Alternative Sourcing Proposals Turn Middle East Risk Into Opportunity and Drive Record 1H Profit; Management Aims to Beat Its Lower Revenue and Profit Guidance, With a Possible Revision Within 3–4 Months in Focus

Summary

In 1H FY3/27, revenue and profit at every level hit record highs for an interim period. HVAC installation, chemicals and energy led profit growth. The Middle East situation hurt the supply chain and raised procurement costs less than management had assumed at the start of the year. Alternative sourcing proposals, built on the company's procurement capabilities as a trading company, also lifted results. Management said the company is shifting from a 2H-weighted earnings profile to one that can build profit in 1H. However, with the Middle East outlook still unclear, it kept full-year guidance for lower revenue and profit unchanged. On shareholder returns, the company raised the interim dividend. It also said it will revise guidance if the full-year landing becomes visible within 3–4 months.

Key Points

• Management Strategy and Market View
  • Initial guidance assumed the temporary disruption from the Middle East situation would settle down during 1H. The President said the plan assumed any damage taken in 1H would be recovered over the full year.
  • Management believes a 2H bias remains, but that a deep project pipeline is turning the company into one that can build profit from 1H.
  • The President believes the rise of AI will shift where SIers create value. He said capturing demand for systems that AI can easily access ("AI operability") would expand business opportunities.
  • Going forward, the President aims to create innovation by layering and linking business areas, and to leverage the company's trading-company role in unlocking suppliers' latent capabilities.
• Current Business Progress and Drivers
  • In Chemicals, higher utilization at electronic component customers and alternative sourcing proposals amid the Middle East situation boosted sales of chemical products in Japan and Vietnam. Contract manufacturing of functional materials also grew after a product for which the company supplies raw materials received MAFF approval.
  • The valuable metals recovery business in Chemicals saw higher volumes, helped by larger copper recovery and rising copper prices. Active pharmaceutical ingredients (API) revenue declined against large sales of in-house products in the prior-year period.
  • HVAC Installation posted record revenue and operating income for the third consecutive year, driven by progress on large new-build projects in Hokuriku and higher value-added work. Orders fell against record-large projects in the Tokyo metropolitan area and Hokuriku in the prior-year period.
  • The revenue and profit decline in Information Systems reflects the absence of a large NEXT GIGA School project booked in the prior year. The President said that, excluding this project, revenue and profit remain on an upward trend.
• Key Strategic Initiatives and Changes
  • In response to the Middle East situation, the company offered proposals to reconfigure customers' supply chains. These included quality-assured supply of overseas ethylene, substitution with plant-derived alcohol and paper materials, and outsourced thinner production in partnership with external parties.
  • The interim dividend was raised from JPY 5 to JPY 6, lifting the annual dividend forecast to JPY 14. The increase follows the company's policy of securing three years' worth of dividend funding.
  • For Active Pharma's continuous flow process, the company will assign one plant per product and add plants based on products and demand. Each plant is roughly the size of two phone booths and needs about one-tenth the space of a batch process.
  • The company obtained a US patent for technology that normalizes diverse risk information into a format AI can easily read. It also disclosed a value-added distribution statement for the first time, showing how value is allocated among stakeholders.

Outlook

• The full-year plan of revenue of JPY 113,000M, operating income of JPY 3,000M, recurring profit of JPY 3,900M and net income of JPY 2,600M was maintained, implying lower revenue and profit. As of 1H, progress reached 61.7% for operating income and 73.1% for net income.
• Guidance was kept unchanged because the damage assumed at the start of the year could still materialize in 2H. The President said guidance will be revised as needed if the landing becomes visible within 3–4 months.
• The President aims to overturn the forecast of lower revenue and profit, targeting a result that will be seen at year-end as higher revenue and profit. If results exceed expectations, the company will also consider further revising the dividend forecast.
• In the environmental business, the company will expand the range of recoverable metals to adapt to changes in the composition of waste. It is also considering building a recovery supply chain for lithium and cobalt, which it expects to increase.
• Investee Helical Fusion expects commercial power generation roughly 10 years out. The company will explore opportunities in materials procurement and architectural design from the pilot plant stage. With Movus technologies, it is considering a business partnership in Southeast Asia based on their track record in Indonesia.

Positive Factors

• Amid procurement difficulties, the company's ability to combine substitute products, alternative sourcing routes and contract manufacturing in its proposals demonstrated its competitiveness as a trading company.
• Active Pharma's continuous flow synthesis of iguratimod achieved an overall yield of 75% and purity above 96%. The results were published in a peer-reviewed ACS journal.
• A policy of releasing AI prototypes as soon as they are built has increased inquiries from companies with no prior relationship. The bear detection system was released about 30 days after planning began.
• In information security, inquiries are coming from companies beyond the POWER EGG customer base, and consulting engagements such as investment planning are increasing.
• In Resin & Electronics, the company has increased the processing speed of its AI-based automated visual inspection machines and is redeploying inspection staff to production. This positions the company to gain an advantage in Vietnam, where labor costs are rising.
• The company is increasing in-person IR exposure. According to the President, the share price is trading at more than double its level of 18 months ago.

Concerns

• The Middle East situation remains uncertain, and management acknowledges the possibility of unexpected industrial damage in 2H.
• AI's impact on the SI business has yet to settle. Misjudging where the value of a system integrator will shift poses a downside risk.
• The President views information security, where AI is also used by attackers, as a risk no smaller than COVID-19 or the Middle East situation. He also acknowledged that the cost of strengthening security will affect results.
• Multiple cost pressures are compounding, including rising labor costs, demands to pass on price increases, and price hike requests from suppliers.
• Housing Equipment remains loss-making at the operating level due to ongoing promotional spending on its original brand.
• HVAC Installation orders declined against record-large projects in the prior year, so the depth of revenue from next fiscal year onward needs to be monitored.

Performance Highlights

1H revenue was JPY 56,780M (+0.3%) and operating income was JPY 1,850M (+9.2%), both record highs for an interim consolidated period. Revenue hit a record for the fifth consecutive period, operating income and recurring profit for the second, and interim net income attributable to owners of parent for the fourth. HVAC Installation drove profit, absorbing declines in Information Systems and Resin & Electronics.

Segment Performance

• Recurring Profit: JPY 2,389M (+4.8% YoY)
• Interim Net Income Attributable to Owners of Parent Company: JPY 1,900M (+3.3% YoY)
• Chemicals Operating Income Progress vs. Plan: 72.5%
• Resin & Electronics Operating Income Progress vs. Plan: 69.0%
• HVAC Installation Operating Income Progress vs. Plan: 63.6%
• Energy Operating Income Progress vs. Plan: 23.4%

Q&A List

• Q

  On the anti-rheumatic drug iguratimod, you announced the development of a continuous flow process. What specific steps are you considering toward commercialization? For example, building a pilot plant?

  A

  We already have a pilot plant running inside Active Pharma's factory. To give you an image, one complete line fits in roughly the space of two old-style phone booths. A conventional batch process using reaction vessels would have required about ten times that space. We have been adding products to our continuous flow lineup: tamsulosin last time, and iguratimod this time. With reaction vessels, after producing tamsulosin, for example, we had to clean the equipment and change over the setup for iguratimod every time. Going forward, one continuous flow plant will produce one product continuously, so we will add plants as we add products. It is not strictly one plant per product; for high-volume products, we can build two plants for a single product. We want to add products and expand our continuous flow production lines in the factory based on demand.

• Q

  In Resin & Electronics, the materials state that operating income declined due to investment for business expansion. What specifically did this involve?

  A

  Including items we have announced in recent releases, we have been investing actively in automated visual inspection machines. We produce plastic products in quantities of tens of thousands per item. Previously, staff manually checked around ten points on each item to approve it before shipment. This initiative automates inspection using AI and cameras, with a focus on improving cycle time. For example, if a machine produces 10 units per minute but inspection handles only 8 per minute, a backlog builds up. Our approach is to raise inspection to 10 units per minute. One could argue that if four lines produce 40 units, placing five inspection machines that each handle 8 units would balance out. Instead, we are first improving AI response speed to raise throughput and expanding the range of items that can be inspected automatically. That lets us redeploy inspection staff to production with the same headcount, so we see this as a highly worthwhile investment. Labor costs are also rising in Vietnam, and we see this as groundwork for a strong competitive position there.

• Q

  In Energy, the materials state that unit profit on industrial fuel increased due to the Middle East situation. Is it correct to understand that you built up profit on rising industrial fuel prices?

  A

  Yes, that understanding is correct.

• Q

  The environmental business in Chemicals grew. Could you explain in more detail the significance of this initiative and its outlook?

  A

  Many items end up in landfill if they are not recovered, yet a wide range of electronic components contain metals. In recent years, a large share has been solar panels past their useful life, and we help collect these discarded products. We find processors capable of separating metals from the collected waste, outsource the work to them, and recover the recycled metals. The significance is as generally understood: addressing the global environment and Japan's position as a resource-poor country. Another significance I see is that we are bringing in small local factories and businesses that have never been involved in metal recovery. Developing contractors is one of a trading company's core value propositions. However, these contractors do not necessarily advertise metal recovery services, and some do not know what their own plants and production capacity can be used for. We show them how it can be done. If a process generates toxic gas along the way, we sometimes install an exhaust gas treatment plant as our own asset inside the supplier's factory and operate it together. Trading companies that take orders and outsource them are often said to have no involvement in actual manufacturing. But we see value in using our capabilities to unlock our suppliers' capabilities. I believe Japan still has many companies with untapped potential. We also approached companies that suddenly had nothing to produce due to the Middle East situation around the Strait of Hormuz, inviting them to join the metal recovery business. We do this constantly, not only in metal recovery, and consider it highly meaningful. Copper prices have risen in recent years, and higher copper recovery volumes and prices have had a positive impact. Our recent focus has been expanding the range of metals we can handle. Once the first generation of solar panels has cycled through, the next generation uses less metal in manufacturing in some cases, so we need to expand our processing capabilities and the metals we can handle. We are increasing the range of recoverable metals while reading trends in what types of waste are increasing. For metals whose usage has declined, recycling volumes also fall, so we secure revenue by broadening the metals we handle. Lithium and cobalt are likely to increase going forward, and we see our role as building a supply chain capable of recovering them.

• Q

  How large is the environmental business in terms of revenue at present?

  A

  We do not disclose it. It is not that large yet.

• Q

  Does it cover all of Japan?

  A

  Yes, nationwide. We have no chemicals base in Kyushu, but we develop general contractors there and unlock their capabilities together with them. We are also active in Hokkaido.

• Q

  Is it correct to understand that the revenue and profit decline in Information Systems reflects a large project in the prior year rather than weakness this year, and that there were no particular negative factors this year?

  A

  That is correct. As with the original GIGA School program, NEXT GIGA School projects add several billion yen all at once. We believe the right comparison is the figures from two or three years ago, and we have shown them side by side in our materials. Please understand that, excluding the GIGA School projects, revenue and profit have been on an upward trend.

• Q

  So performance is strong compared with two years ago?

  A

  This only happens in special years, such as for education-related projects.

• Q

  Could you elaborate on the background to building the bear detection system?

  A

  Originally, one or two of our engineers built a prototype on their own initiative to detect things from images, out of personal interest, and said it would be nice to use it for something someday. Bears had been sighted even at Kenrokuen in Kanazawa before then, but from last year to early this year, bear sightings dominated the news. At that point, someone suggested using the prototype for bears, and we quickly customized it into a bear detection system. Because the prototype already existed, I believe we released it within 30 days of planning, and we wanted to showcase it as an example of very nimble development. The biggest factor in the background was heightened public awareness of bear sightings.

• Q

  Has the bear detection system actually prevented any incidents?

  A

  Nothing has been detected yet, and we hope nothing will be. For business reasons, some employees work at an office in hilly terrain with a high risk of bears. The biggest benefit so far is that they can work with peace of mind.

• Q

  What kind of response framework does the disaster BCP system establish? Was it developed against the backdrop of the Noto Peninsula Earthquake and the Oku-Noto heavy rains?

  A

  During the Noto Peninsula Earthquake, for example, relief supplies kept pouring in to MITANI SANGYO CO.,LTD. Companies and organizations far away contacted us, saying they would send tons of water to Ishikawa Prefecture or asking us to receive the supplies they had collected. We can only guess at the prefecture's circumstances, but there seems to have been a period when its warehouses were full and it could not accept more. MITANI SANGYO CO.,LTD. stepped in as an intermediate logistics hub. Supplies arrived from many companies and celebrities with whom we had no prior connection. One context for the system was making that kind of response more efficient through technology.

• Q

  So the system also reflects a desire to apply the experience of the Noto Peninsula Earthquake to future disaster prevention and mitigation?

  A

  In such situations, many systems are used for the first time when a disaster occurs. Work styles have changed, and more companies have employees working remotely. In that environment, tasks such as safety confirmation and supply management can be streamlined with systems built using AI. We have been developing systems that operate in such emergencies.

• Q

  There were many disasters across Japan this year as well. Do you intend to deploy the system in such situations going forward?

  A

  Whether we can make such proposals to companies in normal times is another matter; in many cases, awareness does not rise until a company has experienced the pain firsthand. However, with all kinds of disasters occurring nationwide, we believe the "better safe than sorry" mindset will create demand for AI applications that take an approach not found in conventional BCP management.

• Q

  So having experienced the disaster in your home prefecture of Ishikawa, you can communicate the need persuasively even to companies that have never felt that pain?

  A

  Yes. We were affected as well, though not severely, and our head office served as an intermediate logistics hub for Noto for a time. Many of the things we felt were needed from the perspective of those directly affected did not exist as off-the-shelf systems. We built them quickly with AI, so we think they can be useful to a wide range of customers.

• Q

  Is it correct to understand that the full-year forecast of lower revenue and profit largely reflects the impact of the Middle East situation?

  A

  Yes. Our initial targets and full-year forecast assumed the unstable situation would settle down by the end of 1H. However, even after the end of September, the direction remains unclear, and we cannot let our guard down. Naturally, we want to defend the original full-year forecast at all costs and aim higher. Some may call us conservative given how strong 1H was. But assuming unforeseen industrial damage could occur in 2H, we have chosen not to change the full-year forecast for now. We expect the landing to become reasonably clear within 3–4 months, and we will revise guidance as needed, but we judge that now is not yet the time.

• Q

  For full-year results, are there negative or positive factors you are considering besides the Middle East situation?

  A

  Various factors are hitting at the same time. Labor costs are rising, and the nature of the government's requests to private companies is changing, such as an effective obligation to allow price pass-through. Mid-sized and large companies nationwide appear to be changing their policies on price increase requests from suppliers. Amid a general upward trend in prices, the events in the Strait of Hormuz occurred, and we still occasionally see news of attacks in the Middle East; the long-term picture remains unclear. Then there is the rise of AI. SaaS stocks fell across the board in what was dubbed the "Anthropic shock," but there is no consensus yet on how AI will hurt enterprise system integration work. Some declared that "SaaS is dead," but we are not that pessimistic. That said, our role will certainly change. For a very small company, running operations on AI-built systems without much regard for risk may be one option. But at a company of several dozen people, the processing logic and rationale would remain only in the individual developer's AI chat logs. Others would be unable to reverse-engineer it, and even the developer might not understand it because AI built it. So SaaS is not dead, but what is valued will change. Specifically, information systems have been something people interact with, but AI will increasingly read and operate them. There is a concept called AI operability: systems need to be prepared and structured so that AI can access them easily and without error. Building systems solely on the assumption that people will use them will be problematic going forward. But if we properly position information systems for a society where AI and people work together, the volume of work could actually increase, turning this into a positive. Closely related, security issues are arising at the same time. We see very large companies struggling greatly. Rather than viewing this as someone else's problem, if we can effectively steer our own security approach and framework, as well as those of customers who entrust us with their information assets, it can become a positive factor.

• Q

  Is it fair to say that AI can be a weapon if used correctly but harmful if misused, so caution is needed?

  A

  How it is used certainly matters, but I feel it depends more on how we interpret the significance of AI penetrating the business world to this extent. The environment is changing. If we misjudge where our value as a system integrator will remain and where it will shift, things will go in a bad direction. If we judge correctly, we can seize the opportunity and expand the business. That is how I see it as a manager.

• Q

  Is it correct that no major damage from information leaks has been confirmed so far, including at MITANI SANGYO CO.,LTD. group companies?

  A

  In the recent series of incidents, none has been confirmed at our group. I would like to proudly say we have had zero incidents all along, but looking back several decades, there were a few cases of lost paper ledgers, and we apologized to customers each time. Protection comes from firewall-type software and network configuration, but also from how people behave. Losing paper ledgers is a problem in itself, but as a result we eliminated paper and moved to digital, and standardized procedures for collection staff carrying ledgers. Overall, I think this has allowed us to reduce leak risk. Some of our customers have fortunately never experienced a leak. We suspect that, beyond system and cybersecurity enhancements, some of them still have more basic operational gaps. If a company that has been fortunate so far suffers a larger leak or security incident because inexperience delays its response, it can no longer be called fortunate. We see our role as raising the information security level of both ourselves and our customers, learning from our own experience and from the hardships many other companies have endured.

• Q

  Do you mean that information security has become a fairly major risk, if not on the scale of the Middle East situation or, to bring up an old topic, the COVID-19 pandemic?

  A

  For society at large, it could arguably be a bigger risk than COVID-19. It may not be life-threatening, but some information, if leaked, could threaten lives or survival, so the risk is unknown and unpredictable. Compared with COVID-19, where it was initially hard to know how to respond, information security is an area where what needs to be addressed is somewhat clearer. Even so, it is easy to imagine the enormous costs involved. Moreover, attackers are using AI, and attacks are coming at unexpected speed, before security holes or gaps are even identified. Given that, it is hard to say the risk is smaller than COVID-19 or the Middle East situation. Information security is partly our line of business, so we believe we have been doing what we can properly within the group. However, the large companies hit in recent years were certainly not doing nothing, so we cannot predict where the pitfalls lie. In that sense, we see the risk as very large. We need to strengthen our own security and increase proposals to customers, so it will undoubtedly have some impact on our results.

• Q

  Many companies use POWER EGG and similar products. Are you receiving inquiries or requests from them to strengthen security?

  A

  We receive inquiries even from companies that are not POWER EGG customers, asking us to share MITANI SANGYO CO.,LTD.'s approach to security. Even when they say they cannot go as far as MITANI SANGYO CO.,LTD., a growing number of companies engage us for consulting. We help them map out which risks to realistically eliminate, set milestones and draw up investment plans. Everyone is struggling with this. We do not know whether we have a perfect answer either, but we intend to stay on top of the latest information and closely follow attackers' trends.

• Q

  With risks such as the Middle East situation and information security, could the President share his management outlook and aspirations for the coming year?

  A

  We want to overturn the full-year forecast in a good way. Especially regarding the forecast of lower revenue and profit, we want to work hard enough that people will say we achieved higher revenue and profit when all is said and done. From next fiscal year onward, we want to keep valuing our current approach of creating innovation by layering and linking our business areas. We also want to contribute to Japanese innovation, including by unlocking the capabilities of our suppliers across many fields.

• Q

  Looking at the earnings summary, revenue and net income rose only slightly, though there was also talk that profit is rising despite the 2H bias and that results were strong. Perhaps last year's results were particularly good. Why did you decide to raise the interim dividend while forecasting lower full-year revenue and profit?

  A

  We set our dividend based on a policy of securing three years' worth of funding. Since results up to last year were also strong, we first judged that a JPY 1 increase would not significantly impair the full-year guidance. We are raising the dividend after securing three years' worth of funding. Please also view this policy as a way to avoid having to cut the dividend immediately when results fluctuate. We have a very large number of long-term general and individual shareholders, many of whom regard our shares as a stable, long-term financial asset. We believe this dividend policy contributes to that. I think it is rare for a company to have so many individual shareholders who have held the stock for decades. Please understand that our approach is not to pay out the full amount as dividends as soon as earnings spike in a given year, but to secure three years' worth of funding and deliver stable dividends.

• Q

  If you handled the chemical supply risk from the Middle East situation as a trading company should, why not raise guidance? Why are you taking such a cautious view?

  A

  This year's guidance was built on the view that we were likely to take a major hit at some point in 1H and would recover from that damage over the year. We presented it on the premise of absorbing damage in the first half and still delivering the numbers for the full year. 1H was very strong, and looking at that alone, an upward revision is naturally an option. However, we do not really expect 2H to be uneventful, and what we assumed at the start of the year could happen in 2H. In that case, even with such a strong 1H, we judged the landing would likely be in line with the original forecast, so we kept it unchanged this time. That said, the landing becomes visible before the fiscal year closes, so if it becomes clear within 3–4 months, we intend to revise guidance.