Source: Zhongjin Dim Sum
Authors: Zhang Wenjie, Ding Rui, etc.

summary

An evolving business model. In line with the changing times, Mitsubishi Corporation's business model ranged from earning price differences and service fees for imported and exported goods in the 1980s to strengthening upstream and downstream industrial investment to obtain investment income in the 1990s. After 2000, it participated more directly in the operation of investment enterprises, and optimized the value chain by integrating upstream and downstream resources. The core of its profit is investment+operation+trade.

Unique business cycle management system. Based on the profit model, we believe that Mitsubishi Corporation has done a good job in asset management. The company emphasizes the life cycle management of each business, that is, finding new business growth points -> developing into a pillar business through management -> selling the business to obtain capital gains (if the company believes it cannot create new value increases) -> investing capital in the new business. In the fiscal year 2016-2022, the company invested an average of about 814.1 billion yen, and the average annual capital for asset sales and recovery was about 532.1 billion yen.

The company guides double-digit ROE, healthy cash flow, and good shareholder returns for the fiscal year 2021-2024. According to the company's announcement, the company's net profit for fiscal year 2023 is about 950 billion yen, and shareholder return is about 890 billion yen (290 billion yen dividend and 600 billion yen repurchase). In the mid-term development strategy for the fiscal year 2022 to 2024, the company is expected to maintain a double-digit ROE, and free cash flow will be positive after dividends.

The model for large Chinese supply chain companies and Japanese trading companies is similar but different. Japanese trading companies focus on expanding commercial rights to establish a vertically integrated transaction network system through investment or financing; large Chinese supply chain companies focus more on supply chain supporting services. Referring to the development trajectory of Japanese trading companies, we believe that large Chinese supply chain companies may show three major trends in the future: 1) they are expected to continue to increase their concentration, 2) continue to increase their overseas efforts, and 3) expand their categories and services.

risks

Commodity prices fluctuated sharply, the yen exchange rate fluctuated greatly, and investment risks increased.

body

Mitsubishi Corporation: Japan's largest general trading company

• Mitsubishi Corporation is the largest general trading company in Japan

The company was founded in 1954 and has operations all over the world. As of February 2024, the company had 107 overseas branches, covering about 90 countries and regions around the world, and employing about 80,000 people (as of March 31, 2023). The company's business covers a wide range of areas, with a total of ten divisions: natural gas, integrated materials, petroleum and chemical solutions, metal resources, industrial infrastructure, automobiles and mobility, food industry, consumer industry, power solutions, and complex urban development (a new industrial DX department was established in 2022 to support the digital transformation of various business divisions). According to the company announcement [1], the company will restructure the original ten divisions into eight divisions starting April 1, 2024 [2].

Mitsubishi Corporation is the largest comprehensive trading company in Japan. According to the 2022 fiscal year data announced by various companies (as of March 31, 2023), Mitsubishi Corporation ranked first among the five major general trading companies in Japan in terms of revenue scale, net profit to mother, total assets, and net assets attributable to mother.

• Balanced development of resource and non-resource businesses

The profit contribution of resource-related and non-resource-related businesses is approximately 1:1

In fiscal year 2022, Mitsubishi Corporation achieved revenue of approximately 21.6 trillion yen and net profit to mother of approximately 1.2 trillion yen. In the 2018-2022 fiscal year (the company redivided its business divisions in 2019), the compound growth rate of the company's revenue was 7.6%, and the compound growth rate of net profit to mother was 18.9%.

By business sector, resource-related businesses (metal resources+natural gas) accounted for 26.4% of revenue and 51.6% of net profit due to mother; non-resource-related businesses (consumption, integrated raw materials, food, automobiles and mobility, industrial infrastructure, power solutions, complex city development, chemicals) accounted for 73.6% of revenue, accounting for 48.3% of net profit attributable to mother; the compound growth rate of revenue and net profit margin of resource-related businesses in fiscal year 2018-2022 was 21.4%/15.6%, respectively. The compound growth rate of net profit margin to mother was 4.2%/23.1%, respectively, and non-resource-related businesses contributed more to the company's profit growth.

The past and present life of Mitsubishi Corporation

• Development history: comprehensification and globalization

On July 1, 1954, Mitsubishi Corporation was established.

1950s-1970s, the field of trade was comprehensively diversified, and globalization began at the same time

Beginning in 1960, the Japanese economy entered a period of rapid development, and the scale of international trade was increasing. The government promoted rapid development of the national economy led by the heavy chemical industry, and integrated trading companies became more and more important as economic and trade windows. This also encouraged comprehensive trading companies to transform their business strategies into comprehensive domestic trade and globalization of overseas businesses. The company's business covered “everything from instant noodles to missiles.”

Entering the 70s, the oil crisis put the Japanese economy in trouble, and the profit margins of trading companies were compressed. At the same time, some manufacturing companies gradually developed into multinational companies, and their dependence on trade intermediaries decreased. As a result, the scope of activities of Mitsubishi Corporation as a trader gradually shrank. As a result, it began to actively promote multilateral overseas investment, shifting from simple investment and import trade to direct investment and trade, and continuously expanding multilateral trade.

1980s-2010s, acceleration of globalization, deep penetration upstream and downstream of the industrial chain

The dollar depreciated sharply against the yen after the “Plaza Accord” in September 1985. The appreciation of the yen meant that Japan was unable to continue its model of benefiting from trade and exports. As a result, Japanese companies adopted a strategy of expanding foreign direct investment, shifting from Japan-centered trade to world-centered trade. Mitsubishi Corporation also began large-scale overseas expansion, promoting and supporting manufacturers to build and set up companies overseas, expand re-export transactions, and strengthen industrial investment and enhance its financial efficiency.

Overseas direct investment is mainly through shareholding. On the one hand, it reduces the risk of international investment, and on the other hand, avoids the control difficulties caused by controlling production enterprises themselves as commercial enterprises. Although holding a small amount of shares, trading companies can still effectively control the enterprise through the introduction of production lines, procurement of raw materials, product sales, and enterprise financing.

• Several changes in the company's strategy in recent years

Ken Kobayashi's tenure as CEO from 2010 to 2015:

► The mid-term development strategy for 2010 to 2012 was formulated, with an emphasis on growth, mainly through two aspects: 1) investing in strategic businesses and strategic regions, and 2) restructuring existing businesses according to risk and capacity.

► In 2012, the company formulated a longer-term vision, which emphasizes cultivating advantageous business groups, with a medium- to long-term ROE target of 12-15%. Among them, resource-based businesses should improve profitability (by expanding business scale and focusing on operations), while non-resource-based businesses should carry out business restructuring to accelerate the sale of low-profit businesses while continuing to find high-yield businesses.

From 2016 to 2021, Takehiko Kakiuchi served as CEO:

► The mid-term development strategy formulated by the company emphasizes the shift from “business investment” to “business management”. The paths include: 1) rebalancing resource business with non-resource business; 2) three-year cumulative cash flow inflow is higher than cash outflow; 3) participating more deeply in business operations.

► The 2018-2021 mid-term management strategy formulated by the company continues to emphasize the business business model, but unlike the previous three years, it emphasizes the planned construction of business assets corresponding to changes in the external environment; 2) business restructuring: in April 2019, it was restructured into 10 departments, streamlining the original business areas and emphasizing cooperation between departments and digitalization; 3) Personnel system reform: making better use of staff with 5-10 years of experience, so that they can perform management responsibilities as soon as possible; In terms of remuneration, a system of share remuneration is introduced while evaluating and paying flexible remuneration based on results.

From 2022 to now, during his tenure as CEO, Katsuya Nakanishi:

► The company's mid-term development strategy for 2021-2024 emphasizes co-creation value, that is, solving social issues (carbon neutrality, sustainable development, innovation, etc.) through the comprehensive strength of Mitsubishi Corporation, thereby continuously creating co-created value on a certain scale. The company plans to invest about 3 trillion yen within three years, of which about 1 trillion yen will be invested in main businesses, including coking coal, automobiles, and food. Approximately 2 trillion yen will be invested in energy transformation (EX, including copper, natural gas, and new energy) and digital transformation (DX) fields, and to promote regional revitalization through EX and DX.

► Develop a business cycle management system and pursue improvements in capital efficiency. Mitsubishi Corporation has a unique business cycle management system, that is, finding new business growth points -> developing into a pillar business through management -> selling the business to obtain capital gains (if the company believes it cannot create new value increases) -> investing capital into the new business.

Evolving business model: organic combination of trade and investment to optimize the entire value chain

• What do trading companies profit from?

We believe that a trading company is first and foremost an asset management company

Why do we think a trading company is first and foremost an asset management company? There are three reasons:

► The company's investment needs to determine which fields and regions. For example, in the mid-2012 development strategy, China, India, and Brazil invest in infrastructure businesses, while the 2024 mid-term development strategy plans to focus investment on energy transformation, etc.

► The concept of reorganizing and replanning assets/businesses has continued throughout: in 2016, the company proposed “asset replanning based on the life cycle of the business” (referring to the life cycle of the business and the depth of the company's participation in business operations, investing more resources in the business during the growth period and high level of participation); in 2018, the company proposed a “circular development model”, which means continuously searching for potential growth-driving businesses and making them the core business through the management of Mitsubishi Corporation. If the company finds that it can no longer add more value to this business, the company will choose to sell This business (even the core business) obtains capital gains, and the capital obtained is invested in the new business to complete a cycle.

► In terms of actual implementation, the company is indeed constantly upgrading its assets. From the 2016 to 2022 fiscal year, the company invested an average of about 814.1 billion yen, while the average annual asset sale and recovery capital was about 532.1 billion yen. The company's mid-term development strategy for 2024 guided an investment of about 3 trillion yen in the 2024 mid-term development strategy, and the sale brought about a return on investment of about 1.5 trillion yen.

The core of profit is investment and trade

In business operations, we believe that the core of profit for Japanese trading companies is investment+trade. Investment obtains benefits from all links in the industrial chain (reflected in dividend income+investment income calculated by equity method), and also obtains upstream and downstream agent sales rights or trade rights, and obtains benefits from price differences and services (including logistics, finance, etc.) through distribution or trade. Judging from the company's history, dividend income+investment income calculated by equity method accounts for an average of 44.2% of profit before tax; and as the scope of investment reaches upstream and downstream companies, it is even wider Can do more By being deeply involved in the operation of physical enterprises, trading companies can maximize value by integrating the industrial chain.

Next, we will introduce the company's specific business model by dividing resource-based and non-resource-based businesses.

• Resource-related business model: equal emphasis on investment and trade, affected by the price of resource products

The company's resource-related business is the metal resources and natural gas business. According to the company's announcement, the two together accounted for 26.4% of the company's revenue and 51.7% of net profit attributable to mother in fiscal year 2022.

Metal resources business: coking coal and copper are the main types of business

According to the company's official website, the company is mainly engaged in mineral resources investment and trade (the group level is also divided into investment departments and trade departments). According to the company's announcement, the net profit of the metal resources business for the first three quarters of fiscal year 2023 was 216.9 billion yen, of which the coking coal/copper/coking coal business contributed 60.5%/25.5%/5.4% respectively [3]. Since the coking coal business accounts for a relatively large share, the company's metal resources business profit was affected by the price of coking coal.

The company's copper business contributed to a sharp increase in profit as Quellaveco's production climbed (55.4 billion yen in the first three quarters of 2023, up about 253% year on year. Quellaveco accounted for 57.2% of the company's copper business profit). The company's equity copper production in 2022 was about 250,000 tons, and the company is expected to reach 400,000 tons in the short term, rising to the top 15 copper companies in the world [4].

Natural gas business: LNG with a global layout

According to the company's official website and announcements, the natural gas business mainly develops natural gas and liquefied natural gas in North America, Southeast Asia, Australia, etc. In addition, Mitsubishi Corporation has a natural gas marketing company that sells liquefied natural gas corresponding to Mitsubishi Corporation's interests and provides liquefied natural gas carrier business (ship chartering, shipping management, etc.).

According to the company's announcement, as of December 31, 2022, the company has reserves of 1,405 billion barrels of crude oil; in 2023, the company's equity natural gas production will be 12.19 MTPA. The company expects that after the project under construction is put into operation, equity natural gas production is expected to rise to 14.29 MTPA, an increase of 17.2%.

The profit from the company's natural gas business mainly comes from dividends from equity investment and investment income calculated by equity law. Since most natural gas projects are long-term contracts linked to the price of crude oil, the net profit from the natural gas business is highly correlated with the price of Brent crude oil.

• Non-resource-related businesses: diversified development, going hand in hand

The company's non-resource-related business involves all aspects of production and life. Let's take the automobile and mobile mobility business and food business, which account for a relatively large share of the company's net profit to mother (both accounted for 11.1% and 5.4% of total net profit for fiscal year 2022, respectively).

Automotive and Mobility Business: In-depth Cooperation with Mitsubishi Motors and Isuzu Motors

According to the company's official website and announcements, the automobile and mobility business mainly has joint ventures with Mitsubishi Motors, Mitsubishi Fuso Truck and Bus, and Isuzu Motors to operate production, distribution, import, and general sales agents in ASEAN, Europe and the United States. In addition to production, the automobile business also includes derivative businesses such as post-sale, finance, and leasing. There is equity investment throughout the automobile value chain to maximize value chain benefits.

For example, cooperating with Mitsubishi Motors and Mitsubishi Fuso Truck and Bus: According to the company's announcement, the company invested in the production plant of Mitsubishi Motors and Mitsubishi Fuso trucks in Indonesia, and is also the general import and sales agent. In 2023, Mitsubishi Motors sold 58,000 vehicles in Indonesia, with a market share of 8.7%; in addition to Indonesia, Vietnam is another important market for the company, and Mitsubishi Motors's sales share in Vietnam in 2023 was 10.2%.

The operation of this business is relatively steady (net profit margin of about 12% under steady state in the 2018-2022 fiscal year), but was still affected by depreciation of investment assets in individual years (such as FY2019 and 2020).

Food business: Mainly holding, full range coverage, perfect upstream and downstream layout

The company's food business covers grains, seeds, sugar, coffee beans, aquaculture, animal husbandry (meat, dairy products), nutritional products, etc. The core holding subsidiaries include Cermaq (acquired in 2014, raising about 200,000 tons of salmon in Norway, Chile and Canada), Itoham Yonekyu (meat food processing), and Agrex (acquisition and production of grains, located in Brazil).

The company has a comprehensive upstream and downstream layout in some vertical fields. For example, the company procures grain through Agrex (100% company holding), supplies compound feed production to Nosan Corporation (company holding 92.7%), feeds are supplied to Japan Farm (company holding 92.7%) for poultry farming, then processed by Itoham Yonekyu (company holding 40.7%) or Foodlink (company holding 99.4%) and then transferring it to KFC Japan (company holding 99.4%) (35.2% holding).

Why is Mitsubishi Corporation's stock price repeatedly reaching new highs?

• The recent round of rise was driven by a double rise in profits and valuations

From its listing in 1983 to March 27, 2024, the stock price of Mitsubishi Corporation has doubled about 41 times, with an annualized share price return of 9.5%; since March 2020, the stock price has doubled 5.1 times, significantly outperforming the Nikkei 225 Index by 296 percentage points, while the annual stock price earnings reached 42.0% in 2020-2024.

The recent round of gains was driven by a double rise in profits and valuations. The company's net profit to mother rose from 326.8 billion yen in FY2020 (after deducting one-time income/loss) to about 1.18 trillion yen in FY2022, and the company's guide net profit for fiscal year 2023 is about 950 billion yen (according to the company announcement); at the same time, the company's P/E ratio has risen from 6.7 times the same period in March 2020 to 14.8 times now (March 27, 2024) (P/E is based on what we think EPS is based on the company's forecast). The increase in valuation comes from two aspects:

► Market valuation is increasing: the P/E valuation of TTM for all stocks on the Tokyo Stock Exchange rose from 12.5 times in March 2020 to 17.8 times in March 2024, and the P/E valuation of TTM of the Nikkei 225 Index increased from 11.4 times to 17.2 times during the same period;

► The company continues to increase shareholder returns (see below), and the company's repurchases combined with additional capital (such as continued Berkshire Hathaway purchases) indicate that the company's value is increasingly being recognized by the market.

What does Berkshire Hathaway like about trading companies?

Berkshire Hathaway's purchase of shares in Japan's top five trading companies began in 2019. On August 31, 2020, Berkshire Hathaway announced that it held more than 5% of the shares in Japan's top five trading companies, which is the result of cumulative purchases on the Japan Exchange over the past 12 months, and is not expected to increase its holdings by more than 9.9% in the future (without permission from the board of directors) [5]. On April 12, 2023, Buffett said in an interview with CNBC that Berkshire Hathaway had increased the five major trading companies' holdings to 7.4% [6]; on June 19, 2023, Berkshire Hathaway had increased the five major trading companies' holdings to more than 8.0% [7]. On February 24, 2024, Berkshire Hathaway mentioned increasing its holdings of the five major trading companies to 9.0% in its 2023 annual report [8].

Berkshire Hathaway's views on the five major trading companies during the purchase are as follows:

► Will hold shares of trading companies for a long time [9];

► The five major Japanese trading companies have many joint ventures around the world, and it is likely that there will be more in the future. I hope there will be opportunities for mutual benefits in the future [10];

► The company is big, the business model is clear (like Berkshire Hathaway), and the company's stock price is cheap [11].

• Stock price reopening: when the commodity is booming, it clearly outperforms, and when the commodity is weak, it loses in stages

It outperformed the market during the period of weak commodity prices in 2011-2015. Commodity prices were relatively weak in 2011-2015. The CRB Spot Composite Index fell by 28.4% in 4 years, and the company's profit also fluctuated. The company's net profit loss for fiscal year 2015 was about 149.4 billion yen, achieving profit of about 245.6 billion yuan after deducting one-time impairment, while net profit to mother for the 2011-2014 fiscal year was in the range of 300 billion yen to 500 billion yen. In 2011-2015, the company's stock price outperformed the Nikkei 225 Index by 77.5 percentage points.

Commodity prices gradually picked up in 2016-2018, and the company outperformed, mostly driven by profit recovery. Commodity prices picked up marginally in 2016-2019, and the CBR index rose 9.2% cumulatively. The company emerged from profit losses in FY2015 and achieved net profit of about 590.7 billion yen in FY2018. The company's stock price rose 66.6% in 2016-2018, outperforming the Nikkei 225 Index by 46.2 percentage points.

In 2020-2024, the company's stock price significantly outperformed the market, and both valuation and profit increased. The CBR commodity index had a cumulative increase of 53.0% (highest increase of 83.0%) in March 2020-2024. The company's stock price performance was outstanding, with a cumulative increase of 470.3%, outperforming the Nikkei Index. As mentioned above, the rise in stock prices at this stage was driven by both profit and valuation.

• Greater shareholder returns: progressive dividends and share buybacks

We believe that companies are increasingly focusing on shareholder returns:

► The dividend ratio set by the company in the mid-term development strategy for the 2010-2012 fiscal year is in the 20-25% range (the company's dividend ratio for the 2008-2010 fiscal year was 22%);

► The company introduced a new dividend policy in fiscal year 2012, with a minimum fixed dividend per share + variable portion (if the profit exceeds a certain amount, the excess portion is distributed at a rate of 30%). Since then, the company's DPS has not been less than 50 yen (even in the case of a loss in fiscal year 2015); at the same time, the company carried out stock repurchases when the stock price fell in the 2014-2015 fiscal year;

► In the mid-term development strategy for the 2016-2018 fiscal year, the company guides progressive dividends. If profits grow sustainably, the company's dividends will grow flexibly;

► In the mid-term development strategy for the 2018-2021 fiscal year, the company's guidelines are based on the original progressive dividend mechanism. The company hopes to increase the distribution ratio to 30%-35%, while the company has repurchased 70 billion yen of shares in fiscal year 2021;

► In the mid-term development strategy for the 2021-2024 fiscal year, the company guidelines are based on the original progressive dividend mechanism. The company's guidelines hope to increase the distribution ratio to 30%-40%, while flexibly implementing stock repurchases. The company repurchased approximately 170 billion yen of shares in fiscal year 2022, and announced an increase of 200 billion yen in stock repurchases when disclosing the FY2022 annual report; the company expects an additional 500 billion yen to carry out stock repurchases in fiscal year 2023 (there have already been 100 billion yen repurchases).

• Strict financial discipline

The company's financial discipline is reflected in three aspects:

► Cash inflows greater than or equal to cash outflows: Cash inflows are mainly operating cash flow and cash from asset divest/sale, and cash outflows are mainly investment and shareholder returns; according to company announcements, the company expects cumulative cash inflows of about 5.5 trillion yen (of which 3.5 trillion yen comes from operating cash flow and 2 trillion yen from asset divest/sale), while cash outflows are about 5.5 trillion yen (of which 3 trillion yen is for investment, 2 trillion yen for shareholder returns, and 0.5 trillion yen may be used to increase investment or shareholder returns);

► Controlled net debt: The company's net debt gradually declined from 4.0 trillion yen in fiscal 2016 to about 3.2 trillion yen in fiscal 2022, and the corresponding net debt/shareholders' equity coefficient fell from 0.8 to 0.4;

► Stable net business cycle: The net business cycle of the company's combined accounts receivable, inventory turnover and payables is approximately 45 days (average value over the past 5 years).

Risk warning

► Drastic changes in commodity prices: According to the company's announcement, if the price of copper rises or falls by 10 cents per pound, the company's net profit to the mother in fiscal year 2023 will increase or decrease by 6.4 billion yen; if the price of oil rises or falls by 1 US dollar per barrel, the company's net profit to the mother for fiscal year 2023 will increase or decrease by 1.5 billion yen;

► Exchange rate changes: According to the company's announcement, if the exchange rate of the yen appreciates or depreciates by 1 yen against the US dollar, the company's net profit to mother for fiscal year 2023 will increase or decrease by 5 billion yen;

► Increased investment risk: The company plans to invest a large amount every year, and increased uncertainty in the overseas market environment may increase its investment risk.

[1] https://www.mitsubishicorp.com/jp/en/pr/archive/2023/files/0000052514_file2.pdf

[2] Note: Since the company's financial reports for previous years are not disclosed according to the restructured department, all text analyses will use the original disclosure standards.

[3] Statistical calculations for subsidiaries and joint ventures announced by the company may be inaccurate

[4] For details, see Mitsubishi Corporation Mineral Resources Group, https://www.mitsubishicorp.com/jp/en/ir/event/bsm.html

[5] https://www.berkshirehathaway.com/news/aug3020.pdf

[6] https://www.cnbc.com/2023/04/12/warren-buffett-why-he-bought-5-japanese-trading-houses.html

[7] https://www.nasdaq.com/articles/berkshire-hathaway-adds-to-japan-trading-company-holdings

[8] https://www.berkshirehathaway.com/2023ar/2023ar.pdf

[9] https://www.berkshirehathaway.com/news/aug3020.pdf

[10] https://www.berkshirehathaway.com/news/aug3020.pdf

[11] https://www.cnbc.com/2023/04/12/warren-buffett-why-he-bought-5-japanese-trading-houses.htm

Editor/Somer