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ORIX Corporation: Portfolio Optimization And Capital Return To Support ROE Target (NYSE:IX)

Elevator Pitch

I have a Neutral rating on Japanese financial services conglomerate ORIX Corporation (IX, 8591:JP). I like ORIX Corporation’s portfolio optimization and capital return initiatives to improve ROE. But it could take quite a while for the company’s earnings to return to pre-COVID-19 levels (FY 2023 as guided by the company), because the coronavirus pandemic continues to have a negative impact on ORIX Corporation in 2Q FY 2021.

I recommend that investors wait for signs of either a relaxation of international travel restrictions (negative impact on aircraft leasing and concession businesses) or a QoQ improvement in earnings, prior to consider initiating a position in ORIX Corporation. This will mark the inflection point where short-term earnings pressures have subsidised and investors start to build confidence in the company’s ability to meet its medium-term ROE target.

ORIX Corporation’s net profit attributable to shareholders fell by -41% YoY to JPY93.8 billion in 1H FY 2021, due to reduced investment gains and the negative impact of COVID-19 on its businesses. ORIX Corporation’s medium-term ROE target of 11% or higher will be supported by both portfolio optimization and capital return initiatives. Nevertheless, the company only expects to return to net profit of JPY300 billion (FY 2020 level prior to COVID-19) by FY 2023. ORIX Corporation trades at 9.3 times consensus forward FY 2021 (YE March) P/E and 0.64 times P/B, and it offers a consensus forward FY 2021 dividend yield of 5.2%.

Readers have the option of trading in ORIX Corporation shares listed either as ADRs with the ticker IX or on the Tokyo Stock Exchange with the ticker 8591:JP. For those shares listed as ADRs, average daily trading value for the past three months is decent at $3 million but lower than that for the Japan-listed shares.

For those shares listed in Japan, there are limited risks associated with buying or selling the shares in terms of trade execution given that the Tokyo Stock Exchange is one of the major stock exchanges that’s internationally recognized and there’s sufficient trading liquidity. Average daily trading value for the past three months exceeds $90 million, and market capitalization is above $18 billion, which is comparable to the majority of stocks traded on the US stock exchanges.

Institutional investors which own ORIX Corporation shares listed in Japan include Nomura Asset Management, The Vanguard Group, BlackRock, Daiwa Asset Management, and J O Hambro Capital Management, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers and Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

Company Description

Started in 1964, ORIX Corporation refers to itself as “a leader in numerous domains including leasing, corporate finance, industrial/ICT equipment, environment and energy, automobile-related, real estate-related, private equity investment and concession, banking and life insurance businesses” on its corporate website.

Over the past 56 years, ORIX Corporation has transformed itself from a leasing company in Osaka, Japan, to a financial services conglomerate by expanding into related business areas. During the same period, the company has also diversified beyond its home market, Japan, to become a multi-national enterprise with a presence in 34 countries around the world.

An Overview Of ORIX Corporation’s Businesses

(Source: ORIX Corporation’s November 2020 Investor Presentation Slides)

ORIX Corporation’s Earnings And Assets By Business Segment

(Source: ORIX Corporation’s November 2020 Investor Presentation Slides)

ORIX Corporation’s History Of Expansion Into Various Business Lines

(Source: ORIX Corporation’s November 2020 Investor Presentation Slides)

Negative Impact Of COVID-19

Similar to many other companies globally, ORIX Corporation had been badly hit by COVID-19 and its associated lockdown measures in various parts of the world. The company reported its 1H FY 2021 financial results on November 2, 2020, and its financial performance was poor for the period between April 1, 2020 and September 30, 2020.

ORIX Corporation’s net profit attributable to shareholders fell by -41% YoY from JPY159.2 billion in 1H FY 2020 to JPY93.8 billion in 1H FY 2021, and its annualized ROE decreased from 10.9% to 6.3% over the same period.

In a challenging market environment, the company’s investment gains relating to the divestment of rental properties, investment securities, and subsidiaries & affiliates, dropped by -50% YoY to JPY36.8 billion in 1H FY 2021. More importantly, many of ORIX Corporation’s core businesses, such as real estate (facilities operation), airport concession and aircraft leasing, were negatively impacted by the coronavirus pandemic.

The company’s real estate business saw segment profit plunge -78% YoY to JPY10.4 billion in 1H 2020 because all of its accommodation facilities such as hotels and inns were temporarily shut down as a result of lockdown measures being implemented to combat the spread of COVID-19. As of September 30, 2020, all but one of ORIX Corporation’s facilities have already re-opened.

Segment profit for ORIX Corporation’s Private Equity & Concession business also dropped by -79% YoY to JPY4.1 billion in the first half of FY 2021, as international flights for Kansai Airports decreased significantly due to travel restrictions. The Private Equity & Concession business segment has a stake in the company Kansai Airports Kobe, which manages the Kobe Airport concession.

The company’s Aircraft & Ships business saw a -72% YoY fall in segment profit to JPY4.7 billion in 1H FY 2021, due to weakness in aircraft leasing. ORIX Corporation witnessed lower lease revenue and gains on disposal, as there was a decrease in both the number of aircraft owned and divested.

ORIX Corporation’s Aircraft Leasing Business

(Source: ORIX Corporation’s 1H FY 2021 Results Presentation Slides)

Looking ahead, ORIX Corporation has guided for a full-year net profit attributable to shareholders of JPY190 billion in FY 2021, which will imply a -37% YoY decline from its net income of JPY302.7 billion in FY 2020. Sell-side analysts are slightly more bullish, as they expect ORIX Corporation to register a net profit attributable to shareholders of JPY 208 billion in the current fiscal year.

Notably, the pandemic continues to have a negative impact on ORIX Corporation in 2Q FY 2021. As per the table below, the adverse effects of COVID-19 on the company’s aircraft leasing and concession businesses have gotten worse on a QoQ basis in 2Q FY 2021. Daily confirmed cases of COVID-19 in Japan continue to surge and hit record highs, while there are no clear signs that international travel restrictions will be lifted anytime soon. This suggests that ORIX Corporation will likely take a longer time to return to pre-COVID-19 profit levels.

QoQ Comparison For The Company’s Key Businesses Affected By COVID-19

(Source: ORIX Corporation’s November 2020 Investor Presentation Slides)

Financial Strength And Liquidity To Weather The Storm And Invest In Future Growth

ORIX Corporation has the financial strength and liquidity to weather the current storm and also invest in future growth opportunities. The company has A- ratings from all the three major credit rating agencies, S&P (SPGI), Moody’s (MCO) and Fitch. ORIX Corporation also has liquidity (including cash and credit lines) of approximately JPY1,122 billion as of September 30, 2020, which is equivalent to 59% of its market capitalization.

In its November 2020 investor presentation, the company emphasized that it “will maintain financial soundness commensurate with an ‘A’ rating over the medium to long term” and “aim to build a more robust portfolio through M&A, asset replacement.”

Portfolio Optimization To Support ROE Target

Putting near-term headwinds aside, ORIX Corporation’s medium-term target is to achieve a ROE of 11% or higher via both portfolio optimization (new investments and asset sales) and capital return (dividends and share buybacks). The company’s ROE was 10.3% in FY 2020 prior to COVID-19, and its annualized ROE fell to 6.3% in 1H FY 2021 as a result of COVID-19.

At its 2Q 2021 earnings call on November 2, 2020, ORIX Corporation acknowledged that its ROE “will take several years to go back to the 11% level based on the existing portfolio”, so it wishes to “accelerate this recovery scenario through identifying new investments and increasing gain on sales.”

The company has a pipeline in excess of JPY1.5 trillion in new investments, and a recently announced deal was the acquisition of a 20% equity interest in Greenko Energy Holdings. Greenko Energy is India’s largest renewable energy company with an existing renewable energy capacity of 4.4 GW and another 8GW under construction and development.

Separately, ORIX Corporation expects to return to net income of around JPY300 billion by FY 2023. More importantly, the company sees divestment gains accounting for approximately a third of the JPY300 billion in net profit.

Capital Return To Shareholders

Improving capital return to shareholders is also another key contributor to ORIX Corporation’s ROE enhancement.

The company offers consensus forward FY 2021 and FY 2022 dividend yields of 5.2% and 5.1%, respectively. It has guided for a “full-year dividend of 76 JPY per share or 50% payout ratio, whichever is higher” for FY 2021. Notably, this implies that ORIX Corporation will at least maintain its absolute dividend payout at JPY76 per share for FY 2021 (to be same as FY 2020), notwithstanding an expected decline in its net profit for the current fiscal year.

Also, ORIX Corporation aims to complete its JPY100 billion repurchase program for the remainder of FY 2021. The company still has JPY44.2 billion remaining from its JPY100 billion share buyback program, after spending JPY45.7 billion and JPY10.1 billion on share repurchases in FY 2020 and 1H FY 2021, respectively. ORIX Corporation had earlier suspended the share repurchase program due to uncertainty resulting from COVID-19, but it has now decided to resume share buybacks.

It is noteworthy that the company highlighted at its recent 2Q 2021 results briefing that “from the next year onwards, we may want to perhaps come up with yet another round of repurchase program.” This is a strong signal that ORIX Corporation will continue to increase the amount of excess capital returned to shareholders going forward.

Valuation

ORIX Corporation trades at consensus forward FY 2021 (YE March) and FY 2022 P/E multiples of 9.3 times and 7.5 times based on its share price of JPY1,525 as of November 20, 2020. The stock is also valued by the market at 0.64 times P/B, versus its three-year and five-year mean P/B multiples of 0.75 times and 0.82 times, respectively.

Risk Factors

The key risk factors for ORIX Corporation are a longer-than-expected time taken for the company’s earnings to return to pre-COVID-19 levels, new investments that fail to create value for the company and its shareholders, and lower-than-expected capital returned to shareholders via dividends and share buybacks.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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