Pursuit of Ongoing Improvements to Corporate Value
Aggressively conducting new investments while continuing to maintain a stable financial foundation
Sojitz’s fundamental stance is to secure a positive core cash flow over a predefined period to maintain a stable financial foundation. Core operating cash flow*1 dropped temporarily in the year ended March 31, 2021, as the COVID-19 pandemic impacted our various businesses. At the same time, we were unable to carry out investments in accordance with our plans. As a result, we posted aggregate levels of ¥56.0 billion for core cash flow and ¥108.0 billion for free cash flow, both well into the positive, over the three-year period of Medium-Term Management Plan 2020 (“MTP2020”). I am proud of our ability to consistently maintain a stable financial foundation. At the same time, the fact that investments did not progress as planned means that we were unable to take advantage of some of the growth opportunities placed in front of us. In part to rectify this issue, we intend to conduct ¥300.0 billion in new growth investments coupled with ¥30.0 billion in non-financial investments under Medium-Term Management Plan 2023 (“MTP2023”). This aggressive investment move will result in core cash flow falling into the negative on an aggregate basis over the three-year period of this plan, but we expect to maintain a positive core cash flow over the six-year period that encompasses this plan as well as the previous plan.
We changed our target for the net debt equity ratio under MTP2023 to approximately 1.0 times, compared with the target of 1.5 times or lower under the previous plan. The purpose of this change is not to limit leverage, but rather to maintain the balance deemed appropriate at this point in time. Moreover, MTP2023 allows for the freedom to conduct investments earlier than scheduled with the goal of realizing earnings contributions during the period of the plan. Such ahead-of-schedule investments will likely result in the net debt equity ratio rising to around 1.2 times on March 31, 2022, but we expect to lower this ratio back to around 1.0 times by the end of the plan on March 31, 2024.
Sojitz is a company that is still growing. For this reason, we need to boost top-line revenues by aggressively investing while maintaining an appropriate level of leverage.
*1 Core operating cash flow = Net cash provided by (used in) operating activities (as calculated for accounting purposes) – Changes in working capital
Cash Flow Management
Target positive core cash flow over six-year period encompassing periods of Medium-Term Management Plan 2020 and Medium-Term Management Plan 2023
Gauging and assessing value creation through the introduction of the new management indicator of CROIC
MTP2023 reasserts Sojitz’s policy for creating value. To gauge and assess our value creation efforts, we will target return on equity (ROE) of 10% or above on average over the three-year period of the plan, with our top priority being ROE that sufficiently surpasses the level of 8% for shareholders’ equity costs.
We have introduced cash return on invested capital (CROIC)*2 as a new management indicator. CROIC measures returns on a cash basis in order to ensure that the aforementioned ROE target is fully incorporated into business division management. Each division has set targets for the minimum level of three-year average CROIC as “value creation guideline figures” based on their respective business characteristics and capital efficiency levels as well as investment strategies for the period of MTP2023. These value creation guideline figures have been formulated in a manner that will ensure the accomplishment of our Companywide ROE target of 10% or above, if each division is able to achieve CROIC that exceeds their guideline figure.
We have also revised our standards for screening individual investment candidates to focus on whether said investment will contribute to improved corporate value. Specifically, we have simplified the hurdle rate standards for the initial screening of new investments to look at two factors: cost of capital based on the functional currency of the investment candidate and country risk premium. Our prior hurdle rate was based on risk profiles and entailed determining the amount of returns we expect in comparison to the risks associated with a project. Over more than 15 years since the establishment of Sojitz, we had continued to include any new risks identified into hurdle rates, adding new layers to our risk premium and thereby making it difficult for business divisions to find investment candidates with potential that surpass this risk premium. This standard led me to seeing projects with sales growth targets that lacked objectivity in my position as chairperson of the Finance & Investment Deliberation Council. Business plans for such projects often do not go as intended, and their recovery plans also fall behind the curve.
The operating environment has been growing increasingly volatile in recent years, meaning that it is incredibly difficult to advance projects in accordance with our initial business plans. Our decision to cut down on components comprising hurdle rates was in part a reaction to the fact that the current operating environment makes it difficult to decide on investments based purely on quantitative factors. These issues are exemplified in occurrences such as the COVID-19 pandemic, something that would have normally been considered a tail risk. Rather than asking business divisions to develop business plans that exceed hurdle rates, we will call on them to ensure the objectivity of their plans based on the investment policy of adopting market-oriented initiatives put forth in MTP2023, which will entail formulating business plans that are as free as possible from biases. In addition, business divisions will be expected to develop and swiftly implement measures for preemptively addressing market trends and to define key performance indicators to be monitored in relation to these measures. Another aspect of the change in the hurdle rate policy is having the corporate divisions in the deliberation adopt a different approach by exercising additional responsibility in qualitatively assessing risks to judge whether or not they should be taken.
Should we fail to meet our initial targets for a project after investing, we will do our best to get the project back on track. However, if it is judged that this project cannot generate the minimum expected level of value for the Company, we will, in principle, withdraw. To facilitate the implementation of this policy, Sojitz will measure whether the return on invested capital (ROIC) and the CROIC levels of each investment exceed their levels of weighted average cost of capital (WACC).
*2 CROIC = Core operating cash flow ÷ Invested capital
Pursuing value creation through engagement and targeting PBR
MTP2023 targets a price book-value ratio (PBR) of 1.0 times or above. Sojitz’s PBR is currently lower than 1.0 times. This level is thought to reflect concern from investors that our portfolio contains risks with the potential to diminish net asset value as well as low faith in our ability to generate future earnings. Shareholders’ equity costs are around 8% for the Company, and we believe that there is a disparity between the market’s evaluation of Sojitz and its actual condition. Our risk premium is no doubt a factor behind this disparity. There is thus a need to address the concerns of investors by alleviating information gaps.
Sojitz has always sought to enhance disclosure of financial information, including detailed breakdowns of individual segments. Our disclosure of value creation guideline figures for CROIC is one example of this diligence. At the same time, we recognize the need to communicate to society the fact that Sojitz is sustainable. Accordingly, we practice disclosure of non-financial information with a particular focus on decarbonization and other environmental initiatives as well as human rights-related matters, such as efforts for protecting human rights across the supply chain. We will continue to rectify any deficiencies in our disclosure of financial and non-financial information going forward as we seek to provide information that will lead to the reduction of our risk premium.
As part of these efforts, we decided to underscore the commitment indicated by the target of achieving PBR of 1.0 times or above with a dividend policy of targeting a consolidated payout ratio of 30% and defining the minimum level for dividend payments until our PBR reaches 1.0 times as representing a market price-based dividend on equity ratio of 4%. As we enhance information disclosure, we will also engage with investors to give them a clear picture of the goals Sojitz is pursuing. Meanwhile, we will back our words with our actual performance in order to give investors greater faith in our future earnings potential. We also understand that fulfilling our responsibilities toward society is a prerequisite to our pursuit of profit. We must avoid, at all costs, a situation in which Sojitz loses sight of its social responsibilities, and consequently the trust of society, by engaging in unethical activities. For this reason, we will work toward our goal of a PBR of 1.0 times or above by creating two types of value: value for society and value for Sojitz.
Fulfilling responsibility as CFO to improve Sojitz’s corporate value
I am one of the few people of an age to remember the time when Sojitz was suffering from immense management challenges. This experience has filled me with a strong sense of commitment to ensure that we never again fall on such hard times. Fortunately, the Company succeeded in generating profits in the years ended March 31, 2020 and 2021, despite the impacts of the COVID-19 pandemic, and we were thereby able to pay stable and continuous dividends. Even in the face of this unexpected adversity, Sojitz managed to create cash flows to a certain degree and continued to issue shareholder returns, including share buybacks. I cannot help but be impressed by all that has changed since the period of management instability around the time of Sojitz’s founding. We could not have come this far without the support of our employees and all of our other stakeholders. I am truly grateful for this support. Also, as CFO, this support makes me all the more cognizant of my responsibility toward ensuring that Sojitz continues to thrive into the future.
My greatest responsibilities as CFO are to improve Sojitz’s financial soundness, ensure investment discipline, and identify the risks that the Company should take. These responsibilities are linked to our approach toward improving corporate value. Improvements to corporate value go beyond increasing net asset value; realizing such improvement requires Sojitz to become an entity that society deems as having value.
Furthermore, we must respond to change by changing ourselves if we hope to achieve ongoing improvements to corporate value in today’s highly volatile operating environment. In other words, we must undergo a corporate transformation.
I often receive questions about what, exactly, is the essence of Sojitz. However, I do not see a need to tie us down to a single concept. Rather, I believe that Sojitz should be a company that continues to transform, create new businesses, and cultivate human resources. It would make me incredibly happy if this flexible ability to adapt became recognized as the essence of Sojitz.
Sojitz has a strong foundation formed by its workforce of dedicated employees who are passionate about boldly tackling challenges. I hope that Sojitz will always be a company that is supportive of the efforts that its employees make to work together as one, in unison with the Company and aligned toward a common goal.
Disciplined Balance Sheet and Cash Flow Management