【K Line’s Own Businesses】
Q-1-1: What was your approach to forecasting for the second half? It seems your overall profits for the second half remain on par with the previous announcement in May. Containership Business is performing better than expected, while Dry Bulk and other segments are underperforming. What kinds of risks do you see for the non-container segments, namely, Dry Bulk and Energy Resource Transport?
A-1-1: For Energy Resource Transport, we believe that the key points to watch are the US presidential election and the situation in the Middle East. Current crude oil prices are being affected by somewhat weak Chinese demand. Depending on the situation in the Middle East, however, market prices could rise and the supply-demand balance could become even tighter. Depending on the outcome of the US presidential election, Donald Trump or Kamala Harris would likely pursue completely opposite energy and environmental policies. This is an important point to consider. As for Dry Bulk, the lingering uncertainty surrounding the Chinese economic outlook poses a risk. In the first half of the year, cargo movements remained steady, mainly for Capesize, but we are approaching the second half with caution. In terms of market conditions, however, while we expect some fluctuations, our assumptions have not changed since our last announcement in May. The apparent slight decrease in profitability is due to the impact of exchange rates. This decrease is due to the adjustments made between the first and second halves of the year, but the fundamental profitability assumptions for Dry Bulk have not changed. However, we do face some risks, and we have been working to manage our exposure since the beginning of the fiscal year, by steadily reducing it while securing cargo.
Q-1-2: Regarding the first-quarter results for Energy Resource Transport, could you elaborate on the background of the decrease in profits compared to the same period last year due to temporary factors?
A-1-2: The temporary effect was due to vessel replacement.
Q-2-1: In Product Logistics segment excluding Containership Business, profits rose in the first quarter, but are expected to fall starting in the second quarter. Even when comparing the forecast for the second half of the year with the one previously announced, there has been a downward revision. It appears that the expected decrease in profits compared to the same period last year has also become greater. Could you let us know whether this is due to Car Carrier Business or Logistics Business?
A-2-1: Basically, for Product Logistics excluding Containership Business, most profits come from Car Carrier Business. Logistics has relatively stable earnings, so we expect Car Carrier Business to perform at a slightly lower level in the second half compared to the first half.
Q-2-2: In terms of year-on-year comparison, Product Logistics excluding Containership Business is expected to experience a decline in profits starting in the second quarter. Can this decline be attributed to Car Carrier Business? If we compare their forecasts for the second half of the year, there has been a downward revision for Product Logistics excluding Containership Business. If this is due to a drop in expected performance for Car Carriers, what is the reason for it?
A-2-2: We are carefully monitoring the situation for Car Carrier Business, including future developments. The exchange rates used for the first half and the second half are different, and in technical terms, I would say we make exchange rate adjustments, including balance sheet items, at the end of the first half and in the second half, which is why the figures for the second half appear lower.
Looking at the entire fiscal year, we do not believe that business trends will worsen compared to the beginning of the fiscal year. On the other hand, there is a shortage of shipping capacity as ships are unable to pass through the Red Sea and need to detour around the Cape of Good Hope. There is also a lot of shipping volume destined for the North American market, which remains strong. Therefore, rather than indicating an overall downward trend in performance, this apparent drop is a product of differences between the first and second halves of the year when calculating the figures for the full fiscal year.
The outlook for the second quarter is not bad at all. However, please note that the second quarter of the previous fiscal year was also very strong, which is part of the reason for the year-over-year difference.
Q-3: Regarding your profit forecast for the second half of the year, compared to the forecast released in May, the figure for Containership Business has been revised upward by 8.0 billion yen, while Dry Bulk has been revised downward by 1.5 billion yen. Energy Resource Transport is down by 500 million yen, and Car Carriers and others are down by 5.0 billion yen. Could you confirm whether these are meaningful downward revisions or simply fine-tuning of the figures?
A-3: The exchange rate assumptions we used for the first and second halves are significantly different. The average rate for the first half of the year is 154.35 yen and the one for the second half is 140 yen. So there is a difference of about 15 yen. Differences in end-of-period exchange rates for the first and second quarters, as well as for the second half of the year, affect profitability forecasts due to the end-of-quarter valuation of balance sheet items. Looking at the first and second halves of the year, the second half does appear to be slightly lower. However, while Containership Business is facing some uncertainty, we do not anticipate any major changes in market conditions or business fundamentals for our other businesses.
【Containership Business】
Q-1-1: What are your thoughts on the containership market outlook? The Shanghai Containerized Freight Index (SCFI) is currently falling. Do you think the container market will continue to gradually decline due to the impact of front-loaded demand?
A-1-1: When it comes to the containership market, it is difficult to predict the future. This fact is also mentioned in the material from OCEAN NETWORK EXPRESS (ONE). Conditions in this market depend not only on supply and demand, but also on the situation in the Middle East and North American labor negotiations. The contract with the ILA labor union on the East Coast of North America is due to expire at the end of September, and negotiations on a renewal of contract are currently in the final stages. The situation is similar on the West Coast, as negotiations are underway with the ILWU union in Canada. In terms of general supply and demand balance, there is usually a gradual decline in demand from early autumn onwards, and we are assuming the same trend for this year as well. It is impossible to predict the impact of any external factors that may arise, or the possibility of another major supply chain disruption such as the one that occurred during the COVID-19 pandemic. Therefore, it is difficult to make any definitive statements. In any case, fundamental supply and demand will likely stabilize. Short-term freight rates appear to have peaked in July and are expected to gradually decline going forward. It remains to be seen whether this trend will continue and to what level the actual freight rates and liftings will decline in the fall. ONE and its shareholders, including us, currently expect that around the fourth quarter freight rates and liftings will return to the levels predicted at the beginning of this fiscal year.
Q-1-2: Is the expected early autumn market decline based on a general seasonal trend?
A-1-2:Your understanding is correct, but this year presents several uncertainties. With the US presidential election coming up in the fall, we can expect to see increased demand ahead of the year-end sales season and shipments being sent earlier. On the supply side, the situation in the Middle East is a source of uncertainty, but ONE assumes that the short-term freight rate will gradually stabilize starting in early autumn.
Q-1-3: In the current business environment of uncertainty, it has seemed ONE prefers to leave forecasting to its three shareholders. Given this current situation, what kind of discussions led to the firm predictions ONE is making now?
A-1-3: It has been six years since ONE started its business, and the company has accumulated a wide range of experience. It has also done a lot of its own analysis of the forecasting and results. Please understand that we have now reached the point where ONE itself, rather than its three shareholders, can make its own forecasts, as it should be.
Q-2-1: Regarding ONE’s FY2024 first-quarter results, ONE's financial results material on page 3 shows that the effect of increased profits from freight rate was 124 million US dollars compared to the same period last year. When this is divided by revenue, it appears to be only about 3%. This seems very low given the short-term freight market conditions and the rise in freight rates for the Asia-North America eastbound and Asia-Europe westbound routes as indicated on page 4 of this material. Could you explain this? Is it possible that while freight rates for transport to North America and Europe have risen considerably, rates for Asia and other routes are actually falling? My impression is that the effect of increased profits due to freight rate increases appears to be very small compared to recent short-term freight trends. Could you shed some light on this?
A-2-1: Liftings had a greater effect on the increase in profits than freight rates, and this became the factor affecting the increase in revenue. The increase in actual demand is the apparent reason.
Q-2-2: Looking at the freight index for North America and Europe on page 4 of the material, compared to the same period last year, Asia-North America Eastbound has increased by just under 10%, while Asia-Europe Westbound has increased by about 40%. I believe these are based on average rates including annual contract rates. Given this, the growth seems very small. I might not be understanding the situation correctly, but could you explain this to me?
A-2-2: The proportion of long-term freight rates to short-term freight rates within total liftings shows the general trend for the entire year, but it can vary from time to time, even during the year. I believe this is one of the factors contributing to the situation you pointed out.
For example, the high freight rates for fiscal 2022 service contracts continued into the first quarter of fiscal 2023. Also, revenues are recognized based on the degree of voyage progress made in satisfying the performance obligation, and short-term freight rates peaked from May to July. These factors may make it difficult to get a clear picture of the trend.
Q-3: Looking at ONE's financial results, comparing the first quarter of this fiscal year (April-June), which has just been disclosed, with the fourth quarter of the previous fiscal year (January-March), revenue has increased, while expenses have decreased compared to that previous quarter. Could you explain this?
A-3: Operating costs have been decreasing, mainly due to lower fuel costs.
Q-4: Looking at the assumptions used for Containership Business, ONE's forecast is apparently based on the assumption that short-term freight rates peaked in July. However, the situation for short-term freight rates varies greatly from route to route. While freight rates for routes to the West Coast of North America rose too high and have now fallen as a result, rates for other routes have not changed much. Nevertheless, based on ONE's freight rate index, the rates for routes to North America remained largely unchanged between January-March and April-June. How much impact will short-term freight rate adjustments have on ONE's performance? Does this mean that ONE’s assumption is that all short-term rates will be adjusted for all routes, not just for some routes?
A-4: I will not go into details for each route, but looking at the current trend after peaking in July, it is true that the largest rate decline is for routes to the West Coast of North America. In comparison, the decline in the East Coast of North America is still relatively small. Rates for routes to Europe have not fallen as much yet, and rates for each route are based on particular circumstances. As I mentioned earlier, routes to the East Coast of North America face uncertainty in the form of labor-management negotiations that are still in progress. Instability in the Middle East will continue to impact the routes to Europe as well. Despite these factors, there is a general trend whereby if some freight rates start to fall, eventually the overall market will fall, which is something that shipping companies do not want to see. Therefore, keep in mind that rather than being focused on the severity of decline on particular routes, we are factoring in a certain degree of decline across all routes based on past trends.
【Cash Allocation, Shareholders Return】
Q-1: While you have not announced any changes to your plans for shareholder returns this time, you intend to consider additional returns in a flexible way, based on criteria such as the equity ratio and cash flow situation. What discussions led to the decision not to make any changes to planned shareholder returns, despite the upward revision to consolidated financial forecasts for FY2024 announced just before first-quarter financial results disclosure?
A-1: When we announced our financial results in May, we revised our shareholder return forecast upward from 500.0 billion yen or more to 700.0 billion yen or more. Our investment plan was also increased from 630.0 billion yen to 740.0 billion yen. The internal discussions that led to the announcement of this plan took place over six months. This included deciding the details of the shareholder return policy, as well as the investment plan and projects. Three months have passed since the May announcement. Certainly, first-quarter operating cash flow is projected to be higher than expected, and some of this is due to “K” Lineʼs own businesses. However, we were not anticipating a substantial cash flow increase at the beginning of the fiscal year due to factors such as the strength of Containership Business and exchange rate trends. Accordingly, we need to first ascertain and confirm the size of the additional increase in operating cash flow, and then discuss internally what measures we should take. It would have been nice to make some sort of shareholder returns announcement as part of the release of our financial results at this time. However, we would like to carefully review the current situation and spend a little more time discussing the best course of action.
Q-2-1: With regards to the increase in operating cash flow, it seems to me that without dividends from ONE, your operating cash flow would not have increased. Can we simply assume that there have been no changes to your cash flow forecast this time because it is unclear what amounts could be expected as dividends from ONE?
A-2-1: It is a little unusual to discuss a breakdown of cash flow, but I would like to point out that, even in “K” Lineʼs own businesses, operating cash flow is on the rise. Also, it is expected that if ONE's profits rise, dividends will rise accordingly. However, the specific dividend policy is not yet determined. ONE2030 outlines the company’s basic dividend policy, but its shareholders will need to discuss the actual policy for fiscal 2024. Specifically, we will need to discuss how to determine the dividends based on the recent increase in profitability. So we believe that there will be increased cash flow from “K” Lineʼs own businesses. In addition to that, the question is how much more cash flow will be added based on discussions between ONE's shareholders. At any rate, there are some cash flow areas that we are fully aware of, and we are now discussing internally how to apply our capital policy to those areas.
Q-2-2: Could we say that the increase in operating cash flow is mostly due to Containership Business, since the forecasts for “K” Lineʼs own businesses have not changed significantly?
A-2-2: We are not focusing all our expectations on Containership Business, as “K” Lineʼs own businesses are also growing proportionally. Thus, we are giving full consideration to cash flow areas that we are already aware of, such as the growth in “K” Lineʼs own businesses.
