After shopping spree, Japanese trading houses take hard look at resources

TOKYO Fri Aug 8, 2014 5:52am EDT

TOKYO Aug 8 (Reuters) - After going on a spending spree during the global commodities boom, many Japanese trading houses have stretched their balance sheets and are now looking to sell off some of the assets to fund future investment plans.

Japan's five biggest trading houses all booked lower profits in their metal resources businesses for the April-June quarter, making coal and other minerals prime candidates as they look to offload unprofitable assets and find others with more promise.

"They're not getting any more capital to allocate to resources investments, so if they want to take advantage of asset-buying opportunities, they need to sell some assets before they can buy assets," said Mike Elliott, global metals and mining leader at advisory firm Ernst & Young.

"Recycling is a portfolio upgrade opportunity for them. They may mix between commodities. They may see some advantage in selling coal assets and buying copper, for example. They're not wedded to staying within any particular commodity," he added.

Lower prices of coal and iron ore caused metal resource profits to fall at Mitsubishi Corp, Mitsui & Co , Itochu Corp, Marubeni Corp and Sumitomo Corp.

Marubeni still made a record net profit overall and Itochu posted higher net income, but Mitsubishi, Mitsui and Sumitomo all booked lower net profit for the quarter.

The trading houses, which have business portfolios like investment funds, invested aggressively in commodities during the resource boom of the 2000s, but a fall in prices has hurt profitability in the sector and the outlook remains gloomy.

The price of iron ore is forecast to continue falling into next year, as is that of coking coal, with global economic growth still fragile, including in top resource buyer China.

Itochu spent $1.5 billion in 2011 for a 20 percent stake in the Colombian business of coal mining firm Drummond Co, but the stake contributed only 500 million yen ($4.9 million) to net profit for the business year that ended in March.

To improve performance, some trading houses such as Sumitomo may be prepared to take on the role of operator in some of the ventures in which they have a stake, analysts say, noting that Sumitomo operates a silver, lead and zinc mine in Bolivia.

They may have to innovate in other ways, too.

For example, industry observers say it is often hard for the trading houses to sell their minority stakes in ventures. But sources said last month that Sumitomo and Itochu were looking to jointly sell their stakes in the Collinsville and Newlands mines in Queensland, which make up the sixth-largest coal-producing complex in Australia.

Elliott at Ernst & Young said he envisaged more such sales.

RATINGS WARNING

High debt is compounding the problem of poor profitability and Moody's Investors Services recently revised its ratings outlook for Sumitomo and Mitsubishi.

"The rise in leverage has occurred due to a build-up in debt associated in turn with substantial investments, eroding all headroom within the company's ratings to absorb any unexpected volatility in its operating environment," Moody's said of Mitsubishi in June.

To develop more stable profit streams, trading houses have lifted the pace of investment in non-resource assets, but very few projects are expected to boost profits significantly in the short term, so getting rid of non-performing assets is vital.

"Trading houses have become more and more focused on asset divestitures since their balance sheets have ballooned to a size that is difficult for them to manage," said Thanh Ha Pham, an analyst at Jefferies who covers Japanese trading houses.

Mitsui plans to sell off 700-900 billion yen of assets by the business year that ends in March 2017, according to its medium-term plan released in May.

Sumitomo said last year it would divest or reduce assets by 770 billion yen, while Mitsubishi wants to have 35-40 business divisions in 2020, down from 47 in the year to March 2013.

Mitsubishi says it is not looking to sell metal resources since it has taken steps to limit losses and does not see prices falling further. But it does not rule out the idea completely.

"If prices were to fall further, there could come a time when our thinking might change, but that is not the case at this point in time," CFO Shuma Uchino said on Thursday.

Still, with miners like BHP Billiton, Rio Tinto and Anglo American shedding assets to focus on their most profitable businesses, there are bargains to be had by the Japanese trading houses and a chance to upgrade.

"They're looking to sell some of the other assets they hold, where they may have extracted most of the value from them," Elliott said. "For them it's a value upgrade if they're looking to invest into other assets." (1 US dollar = 102.0700 Japanese yen) (Additional reporting by Manolo Serapio Jr in Singapore and Sonali Paul in Melbourne; Editing by Alan Raybould)

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