CFO Message

Emphasis on Improving Corporate Value under Medium-Term Management Plan

As COO of the Corporate Planning Department, I was involved in the formulation of Medium-Term Management Plan 2023, which was launched in April 2021. I would thus like to begin by talking a little bit about this plan. Medium-Term Management Plan 2023 is not just about achieving earnings growth up until its final year. Rather, we went about formulating this plan by taking a deep dive in what exactly constitutes Sojitz’s corporate value, based on which we sought to lay out a road map for how to improve this value over the medium to long term. With this groundwork, we must not allow ourselves to be satisfied by accomplishing our targets for any given year, especially if that year presented favorable conditions. In such favorable years, we need to achieve results surpassing targets. Conversely, even in particularly challenging years, we must move forward with preparations to secure growth in the following year. Based on this approach, we emphasized ensuring that the Company would achieve a certain degree of performance over the medium term, no matter how the operating environment may change, when setting quantitative targets. This is why we chose to put forth three-year targets, as opposed to targets for the final year of the plan. The plan also presents targets for return on assets (ROA) and return on equity (ROE) as a symbol of our dedication to generating returns that surpass cost of capital. To facilitate our accomplishment of these targets, we introduced the indicator of cash return on invested capital (CROIC)*1 and described investment standards in Medium-Term Management Plan 2023. The idea of “corporate value improvement” is rather abstract, and there can be a lot of different interpretations. To move away from such subjective concepts, we have defined increases to our equity spread as a common goal, based on which we aim to entrench within the organization a mindset that will make direct contributions to improvements in corporate value. Other important themes of Medium-Term Management Plan 2023 include human resource strategies, decarbonization initiatives, and environmental, social, and governance (ESG) initiatives. We recognize that ESG and other non-financial initiatives will likely have an impact on our future financial position or, in other words, be important factors influencing our future corporate value. Based on this recognition, these initiatives have been incorporated to clearly indicate our intent to advance such initiatives to both internal and external stakeholders and to share and track the progress thereof.

• CROIC = Core operating cash flow ÷ Invested capital

Evaluation of Progress after Second Year of Medium-Term Management Plan 2023

Looking back at the year ended March 31, 2023, the second year of Medium-Term Management Plan 2023, we managed to deliver results that surpassed nearly all of the quantitative performance targets we had set. One factor behind this record-breaking performance was the earnings-buoying benefits of higher resource prices. At the same time, our non-resource businesses, which are resilient to impacts of market fluctuations, helped drive up our overall earnings power. In terms of profitability, a solid improvement was seen in ROE, which rose from 12.2% in the year ended March 31, 2022, to 14.2% in the year ended March 31, 2023. The only quantitative target yet to be met is a price-to-book ratio (PBR) of 1.0 times or above. This ratio stood at 0.82 times on August 31, 2023.

We have also set value creation guideline figures representing the minimum level of CROIC to be achieved by each division on average over the three-year period of the medium-term management plan. The levels of these guideline figures were decided based on the business characteristics and capital efficiency of the respective divisions. Figures for divisions with relatively high volatility were set higher, whereas divisions that will be the target of concentrated investment or major portfolio restructuring during the period of the medium-term management plan were given lower figures. Both of the divisions that did not reach their value creation guideline figures in the year ended March 31, 2023, were in the latter group: the Infrastructure & Healthcare Division and the Retail & Consumer Service Division. This is due to the fact that these divisions have been identified as focus areas and therefore continue to be the target of new investments aimed at future growth. This was also true in the year ended March 31, 2022. We expect to see improvement in this situation as the new investments conducted in these divisions start making greater contributions to earnings. In fact, CROIC in the Retail & Consumer Service Division is expected to get very close to the value creation guideline figure in the year ending March 31, 2024, given the anticipated recovery from the impacts of the COVID-19 pandemic and benefits of proactive asset replacement in domestic real estate, textile, and other businesses. In this manner, the introduction of the value creation guideline figures has fostered a CROIC-oriented mindset that inspires employees to implement strategies aimed at achieving ongoing growth while generating the greatest possible cash returns from investments. This mindset has taken root in all divisions, including those that have been successful in surpassing their guideline figures. As such, we are now in a position to accelerate concrete initiatives targeting improvements in CROIC. I briefly touched on the domestic real estate business a moment ago, but, to be more specific, we have withdrawn from this business. Our domestic real estate business has continued to generate earnings for quite some time. However, we have to examine whether allocating people and funds to a given business makes sense when thinking about the future growth of the Sojitz Group. When it comes to such discussions, no asset is safe from being put on the chopping block.

The processes we use when screening individual investments were also revised as part of the process of formulating Medium-Term Management Plan 2023. Now, our primary focus is when a given investment will contribute to higher corporate value. This has led to increased transparency in business plans and their underlying hypotheses and made an objective perspective a given when discussing investment decisions. Terminal value is calculated as one factor used in determining acquisition prices. Our new investment screening standards have lent an additional element of clarity to objective and quantitative discussions of how we can improve terminal value. I feel that this approach has resulted in a substantially greater focus on corporate value improvement, whether looking at a post-execution investment or at an investment being screened. In addition, Sojitz has an organization tasked with proposing one-stop solutions for all steps of the investment process, spanning from screening to post-merger integration. This organization has begun incorporating external insight in order to further enhance its solutions. In terms of nonfinancial initiatives, we are accelerating efforts based on the underlying human resource, sustainability, and digital strategies as we seek to cement our foundations for transforming the Company and our employees.

Ongoing Generation of Returns Surpassing Cost of Capital

Medium-Term Management Plan 2023 was formulated in the year ended March 31, 2021. This timing coincided with the start of the COVID-19 pandemic, which sunk demand, disrupted logistics flows, and forced Sojitz to shoulder a massive drop in earnings. Fortunately, Sojitz had continued to practice extensive discipline in financial management, based on which it sought to improve the quality of its asset portfolio through ongoing asset replacement aimed at strengthening its resilience to market changes and to continue creating and growing clusters of revenue-generating businesses. These basic policies were shaped by Sojitz’s past experience with restructuring its management. As a result of this discipline, we were able to keep conducting the investments necessary for growth, without feeling any negative impacts to our financial health, even under such extreme circumstances. This reality indicated that Sojitz had, in the truest sense, completed restructuring its management and reinforcing its foundations and was thus now prepared to move onto a stage of advancing toward future growth. Based on this judgment, Medium-Term Management Plan 2023 was designed with an emphasis on ongoing growth over the next decade leading up to 2030.

The year ending March 31, 2024, will be a year of determining what we need to do in order to prepare for the next medium-term management plan. Under Medium- Term Management Plan 2023, I feel that Sojitz has access to a significantly wider range of investment opportunities than was available during the periods of prior plans. In the past, our lack of funds and experience limited our options for new investments and made it difficult to expand and broaden the scope of our businesses. Nevertheless, we proceeded to engage in numerous projects and to create new businesses by exercising ingenuity to address customer and market needs, instead of just throwing money at a project. In recent years, our capacity for investment has grown and we have amassed a staff of experienced and skilled individuals while developing a global network of interpersonal connections. As a result, we now find ourselves able to take advantage of a much wider range of investment opportunities. If we are to effectively capitalize on these opportunities to drive future growth, we will need to select businesses with an emphasis on competitiveness and growth markets while maintaining our disciplined approach toward management. Through this process, we will take a big picture perspective to broaden and build upon our operations and thereby achieve further growth. The policies for how we invest and allocate resources to this end will be an important point of consideration in the final year of the current medium-term management plan and over the period of the next plan.

At the same time, Sojitz needs to strive to shrink the gap between its ideal shareholders’ equity costs and that deemed appropriate by the market. In the past, we thought that giving the market a better understanding of Sojitz’s business would reduce this gap. Now, we recognize that just ramping up information disclosure and gaining a better appraisal from the market will not shrink this gap in the way we had anticipated. The calculations we had conducted previously led us to believe that Sojitz’s shareholders’ equity costs should be around 8%. Given the global rises in interest rates and other changes in the operating environment, we now think that 9% is a more appropriate assumption. We remain dedicated to more robust and proactive information disclosure. However, we also recognize the need to invest in creating businesses with even greater earnings power, and in using these businesses to expand our business scope and branch out into other areas. It is also important that we present the market with results and with strategies and frameworks that give it hope for the future growth of Sojitz. Our operating environment is always changing, as is how the market views Sojitz. This is why we will continue to value our opportunities for direct communication with investors and other stakeholders as chances to tell a compelling narrative of our growth in the years to come.

Acceleration of New Investments While Maintaining a Stable Financial Base

Sojitz’s basic approach toward financial discipline is really quite simple: We use the cash generated from operations and recovered through asset replacement to conduct new investments and shareholder returns. We will utilize borrowings to secure the working capital needed to start up a new business. However, we have no intention of using debt to make new acquisitions that entail massive amounts of goodwill, as this will expose us to the risk of not being able to recover our investment. Medium-Term Management Plan 2023 prescribes a focus on growth and financial discipline, based on which we have set a target of achieving a positive core cash flow over a six-year period encompassing the periods of the current plan and the previous plan. The emphasis on financial discipline put forth by this plan has become entrenched throughout the Company. In the first two years of the current plan, we have been accelerating earnings production and asset replacement, which has enabled us to secure a substantial amount of cash to redirect toward investment. We therefore chose to ramp up the amount of investments we intend to make during the period of the plan, for the initially earmarked amount of ¥300.0 billion in standard investments plus ¥30.0 billion in non-financial investments, to ¥500.0 billion. Based on this new budget, Sojitz will be pursuing growth by ramping up substantive new investments based on its strategies centered on the focus areas defined by Medium-Term Management Plan 2023, namely, the infrastructure and healthcare field, growth markets to be approached through market-oriented initiatives, and the materials and circular economy field.

As for shareholder returns, our basic policy is to pay stable, continuous dividends. Based on this policy, the Company will target a consolidated payout ratio of approximately 30%. In addition, a market price-based dividend on equity ratio (DOE)*2 of 4% will be set as the lower limit for dividend payments for any year in which our PBR is less than 1.0 times at the fiscal year-end, while the lower limit will be represented by a book value-based DOE*3 of 4% when the year-end PBR is above 1.0 times. It is only natural for a company to pursue ongoing growth over the medium to long term. Sojitz has thus laid out shareholder return policies that are based on medium-term performance, as opposed to single-year performance, and we will make ongoing efforts to ensure that shareholders find these policies to be compelling.

Expected Role of CFO at the Sojitz of Today

I am often asked about the essence of Sojitz, or, in other words, our corporate culture. Sojitz’s corporate culture could be seen as one of embracing free and open ideas and valuing hard work. We have continued to cherish this culture over the years, and I hope we will continue to do so, even as we find ourselves approaching a new stage in which we are able to rely more on our increased financial capabilities. However, I also realize that a corporate culture is not static; it is something that changes dynamically as we shape it.

The question then becomes: How do we elevate our corporate culture, our essence, into a source of strength for the Company. One answer to this question can be found in Sojitz’s vision for 2030 of becoming a general trading company that constantly cultivates new businesses and human capital. My interpretation of this vision does not entail our finally becoming such a company in 2030, but rather being such a company that, in 2030, we can say that we have been constantly cultivating new businesses and human capital as a matter of course. Accomplishing this vision will require that we not be bound by the past, but rather we continue to change and evolve.

In a similar vein, the role expected of a CFO changes based on the given operating environment and stage of a company. Up until now, a major part of the role of the CFO at Sojitz has been protecting the Company through funding and risk management to ensure that we are never again at risk of bankruptcy. This role was a reflection of the struggles that Sojitz had to surmount in the past. Of course, protecting the Company from bankruptcy will always be part of the CFO’s role. However, as we move on to a new stage of our development, the CFO will also need to play a more proactive role in driving the progress of the Company. Accordingly, I feel that the role of the CFO at the Sojitz of today is to increase our equity spread, with a constant emphasis on improving corporate value through the ongoing generation of the value that fuels our sustainable growth, while also crafting a balance sheet that contributes a larger equity spread. My personal definition of corporate value improvement involves increasing the returns that constitute the numerator for ROE, returns including our future financial impact, and fostering a sense of anticipation regarding Sojitz’s growth. I am utterly dedicated to contributing to such improvements in corporate value.

Sojitz currently has a foundation that is capable of generating profit for the year of more than ¥100.0 billion a year, indicating that it has reached a new stage of its growth. In this new stage, we will keep pursuing ongoing growth through constant transformation and continuous efforts to build a business portfolio that can consistently generate value. Moreover, we will actively communicate the appeal of Sojitz and its value creation to investors. I hope you will look with anticipation toward the future growth of Sojitz.