With respect to its business and accounting status, the Kumagai Gumi Group has recognized the following as the major risks that will have significant impact on its financial conditions, business results, and cash flow. The following, however, is not an exhaustive list of all the risks associated with the Group, some of which are not considered significant and may be difficult to foresee at this point in time. Forward-looking statements in the text are based on the Group's judgment as of the end of fiscal 2020.
1.Investment Trends in Construction
The Kumagai Gumi Group’s main customers in the construction business are the public and private sectors. Investment trends in construction will fluctuate over the medium to long term depending on factors such as the financial situation and policy changes of the public sector and the economic environment and consumption trends for private companies. Japan's investment in construction has been on an upward trend since fiscal 2011, but if it begins to shrink, competition in the industry may intensify, which could lead to a decrease in orders received and a decline in profitability.
In order to build up a versatile corporate structure that can flexibly respond to qualitative and quantitative changes in the construction market, the Group has established a long-term vision "a new management policy that looks ahead to 2030 and beyond" and is working on various policies based on these plans.
2.Changes in the Conditions of the Construction Materials Market and Labor Costs
When entering into a construction contract, the Kumagai Gumi Group strives to ensure that the price of construction materials and unit labor costs are priced appropriately. However, after the contract is signed, the price of such materials and labor costs may rise suddenly. In the case of public works, we are able to request a change in the price equivalent to the increase in the construction costs in accordance with the terms of the contract. In the case of public works, the contract clause allows you to claim a certain amount of increase from the original contract price. In the case of private sector construction, however, it is a matter of consultation with the client company, and depending on the circumstances, it is possible that we may not be able to obtain the increased amount. Therefore, when market conditions and other factors are on upward trends, it is necessary to take such measures as estimating the price of the construction work by factoring in future price increases and procuring materials at an earlier stage.
3.Shortage of Skilled Construction Workers
The number of skilled workers in the construction industry is on the decline as the population ages and the hiring and retention rates of younger workers do not increase. Estimating a large number of elderly workers leaving the workforce over the medium and long term, it is critical to secure and train future leaders by passing skills on to the next generation. If the number of skilled laborers continues to fall, labor costs will rise due to the intensifying competition in the industry seeking skilled workers, which could also mean that order volume will decrease due to reduced construction capacity as the result of the skilled worker shortage.
The Kumagai Gumi Group is collaborating with the Yuh-ei Cooperative Association, an organization consisting of specialized construction companies and other subcontractors, to establish a stable construction system, and is taking the initiative to resolve the shortage of skilled laborers and to secure talented human resources. It is imperative to raise unit labor costs of skilled workers to the average costs of workers in all industries, which is the challenge for the construction industry at the moment. In addition to raising unit labor costs, the Group is also working on the operation of a certification system for highly skilled workers, including payment of allowances, and on the introduction of a career development plan to create an environment in which workers can receive benefits commensurate with their abilities and experience. We are also promoting measures to improve working conditions such as a shift to a two-days off per week at construction sites.
4.Securing Human Resources
While the construction industry is experiencing an increasing trend in investment, it is also facing a decline in the number of construction engineers. The Kumagai Gumi Group is fully aware of this issue and strongly believes that it is our urgent task to secure capable architects and engineers and train them in order to improve the quality of our construction work, as well as to increase revenue. In response to this challenge, we are expanding our mid-career hiring of experienced construction management personnel by establishing the Job Return System and other measures in addition to hiring new graduates. As part of our efforts to promote diversity, we are also actively employing of senior citizens, women and foreign nationals.
In bidding for construction work and management, engineers are sometimes required to have certain construction experience and specific qualifications for each type of construction project, and if there is a shortage of qualified personnel, opportunities to receive orders may be missed, which could lead to a decrease in order volume. There have been some cases where we have been forced to give up participating in bidding for some types of construction projects because we were unable to secure the necessary personnel due to the timing of the order. For this reason, in addition to systematically providing our engineers with a wide variety of experience in construction, we provide them with in-house training in different fields and levels of expertise with an eye toward future projects. Moreover, we support and promote the earning of official qualifications, such as professional engineer and first-class architect, by holding in-house seminars and mock exams for those who want to earn these qualifications.
5. Overseas Business Development and Operations
The Kumagai Gumi Group's overseas operations are currently focused on construction projects in Asian countries. Overseas operations may be delayed or become impossible to carry out in the event of significant political, economic, or social turmoil in the countries where the Group operates, or if laws and regulations are strengthened. There is also an inherent risk that developing legal and social systems and differences in culture and business practices could make it difficult to achieve fair billing and the collection of construction fees, or that the Group may incur unexpected costs. For this reason, the Group has decided to expand and operate its business only in the countries and regions with which we are familiar, and in principle limits the construction work it undertakes to ODA (Official Development Assistance) projects from Japan as well as projects by Japanese companies.
In addition to transactions denominated in foreign currencies such as local currencies at the business locations and U.S. dollars, assets, liabilities, revenues and expenses denominated in foreign currencies are converted into yen based on specific standards. Although the Group's current scale of overseas operations is less affected by fluctuations in foreign exchange rates, it nevertheless tries to mitigate foreign exchange risk by generally matching the currency composition of transaction income and expenditure and the timing of deposits and withdrawals.
6. Effects of Natural Conditions and Disasters on Construction Projects
If the geological features, land, weather or other natural conditions are unique to a construction project, failure to know these factors in advance could result in changes in construction methods and rework, which may increase construction costs. If a construction site is struck by an earthquake, typhoon, torrential downpour or other natural disasters, there is a risk of significant damage, such as interruption of construction work and significant costs and time required for restoration.
In order to ensure that the profitability of construction projects will not decline due to unforeseen natural conditions, the Kumagai Gumi Group conducts thorough preliminary investigations and studies of construction methods and works, and takes proactive measures to minimize losses, such as purchasing various types of insurance against natural disasters.
In the event of a global pandemic, profitability is expected to decline due to costs associated with delays in construction and infection control caused by interruptions in construction and the delivery of materials and equipment. A slump in capital investment, particularly in the private sector, may result in a decline in order volume.
8. Defects in Construction
There are a wide range of specifications and construction conditions for construction projects, and the construction may be influenced by external factors that are beyond our expectations and assumptions. Under these circumstances, it is difficult to completely eliminate the possibility of defects, so a certain amount of money is allocated to cover the cost of potential defects. If, however, a serious defect should be found in a construction project, the Kumagai Gumi Group could incur significant repair costs and liability for damages in excess of the amount of this allocation. In addition, the Group could lose the public’s confidence, which could lead to a decrease in the number of orders received.
In the design and construction of building projects, the Kumagai Gumi Group strives to provide high-quality products and services through the steady operations and continuous improvement of its quality management system.
9. Work-related Accidents and Incidents in the Construction Business
The construction business may cause more serious industrial accidents than other industries, depending on the nature of the work and the work environment. It is more likely to experience accidents that cause damage to third parties. In the unlikely event of a serious industrial accident or incident, we may incur substantial compensation costs, lose public confidence, be suspended from bidding on construction projects by the relevant government agencies, and thereby experience a decline in orders received.
The Group places the highest priority on occupational accident prevention and related countermeasures. The Group strives to eradicate work-related accidents and injuries through the strict operation of a health and safety management system that includes safety training, daily safety inspections, enhanced coordination between construction and safety departments, and careful construction planning.
10. Loss of Fixed Assets and Investment Securities
The Kumagai Gumi Group is acquiring real estate as part of its efforts to create new businesses such as urban renewal and redevelopment projects. However, if the profitability of assets held by the Group declines or the market value of assets falls due to a significant deterioration in the business environment or other factors, the Group may incur an impairment loss on fixed assets.
Additionally, the Group holds the securities of its client companies and business partners to capture revenue opportunities and strengthen relationships. If the performance of a company in which we invest deteriorates or the stock price of such company falls, we may incur an impairment loss as well.
The Group has established investment and financing criteria to quantitatively manage the risks associated with its various asset valuation methods and investment and financing activities. For projects with significant financial impact, the Management Committee and the Board of Directors review acquisitions based on the outlook of management indicators and the maintenance of fiscal discipline. After an acquisition, if it is determined that profitability is expected to worsen as a result of monitoring for verification of profitability, and it is extremely unlikely that future rates of return will exceed our target thresholds, or if it is judged that the Group's holdings of securities will not be useful for the operations of its business, then the Group will consider selling these assets in order to minimize losses.
11. Customer and Client Confidence
In the event that a client becomes credit insecure or goes into bankruptcy after construction begins, it is possible that accounts receivable, notes receivable and other receivables may become uncollectable. In addition, if a subcontractor or other business partner were to find itself in a similar situation, the construction process could be delayed and construction costs could increase.
The Kumagai Gumi Group holds a series of meetings and has specialized departments to determine the creditworthiness of its client companies, examine the contents of the contract and methods of claim protection. In addition, the Group has established internal rules for credit management and standards for setting credit limits in preparation for the closing of construction contracts, as part of its efforts to ensure thorough credit management. We examine the creditworthiness of business partners when we start a transaction with them, based on their most recent financial statements. For subcontractors with whom we do business over a certain size, we conduct an annual evaluation of their overall management through interviews and other methods, in addition to a financial evaluation.
The operation of the construction business is regulated by various laws, including the Construction Industry Act and the Antimonopoly Act. Violations of these laws and regulations, as well as actions that go against the demands of society, could result in criminal penalties, administrative penalties, liability for damages, and other such consequences. This can lead to a loss of trust from customers, shareholders, business partners and other stakeholders surrounding the company.
In order to eliminate these risks, the Kumagai Gumi Group has established various rules and regulations, including the Code of Conduct and the Compliance Rules of Conduct, and has built a compliance system centered on internal functions, as well as established the Compliance Audit Committee as an organization independent of management, and has established a system for evaluation and recommendation by outside experts. In addition, we are working to raise awareness of compliance among all officers and employees through compliance training and other educational programs.
13. Environmental Issues
The depletion of resources, global warming and other environmental issues caused by global population growth and the rapid expansion of industrial activities are recognized as social issues that need to be addressed and resolved worldwide.
The construction industry, which is responsible for the construction of social infrastructure, must actively reduce the environmental burden of CO2 emissions from construction work, construction waste, and surplus soil generated from construction, and must bear a certain amount of costs for these purposes on an ongoing basis.
Construction work is subject to a variety of environmental laws and regulations. In the event of an environmental accident, such as soil or water contamination, restoration costs, damages and other compensation could be incurred and the Kumagai Gumi Group's reputation would be impaired, which could lead to a decline in the number of orders received.
We are working to reduce our environmental impact and create a better environment through the proper operation and continuous improvement of our environmental management system. We are also promoting the creation of a low-carbon and recycling-oriented society by reducing CO2 emissions under our "Eco-First Commitment" program, by reducing the amount of mixed waste at construction sites, and procuring materials and equipment subject to green purchasing, as well as striving to prevent environmental accidents in compliance with environmental standards.