IX - ORIX: Multiple Catalysts

Summary

• ORIX Corporation's Aircraft & Ships and Real Estate segments are benefiting from the reopening of economies, as seen with their respective Q1 FY 2023 performances.
• IX has divested some physical assets in the recent quarter while continuing to work on certain PE exits; I expect its capital recycling activities to create value for the company.
• ORIX Corporation has been increasing the amount of capital it returns to its shareholders via both dividends and buybacks in recent years.
• ORIX Corporation is rated now as a Buy, in view of its current undemanding valuations and the multiple catalysts for the stock.

Elevator Pitch

I upgrade my investment rating for ORIX Corporation's ( IX ) [8591:JP] stock from a Hold to a Buy.

My earlier November 23, 2020 initiation article for ORIX Corporation highlighted how the COVID-19 pandemic had affected the company's financial performance.

In this latest article, I turn my attention to the multiple re-rating catalysts for IX, which include the positive impact of reopening on specific business segments, an improvement in shareholder capital return, and a faster pace of capital recycling. The market currently values ORIX Corporation at a 20% discount to its book value, and I am of the view that IX can trade above book value in time to come when these catalysts are realized. As such, I decide to assign a Buy rating to ORIX Corporation.

A Beneficiary Of Reopening

As the COVID-19 moves gradually towards an endemic state, the reopening of economies will be positive for many businesses that suffered from various lockdowns and restrictions during the worst of the pandemic. ORIX Corporation's Aircraft & Ships and Real Estate businesses will be among these beneficiaries.

Previously, IX stressed at the company's FY 2022 (YE March 31) investor call on May 11, 2022 that it is "expecting recovery (for these segments impacted by COVID-19 pandemic) to some extent" which "will turn from negative to positive contributions." ORIX Corporation has proven to be right.

The company announced its most recent Q1 FY 2023 financial results on August 3, 2022, and IX's Aircraft & Ships and Real Estate segments were the key outperformers in the first quarter of fiscal 2023.

The Aircraft & Ships business segment turned around from losses of -JPY5.0 billion in Q1 FY 2022 and -JPY5.2 billion in Q4 FY 2022 to generate positive earnings of JPY5.4 billion for Q1 FY 2023, as indicated in its most recent quarterly earnings presentation . At its Q1 FY 2023 earnings briefing on August 6, 2022, IX emphasized that "earnings are in an uptrend" for its aircraft leasing business, which is attributable to "recovery in (air travel) passenger demand." According to The International Air Transport Association's most updated June 2022 forecasts , the global airline industry is expected to return to profitability in 2023 which bodes well for the recovery prospects of ORIX Corporation's aircraft leasing business.

Segment profit for IX's Real Estate business grew by +120% QoQ and +12% YoY to JPY11.9 billion in the most recent quarter. ORIX Corporation operates hotels as part of its Real Estate segment, so the recovery of the Japanese tourism sector with the easing of border restrictions has been a key tailwind. In a further boost for ORIX Corporation's Real estate business segment and Japanese hotel operations going forward, Bloomberg recently reported on August 31, 2022, that Japan will "allow non-guided group tours from September" 2022. This represents a major step in the normalization of the tourism market in Japan.

Looking forward, IX's future earnings growth should be supported by a further recovery in the Real Estate and Aircraft & Ships business segments over time.

Leveraging On Capital Recycling To Create Value

ORIX Corporation's PE (Private Equity) Investment & Concession business, first set up in 2012, is a key value driver for the company, as this segment helps IX to seek out new business growth opportunities and recycle capital to improve returns.

In its Q1 FY 2023 results presentation, ORIX Corporation specifically highlighted that one of the key purposes of having the PE Investment & Concession unit is "to develop new business segments for ORIX." As indicated in the chart below, IX had invested in a number of healthcare and technology companies via its PE Investment & Concession business.

Selected Investments Made By ORIX Corporation's PE Investment & Concession Business Segment

More significantly, the PE Investment & Concession unit provides a way for ORIX Corporation to create value by recycling capital from low-return investments or assets into higher-yielding investment opportunities with greater growth potential.

IX's PE Investment & Concession business has had a good track record, achieving a mean Internal Rate of Return or IRR of approximately 30% for the eight divestments or exits it has completed between 2012 and 2021. ORIX Corporation emphasized at the company's recent first-quarter investor briefing that "we will be doing some of them (PE exits)" for the remainder of fiscal 2023.

Also, it must be noted that ORIX Corporation's capital recycling activities aren't just limited to its PE Investment & Concession unit. IX disclosed at its Q1 FY 2023 results call that it divested some physical properties and ships in the recent quarter, and it highlighted that this will free up excess capital for "additional investment to be made in" its "existing line of businesses" as well.

ORIX Corporation's goal is to improve the company's overall Return On Equity or ROE from 9.9% in fiscal 2022 to 11.7% by fiscal 2025. Apart from capital recycling, capital return is also a key component of IX's strategy to expand its ROE (by shrinking the capital base) which I will touch on in the next section.

Shareholder Capital Return

IX has done an excellent job in returning an increasing proportion of the company's excess capital back to its shareholders.

Excluding the fiscal 2021 (April 1, 2020 to March 31, 2021) period which was affected by the pandemic, ORIX Corporation's dividends have been steadily increasing in the past few years. IX's dividend payout ratio increased from 30% in fiscal 2019 to 32% in fiscal 2020, prior to rising to 33% for fiscal 2022.

If one includes share buybacks, it becomes even more apparent that ORIX Corporation is indeed returning more capital to the company's shareholders in a very aggressive manner. IX's total shareholder return ratio, calculated as the amount allocated to dividends and buybacks as a proportion of earnings, grew from 30% for FY 2019 to 47% for FY 2020, and increased again to 49% in FY 2022.

Moving ahead, ORIX Corporation has committed to a dividend "payout ratio of 33% or previous fiscal year’s dividend (in absolute terms), whichever is higher" as mentioned in its recent quarterly results presentation. Separately, IX has allocated JPY50 billion to share repurchases for FY 2023, and it has already spent JPY17.3 billion on buybacks between April 1, 2022 and July 30, 2022. The company has sent a very clear signal that its intention is to further enhance shareholder capital returns.

Bottom Line

ORIX Corporation is deserving of a Buy rating. IX is currently valued by the market at a trailing P/B multiple of 0.8 times. At its FY 2022 earnings briefing on May 11, 2022, ORIX Corporation noted that it hoped to "bring back the share price level" so as "to achieve a PBR (Price-to-Book Ratio) of more than 1 times." I think that IX's P/B valuation multiple can re-rate from the current 0.8 times to above 1 times in the future, as its ROE increases with the recovery in pandemic-hit segments, more aggressive capital recycling and improved shareholder capital return.

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