2023-08-07 01:29:06 ET
Summary
- ITOCHU Corp.'s non-resource businesses are allowing it to deliver planned results this year despite weak commodity prices.
- Improvements at FamilyMart as well as automotive and food businesses are sources of growth, as well as acquisitions in construction machinery and IT consulting.
- The company announced an intent to target a 40% payout ratio which could result in dividend raises later this year.
Non-Resource Businesses Pick Up The Slack
ITOCHU Corp. (ITOCY)(ITOCF) fiscal 1Q 2023 results were perfectly in line with company expectations. The company earned ¥213.2 billion in the quarter, 27% of the full year plan of ¥780 billion. As I expected last quarter , the non-resource businesses are the growth drivers this year. Every segment except for Metals & Minerals and Corporate and General Products & Realty had higher profits than last year's first quarter, however within the Energy & Chemicals segment, this is because of an extraordinary mark-to-market gain on a lithium battery company.
The two main drags on profits are factors outside the company's control. Resource prices, especially coal and iron ore, were a ¥17.5 billion hit compared to last year. Higher interest expense subtracted ¥13 billion, partially offset by ¥7 billion of foreign exchange benefits from the weak yen. The improvements came from the non-resource businesses.
My regular reviews of the Japanese trading companies usually include a discussion on commodity prices. There is really no need for one this quarter. While lower prices are the main negative influence on Itochu's results, this was part of the plan. Prices have not moved much since last quarter, especially for coal and iron ore . Given this stability, none of the 5 major trading companies changed their profit or dividend forecast for the year in their 1Q results. We can spend some more time on the non-resource businesses and their outlook for the rest of the year. I believe there is still room for a dividend increase even if commodity prices remain low.
Machinery
This segment contributed to ¥7 billion of core profit improvement and is already 30% of the way to its full year target. Automotive related subsidiaries performed well with the easing of supply chain constraints. Heading into the year, manufacturers were already a predicting a strong increase in production , but still considered the chip shortage a risk. The chip situation has since improved , based on Toyota's ( TM ) latest results . Itochu is also seeing the benefits from its acquisition last year of a stake in Hitachi Construction Machinery.
8th Company
This segment contributed to ¥6.5 billion of core profit improvement and is already 50% of the way to its full year target. After some impairment losses and capital investments last year, convenience store chain FamilyMart is showing improvement. Same store sales are up 5.7%, with increases in both customer visits and amount spent per customer. New stores are also showing considerably higher sales per store compared to last year.
ICT and Financial
ICT and Financial added ¥4.5 billion of operating improvement to core profit. While it may appear behind plan at 18% of its full year target, Itochu is increasing its stake in Itochu Techno-Solutions via a tender offer . The segment is also benefitting from higher insurance agency commissions and last year's purchase of a stake in foreign exchange broker gaitame.com.
Food
The Food segment added ¥4 billion to core profit. Better profitability at food distribution subsidiaries like Nippon Access were a key driver. Combined with an extraordinary gain from an asset sale, the segment has delivered 34% of its full year profit plan.
General Products & Realty
This is the one non-resource segment that is lagging last year's results. It is a ¥10.5 billion drag on core profits. One key driver is the company's European wood pulp business. This was boosted last year by a cut-off of supply from Russia , but other countries have stepped in to fill the gap at the same time demand from China has fallen. The segment is also seeing a slowdown from last year's strong demand in North American construction materials. The segment is behind plan at 19% of the full year target.
Valuation
Although I mentioned last quarter that Itochu stock price performance was improving relative to the other trading companies, it was once again a laggard since my last article, finishing second from the bottom.
After the strong run by Mitsubishi ( OTCPK:MSBHF ) stock, Itochu no longer has the highest P/E of the group. It is now second highest at 10.43 compared to 11.00 for Mitsubishi. This is despite Itochu still having the highest return on equity based on FY 2024 earnings, at 15.3%. Mitsubishi appears to have run too far, as it still has the lowest ROE at 10.9%. Itochu still has the highest price/book, however, at 1.59.
After announcing the biggest dividend raise of the 5 trading companies at the start of the fiscal year, Itochu's dividend yield is in the middle of the pack at 2.9%. None of the trading companies announced a dividend increase with 1Q results, but Itochu hinted at the possibility of one later in the year.
Capital Management
Itochu had core free cash flow of ¥121 billion in 1Q, down from ¥138 billion in the same period last year. The full year dividend forecast of ¥160 per share would use ¥232.8 billion. Additionally, the company just announced share buybacks of ¥25 billion to be completed this quarter. Assuming FCF delivery the rest of the year in line with 1Q results, the dividends and buybacks are easily covered.
In the 1Q results presentation , the company noted that the total capital return announced so far of ¥257.8 billion represented a payout ratio of 33% of plan net income this year. However, they also stated that "we will execute additional shareholder returns, aiming at 40% total payout ratio when we revise upward the forecast during the fiscal year."
Even without an upward revision to the profit forecast, a 40% payout ratio would imply capital return of ¥312 billion. I would expect some of the increase to come as additional buybacks announced in the second half of the fiscal year after the current authorization expires. The total will probably be around the ¥60 billion done the last two years. That leaves ¥252 billion for dividends, which would allow a raise to ¥173 per share, an 8% raise from the current plan and 23.6% over last year's payment. If the profit forecast also increases, these numbers could go higher.
Conclusion
Commodity prices are a headwind for Itochu in FY 2024, but the non-resource businesses can provide the growth needed to deliver the annual plan. Strong performance in automotive, food distribution, and convenience retail should offset a slower pulp and paper business. The company will also benefit from inorganic growth in construction machinery, forex brokerage, and IT consulting.
Itochu continues to have the best return on equity of the 5 trading companies, and now no longer has the highest P/E ratio. If commodity prices hold at low levels this year, Itochu stock performance should catch back up to its peers. Itochu has already planned the highest full year dividend increase of its peers vs. fiscal 2023 and there is room for further raises given the intent to target a 40% payout ratio.
For further details see:
Itochu: On Track Thanks To Diversification