2023-08-10 14:08:21 ET
Summary
- Japan’s largest trading house is on the move.
- The ambition is increased profit for shareholders.
- But progress is slow, and much more remains to be done.
Thesis
Japan's largest trading house Mitsubishi ( MSBHF ) is changing, albeit slowly. It is making tentative progress on its mid-term corporate strategy to 2024 which has aimed to increase profitability and shareholder returns, mainly through portfolio optimization. However, the sustainable impact of this effort may not become immediately obvious. The company's sheer size is daunting, and a large exposure to the resources sector makes its performance decisively unsteady.
On Japan
Japanese conglomerates were never popular with Western investors. Trading companies among them used to be particularly loathed as unwieldy behemoths with ossified attitudes. One man helped changed that.
Warren Buffett’s purchase of Japan’s big trading conglomerates in 2020 was unexpected, given his abiding distaste for complex business models and no-moat companies. He happened to speak about it some two decades ago, limiting opportunities in Japan to “cigar butt” investing of buying troubled assets.
Something must have happened for Buffet to change his mind and buy shares in not just one but five trading houses. That something had a lot to do with corporate governance reforms started by the late Shinzo Abe which have resulted in markedly more shareholder friendly practices.
Berkshire Hathaway has increased stakes in the Japanese companies twice this year. Their price return year-to-date ranges from 57% to 22%, led by Mitsubishi. Itochu ( ITOCY ) ( ITOCF ) is in last place but still tops 17% delivered so far by S&P 500. In contrast, the broad index of Tokyo-listed stocks TOPIX returned 21% to August 8.
The rally, however, may not last unless better economic conditions set in. And the Japanese stock market has disappointed many times in the past . Growth in real wages and consumer spending is lagging ; the economy is expanding , but just barely. Although corporate performance has improved, revenue and earnings per share still trail behind the averages in much of the rest of the developed world.
Mitsubishi
As the largest trading house, it seems to fit the definition of a typical Japanese corp the most. But even Mitsubishi is changing, albeit slowly.
There is greater focus on increasing profitability and generating cash that the management is now more keen on returning to shareholders. The targeted payout ratio for FY2023 is 40%, on top of a share buyback program of ¥100bn.
The mid-term corporate strategy 2024 has been pushing through divestments in low-yield operations and investments in new growth initiatives. The latter is dominated by “EX” used in reference to renewable energy and decarbonization technologies .
Though the bulk of Mitsubishi’s earnings base is made up of mineral assets, it is exiting the dirties ones and has promised not to add to them (except allegedly different met coal ).
But this huge exposure to the resources sector means that revenues tend to be volatile. Which is what happened in the last Q1’FY23: the main reason why net income fell 41% year-on-year and profit margin skidded from 9.8% to 6.7% was lower commodity (primarily Australian coking coal) prices.
Nonetheless, the company has always had a strong balance sheet, with debt (debt-to-equity standing at 52.4%) well covered by operating cash flow (33.9%). Financial health has allowed Mitsubishi to ramp up dividends which have grown 12.8%, on a compounded basis, over the past ten years. The ongoing replacement of assets (in industries including food and real estate) is supportive of this trend. With a trailing yield of 3.9%, it is in the top quartile of Japanese dividend payers.
Valuation
Japanese companies are famously inexpensive. Even with all the attention the Tokyo market has been getting as of late, the trading companies are still affordable, with price-to-earnings ratios of below ten. Mitsubishi (TSE:8058) currently trades at 10.3x, just below the priciest Itochu at 10.4x. The five trading houses average 8.3x.
Based on price-to-book, Mitsubishi looks even more affordable, its ratio exactly at the peer average of 1.2x, below Itochu’s 1.6x and Marubeni’s ( MARUY )( MARUF ) 1.3x. However, the near-term prospects may not be bright. Analysts expect the share price to increase by just 5.3% over the next 12 months.
Conclusion
The obvious allure here is decent returns at low prices. But it is hard to make a strong case for Mitsubishi for the near term. The company’s revenue is forecast to decline or remain flat in the best case scenario. Return on equity too is predicted to fall from 11.1% at present to 10.2% in three years’ time. Although its portfolio management strategy is a step in the right direction, as an organization Mitsubishi remains top-heavy and far too vulnerable to forces beyond its control. Structural changes will take time; corporate Japan moves slowly.
For further details see:
Mitsubishi: Slow But Steady