Warren Buffett (Trades, Portfolio) recently made $6 billion dollars worth of investments into Japan's five major trading houses. Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) holds the investments through subsidiary National Indemnity, with 5% stakes in each of the houses: Mitsubishi Corp. (OTCPK:MSBHF), Mitsui & Co. (OTCPK:MITSY), Itochu Corp. (OTCPK:ITOCF), Sumitomo Corp. (OTCPK:SSUMF) and Marubeni Corp. (OTCPK:MARUF).
The five appear cheap from my analysis. Most of them have been hit by the global pandemic and are viewed as commodity businesses.
Buffett has communicated he intends to hold for the long term and could increase his investments further. Berkshire has in excess of $150 billion of cash and an equity portfolio worth over $200 billion. The investments will not impact the portfolio to a great degree, but if Berkshire takes the stakes up to 10% per trading house it could amount to a significant $12 billion.
The five trading houses are traditionally commodity traders, which invest and own assets throughout the entire supply chain and leverage the data and knowledge to generate profits in excess of what's usually generated by commodity businesses through logistics and trading of physical commodities.
But over time, the trading houses have shifted away from those businesses and invested cash flows into new ventures, much like Berkshire itself. Some of them have up to a thousand subsidiaries. Many are fully owned, but large swaths of investments consist of stakes of 20%-50%. Those are accounted for under the equity method, and if these are unprofitable growing businesses, that method can understate their intrinsic value.
Mitsubishi Corp
Mitsubishi Corp encompasses 1700 fully and partially owned subsidiaries. It divided those across ten segments: Natural Gas, Industrial Materials, Petroleum & Chemicals, Mineral Resources, Industrial Infrastructure, Automotive & Mobility, Food Industry, Consumer Industry, Power Solution and Urban Development. The company trades at 6.2 times free cash flow, 9.7 times earnings and 0.75 times book value. Even though the company is trading at a very modest free cash flow multiple, it is likely depressed as the operating cash flows are dragged down by investment portfolio losses.
Mitsubishi Corp does not appear to be as interested in creating shareholder value as some of its peers. However, it did recently institute a strategy change. Traditionally it has been a buy-and-hold forever type of owner. Instead, the institution now wants to sell off its mature portfolio where it believes it can no longer add value. That frees up assets to invest in communications, data assets, logistics & leasing businesses, e-commerce and internet services, distributed power generation, mobility services, urban development and retail. It views those as areas of future growth.
Management believes its refreshed approach can get it to achieving returns on equity in the double digits. Its previous strategy managed to get it between 7%-9% over the past four years.
Mitsui & Co
Pretty much all conglomerates with equity portfolios are currently facing pressure on cash flows due to investment results. Yet, they trade at low cash flow multiples anyway. Mitsui owns an attractive Asian-focused healthcare business and an LNG focused segment that is poised to do well in a future where we're increasingly moving towards clean energy.
Mitsui is still below the levels it traded at before the Great Financial Crisis. In the meantime, book value has continued to compound. The twenty years before that crisis, Mitsui usually traded at a premium to book. Recently, it is trading far below.
At 12 times free cash flow, 9.5 times earnings and 0.8 times book value, it looks very reasonably priced. Mitsui also shells out a 4% dividend. Over the past few years Mitsui has been buying back shares at a clip of 2%-3% per year.
In the near term, the company is focused on return on equity, core operating cash flows as well as earnings per share. It appears the company is making a real effort to execute shareholder-friendly policies.
Itochu Corp
Itochu Corporation was first founded in 1858 as a linen trading operation. Perhaps the history of this company takes Buffett back to the humble beginnings of Berkshire Hathaway itself.
Itochu has segments focused on domestic trading, import/export and overseas trading of various products such as textiles, machinery, metals, minerals, energy, chemicals, food, general products, realty, information and communications technology and finance.
The company trades at 5.4 times free cash flow, 9.2 times earnings and 1.36 times book value. It is the only one of the five with price momentum and strong share price performance over the past years.
However, there's been a short-selling campaign in the past where Glaucus research alleged Itochu's accounting wasn't up to snuff. The report is from 2016. Here is one quote that stood out to me:
"Based on our analysis, which we present in full in this report, we believe that Itochu will be embroiled in an accounting scandal as large as Toshiba. Accordingly, we value Itochu at ¥631.00 per share, a downside of 50% from its current traded price."
Sumitomo Corp
Sumitomo Corp is a trading house that's active in metal products, transportation, infrastructure, media & digital, living-related & real estate, mineral resources, energy, chemicals and electronics. The company strives to improve its returns on equity and profitability. It aims for 10% return on equity.
The company views energy, retail (in Asia) and food & agriculture as its future drivers of growth. The company wants to focus on Brazil, India, Myanmar Turkey, and Sub-Saharan Africa as areas of specific interest.
Overall, it doesn't appear as shareholder-friendly to me as some of the other trading houses. The company wants to increase its dividend but is currently not engaging in buybacks.
The valuation looks quite attractive. It trades at 21 times earnings and 0.4 times book value. If the company can really achieve 10% ROE, it is very cheap.
Marubeni Corp
Marubeni is active in lifestyle, real estate ICT, forestry, food and agriculture, chemicals, power business, energy, metals & mineral resources, plants, aerospace & marine, finance & leasing and venture capital. Agriculture and metals & mineral resources are particularly important because they make up a large portion of profitability.
The company is currently deleveraging because management views the debt as too high given we're amidst a global pandemic. Marubeni Corp's management has an interesting way to phrase its short term goals in its annual report:
"First is to "Rebuild and Strengthen Financial Foundation". As a result of a huge loss in the fiscal year ended March 31, 2020, our top priority is to focus on cash flow management in order to rebuild and strengthen our financial foundation."
Repayment of debt is prioritized by accumulating positive free cash flow after delivery of shareholder returns during the GC 2021 period and to achieve net DE ratio of around 1.0 times at the end of March 2022.
Unfortunately, that means no buybacks yet, but it does pay a 5% dividend yield. For growth, the company seems to be looking at its food group.
The company achieved double-digit return on equity figures for the past few years. This year brought the five-year average down to a mundane 7%.
Marubeni Corp trades at a 6.4 times earnings, 3.75 times free cash flow and 0.76 times book value. If the company can get back to its run-rate of 10% ROE, it looks quite cheap.
author [disclosure]: no position
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