Itochu’s big bet on China’s Citic puts profit target in jeopardy

Linda J. Dodson

TOKYO — While other Japanese trading houses grapple with plunging resource prices, Itochu faces a different sort of risk through its business ties to China, whose economy has just begun to recover from the coronavirus pandemic.

Itochu in 2015 acquired a roughly 10% interest in Citic, China’s largest state-owned conglomerate, which operates in various fields including finance, information technology and infrastructure.

The blow dealt to stock prices by the pandemic raises the question of whether the trading house will need to write down the value of this stake — and potentially miss its fiscal 2019 net profit forecast of 500 billion yen ($4.66 billion).

Nikkei considered this possibility based on Citic’s stock price and earnings as well as conversations with sources.

The Chinese group’s share price stood at 8.11 Hong Kong dollars at the end of Itochu’s fiscal year in March. Citic is believed to have been valued at HK$13.80 a share when Itochu made its 600 billion yen investment, which would equate to a drop of around 40%.

But the trading house already booked a roughly 140 billion yen write-down on the shares in 2018, lowering their value on its books to somewhere around HK$10.50. That would bring Itochu’s loss to just above 20%, short of the 30% to 50% range that would require impairment testing.

On the earnings front, Citic’s net profit rose 7% last year to about HK$54 billion ($7 billion) thanks to a strong showing by its finance and real estate operations. Itochu can book about $700 million from its interest in the conglomerate — more than the trading house’s initial estimate.

This suggests that Itochu should be safe from a major write-down on its Chinese operations. Then how does its overall fiscal 2019 net profit look?

Resource-related operations make up a smaller share of profits at Itochu than at other big Japanese trading houses, meaning the company is less severely affected by factors such as last month’s plunge in crude oil prices.

The company reported net profit of 426.6 billion yen for the nine months through December, about 85% of its full-year forecast. Itochu also has yet to touch its 30 billion yen emergency buffer. Considering recent trends in its portfolio, full-year net profit could land between 450 billion yen and 500 billion yen, compared with 500.5 billion yen in fiscal 2018.

Other trading houses have been hit harder.

Marubeni slashed its fiscal 2019 net profit estimate by 390 billion yen. Mitsui & Co. warned of possible losses of 50 billion yen to 70 billion yen from various sources, while Sumitomo Corp. noted a potential 100 billion yen undershoot of its target. Mitsubishi Corp. has made no official announcement but could take losses on its shareholdings and resource operations.

Though Itochu shows resilience now, fiscal 2020 may prove a different story. Japan’s state of emergency is expected to bring a sharp contraction in consumer spending, hitting the nonresource businesses that generate 80% of the trading house’s profits. Whether Itochu will be able to give annual earnings guidance at all remains in question.

Itochu-affiliated sportswear maker Descente is expected to fall into the red for fiscal 2019 amid economic slowdowns in China and South Korea. Convenience store operator FamilyMart, an Itochu subsidiary, missed its profit forecast for the year through Feb. 29. Department store closures are squeezing sales of fashion brands, normally one of the trading house’s strengths.

The 16% slump in Itochu’s shares since the end of last year “can be taken to mean that its real net profit, mainly from nonresource operations, is deteriorating,” said Akira Morimoto, senior analyst at SMBC Nikko Securities.

Investors will watch Itochu not only for its earnings, but also for preparations to meet the post-coronavirus landscape. The trading house will need to accelerate its moves to increase digital investments and retreat from areas such as retail, resources and manufacturing.

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