My investment rating for ORIX Corporation (NYSE:IX) [8591:JP] the stock remains a Buy.
In the previous coverage I wrote about sales of IX’s assets and purchases of shares in mine Article of September 8, 2023. The focus of the present paper is ORIX Corporation’s return on assets or ROA improvement potential.
ORIX Corporate’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 second half of this fiscal year. I maintain a Buy rating on ORIX Corporation based on my expectations that the company’s ROA will be higher in the near term.
Declining return on assets and depreciation
ORIX Corporation’s ROA was up to 2.28% for fiscal year 2022 (April 1, 2021 to March 31, 2022) as shown in the company’s FY2nd quarter 2024 financial results presentation of additional information. But the company’s ROA subsequently fell to 1.96% and 1.65% for full year FY 2023 and 1H FY 2024, respectively.
As such, it’s no surprise that ORIX Corporation’s consensus trailing twelve-month EV/EBITDA compressed from over 20x for most of FY 2022 to 11.9x (source: S&P Capital IQ) on November 17, 2023. In other words, the depreciation of ORIX Corporation in the last year and a half (FY 2023 and 1H FY 2024) is in line with the decrease in the company’s ROA during the same time period.
In the following sections, I highlight the key drivers of ROA expansion for IX.
The bank and credit have 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 shown in the chart below. On the other hand, the Banking and Credit segment has the largest asset base among the various businesses of IX with assets of JPY 2,705.8 trillion at the end of the second quarter of FY 2024.
Corresponding 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 wants to expand the company’s overall ROA. IN Q2 FY 2024 earnings call, ORIX Corporation revealed that the Bank and Credit business objective is to increase ROA from the current 0.8% to 1.0% in the future. IX has plans to increase the future ROA of the Banking and Credit segment by shrinking the asset base and seeking new drivers of earnings growth.
ORIX Corporation noted in the company’s most recent quarterly conference call that its goal is to reduce aggregate assets for the Banking and Credit business by approximately -17% to 2.5 trillion JPY. Separately, IX disclosed in its second quarter FY 2024 results that the Banking and Credit segment will “develop and sell (new) financial products” by “leveraging its trust banking license” and this is expected to be a key lever of profit growth for this. business.
The International Renewable Energy business has the potential to deliver an ROA of 3%.
Late last year, ORIX Corporation issued a Press release revealing that it acquired “the remaining 20% of the shares of Elawan Energy SL, a global renewable energy company headquartered in Madrid, Spain” to make it a “wholly owned subsidiary”.
IX shared in its FY 2024 Q2 results that Elawan has “a mature portfolio for future capital recycling,” which makes the company confident that Elawan can “achieve an ROA of 3% or more high” in the future tense. The total capacity of Elawan’s renewable energy assets currently in operation amounts to approximately 1.65 GW, and Elawan still has 8 GW of renewable energy capacity in the pipeline.
ORIX Corporation has already identified some of Elawan’s mature assets that could potentially be sold in the current or next fiscal year. As IX disposes of Elawan’s assets with lower ROAs and invests in new assets with higher ROAs, it is natural to assume that Elawan’s overall ROA may gradually increase to 3%.
Positive perspective of earnings from investments of 2 H FY 2024
Moving away from individual business units, IX has guided for a significant increase in earnings from investments related to asset sales in the second half of the current fiscal year.
ORIX Corporation recorded investment gains of JPY 23.6 billion related to asset disposals in 1H FY 2024. Looking ahead, IX expects to realize investment gains of up to JPY 150 billion at the end of its financial guidance outlined in second quarter of FY 2024 slides for presentation of results. According to the company’s recent Q2 earnings presentation, ORIX Corporation sees “real estate (strong overseas demand)” and “domestic PE (private equity) investment (many potential buyers)” as business areas where it has more sales opportunities.
In short, a faster pace of asset disposal for the company as a whole will be another driver of ORIX Corporation’s ROA expansion.
There are a number of levers ORIX Corporation can pull to increase the company’s ROA going forward. A higher ROA going forward will translate into valuation multiple expansion for IX, and this supports a Buy rating on this stock.