Mitsui & Co.: Not Enough Progress For An Upgrade (OTCMKTS:MITSY)

Small Forecast Bump, Not Enough To Excite Investors

I have been covering Mitsui & Co. (OTCPK:MITSY) (OTCPK:MITSF) on Seeking Alpha since Berkshire Hathaway’s (BRK.A) (BRK.B) 2020 purchase of shares in all five major Japanese trading companies. Most recently, I downgraded the stock to a Hold last quarter from the Buy rating I had on it since February 2022. Last quarter, Mitsui increased its full year profit forecast and raised the dividend, thanks to improved iron ore prices and a weaker yen. Despite these positive factors, I rated the company a Hold based on concerns over these factors reversing in a weaker economy.

Since then, Mitsui’s US ADRs have returned 13.5%, in line with the iShares Japan ETF (EWJ) but fourth out of the five trading companies. Most of this gain has come in the past month in the run-up to the fourth quarter earnings release.

The most positive change in Mitsui’s operating environment since last quarter has been the strength in the price of iron ore, the company’s highest volume commodity. Despite negative shocks to the Chinese real estate market such as the failure of Evergrande (OTCPK:EGRNQ), imports of iron ore to China have increased as the country’s steel mills prepare to ramp up for the start of the construction season following slowdowns for pollution control during winter. China also recently cut bank reserve requirements to stimulate the economy through greater lending.

Looking at the other key commodities, metallurgical coal prices have held steady since last quarter after recovering from a big dip in the summer of 2023. Oil and gas prices have also not changed enough to produce a significant change in Mitsui’s forecast. Also, the yen started strengthening in November and December 2023, but this has largely reversed since the start of the year. Expectations of higher interest rates later this year seem to have evaporated when the Bank of Japan reduced its inflation forecast for 2024 and kept the 2025 inflation forecast below 2%.

As one would expect from these trends, the Mineral & Metal Resources segment had the biggest forecast bump this quarter, up ¥35 billion to ¥325 billion for the year. The Energy segment is behind plan year-to-date, but this is largely due to a ¥13 billion charge taken in the Russian LNG business when it was sanctioned by the US in November. For the rest of the fiscal year, Mitsui expects a gain on an asset sale and better contributions from LNG trading. This allowed the company to raise the profit forecast for the segment by ¥20 billion to ¥160 billion.

Outside of the natural resource businesses, Mitsui is seeing good performance in the Machinery & Infrastructure segment from the transportation related businesses (automotive and ship building) as well as construction and industrial machinery. Offsetting this is an expected gain on asset sale that won’t hit the books until fiscal 2025, so the FY forecast for this segment was reduced ¥15 billion. The remaining segments totaled another ¥15 billion reduction in the FY forecast. Overall, the change in the FY 2024 profit forecast nets out to just +¥10 billion, to ¥950 billion.

With this small change in the profit forecast, Mitsui left its dividend plan unchanged at ¥85 per share for the yearend dividend paid in July, or ¥170 for the full year. Mitsui is usually the first of the trading companies to report earnings. This quarter, Marubeni (OTCPK:MARUF) (OTCPK:MARUY) also reported on the same day. Marubeni left both its profit and dividend plans unchanged for the fiscal year. Both companies disappointed the market, trading down about 3.5% in Japan on the day of the earnings release. The other trading companies report during the first half of next week, and the bar has been set low. If any of the three remaining trading companies have a bigger profit forecast increase or a dividend hike, they could be rewarded by the market. I expect Mitsui to be an average performer unless it can impress investors next quarter when the FY 2025 plan is released. Until then, it remains a Hold.

Delivering the Three-Year Plan

Fiscal 2024 is the first year of the 3-year Medium-Term Management Plan, with the theme “Creating Sustainable Futures”. In terms of capital allocation, Mitsui is well ahead of the pace needed to deliver the plan’s asset sales and investments. In the latest quarter, the company sold an Australian power plant, a healthcare business, and oil field, and collected a loan to a steel products subsidiary. Mitsui has now delivered half the planned asset sales, despite being only one fourth of the way through the three-year plan period. On the investment side, this quarter saw investments in a floating oil production and storage platform, a natural gas field in Australia, and the renewable natural gas business. Investments are also already halfway to the 3-year target.

Looking ahead to FY 2025 (starting in April 2024), Mitsui will not issue its 1-year plan until next quarter. My expectation is that, unlike the past few years, we will not see big swings in commodity prices. Having been through the pandemic and supply chain interruptions, I expect supply and demand to be in better balance. The US will continue to have healthy GDP growth while the rest of the world grows more slowly but avoids a serious recession. In that environment, commodity prices should be stable, as they have been in the past quarter. One positive we can take away from Mitsui’s latest presentation, though, is that they expect volume growth in their key commodities next fiscal year. To summarize the main ones from the slides, Mitsui expects the following production increases:

• Iron Ore +5%
• Met Coal +31%
• Copper +3%
• Natural Gas / LNG +21%
• Crude Oil +2%

I don’t expect a huge growth contribution from the non-resource businesses, but they can at least grow in line with GDP. With those volume growth assumptions, here is my first pass at a FY 2025 profit forecast by segment:

Click to enlarge

Please note that Mitsui estimates these volume growths slowing in 2026, so the 8.8% profit growth in FY 2025 is a nice bump, but probably not a sustainable number for long-term growth rate. Nevertheless, it should allow Mitsui to continue to grow the dividend in accordance with the stated 3-year plan of ¥170 minimum with progressive growth. I am estimating ¥185 in FY 2025 and ¥190 in FY 2026, slower growth than recent years. Mitsui could possibly increase the dividend further but would have to reduce buybacks from this year’s level to do so.

Valuation And Capital Management

At ¥5846 on the day of the earnings release, Mitsui shares are 9.3 times the FY 2024 forecast, an increase from 8.7 at the time of my last article. On a trailing P/E basis, Mitsui remains the second cheapest of the 5 trading companies.

Mitsui’s price/book is 1.23, up from 1.16 last quarter and still in the middle of the pack.

With the increase in share price since last quarter and no change in the dividend, Mitsui now yields 2.9%. The 2024 dividend is 27% of the new EPS forecast of ¥630.2 and will use ¥255 billion in cash. Mitsui has also completed ¥120 billion worth of buybacks this year, wrapping up the last ¥50 billion at the end of January. The resulting ¥375 billion of capital returned this year is 37.5% of the latest operating cash flow forecast of ¥1 trillion. This is close to the 3-year plan target of 37%.

Since the start of the fiscal year, debt is down ¥0.1 trillion to ¥4.5 trillion, while cash is down ¥0.3 trillion to ¥1.1 trillion. The resulting net debt of ¥3.3 trillion is 0.47 times equity of ¥7.1 trillion. That represents a slight improvement in the debt/equity ratio from 0.50 at the start of the fiscal year. Mitsui has done a better job with its balance sheet than Marubeni, which saw debt/equity ratio increase from 0.5 to 0.6 this year.

Conclusion

Mitsui’s latest results showed little change in the outlook for FY 2024, mainly just a positive tweak to iron ore prices. This allowed Mitsui to make a small profit forecast increase and no change in the dividend. This was at least better than Marubeni which also did not raise its profit forecast. The remaining three Japanese trading companies will probably have equally unexciting results when they report next week. Unlike in recent years, commodity prices have been more stable and are not a big driver of changes in the profit forecast for the year. I expect this trend to continue into FY 2025. On the bright side for Mitsui, commodity volumes are expected to increase, allowing for high single digit profit growth in my estimate. Mitsui is delivering its 3-year plan commitment to return 37% of core operating cash flow to shareholders via the ¥170/share dividend and ¥120 billion of buybacks. The commodity volume growth will allow Mitsui to deliver progressive dividend growth above this level, although this growth will be slower than recent years.

Mitsui’s relative valuation has not changed since last quarter – middle of the pack on price/book and second cheapest on trailing P/E. Given the run-up in the share price in January and the minimal change to the full year forecast, I am leaving my rating on Mitsui at Hold. Any pullbacks to the ¥5400-¥5500 level ($733-$747/US ADR) level would be a buying opportunity as the market waits for the FY 2025 plan to come out in May.

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