Mitsui & Co: An Attractive Conglomerate At A Low Price To Book (OTCMKTS:MITSY)

Investment thesis

Our current investment thesis is:

• Mitsui (OTCPK:MITSY) is a play on superior asset allocation in our view. The company is generating significant cash and reinvesting it in a range of industries, leveraging its global relationships and ability to buy-and-build to generate superior returns to its peers. Based on our analysis of case studies and its business model, we believe this is deliverable going forward.
• The company is clearly agile despite its size, while it takes a long-term view to allocating capital, positioning it to outlast trends and ensure it is exposed to the industries of tomorrow. Its growing investment in growth assets could be a turning point for the coming decade.
• Mitsui is trading at a P/B of 1.2x and a P/OCF of 7x, both of which imply upside in our view. Both metrics are below its peers’ average.

Company description

Mitsui Corporation is a Japanese conglomerate founded in 1876, operating globally across various industries. With a diverse portfolio, Mitsui engages in businesses such as trading, investment, and service provision in sectors including energy, infrastructure, chemicals, and finance. The company is known for its strategic partnerships and a commitment to sustainable business practices.

Mitsui is one of Japan’s 5 largest “Sōgō Shōsha”, the equivalent of a diversified Western conglomerate / trading company.

Warren Buffett (BRK.B) (BRK.A) has been building an equally (large) position in all 5 stocks over the last few years, drawing interest again back to Japan.

Share price

Mitsui’s share price performance has been strong, significantly outperforming other Japanese equities and even the S&P 500. This is a reflection of its consistent financial improvement.

Further, when compared to its directly comparable peers, Mitsu also shines. It only lags behind Itochu in total returns. This suggests its fundamentals and execution are leading.

Financial analysis

Presented above are Mitsui’s financial results.

Revenue & Commercial Factors

Mitsui’s revenue has grown at an impressive CAGR of +9% during the last decade, while EBITDA has lagged behind at only +5%.

Introduction

Mitsui operates across a wide range of industries, including metals (39% of FY23 net profit), energy (27%), machinery (15%), chemicals (6%), consumer lifestyle (5%), and finance. Mitsui is fundamentally a trading company, engaging in the import and export of goods and commodities. The company also makes strategic investments in various sectors, participating in the success and growth of partner companies (>500 affiliated companies). This diversification minimizes risks associated with economic and social fluctuations in specific sectors, contributing to long-term stability and the concept of always succeeding in spite of short-term trends.

Mitsui has a strong global footprint, with ~53% of FY23 revenue from Japan. This global presence enables the company to tap into diverse markets and develop relationships, allowing for access to resources and leveraging opportunities on a worldwide scale.

We will now, very briefly summarize each of the key segments, noting that a paper on each could be written as they are truly standalone businesses:

• Mineral and Metal Resources (”M&M”):
  • 39% of FY23 net profit, 14.3% ROA.
  • Full spectrum M&M business, with mining, trading, and production-related services.
  • Strong portfolio of global assets and partnerships with leading M&M businesses, noting in particular its assets in Australia and Chile are of the highest quality globally.
  • Management has positioned the business well for long-term growth, expanding its exposure to the energy transition wave by supporting trends such as Electrification.
• Energy:
  • 27% of FY23 net profit, 10.3% ROA.
  • Full spectrum Energy business, with extraction, trading, and production assets. Heavy weighting toward Trading, as well as a number of energy transition assets, including a carbon credit business, next-gen fuel, and low-carbon solutions.
  • Again, Mitsui boasts a strong portfolio of assets and partnerships, noting, in this case, the company has heavily benefited from reinvesting cash from its traditional Energy assets into the next-gen ones, allowing it to be a global player.
  • While the company is still exposed to oil/gas prices, there are significant opportunities in cleaner and clean energy (NatGas, LNG, CCS/CCUS etc.), as well as in related industries. Mitsui is almost uniquely positioned relative to its peers.
• Machinery and Infrastructure (”M&I”):
  • 15% of FY23 net profit, 5.3% ROA.
  • Businesses across a range of industries, including (but not limited to): Power (power generation, clean energy), Infra (Natural resources, logistics, digital), Automotive and Construction (incl. related financing), Ships, Aerospace, Rail and Space.
  • Unrivaled expertise, experience, and relationship development given its wide range of services. Industry is underpinned by a renewed wave of global infrastructure spending, underpinned by economic development in growing nations.
  • Almost every segment is positioned well for an improvement in growth, although (again) the climate transition businesses will likely perform the best.
• Chemicals:
  • 6% of FY23 net profit, 4% ROA.
  • Full spectrum offering, including traditional chemicals, agriculture, tank terminal, and forestry.
  • Stable business, benefiting from economic growth and environmentally conscious trends.
• Iron and Steel:
  • 2% of FY23 net profit, 2.9% ROA.
  • Traditional Iron and Steel businesses, alongside Wind power assets.
  • Stable demand is expected to improve due to growth in Asia, as well as the need for assets to successfully achieve decarbonization and a circular economy.
• Lifestyle:
  • 5% of FY23 net profit, 2.2% ROA.
  • Full spectrum businesses in a number of verticals, including Food, Retail, Medical, Hospitality, and Professional services.
  • Exposure to economic growth, growing demand/need for healthcare solutions, and social development, underpinned by supply capabilities.
• Innovation and Corporate development:
  • 6% of FY23 net profit, 4.1% ROA.
  • A range of investments in growth industries, including Digital solutions/platforms, CRM, Finance, Real estate, and Logistics.
  • This segment is fundamentally underpinned by Mitsui’s relationships, partners, and business-building capabilities. Technological development and innovation are driving value for the future and Mitsui is seeking to be a larger player in this. The opportunity here is clear, but the outlook is naturally limited.

Business Model and Valuation Creation

The acquisition and disposal of companies/assets are fundamental to the operations of Mitsui. Management takes a long-term view, seeking to leverage its expertise through hands-on management to improve and grow businesses with long-term potential. Mitsui is increasingly relying on its global relationships to source assets and the best opportunities. Leveraging its existing portfolio and willingness to partner with experts gives it a unique perspective to generating superior returns.

Further, Mitsui is increasingly seeking to invest in growth assets, slightly moving away from its historical conservatism where it would slightly nudge outside of its area of expertise as a means of expansion. Management has likely identified it is in a unique position, with all the resources necessary to be at the forefront of growth drivers.

In recent years, Management has sought to improve its valuation creation model, with a substantial asset-recycling exercise (disposal of low-return assets) to free up capital for additional investments. We are supportive of this strategy, as businesses this large can find themselves bloated with mediocre assets. We commend the review process of Mitsui and its constant business reviews, ensuring its portfolio companies are held to account and supported where necessary.

The outcome of this will be further differentiation away from its M&M, with greater certainty over earning generation, and an improvement in its ROE. We believe the impact of this will be felt in the coming 5 years.

Competitive Positioning

We consider the following factors to be Mitsui’s competitive advantages:

• Risk Mitigation through Diversification – Diversification across industries and geographies helps Mitsui mitigate risks associated with economic downturns in specific sectors or regions.
• Long-Term Investment Approach – Mitsui is not swayed or impacted by short-term distractions, making investments that will yield superior returns long-term.
• Adapting to Market Dynamics – Mitsui’s ability to adapt to changing market dynamics, including technological advancements and shifts in consumer behavior, has allowed it to remain relevant and competitive.
• Financial Strength – The company’s financial strength provides stability and flexibility in pursuing new ventures and weathering economic uncertainties.
• Strong Supply Chain Integration – Integration within supply chains ensures efficiency, cost-effectiveness, and control.
• Leveraging portfolio – Mitsui seeks to exploit its portfolio to cross-benefit firms through collaboration and trading.
• Technology Adoption – Investment in technology-related capabilities within its portfolio companies ensures that Mitsui keeps its respective culture focused on incremental development through new solutions.

Competition

Mitsui competes with industry leaders in its various verticals, as well as its Sogo Shosha peers: Mitsubishi Corporation (OTCPK:MSBHF), Sumitomo Corporation (OTCPK:SSUMF), Marubeni Corporation (OTCPK:MARUF), and Itochu (OTCPK:ITOCY).

Opportunities

We see the following as specific opportunities:

• Renewable Energy Investments – Capitalizing on the global shift towards clean and sustainable energy.
• Technological Integration – Leveraging advancements for competitive advantage in trading and supply chain management.
• Strategic Partnerships – Collaborating with industry leaders, with whom Mitsui has and can create relationships, to explore new business avenues.
• Real estate & infrastructure shortage – In conjunction with a housing shortage across much of the West, there is strong demand for infrastructure in specific verticals such as data centers.
• Economic development – With strong exposure to Metals, Energy, and Chemicals, Mitsui essentially has a call option on economic development, which is almost always underpinned by these factors.
• Strategic Global Expansion – Mitsui appears to be shifting focus slightly toward a global expansion strategy, which positions it to capitalize on emerging market trends and opportunities worldwide.

Economic & External Consideration

2024 is likely to be a difficult year globally, with the cost of living crisis in the West (as a result of elevated rates and inflation) likely coming to a head. The US recession probability indicator has now exceeded 50%, while unemployment sneaks up in many nations and retail sales dip from their barely neutral growth rate.

This will likely impact Mitsui negatively from a M&M, Energy, and Chemical perspective, alongside its other segments to a lesser extent. We suspect this is due to a softer landing, primarily due to the optionality of rates declining to buffer the impact.

The Japanese economy, which will be highly influential also, is likely to further underperform, although Mitsui’s ability to perform thus far illustrates the benefit of diversification and smart asset allocation.

Margins

Mitsui’s margins are materially influenced by changing commodity prices, as the cost of production broadly is consistent. Nevertheless, we are not overly concerned by the slight downward trend (EBITDA-m declined 3ppts), as FCF has disproportionately improved (+6ppts and +2ppts since 2015) and the company’s capex requirements are far lower.

Quarterly results

Presented above is Mitsu’s most recent quarterly results.

The decline of ¥82.8b is primarily driven by:

• M&M (-¥113b) – The decline in M&M is wholly linked to Metallurgical coal and Iron ore prices.
• Energy (-¥29.4b) – Softening oil and gas prices, alongside a reduction in production due to maintenance.
• Chemicals (-¥25b) – Softening demand in its fertilizer and feed businesses.

Offsetting this are gains in the following segments:

• M&I (+¥75b) – Fair value gain on assets.
• Lifestyle (+¥43.7b) – Fair value gains on assets.

Overall, this has been a “correction” half-year, with prices across commodities normalizing, contributing to a decline on a comparable basis. With these trading companies, quarterly./half-year results are less important given the long-term strategy and nature of owning a material amount of non-consolidated businesses.

Balance sheet & Cash Flows

Mitsui is reasonably financed, with a ND/EBITDA ratio of 4.4x and interest coverage of 5.6x. This leaves some room for raising debt, although likely requires continued deleveraging to be afforded flexibility.

In addition to the M&A and asset-recycling strategy discussed above, cash is also allocated to shareholders. Dividends have grown at a +10% during the last decade, while material buybacks were initiated in FY21 (Potentially a Buffett negotiation?). Management has confirmed distributions will grow in the coming years, with good scope for this given its payout ratio is currently 21%.

Outlook

Excluding the commodity business, we suspect industry tailwinds and an acceleration in global investments should contribute to an uptick in its organic growth rate, likely normalizing in the mid single-digit range, with periods of high single-digits.

Peer analysis

Presented above is a comparison of Mitsui to a cohort of its directly comparable peers.

Mitsui performs well relative to its peers. The company’s margin and leverage are similar, while it boasts a superior ROE and growth rate. Much of this is attributable to the outperformance of its commodity and energy businesses, but now positions it with a war chest from which to invest in growth.

Valuation

Mitsui is currently trading at 15x LTM EBITDA and 14x NTM EBITDA. This is a small premium to its historical average.

We believe a premium is justifiable, owing to the significant increase in scale achieved, alongside the reinvestment of cash into superior assets. The business has essentially utilized its M&M businesses as an interest-free bank to fund its future growth. As ROE illustrates, this has been accretive for investors, and we believe this will continue.

When compared to its direct peers, Mitsui is trading at a small discount on an LTM basis (4-26%) but a premium on a NTM basis (12-15%). The NTM/LTM difference is likely a reflection of its M&M weighting relative to others. Importantly, the company is ~21% cheaper on a P/OCF and P/B basis, suggesting downside risk is protected while upside is not wholly priced in.

Based on both a comparison to its historical average and against its peers, we consider Mitsui undervalued.

Key risks with our thesis

The risks to our current thesis are:

• Economic downturns affecting global trade and commodity prices.
• Fundamental shift in commodity demand from China and/or Asia.
• Geopolitical uncertainties impacting international business.
• Further depreciation in the Yen.

Final thoughts

Mitsui is a high-quality business in our view. The company has been run incredibly well and is positioned well for long-term success. We are not the biggest fan of its heavy weighting toward M&M, as we are not commodity investors, but concede it comprises quality assets and allows the business to fund its other ventures with cash.

Looking ahead, we suspect growth and profitability will incrementally accelerate, but gradually over time, as its investments begin to have an impact on financial results. Mitsui is a long-term play for superior asset allocation, similarly to buying Berkshire as a bet on its ability to outperform (but at a cheaper price-to-book).

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.