Best Trading House In A Rough Neighborhood
Japanese trading company stocks suffered a crash in just the first three trading days of August, down between 22 and 32% in Tokyo. ITOCHU Corp. (OTCPK:ITOCY) (OTCPK:ITOCF) was at the better end of this range, down 24.4%. Since I last reviewed the stock in April, rating it a Buy, ITOCHU has held up the best of the trading companies. It is the only one with a positive total return through 8/4.
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The crash does not look related to any specific problem with Itochu or the trading companies. They actually held up well in the second half of July even though the Nikkei 225 (NKY:IND) peaked at 42,300 and has since crashed 21.4% to 33,252.
With Itochu’s Fiscal Q1 2025 earnings release on 8/5/24, all five trading companies have now reported results. None of the companies revised their full year profit targets set in May or their dividend plan for the year. That’s not unusual after one quarter. When it comes to delivering the plan, Itochu is at 23% of the annual profit target, just under 24% ratable delivery. As I discussed in my Mitsui (OTCPK:MITSY) (OTCPK:MITSF) article, the other trading companies are a bit ahead of 25% delivery, buy they have had one-time gains on asset sales boosting their result. Itochu delivered the Q1 result almost all through core operations, with minimal (¥4.5 billion) extraordinary gains. The company also still has a “loss buffer” of ¥40 billion in the full year plan. As we go through the year and unexpected losses are avoided, the buffer gets revised down, providing upside to the current plan. Itochu leads the trading companies with planned profit growth of 9.8% this year.
FY 2025 Plan On Track
Like the other trading companies, Itochu is not expecting a big change in profits from the resource-related businesses like metals and energy commodities. So far this year, pricing is down slightly in dollar terms, offset by a weaker yen, resulting in similar profits in yen terms. The stronger yen since the end of Fiscal Q1 is a possible headwind for the rest of the year. The good news for Itochu is that it has a higher concentration of non-resource businesses compared to the other trading companies. For FY 2025, Itochu expects most of its growth to be in the non-resource area, split between improvements at existing businesses and new investments. The plan for the year has 74% of the profits coming from non-resource businesses.
ITOCHU Corp.
So far, in FY 2025, Itochu is seeing the benefits from taking full control of Daiken, a construction material business, and Itochu Techno-Solutions, an IT service provider. The company also invested in a stake in Japanese auto dealer Wecars.
Food related businesses are improving, including Dole, which is on track to double earnings this year. Improving pork prices in Asia are also benefitting animal feed company C.T. Pokphand as well as Hylife group, a Canadian hog farming operation. FamilyMart growth has slowed from the excellent result in 2024, but the chain still had improving same store sales with growth in both customer traffic (+1%) and spend per ticket (+2.7%).
Itochu is continuing its drive to consolidate more partially owned businesses this year. They just announced two tender offers for the outstanding shares of partially owned subsidiaries. These include C.I. Takiron, a chemical company producing synthetic resins, and Descente, a sporting apparel manufacturer.
Capital Management
Itochu continues to plan for a ¥200 per share dividend payout in FY 2025. The stated policy is a minimum of ¥200 or 30% of profits. Given the current share count, profits would have to exceed ¥960 billion before 30% of that exceeded ¥200 per share. Therefore, I do not expect a dividend raise this year unless there is an unexpected rise in commodity prices. Still, the ¥200 payout represents growth of 25% from last year and a 3.4% yield. While the yield is the lowest of the trading companies, the growth rate is the second highest.
Itochu did not buy back any shares in 1Q, but formally announced its plan to buy back ¥150 billion in shares over the rest of the fiscal year. The total capital return from the dividend and buybacks is ¥437.8 billion, just about in line with the total payout ratio target of 50%.
ITOCHU Corp.
As I discussed last quarter, Itochu wants to invest up to ¥1 trillion this year in growth. Since operating cash flow minus dividends and buybacks is about ¥442 billion, the company would borrow up to ¥558 billion and allow the debt/equity ratio to get as high as 0.60.
Itochu is off to a slow start on these investments in Q1, with just ¥98 billion of net investment cash outflow. As a result, the debt/equity ratio remains unchanged at around 0.51. The two tender offers I discussed above, Takiron and Descente, would use another ¥220 billion if Itochu acquires all the shares.
Itochu has more work to do to reach the ¥1 trillion investment limit this year. The market crash in July may create some opportunities.
Valuation
The recent crash went a long way toward bringing the trading companies back toward more normal valuations. The P/B of 4 of the 5 companies are now back under 1, while Itochu still has a premium valuation around 1.5. Itochu also still has the second highest P/E ratio at 9.6. This premium valuation is warranted because Itochu’s return on equity is the highest of the group at 15.4%.
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Conclusion
Itochu is on track to deliver its FY 2025 plan, which leads the trading companies in growth at 10%. This is helped by Itochu’s lower concentration in commodity businesses, which are performing largely flat to last year in yen terms. Longer term, Itochu has recognized that there is “no growth without investment” and plans to increase capital investment to as much as ¥1 trillion this year. So far, the company is behind this pace but has announced tender offers to fully integrate two subsidiaries for around ¥220 billion.
There does not appear to be any sudden dropoff in the economy that would cause Japanese and world stock markets to decline so quickly in the last month. It looks more like a market correction that came about because stocks advanced too much, too fast. The decline could provide opportunities for Itochu to deploy capital and for shareholders to buy more of the company. Still, if we are headed into recession, the best-in-class year-to-date performance of Itochu stock demonstrates the quality of the company and lower risk profile compared to the more commodity-focused trading companies. That leads me to maintain my Buy rating on Itochu.
Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.
