(1) Selling price increases
In fiscal year 2024 (from April 1, 2024 to March 31, 2025), we forecast lower sales and profits based on the assumption that the exchange rate will be 140 yen to the US dollar and expectations that demand for construction and mining equipment will decline due to persistently high interest rates and the economic slowdown. How-ever, we plan to increase selling prices further by 100 billion yen, the same level as in the past two years. From FY2023, we began disclosing consolidated profit and loss by location and destination at meetings attended by regional managers, making it possible to compare consolidated profit and loss for each region under the same conditions. These disclosures further incentivized regional managers to increase selling prices. From FY2024, we will link the compensation of the top management of group companies to the consolidated results of each region, thereby further promoting the increase of selling prices.
Comparing the changes in selling price with changes in production costs since FY2021 (Figure 3), the increase in selling price exceeded the increase in production costs cumulatively for the first time in the fourth quarter of FY2023. We will reap the benefits of the increases in selling prices further in FY2024.
(2) Fixed cost control
On the other hand, our basic policy regarding fixed costs is to keep them flat, regardless of sales fluctuation. In fact, for the five years from FY2017 to FY2021, despite various changes in the business environment and increases and decreases in sales, Komatsu has controlled fixed costs at a flat level through structural reforms and efficiency improvements. However, from the second half of FY2021, fixed costs increased due to rapid increases in labor costs and expenses against the backdrop of global inflation, in addition to accelerated strategic investments for future growth with an eye to carbon neutrality (Figure 4).
Komatsu breaks down PBR (Price Book-value Ratio) into PER (Price Earnings Ratio) and ROE (Return on Equity). We then break down PER into its components 1) cost of capital and 2) expected cash flow growth rate, and ROE into 3) net income ratio, 4) total assets turnover, and 5) financial leverage. Finally, we compare each item with competitors to discuss and implement measures to improve PBR (Figure 5). In each item from 1) to 5), we ex-plain our initiatives to improve corporate value at Komatsu.
We assume that Komatsu’s global level of cost of shareholders’ equity has been around 8%. We set a management target of ROE of 10% or more, which is higher than the global level, and are work on both improving ROE and reducing cost of shareholders’ equity to increase the equity spread (ROE - cost of shareholders’ equity). In terms of the cost of capital reduction, our main initiatives are composed of reducing business volatility and conducting share buybacks.
Our internal analysis indicates that this item, “Expected cash flow growth rate,” is the one that needs the most improvement compared to competitors. To accelerate growth, Komatsu allocates management resources to growth areas with an emphasis on R&D investments, capital investment, and M&A.
Based on our cash allocation policy, we allocate cash for the following three purposes: (1) capital investments (growth strategies), (2) shareholder returns, and (3) balance sheet improvements (preparation for future M&A activities) (Figure 8). We believe that growth investments are the most important factor to continue stable shareholder returns. To this end, our policy aims to allocate approximately 50% of operating cash flow to capital expenditures and to always be prepared for future M&A.
Komatsu aims to reduce CO2 emission by 50% in 2023 from 2010 levels. We also aim to achieve carbon neutrality by 2050 (challenging goal). To achieve these goals, Komatsu invests heavily in research and development for the future, including for fuel cells, hydrogen engines, and biodiesel engines. We also research and develop hybrid technology, diesel electric, tethered electric, and battery electric, which are already in practical use (Figure 10). These important investment projects are managed separately as mid-term management plan projects. Budgets are allocated to these projects on a priority basis due to the risk that future growth may be significantly impeded if ordinary fixed cost management is applied to reduce these investments.
We will further strengthen our IR activities to clarify the Komatsu growth strategies described above and facilitate understanding among investors.
In profitability management, we use direct cost accounting, which clarifies the definitions of variable and fixed cost items and applies them consistently to the entire group, enabling us to compare profitability in each region. This is the basis of our global cross-sourcing operation for production, which enables us to produce products with the same specifications and quality at production bases around the world.
Overseas markets account for 90% of Komatsu’s sales, and 70% of our employees work outside of Japan. The number of top management of overseas subsidiaries has also increased to national employees. We keep management indicators as simple as possible so that they can be intuitively understood by diverse nationalities and employees who are not in accounting positions. For example, in profit and loss calculation, we define SVM (Standard Variable Margin), CC (Capacity Cost), and CC headcount (headcount considered as fixed cost) as management indicators to improve profitability through continuous sales price increases, fixed cost management, and cost reduction. We will continue to improve profitability by continuously increasing sales prices, managing fixed costs, and reducing costs.
Komatsu introduced ROIC in FY2017. To properly manage working capital, we have been monitoring the cash conversion cycle on a regular basis by expanding and implementing the invested capital in the ROIC calculation formula to working capital + property, plant and equipment. However, ROIC has the disadvantage that the impact of earnings is so large that the indicator improves even if asset efficiency deteriorates if earnings improve, and that the business units cannot directly perceive the improvement due to the “ratio” display. In addition, the ratio display meant that business divisions could not directly perceive the improvement.
From FY2023, we introduced free cash flow (FCF) as a management indicator for each group company with the aim of further improving ROIC for the entire company. The purpose of this measure is to enable each group company to realize whether its asset efficiency is good or bad in terms of the amount of money rather than the rate.
The plan is to add a twist to the standard cash flow statement and break down the sources of FCF generation into four categories: (1) profit, (2) working capital, (3) fixed assets (depreciation - investment), and (4) M&A. We aim to clarify the sources and absolute amounts that should be improved directly and focus on improvements while maximizing future cash flow. The plan is to maximize future cash flows while focusing on improvements by clarifying the “sources” and “absolute amounts” that should be improved directly (Figure 11).
In terms of the balance sheet management, we intend to keep our debt at a level that will enable us to maintain our current S&P and Moody's single-A ratings (Figure 13). In FY2023, our rating improved from AA- (stable) to AA (stable) under the R&I rating agency. We believe this is due to the progress in our geographic diversification of sales and the increased depth of earnings derived from the parts and service business (aftermarket business), which is less susceptible to economic downturns.
Regarding dividends, we will continue our policy of maintaining a stable dividend payout ratio of 40% or more on a consolidated basis, taking into account consolidated financial results, future investment plans, cash flow, and other factors. As in the past, we intend to flexibly implement share buybacks based on the comprehensive consideration of fulfillment status of the above criteria. (Figure 14).
Komatsu has regarded our retail finance business as an important sales promotion tool for construction and mining equipment. The business has expanded progressively to strategically important regions, with its asset size increasing 1.6 times over the past five years.
Komatsu verifies regularly our improvement of corporate value from a finance and accounting perspective using two indicators. One is the total of market capitalization and net interest-bearing debt, which focuses on invested capital. The other method is the cumulative EVA® (Economic value added; net operating profit after tax – cost of capital), which focuses on ROIC and WACC (weighted average cost of capital). In both cases, we confirmed improvement in FY2023.
We also conducted a quantitative analysis of social impact of our core business in FY2023 using Impact-weighted accounts, proposed by Harvard Business School*. We calculated the impact for the Autonomous Haulage System (AHS) and DX Smart Construction, which are priority activities in the mid-term management plan. Our calculations confirmed that we have achieved significant effect. We believe one of the roles of the finance and accounting division is clarify the impact of such ESG investments to help resolve ESG issues and enhance corporate value.
* Joint analysis with ABeam Consulting Ltd. Impact-weighted accounts has evolved from the Harvard Business School’s Impact-Weighted Accounts Initiative to now the International Foundation for Valuing Impacts (IFVI).
