2024-01-03 02:00:21 ET
Summary
- Itochu has a balanced capital allocation strategy, as it focuses on both capital return and capital investments.
- A 1.61 times P/B multiple for Itochu is fair based on my valuation analysis using the Gordon Growth Model.
- Itochu is rated as a Hold after considering its capital allocation moves, the company's expected ROEs, and the stock's valuations.
Elevator Pitch
I have a Hold investment rating for ITOCHU Corporation ( ITOCF ) [8001:JP].
Itochu has maintained a good balance between capital investment and capital return. On one hand, the company has raised its dividend payout ratio and increased the amount of capital allocated to buybacks. On the other hand, ITOCF is targeting to make investments of around JPY700 billion for the second half of fiscal 2024 (YE March 31), which includes tender offers for two of its listed investees. But positives have been priced in, as the stock is deemed to be fairly valued based on my analysis. This explains why I have rated Itochu as a Hold.
Readers should be aware that they can trade in Itochu's shares on the Tokyo Stock Exchange and the Over-The-Counter market. The three-month mean daily trading values for Itochu's OTC shares and Japan-listed shares were approximately $0.8 million and $140 million, respectively according to data taken from S&P Capital IQ . Investors keen on dealing in Itochu's relatively more liquid Japanese shares can utilize the services of US stockbrokers (e.g. Interactive Brokers) which offer trading access for the Japanese equity market.
Company Overview
Itochu refers to itself as "one of the leading sogo shosha" on the company's website . "Sogo shosha" is the Japanese term for a "general trading company" which has "business investments in diverse fields and regions" as defined by Itochu.
Itochu's Key business Segments
In the first half of fiscal 2024 (April 1, 2023 to September 30, 2023), Itochu derived 25%, 15%, 13%, and 12% of the company's net income from the Metal & Minerals, Machinery, Energy & Chemicals and the Other Businesses segments, respectively. None of the other individual segments accounted for more than 10% of ITOCF's earnings for 1H FY 2024.
In terms of geographic exposure, the company generated 77% and 23% of its full-year FY 2023 (April 1, 2022 to March 31, 2023) top line from Japan (its home market) and foreign markets, respectively.
Capital Return
Itochu has done reasonably well in returning a meaningful amount of excess capital to the company's shareholders.
The company completed JPY25 billion worth of share repurchases in 1H FY 2024. For the second half of the current fiscal year, Itochu has a new JPY75 billion share buyback plan that is effective for the time period between November 7 last year and the end of February this year. Based on its latest disclosures , Itochu has spent JPY18.5 billion buying back its own shares in November 2023. In other words, the company has already executed on a quarter of the new share repurchase program in the first month following its initiation.
It is worth noting that Itochu's target of achieving JPY100 billion in share buybacks for full-year FY 2024 represents a new historical high and a +40% increase as compared to the company's actual FY 2023 share repurchases amounting to JPY60 billion.
Separately, Itochu has guided for an increase in its dividend per share distribution from JPY110 in FY 2022 and JPY140 in FY 2023 to JPY160 for FY 2024 as disclosed in its Q2 FY 2024 earnings presentation slides . This also implied that the company is raising its dividend payout ratio to 40% in FY 2024, which is a significant improvement over its actual payout ratios of 27% and 33% for FY 2022 and FY 2023, respectively.
With respect to future shareholder capital return, ITOCF emphasized the words "actively and continuously" when describing its stance on shareholder return for the future at its annual report briefing at the end of November last year. As such, it is reasonable to think that Itochu will continue to distribute excess capital to shareholders via buybacks and dividends in the foreseeable future.
Capital Investments
ITOCF's goal is to register a core net income of JPY800 billion for full-year FY 2024, and the company plans to make the necessary investments to support its financial target. At its Q2 FY 2024 earnings call, Itochu shared that it has set aside JPY700 billion for capital investments in the second half of the current fiscal year.
ITOCF also noted at the most recent quarterly earnings briefing that its strategy is to "invest in companies that we expect will have synergy with the company going forward" such as "business partners and Group companies with whom ITOCHU has long-standing commercial relationships." In October 2023, Itochu disclosed that its equity interest in Daiken Corporation [7905:JP] rose from 36.34% to 87.36% following the completion of a tender offer. Earlier, ITOCF revealed in September last year that it increased its stake in ITOCHU Techno-Solutions Corporation [4739:JP], which is referred to as "CTC" by the company, from 61.24% to 85.93% via a tender offer. In its December 2023 investor presentation , ITOCF describes CTC and Daiken as a "system integrator" and a "building materials manufacturer", respectively.
ITOCF's Plans To Realize Synergies From Its Investment In ITOCHU Techno-Solutions Corporation Or CTC
Itochu's Goal Of Increasing Earnings Contribution From Daiken Corporation With Various Initiatives
As per the charts presented above, there are lots of opportunities for Itochu to create value by exploiting synergies associated with its increased investments in group companies and partners such as CTC and Daiken. For example, ITOCF is targeting to grow the annual earnings of CTC by +20% to JPY50 billion in the near term.
I have a positive opinion of Itochu's capital investment strategy. In my view, it makes a lot of sense for ITOCF to raise its interest in businesses that it is already familiar with, rather than making investments in new ventures or companies.
ROE And Valuations
I think that Itochu is doing well to deliver a high ROE via both capital investment and capital return initiatives that were detailed in the preceding sections of this article. But Itochu is already trading at a fair valuation, taking into account the company's ROEs and P/B multiple.
The sell-side analysts' consensus FY 2024-2028 ROE forecasts for Itochu are in the 13%-16% range (source: S&P Capital IQ ). ITOCF has also set a target of delivering ROEs between 13% and 16% .
The market is now valuing Itochu at a trailing P/B multiple of 1.61 times as per S&P Capital IQ . As per the Gordon Growth Model, a fair P/B metric is calculated by dividing [ROE minus the Perpetuity Growth Rate] by [Cost Of Equity minus the Perpetuity Growth Rate]. Therefore, Itochu's fair P/B ratio is 1.6 times based on a 16% ROE (the high end of its ROE estimates), a Perpetuity Growth Rate of 0%, and a Cost Of Equity of 10%.
Final Thoughts
A Hold rating for Itochu Corporation is appropriate. Even though I am impressed with ITOCF's capital allocation (returns and investments) approach, the stock's current valuations are fair based on a comparison of its P/B multiple with its ROE.
For further details see:
Itochu: Positives Priced In