Warren Buffett is investing in 5 largest Japanese trading houses.
In this article, I analyze what may have attracted Buffett to these trading houses and Mitsubishi Corp. in particular.
Valuation, stakes accounted for under the equity method, buybacks, and decent returns on equity could all be factors.
Warren Buffett has pulled the trigger on $6 billion of investments into Japan’s five biggest trading houses. The FT described them as “century-old commodity specialists that are increasingly transforming into global venture capital and private equity businesses”.
Berkshire Hathaway (BRK.A) (BRK.B) holds the investments through subsidiary National Indemnity. Berkshire holds 5% stakes in each of the houses: Mitsubishi Corp. (OTCPK:MSBHF), Mitsui & Co. (OTCPK:MITSY), Itochu Corp. (OTCPK:ITOCF), Sumitomo Corp. (OTCPK:SSUMF) and Marubeni Corp. (OTCPK:MARUF).
This is article is one of a series of five where I go over Sogo Shosha. In this article, I’m going to look at Mitsubishi Corporation to ascertain what attracts Buffett to these names. It is the third installment in a series on the Japanese trading houses. You can read the first installment on Mitsui & Co. here, and the second installment on Itoshu Corp. here.
First, let’s look at what Mitsubishi does. All the trading houses are basically conglomerates that were historically more geared towards commodity-related activities. But all the houses have been diversifying beyond those industries. Often, they have hundreds or even in excess of a thousand stakes in businesses. Some are considered subsidiaries and are consolidated if the company holds a 50% or larger stake. Stakes between 20% and 50% are accounted for using the equity method.
Mitsubishi Group encompasses 1,700 businesses it owns in part or in full. The company has a market cap of about $37 billion. There are ten segments ranging from Natural Gas, Industrial Materials and Petroleum to Automotive and Food and others. The image below is from its annual report and shows the major stakes of publicly traded shares it could easily sell.
The 2019 value of just these securities looks like it is in excess of $4 billion. It also holds in excess of $12 billion in cash. The below statement is from its latest annual report to give you an idea of the values of the different assets:
Reading its annual report and earnings call transcripts, I did not get the sense that it is as interested in creating shareholder value as the previous houses I’ve covered. However, it is quietly taking out a lot of its shares. That’s usually something Buffett really likes.
But the company is implementing a change process as well. That seems to be a theme with the houses. In the past, the company practiced a buy-and-hold approach. Now, the company wants to sell off its mature companies.
Management believes the company adds the least value to these stakes. Subsequently, it wants to redirect those assets towards communications businesses, data assets, towards logistics companies, leasing businesses, and internet services, including e-commerce, in addition to some other areas. Supposedly, that’s where the growth is.
Mitsubishi’s management believes its refreshed approach can get its returns on equity to 10% or better. Over the past years, it has been stuck between 7% and 9%.
In addition to pivoting towards different sectors, it also seems to be increasing its gearing, which should help return on equity a great deal.
Finally, the company is trading at 4x free cash flow, at 0.73x book and 9.5x book. A company achieving 10% returns on equity should probably trade above 0.73x book value. Given its structure, it is very possible that book value is understated. Buying below book value when book value is understated is quite great. If the discounted assets are generating ~10% returns on equity, that’s a recipe for a potentially great investment.
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If you want to know more about a potential 200%+ opportunity in Japan (up 34.72% since my first write-up) go here. This Japanese small-cap, subject of an activist campaign, has a fantastic service business model with a geographical focus in Asia and trades at a P/E of 18x. While this company has better growth prospects a comparable U.S competitor trades at 27x.
Disclosure: I am/we are long BRK.B. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Originally published on Seeking Alpha