dani3315

Investment thesis

We have long valued Marubeni (OTCPK:MARUF) for its coal, natural gas, fertilizer and grain businesses, arguably rare winners in a turbulent 2022 so far.

We are confident that the business will pay off results for the upcoming semi-annual reporting period, but believe this is going unnoticed in the market. Coupled with attractive valuations, we are optimistic that upside gains will occur when its impending strong performance is recognized later this year and beyond.

While OTC tickers are available to US-based investors, we have our exposure through its equivalent on the Tokyo Stock Exchange (TSE: 8002).

The company

Marubeni is one of Japan’s Big 5 trading companies, but smaller in size than market leaders Mitsubishi Corporation (OTCPK:MSBHF) and Itochu (OTCPK:ITOCF). We have already discussed the characteristics of these larger counterparts – in our view, Marubeni’s business model aligns more closely with Mitsubishi’s in its large resource exposure and weighting towards international operations. The key point of differentiation is that Marubeni also has a strong presence in the agricultural and food sectors.

Among Japanese trading companies, we like Marubeni the most due to its large exposure to key commodities which have remained strong throughout 2022 so far despite economic headwinds, namely coking coal (via its Metals and Mineral Resources), LNG (Energy), Fertilizers (Agrifood) and Cereals (Food). All four of these are unwitting beneficiaries of Ukraine’s conflict and have shown enduring resilience in the face of a weakening global economy that has weighed on most of its other commodity brethren. Fiscal 2023 first-quarter earnings were 202 billion yen, mainly due to strong contributions from the aforementioned companies. That was 50% of its full-year forecast of 400 billion yen.

1st quarter results vs forecasts

The strongest contributors are benefiting from the tailwinds in underlying commodity prices. These areas (particularly Metals/Minerals and Agriculture) are on track to hit budget by the half year and will drive the company to bumper full year earnings in our view. (compiled from presentation of financial results)

We expect this forecast to be exceeded by the first half (September) and the full year forecast to be revised to around 650 billion yen in the next period, thanks to still favorable markets for the second trimester. With this in mind, we also expect the full-year dividend floor to be raised to 75 JPY (0.50 USD), which would represent a dividend yield of at least 5%, half of which would be paid out in interim dividend.

Evaluation

The current P/E ratio on a rolling basis is 4.5x, which is lower than historical levels closer to 5-7x. Half-year earnings that reach our revised expected levels will bring the ratio closer to 4x and support our assumption that the stock price will rise to 1,700 JPY ($12) when the P/E multiples normalize.

10 years P/E

Its current P/E ratio (blue dotted line) is lower than most of the past decade. If half-year earnings are as strong as expected, that would bring the multiple closer to 4x. (Looking for Alpha)

We also note that stock price action this year has decoupled from company fundamentals. We think the market ignored the impact of the conflict on Marubeni, and although high commodity prices continued throughout the year, the stock has not retested its 52-week highs since March. We attribute the price disconnect to our expectations as a sign that the company is underfollowing.

8002 since the beginning of the year

We note the absence of a peak during the outbreak of the Ukrainian conflict (yellow circle) as well as the indifference of the market to its impact on Marubeni. This contrasts with the reactionary move when the company reported strong first quarter earnings (pink circle). We expect a similar response in early November, and the stock will retest the 52-week highs (blue line) again shortly thereafter. (Interactive brokers)

Risks

We believe that the favorable conditions for Marubeni are fading as the tight supply of raw materials affected by the conflict in Ukraine resolves. We note that, for example, wheat prices have weakened lately and we expect this slowdown to be reflected in future earnings. Marubeni’s exposure, however, is largest in coking coal (which just hit record highs), so we would consider a significant decline in spot coal prices a sign that its tailwinds have abandoned them.

We also believe that Marubeni will see longer-term resistance in a prolonged global economic downturn, so we fear lower returns if the strength in commodity prices does not persist in a recessionary environment. However, the low P/E multiple reflects a sizable margin of safety, further bolstered by current trading conditions appearing conducive to frontloading gains and building an additional buffer for potentially tougher times down the road.

Conclusion

We advocate that interested investors expose themselves to Marubeni before the ex-dividend date of September 30. We are looking for a substantial beating of earnings expectations for the semi-annual reports scheduled for the first week of November, and a subsequent rise in the share price at that time. Before the end of the year, we expect it to make new 52-week highs and approach 1,700 JPY (US$12).

Over the long term, we seek to hold the stock unless the outlook for its exposed commodities changes dramatically, or we sense significant damage to its outlook in a recessionary environment. We also find that expected dividend yields of 5% are only a short-term lower bound and that future capital returns at an even higher rate.

(USDJPY=144 assumed in analysis)

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