April 8, 2016 6:03 a.m. ET
The sprawling trading houses that built modern Japan have finally begun booking nasty write-downs from the global commodity crash. Sumitomo Corp.
, however, has been slow to admit the extent of its pain.
Sumitomo touches most aspects of industrial Japan—from raw-material imports to electricity generation to minority investments in the commodity projects on which Japan Inc. relies. Two of its fellow omnipresent conglomerates, Mitsubishi
announced big write-downs in their commodity investments at the end of March.
Sumitomo’s bad news has yet to fully hit. The company did take write-downs in the fiscal year that ended March 2015, and in its December-quarter results guided for total impairments of ¥170 billion yen ($1.6 billion) in the just-ended fiscal year. Yet the trader still sounds too hopeful about commodities.
Take Sumitomo’s biggest such investment: a nickel project in Madagascar. It has sunk ¥294 billion into this venture, according to Hiroyuki Sakaida at Goldman Sachs
—equal to 15% of its total investment in affiliate companies as of March 2015.
Nickel prices have plunged 60% in the past two years, partly as a result of declining stainless-steel production. Mr. Sakaida estimates that this project should be impaired by ¥259 billion, or 88%, as a base case, and even that looks generous—he’s assuming a nickel price for 2016 roughly 50% above where it is currently. Taking such a big write-down could imperil Sumitomo’s Canadian partner on the project, though, so a safer Sumitomo impairment might be half that, he says.
In contrast, the write-down Sumitomo announced on this project so far is a measly ¥77 billion. The trader still assumes a mid-to-long-term nickel price that is double today’s and 27% higher than Mr. Sakaida’s 2019 forecast.
The value of this asset should ideally fall further. Yet in reality, Sumitomo may invest more equity to sustain the project, which is already becoming more dependent on the Japanese trader because its partners seem in worse financial shape. This would be worrisome.
The risk of further impairments should spook shareholders, in part because of how ratings companies respond. A trader like Sumitomo relies on a good credit rating to transact cheaply with counterparties and creditors. Its stock plunged after a Moody’s
downgrade in early February.
Impairments will worsen Sumitomo’s ratio of total debt to debt plus shareholder equity, a metric Moody’s considers. It already stood at 63% in December, compared with 53% at Mitsui. Sumitomo is one of the most indebted companies in the industry.
Some investors may still hold on to Sumitomo for its 4.6% dividend yield, a luxury in negative-rate Japan. The company aims keep the dividend payout at least at its current level for the next three years. But if commodity prices stay weak, and if cash is needed to pay down debt, don’t be surprised if the company retreats on this front, too.
Write to Abheek Bhattacharya at [email protected]