We will realize some returns in the year ending March 2014. Likewise, our bio-ethanol business with Dow Chemical in Brazil will likely re-part the benefits in 2013. In power generation, water and other infrastructure businesses where construction usually takes three to four years, we are hoping to enjoy some returns will be gradually.
In Agriculture, Multigrain is in the process of cultivating a land site of about 120,000 hectares in Brazil, which will bear fruits in due course. As many new projects in known resources businesses are Greenfield projects, we have yet to see tangible results for the time being. On their other hand, in mineral resources and energy segments while existing projects are already generating profits. We can prepare ourselves for future businesses by engaging in exploration activities in high quality assets. If you look at Sakhalin II project, it had taken us 25 years before we finally achieved the first LNG shipment.
As for Mozambique gas field, we got involved from the exploration stage because in recent years, higher entry barriers to resources and energy businesses prompted us to participate in the project from exploration stage to secure cost competitive energy sources though, the risk could be higher.
In Mozambique, resources discovered so far is 17 to 30 Tcf though, it could turn out to be even larger as exploration proceeds since there are promising areas that have not been explored yet. Moreover, this project could develop further to include gas infrastructure and ammonia and other petrochemical businesses as we work together with the Mozambique government, which will give us with a strong weapon to compete with in the future.
Unidentified Company Speaker
Next question please.
Thank you. My first question is about page 30 on the analysis of this fiscal year as compared to the previous one. Cost in energy and mineral resources to push down net income are indicated as ¥20 billion here. Of which, a majority is the costs related to shale gas and other unconventional gas project of ¥14 billion, which you referred to earlier. Could you update us on the status of the shale gas project and give us your prospect of future growth and its production volume and how far out in the future, it is expected to continue running deficits.
My second question has to do with dividends from LNG businesses. Your handout indicates a considerable amount of dividend received in the fourth quarter. What are the specific factors behind this? And since you have not assume this much dividend in the forecast for this fiscal year, the net income in the energy segment in your forecast was weaker than the market consensus. Could you tell us more about the potential upside in this regard? The third question is about the increase in net income targeted in the medium-term management plan from ¥400 billion to ¥450 billion. What factors did you assume to push up the net income by ¥50 billion?
Unidentified Company Speaker
You asked three questions. I will answer the first question on the shale gas. Mr. Okada, CFO will answer the second one, and our President will take the third one. In the energy and mineral resources cost, the costs related to shale gas is from the depreciation of carry portion of the development cost incurred when we acquired the assets originally, which tends to concentrate in the early years of the project, which is completely within the plan in terms of accounting. And we expect it will take a bit more time to resolve the situation.
On the other hand, gas prices in North America have been falling resulting a slightly lower than expected net return. But our view is that given the broader supply demand balance in the long run, gas prices are likely to recover. However, compared to the initial production profile, the actual production is slightly slowed down for the time being, which makes sense to deal with the current situation.
In our assets, Marcellus is mainly gas while Eagle Ford is liquid rich. In a portfolio, we are maintaining the balance by accelerating the production in liquid rich areas. With regard to the dividends in the fourth quarter, the one from Sakhalin II increased, but we would like not to disclose the specific amount. In the year ending March 2013, we do incorporate a certain amount of dividends and capital redemption, but please excuses for keeping the amounts and timing and disclose for the time being. Is that answer your question?
In the fourth quarter last fiscal year, there was a particular increase in dividends. What other reasons and would it be difficult to assume the same level in this fiscal year, it is Sakhalin Energy to decide, how much it will payout dividend by watching cash flow and other items. So, we are not in the position to predict the amount. In the last fiscal year, the dividend was more than we had anticipated, but we suspect this amount to go down this fiscal year, I'm sorry, but that is as far we can disclose. To answer your question, how we expect to achieve ¥50 billion increase in net income in the year ending March 2014, first of all, our equity share of output in iron ore, coal, and oil and gas will increase.
Secondly as I said, the two joint ventures with Dow Chemical, chlor-alkali, and bio-ethanol businesses will start realizing returns partially. In infrastructure, water business with Hyflux and (Hizo) coal fired IPP project in China. Among others will also start bearing fruits. Paiton III Power Station completed in March will start operations soon will make a full-year contribution. IHH hospital business and Multigrain are also expected to start contributing to the enhancement of earnings of the company. So, with these non-resources segment starting to contribute in a well-balanced manner, we believe ¥50 billion gross is quite achievable.
So, is it correct to understand that ¥450 billion will be coming from already invested projects with higher degree of certainty and the contribution from planned new investments of ¥1.4 trillion will be on top of this? Yes it is thank you. Well, there is some based on the planned the new investments, but a majority is from already invested once. Thank you.
Unidentified Company Speaker
Next question please.
There are two sets of questions. In the new medium-term management plan described in the consolidated financial results under the heading, evolution of portfolio strategy, you are saying – you are going to ensure investment discipline by reviewing the previous performance evaluation indicators and introducing a concept of base cash flow as a new performance evaluation indicator. Now when one looks at the results of the investments your company has made in the past, especially known resources segments, one would wonder if the investment discipline was really being observed.
I do understand the introduction of base cash flow as a concept, but could you elaborate on – in what specific way, this new indicator will be effective especially when you plan for investments of another ¥1.4 trillion for the next two years. The second part of the question is about the description energy segment in the financial results referring to commercialization of the Mozambique LNG project and pursuing participation in new LNG projects. By new LNG projects, are you referring to something other than Mozambique project and so, are they Browse project or do you have something else in mind since Browse project has already been publicly announced. Those are my questions of medium-term management plan.
The second part of my question is about Sakhalin II, you discussed it already. So, this is going to be a follow-up question. Given the capital redemption and dividends in the fourth quarter in the last fiscal year, cash flow has been increased while the outstanding investment balance must be declining significantly. I'm not sure if there is such a thing as optimum capital structure for the current Sakhalin II, but will there be a time when capital redemption will be completed. I'm interested to know your philosophy and capital redemption in the future.
And in March 2012, the cost recovery was completed and therefore the project will start profit-sharing process. But you said the dividend will be reduced in this fiscal year. So, are there any particular uses of cash in mind in the part of Sakhalin Energy because without such plants, cash will simply be internally retained in Sakhalin Energy? So, could you please elaborate more comprehensively on the philosophy of dividends, cash redemption, and uses of cash in Sakhalin II protect.
Unidentified Company Speaker
With regard to the first question of base cash flow as was described in the financial results, our objective is to ensure investment discipline is followed and to make cash flow oriented business management really sink in. Previously, we have been trying to keep free cash flow zero or in the positive territory were to make investments up to the limit of free cash flow. But in the conventional performance evaluation indicators that was not reflected properly.
Therefore we came up with two new indicators. One is base cash flow and the other is risk return. As you can see from this equation in terms of the base cash flow indicator, what is being emphasized is that if your investment does not generate base cash flow, it will not be rated highly or you need to generate not just operating income, but bring in dividend income as well through you investment.
If I can also explain about risk return, we used to use a concept called PACC or profit after the cost of capital, but this involves such a complicated process of calculating capital cost. It was difficult for the concept of their own capital cost to fully sink in among people in the business units. So, with the change, people would hopefully be more inclined to seek returns to match the risk capital by calculating the capital cost. These new indicators are designed to ensure investment discipline will be observed more thoroughly.
Let me answer the last question on Sakhalin II before the second question. First on the combination of dividends and capital redemption, there is a limit to how much capital redemption you can make and therefore there should be a reasonable balance between capital redemption and dividends in the future. But the joint venture will have to look at all options including future capital investments where new large projects in the future and so discussions around this are being made all the time.
Unidentified Company Speaker
You asked about production sharing agreement. Unfortunately, we are not in a position to disclose details. But there is an agreement with the Russian government obviously. The joint venture makes decisions while always monitoring the balance of cash surplus. As our CFO said, it is not easy for us to predict the dividends to be paid out. In the first quarter of the last fiscal year, the dividend we received was more than we had expected. So, there are many such variables to keep track of. We would budget a number that seems to make sense now. But we'll keep monitoring the situation and having discussions among joint venture partners.
Let me try and answer the second question about LNG. As you rightly pointed out, the new projects mentioned include the project in Mozambique, Browse in Australia, shale gas converted into LNG in North America, which has already announced as well as study on a potential third LNG train in Sakhalin II and some other projects under study. But please excuses for not disclosing any further specifics about them.
Thank you. One follow-up question if I may, would it be correct to say that the third train in Sakhalin II will probably be funded by Sakhalin Energy's retained earnings. For that, the overall balance of the business and future LNG price trends would need to be taken into account just to decide whether the third train will be financed by increasing capital, we're spending the retained earnings by Sakhalin Energy. Both options are possible at this moment. Thank you.
Unidentified Company Speaker
Let's move to the next question.
There are three questions, the first question is about MCH, the coal business, it suffered a quarterly loss in the fourth quarter where there any problems in production. The market prices were not that low in my understanding. So, if you could explain more about this loss, it would be appreciated. My second question is about the medium-term management plan. The DE ratio has planned to keep going down even when the investment plans are taken into account. Where do you see the optimum level of DE ratio is internally, let keep going down. You raised the payout ratio to 25% this time, why 25% looking at the balance sheet of the company some might argue that the more dividends should be paid out. So, I'm interested to know your policy of balance sheet and return to shareholders.
Thirdly, in the actual results and plans of investments, I would like to know if possible, the breakdown in value between those made to expand the existing businesses and those made in completely new projects. I'm asking this question because more recently, the number of investment, the use of your company seems to be lower than that from competitors. Therefore, I'm wondering if this is because your company has been outcompeted by your peers in winning those deals will given the higher prices of recent deals. It is getting increasingly hard for you to identify the kind of deals that would justify the high prices by your standard. Could you please elaborate on that including the actual investment results?
Unidentified Company Speaker
First, although, let me answer your question on MCH coal business. I understand that you're asking the question based on the fourth quarter performance. During the fourth quarter, we had torrential rain, which caused a change in a product mix especially in open cut mining. Specifically, we had a reduced production of hard coking coal, which is relatively higher grade coking coal and an increased production of lower grade coking coal. On top of a reduction in the absolute volume and a change in product mix, another factor that had affected the fourth quarter was falling prices as you're aware.
Another thing that I'd like to mention on the fourth quarter is that in some of the mines we have carried out peacekeeping in order to allow smoother operations going forward. It was done partly to take advantage of the rainy weather, but it incurred substantial one-off expenses. As a result of this activity, however, our expectation is that once it is completed, we would be able to go back to reasonable earnings despite falling prices this fiscal year onward.
The next question was on the balance sheet and the Net DER projected to be falling continuously. In fact, this is something that we have discussed internally. Although, we have not determined what's the optimal level in future would be. Specifically our targeted Net DER in the past is between the 1.2 and 1.5. Nevertheless, if we look at earnings base at present, roughly 80% to 90% of our earnings come from mineral resources and energy, which accounts for less than 40% in terms of total assets.
For the time being, we intend to maintain a kind of Net DER level that is appropriate for resources and energy company with a high level of shareholders equity, for example, events like the Gulf of Mexico oil spill incident has taught us that we will always need to be prepaid and for unforeseeable circumstances. In the meantime when there are any good opportunities, we want to be agile in seating them.
For those reasons, we would like to keep a high level of shareholders equity until our known resource businesses is grow stronger and their respective contributions are insight. However, if you look at our ROE target during the new medium-term business plan, we are planning to maintain about 14% or nearly 15% that is that we are planning to do. As for the shareholders return, our policy is to keep it flexible.
During the process of formulating the medium-term business plan, we did talk about the possibility of setting a target range of between 25% and the 30%, but we decided not to set a cap on our dividend payout ratio. We would rather be flexible in determining the actual level yet considering the ongoing strong demand for investment, we decided to have a target of 25% for the time being, but this is meant to be the minimum of what we are paying out. The next question was on the split between new investments and existing investment. Unfortunately, we do not have a breakdown in value terms. I can tell you however, what our basic policy is for mineral resources and energy in particular, it is true that the entry barrier for new investments is getting higher as was pointed out earlier. Therefore, although, there is some risk. Our policy is to get involved in early exploration stage. Based on this substance, we are currently in negotiation for several mineral resources and energy projects at the moment.
On the other hand for non-resources business, we would look at those opportunities on the case-by-case basis. If prices are too high, we would not pursue them. Is it not the case that the company had some difficulty, were lost some of the recent opportunities to the competitors? I know that there are rumors of us getting involved in some of the deals. But we have not even considered all of the opportunities for which our name has been reported and we do not share such a view that we lost these deals.
I have three questions. First of all, it appears that for oil and gas, the price sensitivity is declining while the volume is increasing this year. What causes the decline in sensitivity? My second question is related to the previous question. I'm afraid that the President's response was a little unclear. Let me ask you in a slightly different way. What has to happen before you decide to raise the payout ratio from 25% to 30%? My third question is related to divestiture. The Company's plan during the medium-term business plan is ¥300 billion, which represents a reduction from ¥400 billion during the past two years.
Well, the total asset is projected to grow continuously, wouldn't you feel it necessary to increase divestiture because otherwise it might cause ROA to decline or do you believe that the company has already done sufficient divestiture. Could you just explain why you have a reduced budget?
Unidentified Company Speaker
Thank you for your question. I'd like to respond to your question about oil and gas sensitivity. We always calculate sensitivity by a bottom-up approach based on the input from business departments. This time, it turned out to be a little lower. We can think of several causes such as the hedging operations carried out in some parts of the business. Since it is a bottom-up approach, each individual subsidiary carries out its own analysis. On how closely, the numbers will be linked to oil prices. The results can be rather sporadic, but they are all added up and reflected on the final number that is how we calculate and disclose sensitivity.
The next question is what has to happen before we decide to raise the payout ratio from 25% to 30%. We do not have concrete criteria. But for example, suppose that there are no more attractive investment opportunities, this would be a good reason for us to increase shareholder return. The amount of investments we are planning to make during the medium-term plan is ¥1.4 trillion. The total amount of investments proposed by business units however, it was more than doubled this figure, still after examining the certainty of each opportunity and our policy to maintain a positive free cash flow. We determined that the ¥1.4 trillion would be appropriate for the next two years. My belief is that we should increase payout ratio when the demand for investments starts to subside. And there are no more attractive investment opportunities that can generate growth for the company.
Unidentified Company Speaker
As for divestiture, we basically used a bottom-up approach because since we made the major divestiture of Sesa Goa, our people's awareness of the importance of this exercise has increased. Each business unit makes proposals for divestitures, which adapt to about ¥150 billion to ¥200 billion per year. But in addition, the management team always keeps a contingency plan with concrete priorities and ideas as to which assets to divest whenever it becomes necessary to do additional divestiture.
For example, we divested part of the equity of Sakhalin II even before operation startup. As we did Sakhalin, if and when it becomes necessary, we can do the same thing for Mozambique project. Thus we can flexibly adjust the level of divestiture in line with the overall earnings of the company.
Thank you for the presentation. I have three questions. The first question on the iron and ore demand supply situation while your capacity expansion is going on in Australia and Brazil, the demand in China appears to be slowing down. I suspect that you might be concerned about possible deterioration of the demand supply situation. What are your thoughts on this? According to the charts on page 40 on equity share of output this fiscal year, there seems to be no growth in production output. I wonder why that would be the case despite the capacity expansion in Australia. Could you comment on this? My second question is on the enhancement of earnings in known resource business. Earlier you said that ¥450 billion includes new earnings contributions from the company's past investments. And going forward, you're expecting the net income to grow further to ¥500 billion to ¥600 billion in three to five years.
In the past, the company has made considerable investments in these projects namely Multigrain, IHH, Phosphorus Ore, and Dow. How much net income do you expect from each of them every year? In other words, how much income can make you happy. Could you give us some general idea? My third question is about the IT business, which is recording a big impairment. This question may overlap with the previous one, but why do you have such big impairment, where were you wrong, was it in pricing or was it in the assumption of industry trend. Could you comment on the root cause and the possible action to prevent recurrence of similar mistakes in the future? Earlier you mentioned the introduction of cash flow related performance evaluation indicators. Is there any more action to be taken or is that everything? Those are my three questions.
Unidentified Company Speaker
First of all, on the iron ore, we are working with big three namely BHPB, Rio Tinto, and Vale. All of them are making progress in a capacity expansion, but on the other slower pace than expected. BHPB and the Rio Tinto are getting behind their schedules due to the labor issue in Australia and the tight supply of equipment and materials. That is why there is not much growth the iron ore equity share of output for March 2013. On the other hand, for the worldwide demand supply situation for iron ore, if you look at the crude steel production in China. Last year, the overall growth was about 9%. But this year, the growth is limited to about 4% reaching approximately 700 million tons.
On the other hand, while the domestic production of iron ore in China is growing considerably. There is a deterioration in the grade or a fee content of iron ore and the many mines are shifting to underground mining, which would make their cost competitiveness much lower and continue their dependency on existing iron ore suppliers including the big three.
In terms of supply demand situation, supply is catching up with demand and so the prices are likely to go up. Like last year when we saw $180 level and instead prices are likely to stay within the reasonable range. Having said that, the current prices for iron are still much higher in an opinion compared with the past. The next question is on the expected return from known resource business. Given the size of investment made so far, our investment criteria of 10%, IRR 5%, return on investment loans and the guarantees and the 20% risk return would have to be satisfied.
Quantitatively, each new project is expected to make a profit contribution of ¥10 billion to ¥15 billion. The major impairment in the IT business arise from our investment in listed shares in Taiwan such as TPV and Formosa Epitaxy. Due to the recent global stock market downturn including Europe and in Japan, we suffered from significant devaluations of these shares, which regrettably caused impairment of these shares within less than a year after investment.
This experience does not necessarily causes to shy away from future opportunities to invest in listed shares. However, we need to be more cautious in the future. For TPV, however, this company has been showing solid business performance. Their EMS business has one orders from Japanese manufacturers, which is exactly what we wanted to see. Except for the impairment, therefore, everything is going just as expected.
Unidentified Company Speaker
Thank you. Since the time is limited, we can accommodate one more question.
I have two questions. The first one is a simple question. It is related to dividend again. The company has raised the dividend payout ratio targets to 25%. My interpretation of this message is that you will not reduce the dividend from the current level of ¥55 billion. Is that the correct understanding? That is my first question. The second question, you have stated that the net income target for March 2014 is ¥450 billion and a net income target in three to five years is ¥500 billion to ¥600 billion. These targets based on the same assumptions in terms of energy prices, currency exchange rate, and so forth as in March 2013.
Unidentified Company Speaker
The net income target of ¥450 billion for the next fiscal year is based on the same assumptions. However, the net income target of ¥500 billion to ¥600 billion is a general image. Although, when we look at the target, we are applying the same assumptions in our mind. This target is not strictly based on adding our individual business units projections based on the same set of assumptions.
Concerning the dividend amount of ¥55, unfortunately we are not ready to make a commitment to that amount today. Although, we can say that we will do our best. It is important to note, however, that when we made the settlement payment in relation to the Gulf of Mexico oil spill incident, we did not change the amount of dividend despite such payment. The amount of dividend was decided based on the net income level of ¥370 billion before the payment, which was subsequently reduced to ¥306.7 billion after the payment. We would make similar efforts going forward.
I have two questions. First one is on page 40, titled equity share of output. The upper right chart shows the trends for oil and gas. My question is whether Mozambique and the shale gas projects that were mentioned earlier whether they are included in these numbers. Mozambique is not included shale gas, however, is included. From when, will you start including Mozambique numbers?
Unidentified Company Speaker
The project is still on the exploration stage. It is yet to identify the size of reserve or the necessary LNG capacity, although, our assumption was 10 Tcf to produce 10 million tons of LNG per year. The latest estimate has already moved up to 17 Tcf to 30 Tcf, which means that the project could potentially produce 30 million tons of LNG per year, but the reserve can still increase. The size of the reserve has yet to be finalized yet. We are waiting for that piece of information before making the final decision to invest. So, it will take some more time.
Thank you, let me ask you then about page 21, earlier the President stated that a key initiative of the medium-term business plan is further expansion into upstream business other than metal and energy. Another important item is food I assume specifically, grain production and origination. Our metal and energy I assume that as a trading company, you have abundant experience and know-how. What about agriculture production and origination, it seems a very different field. How feasible is it, what is the company self-assessment.
Unidentified Company Speaker
First of all, we have a 120,000 hectare field in Brazil, which is nearly the size of the Tokyo metropolitan area. We are doing cultivation and agricultural production on that field. Our intention is to accumulate know-how in the knowledge through the Multigrain project in soybeans, cotton, wheat and others. We still have some room for improvement. Is it mainly for export to China? The soybeans and others produced and originated there are already exported to China. The company also wants to export to other countries including India. Thank you.
Unidentified Company Speaker
This brings us to the end of the Q&A session. Thank you for joining us today.
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