Returns for “K” Line Shareholders

Q-1I would like to ask about “K” Line’s approach for shareholder returns during the next fiscal year and beyond. You have indicated a framework for returns of 400.0 to 500.0 billion yen over the five years of the medium-term management plan. Including the additional return for the current fiscal year, “K” Line will likely provide returns of more than 200.0 billion yen this fiscal year. On that premise, the total returns for the remaining four years would need to be lower and it seems like it might be difficult to keep and deliver the same level of dividend (400 yen per share), that is forecasted for this fiscal year, for the remaining years. Am I correct on this regard? Alternatively, you could raise your stated limit on returns of 400.0 to 500.0 billion yen, depending on the company’s cash flow. Does that mean at this point returns will not decrease in the next fiscal year and beyond?


A-1We cannot say anything definitive yet about our dividend policy going forward. First of all, the cash inflow in our medium-term management plan is also calculated based on certain assumptions. On top of that, we will make business investments that we are still considering at the moment, so neither cash inflows nor business investments are completely finalized or fixed. On the premise these factors could change, either by increasing or possibly decreasing, our approach is that once 400.0 to 500.0 billion yen has been returned to shareholders, additional returns might still be possible. While we cannot make any definitive statements at this time, we hope that you will understand the flexibility of our shareholder return policy.



Q-2Are there any details concerning shareholder returns for the next fiscal year that you can share with us now? The total return ratio for the current fiscal year appears to be around 30%. Does that mean the target ratio for the next fiscal year will also be 30%, or is there a similar absolute amount that you have planned?


A-2When it comes to our shareholder return policy, we intentionally do not indicate quantitative targets such as a dividend payout ratio. As the business environment is changing dramatically, we have created a position that allows us to make responsive investments to deal with these changes, and to provide sufficient returns to shareholders. Therefore, we do not have any formulas or percentages that we can share with you.




Financial Results for 3rd Quarter FY2022 and Forecasts for FY2022

Q-1It seems that the profitability of Dry Bulk Business in the third and fourth quarters has deteriorated significantly compared to the operations of other comparable companies. Could you explain the situation, because the exchange rate impact and temporary losses you indicated appear to be a little large. Could you also answer the same question with respect to Energy Resource Transport Business? In the second half of the year, which is usually the busy season, it seems that almost no profit is being generated. Market conditions do not appear to be bad, so please explain if there are any other factors.


A-1The main reason for the downward forecast revision is temporary foreign exchange losses on some foreign currency-denominated assets. These were caused by exchange fluctuations, namely a sharp appreciation of the yen against the US dollar in the third quarter. At “K” Line, all business divisions are required to share the burden of this kind of exchange loss. Consequently, the profitability of Dry Bulk and Energy Resource Transportation Businesses were affected. On page 8 of the material, you can see that compared to the forecast announced in the second quarter, ordinary income is down 9.0 billion yen for Dry Bulk, and down 3.0 billion yen for Energy Resource Transport. Please understand that most of this is due to foreign exchange losses. Neither Dry Bulk nor Energy Resource Transport suffered any particular losses related to its own business operations.



Q-2You mentioned that Energy Resource Transport Business will post a profit of 0.8 billion yen in the second half, and ordinary income of 0.7 billion yen in the fourth quarter. If the yen-dollar exchange rate remains roughly the same in the next fiscal year, does that mean that profits will be about the same in the second half next fiscal year?


A-2The foreign exchange impact we suffered was not from transactions related to the operation of shipping routes. Rather it was a fixed valuation loss on assets denominated in foreign currency, applicable to the entire company. Accordingly, Energy Resource Transport Business did not incur a foreign exchange loss itself. Please understand that future exchange rate fluctuations will not affect the results of Energy Resource Transport Business, and this is a one-time event that occurred only in the third quarter.



Q-3-1The foreign exchange loss for the three months of the third quarter appears to be around 27 billion yen. What ratio was used to allocate this loss to business segments such as Dry Bulk, Energy Resource Transport, and Product Logistics?


A-3-1Please have a look at page 8 of the material. The decreases in ordinary income from the previous forecast announcement are 9.0 billion yen for Dry Bulk, 3.0 billion yen for Energy Resource Transport, and 43.0 billion yen for Containership Business. There was a 4.0 billion yen increase in ordinary income for Product Logistics excluding Containership Business. In Containership Business, ordinary income decreased by 43.0 billion yen due to a deterioration in profitability for ONE, and the exchange rate impact. Except for Containerships in the Product Logistics segment, performance has actually improved slightly, especially for car carriers. Please remember that the differences from the previous forecast announcement include the impact of foreign exchange losses.



Q-3-2Compared to the previous announcement, the downward forecast revision of 9.0 billion yen for Dry Bulk and 3.0 billion yen for Energy Resource Transport is mostly due to foreign exchange losses. Does that mean that the remainder of the loss was applied to the Product Logistics segment? Can we assume that profits in the Product Logistics segment excluding Containership Business, are actually higher than they appear, since they include one-time foreign exchange losses?


A-3-2That is correct. Regarding the downward revision of ordinary income by 50.0 billion yen compared to the previous announcement, there are also assumptions based on the previous forecast during the period and the current forecast. Therefore, while some of the foreign exchange losses are already fixed, we would like to refrain from disclosing the breakdown at this stage. However, since Containership Business fundamentally account for large part, we think the allocation of the foreign exchange losses to this business may be proportionally larger than for other segments and businesses.




Containership Business

Q-1Looking at ONE's balance sheet as of the end of December, what is the figure for net cash?


A-1That information is not available for public disclosure. However, there is no doubt that it has accumulated considerably.



Q-2Looking at the spot freight rate situation for containerships, I think there is a risk that the level of long-term contracts rates in the next fiscal year will drop to a certain extent and that “K” Line’s consolidated earnings will also decline significantly. Even if profits decline significantly, both “K” Line’s and ONE's balance sheets will have become considerably stronger. Therefore, is it possible for you to take advantage of this to significantly raise the dividend payout ratio and maintain high dividends, or should we consider that a significant reduction in dividends is also possible?


A-2Firstly, we have not yet formulated a specific numerical forecast regarding ONE's earnings for the next fiscal year, so we cannot discuss any specifics such as dividends. Our shareholder returns policy is based on cash flow forecasts. We return to shareholders any surplus that exceeds appropriate capital levels, after necessary investments have been made and internal reserves have been secured. Therefore, if cash inflow changes significantly, we will need to adjust shareholder returns accordingly. At this stage however, we cannot determine a returns policy based on ONE's earnings in the next fiscal year without first ascertaining the profit level for ONE when it reaches cruising speed.



Q-3The downward forecast revision for Containership Business seems large, but basically you have transferred overseas assets to ONE, and you do not think there will be any valuation loss. Is this correct?


A-3Unlike in our other businesses, in Containership Business, ONE's annual profits, which are denominated in US dollars, are converted into yen for the final financial reporting. Based on the accounting rules, we convert ONE’s annual profits in US dollars into yen applying the yen-dollar rate at the end of March 2023, which we have assumed to be 128 yen this time. Since we cannot change the figures that have already been reported as actual results, an exchange rate loss adjustment was made to account for the full-year re-calculation at 128 yen, and this is being reflected in the second half. Moreover, the deterioration in ONE’s profitability is the main reason for the downward forecast revision.



Q-4I’d like to ask a question about ONE. Am I right in understanding that ONE is able to maintain profitability if it operates at the current spot rate?


A-4Yes, according to our calculations, even at the current spot rate, ONE will remain profitable.



Q-5Is it correct to say that if long-term contracts for Asia-Europe east bound and Asia-North America west bound routes can be renewed at the current spot rate, the long-term contracts themselves will be profitable?


A-5Even in that situation, we think profitability will be maintained. Long-term contract rates are generally higher than the spot rate. This is because we promise vessel space to our customers. For customers, this is a premium feature since they are guaranteed to have space during peak season. Otherwise, it would not be a long-term contract. Accordingly, we do not assume that the spot rate will be the same as the rate for long-term contracts.



Q-6You said that the gap between supply and demand for Containership Business would likely worsen next year. Does not that mean spot rates will be even lower than they are currently? Please explain.


A-6There are various opinions about containership supply and demand in fiscal 2023. For example, it is widely believed that the ship supply growth rate will be about 7% in fiscal 2023 and about 14% in fiscal 2024. It is said that new vessels will be delivered. Originally, we thought that ONE would not be able to maintain the level of earnings it has enjoyed the past two years, once fiscal 2023 arrived and the pandemic and supply chain disruptions had subsided. For example, we estimated that it would decrease to about 200 billion yen plus alpha per year. We think that current freight rate levels will probably recover in early spring or later. If that happens, ONE and other container shipping companies will probably be able to raise profit levels to what we consider to be cruising speed. We are currently assuming this kind of scenario, but it could change significantly if the supply and demand environment worsens going forward. While the possibility of containership companies posting losses is not zero, we think it is difficult to imagine at this point. Given the supply-demand gap we are aware of, we do not think it is a realistic possibility for freight rates to plummet or for the containership market’s bottom to fall out.



Q-7Is it correct to think that the current level of spot freight rates will not result in unprofitability on an operational basis? Or does it mean that overall profit, after selling, general, and administrative expenses, will not be negative?


A-7The latter is correct.



Q-8With regard to containerships, you are saying that you can make a profit even at the current spot freight rates. I understand that the current spot rate is around 2,000 US dollars per FEU. If you take the third-quarter operating expenses for ONE and divide it by the volume handled, I think you get around 2,600 US dollars. I am sure you are making various cost reduction efforts, and of course, variable costs, handling costs, and bunker fuel prices are also falling. Specifically, how much cost reduction are you planning for the next fiscal year?



A-8We are not able to give you break-even point in terms of freight rate dollars per TEU. Although we have not investigated individual formulas, container costs, freight costs, and lease fees, etc. are added to the freight rates we charge. When considering the cost of the ship concerned, as well as fuel, vessel and port costs, etc., the bigger the ship, the lower the cost per container. Accordingly, the cost competitiveness per container increases along with the size of the ship. We think that profit will be substantial even at a certain freight rate. This type of competition has been repeated in the history of the containership business. We think that vessel size is now reaching the upper limit of 23,000 or 24,000 TEUs per ship.

By pursuing this efficiency without creating the problem of excessive fleet expansion, we believe it can be a countermeasure for low freight rates.




K Line’s Own Business - Car Carrier Business

Q-1I understand that profit from Car Carrier Business is basically the Product Logistics segment excluding Containership Business although it includes various businesses such as Kawasaki Kinkai Kisen Kaisha and Logistics. In terms of the full-year plan, it appears that 66.0 billion yen, which is equal to 636.0 billion minus 570.0 billion, is close to the profit from Car Carrier Business. I believe that the profit from Car Carrier Business this term is probably the highest ever. However, considering the current supply and demand situation, is there still room for it to improve further? In the previous explanation, you mentioned that earnings will improve each time a contract is renewed. Is there still a possibility of improvement in the next fiscal year, or are you approaching the limit for contract conditions? There are no spot freight rate indicators for car carriers, and my question is based on the fact that, as outsiders, we do not know what the current level is.


A-1In the Product Logistics segment excluding Containerships, as Logistics and Short Sea and Coastal Businesses also contribute considerably to earnings, it is not necessarily true that most of the profits of the Product Logistics segment excluding Containerships derives from Car Carrier Business. However, it is true that Car Carrier Business accounts for the largest portion of the segment, and is earning its biggest profits in the history of our company.

Regarding the future outlook, the renewal term for freight rate contracts is generally two or three years. So when a customer renews at the current high-rate level, we are able to benefit from this rate for a term of about three years. There are few ships available for charter in the market, so even if you want to expand your fleet and increase profits, it is difficult to find ones to charter. Even if you are able to charter a vessel, the charter hire will be very high, and it may not be a profitable idea over the medium term. Inevitably, both “K” Line and other car carrier shipping companies will have no choice but to build new ships in order to expand the scale of earnings. In the case of “K” Line, about eight new LNG-fueled vessels will be completed in 2023 and 2024 or later. Therefore, I do not think earnings will grow rapidly until these are in service. However, it will still be possible to at least maintain the current level of earnings.



Q-2-1For long-term car carrier contracts with terms of two or three years, I think there are still some of these contracts in effect, given the level of spot market conditions. For example, some of these contracts may be renewed around April. Please tell us if we can expect further increases in freight rates in the next period and the one after that, given the gap with the current level of market sentiment.


A-2-1We believe your question is about the difference between the spot market and freight rate levels for contract cargo. For the past year or two, we have been working to restore rates based on the understanding of our customers. So it is true that the difference between spot rates and contract rates has narrowed compared to before.



Q-2-2Do you know what percentage it was before, and what percentage it is now? If theoretically all contract rates were to be renewed to some extent, is it correct to say that the difference between spot rates and contract rates will approach zero?


A-2-2We will refrain from giving specific numbers, but car carriers transport a wide variety of cargo, including passenger cars, high and heavy vehicles, and large vehicles. The freight rates will vary according to the type. Therefore, it is difficult to say that freight rates are at any given level.