IX - ORIX: Eyes On ROA Expansion

2023-11-20 10:24:09 ET

Summary

• ORIX's international renewable energy unit (Elawan), and its Banking and Credit business, are expected to register superior ROAs going forward.
• ORIX Corporation's guidance points to a substantial growth in the amount of asset disposals for 2H FY 2024.
• I retain a Buy rating for IX in view of the potential for ORIX Corporation's ROA to increase in a meaningful way for the future.

Elevator Pitch

My investment rating for ORIX Corporation ( IX ) [8591:JP] stock remains as a Buy.

In previous coverage I wrote about IX's asset sales and share buybacks in my September 8, 2023 article . The focus of the current write-up is ORIX Corporation's Return On Assets or ROA improvement potential.

ORIX Corporation's Banking and Credit segment and its international renewable energy business Elawan are well-positioned to expand their respective ROAs. IX is also guiding for an accelerated pace of asset monetization in the latter half of this fiscal year. I continue to award a Buy rating to ORIX Corporation based on my expectations that the company's ROA will be higher in time to come.

Return On Assets Decline And Valuation De-Rating

ORIX Corporation's ROA was as high as 2.28% for fiscal 2022 (April 1, 2021 to March 31, 2022) as indicated in the company's Q2 FY 2024 financial results supplementary information presentation. But the company's ROA subsequently declined to 1.96% and 1.65% for full-year FY 2023 and 1H FY 2024, respectively.

As such, it is no surprise that ORIX Corporation's consensus forward next twelve months' EV/EBITDA compressed from above 20 times for the most part of FY 2022 to 11.9 times (source: S&P Capital IQ ) as of November 17, 2023. In other words, ORIX Corporation's valuation de-rating in the past one and half years (FY 2023 and 1H FY 2024) is consistent with the decrease in the company's ROA during the same time period.

In the subsequent sections, I highlight the key ROA expansion drivers for IX.

Banking And Credit Has The Largest Asset Base And The Lowest ROA

The ROA for IX's Banking and Credit business segment is below 1.0% in absolute terms, and lower than the company's other business segments on a relative basis as indicated in the chart below. On the other hand, the Banking And Credit segment has the biggest asset base among IX's different businesses with assets of JPY2,705.8 trillion as of end-Q2 FY 2024.

The Respective ROAs For ORIX Corporation's Various Business Segments

The Banking and Credit business represents an area where there is room for improvement, if ORIX Corporation wishes to expand the company's overall ROA. At the Q2 FY 2024 earnings call , ORIX Corporation revealed that the Banking and Credit business' target is to increase its ROA from the current 0.8% to 1.0% in the future. IX has plans to push up the future ROA of the Banking and Credit segment by shrinking the asset base and seeking new earnings growth drivers.

ORIX Corporation noted at the company's most recent quarterly results briefing that its goal is to lower the aggregate assets for the Banking and Credit business by roughly -17% to JPY2.5 trillion. Separately, IX disclosed in its Q2 FY 2024 results briefing that the Banking and Credit segment will "develop and sell (new) financial products" by "utilizing its trust banking license", and this is expected to be a major profit growth lever for this business.

International Renewable Energy Business Has The Potential To Deliver A 3% ROA

Towards the end of last year, ORIX Corporation issued a press release revealing that it bought "the remaining 20% of the shares of Elawan Energy S.L., a global renewable energy company headquartered in Madrid, Spain" to make it a "wholly-owned subsidiary."

IX shared at its Q2 FY 2024 results call that Elawan owns "a portfolio ripe for capital recycling in the future", which makes the company confident that Elawan can "achieve an ROA of 3% or higher" in time to come. The total capacity of Elawan's renewable energy assets that are currently in operation amounts to approximately, 1.65GW, and Elawan still has 8GW worth of renewable energy capacity in the pipeline.

ORIX Corporation has already identified some of Elawan's mature assets that could be potentially divested in the current or next fiscal year. As IX disposes of Elawan's assets with lower ROAs and invests in new assets boasting higher ROAs, it is natural to assume that Elawan's overall ROA can gradually creep up to the targeted 3%.

Positive 2H FY 2024 Investment Gains Outlook

Moving away from individual business units, IX has guided for a significant increase in investment gains associated with asset sales in the second half of the current fiscal year.

ORIX Corporation recorded JPY23.6 billion worth of investment gains relating to the disposal of assets in 1H FY 2024. Looking forward, IX expects to realize investment gains of as much as JPY150 billion at the top end of its financial guidance outlined in its Q2 FY 2024 results presentation slides . As per the company's recent second quarter earnings presentation, ORIX Corporation sees "real estate (strong demand from overseas)" and "domestic PE (Private Equity) investment (many potential buyers)" as the business areas where there are the most opportunities for divestitures.

In a nutshell, a faster pace of asset disposals for the company as a whole will be another driver of ORIX Corporation's ROA expansion.

Final Thoughts

There are a number of levers that ORIX Corporation can pull to increase the company's ROA going forward. A higher ROA for the future will in turn translate into valuation multiple expansion for IX, and this supports a Buy rating for this stock.

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