Writedown Risk Means Japan Trading Houses to Depend on Dividends

Japan’s top five trading houses have announced more than $4.8 billion in asset writedowns, or about half the net income the firms expect to report for last year. And that’s probably not the end of it.

“It’d be no surprise” to see Mitsui & Co. post as much as 100 billion yen ($840 million) in additional impairments when the second-largest trader reports its earnings next week, adding to the 48 billion yen booked in the prior quarter, said Daiwa Securities Group Inc. analyst Jiro Iokibe. In the quarter ended March 31, rival Itochu Corp. may book 60 billion yen of writedowns, Iokibe said. Expect similar from Mitsubishi Corp., said Jefferies Group LLC analyst Thanh Ha Pham.

“There’re still assets that the companies bought at high prices and that will need to drop” in value, said Iokibe, who in October put the maximum impairment risk at the top five at $13 billion. At the time, less than $2 billion in writedowns had been announced.

On May 1, Itochu and Sumitomo Corp. will be the first of the five to report earnings. Joji Okada, then chief financial officer of Mitsui, which reports earnings on May 8, said in February that the firm would need to impair assets if commodity prices fell further.

Iron ore, the biggest contributor to Mitsui’s earnings, is down about 23 percent this year.

Spokesmen for Mitsui, Mitsubishi and Itochu said they were unable to comment on writedowns or other financial results at this time because of listing rules.

The traders had enjoyed record profits in recent years on the back of rising commodity prices. Investments in oil, gas and mining have turned problematic as China’s economy slowed, pushed down raw material prices over the past two years.

‘Sogo Shosa’

Sumitomo forecast its first annual loss in 16 years for the 12 months ended in March. Marubeni in January said profit would be half of the 220 billion yen target it outlined in May 2014. Mitsui in February cut its net income target by 18 percent.

To lessen the blow from writedowns some “sogo shosha,” as the trading houses are known in Japanese, have revalued non-commodity units upward.

In the quarter ended March, Mitsubishi said it expects to post a 68 billion yen gain from a reversal of impairment losses for equity in convenience store operator Lawson Inc. and other assets. Itochu in March said it’ll gain 60 billion yen from the restructuring of its ownership in a Chinese food business.

“Mitsubishi got this windfall and they are using it to see what assets they can write down to cut impairment risk,” Jefferies’ Pham said.

After results for the year ended March are reported, most of the writedown risk will recede, according to Kazuhisa Mori, an analyst at JPMorgan Securities Japan Co.

Share Prices

“But, that alone is not enough to lift shares,” Mori said. “No one feels that commodity prices, like oil or iron ore, have hit bottom yet.”

The Topix Wholesale Trade Index, which includes sogo shosha stocks, is up 9.2 percent since Sept. 30, the day Sumitomo announced that it’ll face multi-billion-dollar losses. Since making all the impairments public, Sumitomo has risen 13.8 percent, while Itochu has added 6.9 percent. Mitsui has lost 3.6 percent and Marubeni 2.8 percent.

The shosha will need to retain investor interest through dividends, as well as by cutting the amount they commit to new investments, Mori said.

Sumitomo has already announced it will keep its dividend this year at 50 yen per share no matter what profit it reports.

‘Worst Case’

“Worst case -- you sit on that, which is good for investors,” Pham said. Other shosha are expected to outline their dividend forecasts in May.

When profits from commodities trading were rolling in, the companies expanded into businesses as diverse as catering, fashion retail, medical services and even running prisons. This has complicated how to measure their performance and forecast returns, say Iokibe and Mori.

“Companies may achieve their overall targets thanks to the non-resource assets, but it’s not clear what the drivers behind those are,” Mori said.

This means the houses get valued at a so-called conglomerate discount, with the company judged to be worth less than the sum of its parts, Iokibe said.

Mitsui’s equity price has dropped to 0.7 times the asset book value as of April 20, compared to 1.29 times five years ago, according to data compiled by Bloomberg.

However, there is a benefit from the shift into non-commodity assets: Earnings are seen as more stable, said Jefferies’ Pham.

“The sector could get re-rated by investors,” Pham said, who said he has spoken with some investors on this subject.

“Profits from power plants and so on are a lot more steady and predictable,” Pham said. “With that greater predictability, we could see the price-to-earnings ratio shosha trade at move from single digits to low double digits.”

Before it's here, it's on the Bloomberg Terminal. LEARN MORE