Sumitomo Bond Risk Jumps to Four-Year High on Commodity Rout

  • S&P cuts its outlook on trading company's A- credit rating
  • Sumitomo withdrew its earnings forecasts on nickel losses

Sumitomo Corp.’s bond risk jumped to a four-year high as a collapse in nickel prices put it at risk of a credit downgrade.

The cost to insure the Japanese trading company’s debt against nonpayment surged 43 basis points this month to 132.5 basis points on Tuesday, the highest since January 2012, according to data provider CMA. Sumitomo withdrew its earnings forecasts last week because of a 77 billion yen ($657 million) charge on its Ambatovy nickel project in Madagascar.

Standard & Poor’s cut the outlook on the trading company’s A- rating to negative from stable as a prolonged slump in resource prices worsens earnings and capital ratios. Sumitomo’s Chief Financial Officer Hiroyuki Inohara said last week investments in oil, coal, iron ore and copper could be vulnerable to writedowns as China’s economy slows more swiftly than anticipated.

“The CDS are really feeling the effects not only of Sumitomo’s earnings but also the impact of commodity and energy prices,” said Yasuhiro Matsumoto, a senior expert for the industrial finance sector at ABeam Consulting Ltd. “Sumitomo should still be able to earn a profit even if impairment losses increase, but how much further commodity prices have to fall is a destabilizing factor.”

Tokyo-based Sumitomo, one of Japan’s big-five trading houses, had expected net income of 230 billion yen in the year to March and said it will issue new earnings guidance at its third-quarter earnings on Feb. 5. CFO Inohara said the company wants to secure a profit of at least 100 billion yen for the year.

The trading house’s writedowns this fiscal year due to the resource market rout may come to 120 billion yen to 200 billion yen including the Ambatovy charge, according to Junki Ojima, a credit analyst at Mizuho Securities Co.

Sumitomo isn’t the only Japanese trading company that’s suffering because of the raw materials slump. The bond risk of Toyota Tsusho Corp. has climbed 75 basis points in the past month, the biggest increase among the nation’s corporate credit-default swaps during the period, while Marubeni Corp. saw a gain of 53, the second most. Sumitomo’s CDS increase was the third sharpest, according to CMA data.

Commodity Tumble

The Bloomberg Commodity Index, which measures returns on 22 raw materials, dropped to the lowest level this month in data going back to 1991. The price of nickel, used to make stainless steel, sank to the lowest since 2003 on Jan. 12 after falling more than 40 percent last year.

A Sumitomo spokesman who asked not to be identified said that while the weakness in resource prices will continue for now, the company’s non-resource business is strong, and it wants to recover the trust of markets and rating companies by strengthening its profitability and financial standing.

The company’s credit-default swaps may have risen excessively, making it worth considering selling the contracts to earn a premium, according to Eri Iwata, a credit analyst at SMBC Nikko Securities Inc.

“There’s a big tendency for the market to overshoot without reflecting the company’s real creditworthiness, at a time when people are concerned about how Chinese risks will affect the market,” Iwata said.

Moves in Sumitomo’s corporate bonds have been muted compared with CDS. The extra yield on the company’s 0.769 percent notes due in April 2024 was 43.5 basis points more than sovereign debt, a gain of one basis point from the end of last year.

Different Investors

“Investors in the corporate bonds are basically Japanese, whereas those for CDS are foreigners,” said ABeam’s Matsumoto. “Corporate bond investors think the company will maintain profits in spite of the impairment losses, and those losses will be limited in any case.”

Sumitomo reported a 73.2 billion yen loss last financial year, its worst result since 1997, on asset writedowns, including U.S. oil and Brazilian iron ore projects. Moody’s Investors Service has a stable outlook on its A3 grade for the company, the same level as S&P, while Japan’s Rating & Investment Information Inc. has it at A+, two steps higher.

“They were quite late to the party and they bought a lot of things when prices were kind of bubblish and that is the reason they are taking the hit now,” said Thanh Ha Pham, an analyst at Jefferies Group LLC, who covers Japan’s trading houses. “The credit rating is a huge deal for these guys. They do a lot of business overseas so if their credit rating is downgraded, it impacts the business in general because they are procuring cheap funds to buy assets.”

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