SSUMF - Sumitomo Corporation: A Work In Progress

2023-12-15 02:38:31 ET

Summary

• SSUMF's FY 2025 net profit target of JPY600 billion is equivalent to a three-year earnings CAGR of just +2%.
• Sumitomo Corporation will require more time to execute on its portfolio restructuring plans, as some of its businesses are still generating below-par ROICs.
• I award a Hold rating to Sumitomo Corporation following a review of the company's mid-term earnings target, its portfolio optimization progress, and its valuations.

Elevator Pitch

Sumitomo Corporation ( OTCPK:SSUMF ) [8053:JP] shares are rated as a Hold.

SSUMF remains a work in progress. Sumitomo Corporation's medium term earnings target is unexciting, and there are signs suggesting that the company might potentially struggle to meet this net profit goal. Also, SSUMF is still in the midst of restructuring the company's portfolio, considering that certain businesses' ROICs (Return On Invested Capital) are still lower than their respective WACCs (Weighted Average Cost Of Capital). But the stock's valuations are not demanding, so a Hold (as opposed to a Sell) rating for Sumitomo Corporation is fair.

Sumitomo Corporation's shares are listed in Japan and on the Over-The-Counter or OTC market. The company's shares traded on the Tokyo Stock Exchange and the OTC market boasted average daily trading values of around $400 million and $0.06 million (source: S&P Capital IQ ), respectively for the last three months. Investors have the choice of dealing in Sumitomo Corporation's Japan-listed shares with US brokerages providing international markets trading services such as Interactive Brokers.

Company Overview

On its corporate website , Sumitomo Corporation describes itself as "an integrated trading company." An April 11, 2023 Seeking Alpha News article also mentioned that SSUMF is among the "largest trading houses" in Japan. Note that Sumitomo Corporation refers to fiscal 2023 as the time period between April 1, 2023 and March 31, 2024.

Sumitomo Corporation's Key Business Units

SSUMF's Asset Mix By Business Unit

As highlighted in its Q2 FY 2023 results presentation slides , the Mineral Resources, Energy, Chemical & Electronics, Transportation & Construction Systems, and Metal Products business divisions contributed 29%, 26%, and 15% of SSUMF's earnings, respectively for 1H FY 2023. Sumitomo Corporation derived the remaining 12%, 9%, and 9% of its recent interim profit from the Infrastructure, Living Related & Real Estate, and Media & Digital business units, respectively.

FY 2025 Net Profit Target Is Unimpressive

Sumitomo Corporation's goal is to register a net income of JPY600 billion for FY 2025 (April 1, 2025 to March 31, 2026) as outlined at its 2023 Investor Relations Day presentation .

Considering that SSUMF recorded actual earnings of JPY565.2 billion in FY 2022, the company's intermediate term target translates into a pretty modest three-year net profit CAGR of a mere +2.0%. The weak earnings growth expectations imply that it is tough for Sumitomo Corporation to witness meaningful valuation multiple expansion even though its consensus forward FY 2023 P/E multiple of 7.6 times is undemanding.

More significantly, the market doesn't think that Sumitomo Corporation can deliver on its FY 2025 earnings target. As per financial data sourced from S&P Capital IQ , the current consensus FY 2025 net income estimate for Sumitomo Corporation is JPY497.5 billion, which is -17.1% below the company's earnings goal of JPY600 billion.

There might be valid reasons for the analysts' skepticism regarding SSUMF's ability to meet its mid-term net profit target.

Sumitomo Corporation's actual Q1 FY 2023 and Q2 FY 2023 EBIT missed the sell side's consensus forecasts by -3.5% and -7.7% (source: S&P Capital IQ ), respectively.

Also, the prospects for certain of SSUMF's businesses are unfavorable. Sumitomo Corporation lowered the full-year FY 2023 earnings guidance for its Metal Products business division by -16.5% to JPY76 billion when it announced its latest second quarter results. At its Q2 FY 2023 earnings call , SSUMF also noted that "the current situation (for its Chemical & Electronics business operations) in some markets is very difficult", and also highlighted that its "sales of agricultural equipment and materials" have been negatively affected by "the decline in market prices."

I explain in the next section of the article why I think that the potential portfolio restructuring catalyst for Sumitomo Corporation won't be realized in the short term.

Portfolio Restructuring Will Take Time

SSUMF has plans to restructure the company's portfolio as detailed in the chart below.

Sumitomo Corporation's Business Portfolio Restructuring Framework

At the company's 2023 Investor Relations Day Q&A session in September this year, SSUMF emphasized that it wants its portfolio to be "managed to its full potential" by exiting from weak businesses at "the earliest possible time" and allocating "management resources further in other areas with strength."

However, it will take some time before Sumitomo Corporation can realize some success associated with the company's ongoing portfolio restructuring process.

Sumitomo Corporation acknowledged at its most recent Q2 results briefing that the three businesses "Ambatovy (Mineral Resources, Energy, Chemical & Electronics division), TBC (Transportation & Construction Systems division), and Fyffes (Living Related & Real Estate division)" haven't "reached the point of meeting ROIC above WACC." These management comments suggest that SSUMF's portfolio optimization plans are still a work in progress. Some of the company's businesses still have ROICs below their WACCs, and some lower-ROIC businesses also need to be monetized to free up growth capital for their higher-ROIC counterparts.

Separately, SSUMF disclosed at the company's Q2 FY 2023 results call that it had allocated JPY50 billion "as a reserve for the asset replacements in order to strengthen the soundness of the portfolio" during the portfolio restructuring process. This sends a signal that Sumitomo Corporation has yet to get to "steady state" with its portfolio restructuring activities, as the company anticipates its short-term financial performance could be possibly affected by portfolio changes.

Financial Review And Outlook

Sumitomo Corporation's recent quarterly financial performance was poor, and the company's prospects are unexciting.

SSUMF's top line and EBIT decreased by -3.8% YoY and -17.5% YoY to JPY1,672 billion and JPY112 billion, respectively for Q2 FY 2023. The company's latest second quarter revenue and operating income turned out to be -0.7% and -7.7% (source: S&P Capital IQ ) below the analysts' consensus projections.

Looking forward, the market sees Sumitomo Corporation's revenue and EBIT declining by -1.1% and -8.4%, respectively for fiscal 2023 as per S&P Capital IQ data. In other words, SSUMF is less likely to witness a strong recovery in the second half of FY 2023, as the company is still expected to record lower top line and operating profit for the full year.

As I mentioned in the preceding section, certain of Sumitomo Corporation's businesses like Metal Products and Chemical & Electronics are underperforming. This explains why Sumitomo Corporation's recent financial performance and financial outlook are disappointing.

Valuations

Sumitomo Corporation is currently trading at a forward P/E multiple of below 10 times (FY 2023 P/E of 7.6 times to be specific), and it is valued by the market at a 13% discount to book value as per S&P Capital IQ data.

In my opinion, a fair value for Sumitomo Corporation will be 10 times forward P/E and 1 times trailing P/B on the assumption that SSUMF makes significant headway with its portfolio restructuring process. As it stands now, Sumitomo Corporation's current P/E (7.6 times) and P/B (0.87 times) multiples are justified, as its three-year earnings CAGR is a modest +2.0% as it is still in the midst of portfolio optimization.

When Sumitomo Corporation achieves substantial progress with respect to its portfolio restructuring plans, I expect SSUMF to start delivering earnings growth in the high single digit percentage range and ROEs at the low-teens percentage level. A stock is typically determined to be trading at fair value when its Price-to-Earnings Growth or PEG multiple is 1, i.e. P/E is equal to its earnings growth. An acceleration of Sumitomo Corporation's future bottom line expansion to the high single digit percentage level will warrant a P/E multiple closer to 10 times.

Similarly, a P/B ratio of 1.0 times is fair for a stock based on assumptions of a 12% ROE, a 12% cost of equity, a 0% perpetuity growth rate using the Gordon Growth formula. As per the Gordon Growth Formula, a P/B multiple for a stock can be calculated by dividing [Return on Equity minus Perpetuity Growth Rate] by [Cost of Equity minus Perpetuity Growth Rate].

Final Thoughts

SSUMF's cheapness is warranted, taking into account its FY 2025 net income goal and the company's portfolio restructuring progress. As such, I assign a Hold rating to Sumitomo Corporation.

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