While Miners Sink, Japan Rises

The commodities slump is a once-in-a-generation buying opportunity for Mitsubishi and Mitsui.

Quick: What's the world's fourth-biggest mining business?

If you named a company with a major listing in London, New York or Sydney, you're out of luck. Measured by the gross value of its mining and energy assets, Japan's Mitsubishi Corp. outstrips Rio Tinto and Anglo American:

Hidden Dragons

Value of mining, energy and metal assets at mining companies and sogo shosha

Source: Company reports

Note: Shows 2015 fiscal year-end data from segment reporting except Teck and Glencore, which are from 2014 fiscal years. Vale shows total assets on balance sheet as its segment reporting standards aren't comparable

The country's sogo shosha trading houses are somewhat opaque to outsiders and tend to fly below the radar. But Mitsubishi, Marubeni, Itochu and Toyota's captive trading house Toyota Tsusho comprise four of the 20 biggest companies on the Nikkei-225 by revenue. Sumitomo Metal this week bought a $1 billion slice of the Morenci copper mine from Freeport-McMoRan, in the biggest mining deal since July. With a slew of assets up for grabs as miners attempt to rebuild their balance sheets, it's time the trading houses emerged from the shadows.

The business model is quite straightforward: the sogo shosha worm themselves into every transaction being carried out by corporate Japan, clipping the ticket on each stage of the supply chain that links raw materials to manufacturing, transportation, and finished products. Most have operations in mining and energy, finance and real estate, infrastructure, logistics, chemicals, food and consumer goods. In the commodities field, they already have stakes in coal and iron ore mines, copper pits in Chile and Peru, gas fields in Australia and Indonesia, and even a Mozambican aluminum smelter.

In these times, the sogo shosha have a crucial advantage over the Western mining and energy companies that operate most of their assets: Thanks to their diversity, they can shrug off even a historic slump in commodity prices and keep paying their debts with earnings from non-resource divisions. Mitsubishi's net income has fallen just 14 percent since its 2011 peak, despite a 94 percent slump in earnings from its metals unit.


A 94 percent slump in Mitsubishi Corp.'s metals profits since 2011 has left the broader group unscathed

Source: Company reports

If you believe, like Mitsubishi, that the current weakness in commodity markets is temporary, the current distress in the sector represents a historic buying opportunity for a well-capitalized company.

And the ambition is certainly there: The company wants to double production volumes in coking coal and copper by 2020 and end up with half of its assets in the energy and metals divisions, from about 42 percent now. Whether you imagine Mitsubishi keeping its asset levels in a steady state or increasing them at the long-term growth rate, a back-of-the-envelope calculation suggests that target will require about 1.3 trillion yen ($11.5 billion) to 1.4 trillion yen in resources investments over the period.

Mitsui also forecasts 1 trillion yen to 1.4 trillion yen of free cash flow over the three fiscal years to March 2017, according to a 2014 company presentation. About 30 percent of that total will be set aside for dividends, but the lion's share of the remainder will go to energy and metals projects, according to the company. Sumitomo is ready to buy or build new mines to meet its target of doubling gold output by 2020, company President Yoshiaki Nakazato said this week.

The Bank of Japan's introduction of negative interest rates are helping these bullish objectives on multiple fronts. It's reducing borrowing costs that are already low thanks to the trading houses' business model: You can insure against a default by Marubeni, the big-five sogo shosha with the highest perceived risk, for almost a percentage point less than the most stable of the miners, BHP Billiton.

It's also providing an incentive to spend. Japanese corporates are sitting on about $3 trillion of cash earning a negative rate of return now, according to Bernstein analyst Paul Gait, and would be much better off deploying it in takeovers or investments. The market's perverse reaction to negative rates, which has driven the yen up 7.3 percent since the Jan. 29 announcement despite the lower yield on government debt, even makes overseas deals a bit cheaper.

Risk Appetite

Spreads on five-year credit default swaps of mining companies and sogo shosha

Source: Bloomberg data

What should they purchase? Miners haven't been particularly shy about stating which assets they want to shed: Anglo American is disposing of niobium, phosphate, nickel and iron ore; Vale is looking at options for its fertilizer and base metals businesses; BHP has lost interest in its nickel unit; and everyone would like to quit thermal coal.

Forget that. The Japanese can afford to be a bit more ambitious. Copper has some of the best long-term demand dynamics of all the base metals. In an ideal world, Freeport would be turning its back on its ill-timed foray into the oil and gas industry, but with $20 billion of debt on its balance sheet it didn't feel in a place to turn down Sumitomo's offer to buy 13 percent of the world's third-biggest copper mine.

That provides a template for the other sogo shosha. Mitsui has a bare 12 percent of the fifth-biggest copper pit, Chile's Collahuasi, with indebted Anglo American and Glencore holding 44 percent each. Glencore and Teck both have stakes in the sixth-biggest mine, Peru's Antamina, which could augment Mitsubishi's existing 10 percent stake. It's time for Japan's trading houses to live up to their names, seize the day, and start trading.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    David Fickling in Sydney at dfickling@bloomberg.net

    To contact the editor responsible for this story:
    Matthew Brooker at mbrooker1@bloomberg.net

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