Management practices that factor in the cost of capital while maintaining profitability and financial soundness
We aim to maximize our Enterprise Value with financial and non-financial integration while supporting the transformation toward the realization of the NGK Group Vision through a financial strategy that ensures profitability and maintains financial soundness.
Achieving the NGK Group Vision
In the NGK Group Vision announced in April 2021, we set targets of 600 billion yen in net sales, 90 billion yen in operating income, and 60 billion yen* in net income for FY2025.
In FY2022, net sales increased 9.6% year-on-year to 559.2 billion yen, owing to foreign exchange fluctuations due to the dramatic depreciation of the yen. As a result, we set a new record high for net sales. However, operating income fell by 20.1% year-on-year to 66.8 billion yen, due to the major impact of fuel prices rising higher than anticipated and other increased expenses such as rising labor costs caused by inflation. In addition, while tax refunds were received pertaining to the transfer pricing taxation (approx. 11.8 billion yen), net income fell by 22.3% year-on-year to 55 billion yen. This was because of the recorded extraordinary losses to optimize production capabilities for the Environment Business, including the impairment loss on fixed assets at our Chinese bases and losses incurred by affiliates due to the decision to stop production in South African facilities, as well as the recorded impairment loss due to the decision to discontinue the manufacture and sale of insulators at the Chita site.
In FY2023, we forecast a record high year-on-year of 565 billion yen in net sales, since automotive products sales for the Environment Business are projected to remain strong despite continued market deterioration surrounding the Digital Society Business caused by decreased investments in semiconductors and data centers. In terms of profit, the target for operating income is 56 billion yen due to reduced volumes for the Digital Society Business as well as increased costs for fuel, labor, and other expenses. Although we are projecting a decrease in profits because of temporary market stagnation, we are accelerating our efforts to improve overall profitability by revising sales prices, improving profits for the Environment Business, expanding the Digital Society Business, and achieving a surplus for the Energy & Industry Business. Going forward, we will appropriately allocate management resources to achieve the targets for the NGK Group Vision while monitoring changes in the external environment and market trends. As part of the capital input into New Value 1000 aiming to achieve sales of 100 billion yen or more from newly launched businesses by FY2030, we plan to invest 300 billion yen in research and development within a 10-year period from 2021. In FY2023, we plan to invest a record of 31 billion yen with carbon neutrality and digital society-related projects accounting for approximately 70% of the total, or over 20 billion yen.
Assuming an exchange rate of 100 yen to 1 dollar and 120 yen to 1 euro
Enhancement of Enterprise Value
We prioritize the interests of our shareholders, and position sustainable improvements to Enterprise Value and profit returns as one of our most important management policies. Our stock market evaluation has a P/B ratio (price-to-book ratio) of less than 1 as of the end of the fiscal year ended March 31, 2023. With the aim of early improvements, the Company will strive to enhance the Enterprise Value by promoting three initiatives: enhanced profitability of capital, secured growth, and the enhancement of non-financial value. The details of these initiatives are as follows.
Enhanced profitability of capital
Our shareholders’ equity cost is assumed to be 9.1% using CAPM (Capital Asset Pricing Model). In order to exceed this cost we promote management focused on capital efficiency targeting more than 10% return on equity (ROE) from a medium- to long-term perspective. We set targets for each business department to improve profitability using ROE and the relevant NGK return on invested capital (ROIC; operating income ÷ business assets) for deployment within NGK based on the capital policy that factors in financial soundness.
We manage our portfolio focusing on two focal points of profitability and growth, review the standards of 10% NGK ROIC and 5% sales growth rate, and examine priority investments into the businesses expected to grow. At the same time, we individually examine the business continuity assessment for each area categorized as low growth or low profit. In addition, we will strengthen R&D to achieve sustainable growth and secure growth to achieve the targets of New Value 1000 by 2030.
The Environment Business that mainly produces automotive parts has become a core business for the time being. Even though sales growth will be limited as a result of the shift to electric vehicles, we endeavor to conduct business operations that are highly profitable and effective while promoting measures for manpower reduction, shortened lead times, and cost cutting. The Environment Business aims to improve cash-generating capabilities in the short-term, factoring in the future transformation to a carbon neutral business structure and the diversion of facilities for these projects, such as direct air capture (DAC).
Moreover, the Digital Society Business, which is the core driver of future growth, increases our competitiveness with the introduction of high value-added products, expands investment, and improves profitability to reinforce growth potential in the medium- to long-term. The Energy & Industry Business improves the profitability for each business to drive future growth areas.
Progress Relative to the NGK Group Vision (performance trends)
Medium-term Business Portfolio Approach
Enhancement of non-financial value
In recent years, intangible capital, such as intellectual capital and human capital, is becoming increasingly important as a yardstick to measure Enterprise Value. In other words, we must factor in non-financial value in addition to financial value. Our management is centered on ESG to achieve sustainable growth and fully transform into a business contributing to carbon neutrality and a digital society as laid out in the NGK Group Vision. The NGK Group fulfills many social responsibilities to reduce its environmental impact and to improve its human capital by enhancing its non-financial value, which will ultimately lead to the enhancement of its enterprise value. As a tangible initiative, we are incorporating NGK version of added value (NGK Value-added) into our management indicators to comprehensively evaluate the compatibility of pursuit of profit and investment in human capital and intellectual capital, which are sources for future growth. NGK Value-added takes into account CO2 emissions costs, labor costs, R&D expenditure, and the attainment of ESG targets for each rating agency in the operating income. In addition to financial value for short-term profitability and medium- to long-term growth potential, we will increase non-financial value that does not appear on a financial statement thereby enhancing our enterprise value.
Relations Between Enterprise Value and Management Indicators
Implementing capital policy after assessing the cost of capital
While we secured 12.9% for ROE in the fiscal year ended March 31, 2022 exceeding the shareholder’s equity cost and 13.3% for NGK ROIC exceeding the 10% Weighted Average Cost of Capital (WACC) before taxes, these are both expected to temporarily fall below 10% in the fiscal year ended March 31, 2023 and fiscal year ending March 31, 2024 due to a downturn in the market.
Regarding capital policy, we are focused on achieving profitability that exceeds the cost of capital while maintaining financial soundness and ensuring profit margins, capital turnover, and financial leverage at sound levels consistent with our business strategy based on an understanding of this situation. We aim to actively provide returns to shareholders including the application of interest-bearing liabilities and flexible share buybacks by reducing capital costs, driving revenue growth for existing businesses, transforming our business portfolio, and expanding new businesses. By doing so we aim to improve ROE, and increase our equity spread. In terms of funds availability, the D/E ratio should be set to 0.4 to maintain financial soundness based on financing with interest-bearing liabilities.
Returning profits policy
We place an emphasis on the benefits for all shareholders and position the sustainable enhancement of Enterprise Value and returning profits as part of our most important policies for management. We will maintain a good balance between securing appropriate investment funds for growth and returning profits with a focus on capital efficiency.
Regarding dividends, we aim to maintain a dividend on equity ratio of 3% and a consolidated dividend payout ratio of around 30% over the medium and long term, while giving consideration to the link between net asset management in line with changes in business risks and our three-year return on equity (ROE). We also give consideration to cash flow forecasts and other factors when determining allocation. Based on this approach, we have decided to implement a shareholder dividend of 66 yen per share for FY2022. In line with the standard dividend payout ratio and dividends on equity, we plan to implement a shareholder dividend of 50 yen per share in FY2023.
Moreover, we have been buying back shares to improve capital efficiency and enhance shareholder returns. In FY2022, we repurchased and canceled 5.5 million stocks (worth 9.6 billion yen). Going forward, we will continue to flexibly implement these measures while comprehensively considering factors such as growth investments, dividend levels, cash on hand, and share price.
Information disclosure and dialogue with investors and shareholders to enhance Enterprise Value
At the NGK Group, we recognize that the essence of IR is proactive information disclosure and dialogue with investors and shareholders, and thus we have enhanced disclosure and communication with investors since the 1990s. Specifically, we hold financial results briefings biannually for institutional investors and provide forums for overseas investors hosted by the lead underwriters, overseas IR activities, individual investor IR activities, telephone interviews, and visits to individual institutional investors. In recent years, interactions have mainly been online due to the impact of the COVID-19 pandemic, but going forward we will revive opportunities for in-person dialogue since the COVID-19 crisis has settled down.
During these dialogues, we are keenly aware of the need to clearly communicate NGK Group’s medium- to long-term direction and initiatives with unbiased current performance reports and to carefully explain the context, situation, and outlook when performance has deteriorated.
Feedback from stakeholders is extremely beneficial in improving the quality of management. We considered these shared opinions to be a vote of confidence in the NGK Group. We continuously strive to increase opportunities for dialogue with stakeholders, aiming to further enhance our Enterprise Value and shareholder value.
Note: This interview was conducted in May 2023.