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Morningstar | Sumitomo Realty Continues to Achieve Excellent Results, but Lags Peers on Governance

Sumitomo Realty reported net profit of JPY 131 billion for the year ended March 2019, in line with expectations, and guided for net profit of JPY 140 billion for the new year. The company has generated annual return on equity between 10% and 15% every year since the mid-2000s and is poised to continue to do so. Its higher and more stable ROE than its peers partly reflects some peers’ lack of financial leverage but also Sumitomo Realty’s focus on a few business areas where it has competitive advantage, instead of branching out into many segments. In the core office leasing business, Sumitomo Realty sticks to the Tokyo market only and tries to hold a 100% stake in all its projects, resulting in a stronger operating profit margin than peers. In condo development, it is the biggest player in Japan.

However, unlike Mitsui Fudosan and Mitsubishi Estate, which in the past year have both undertaken their first ever share buybacks and increased their shareholder returns, Sumitomo Realty’s dividend payout ratio is only 11% and dividend yield is 0.8% compared with 1.5% for Mitsubishi Estate, 1.7% for Mitsui Fudosan, and more than 2% for other developers. This might be fine considering Sumitomo Realty’s track record of consistent strong returns and slightly higher financial leverage, but we think Sumitomo Realty is behind peers more broadly in strengthening corporate governance. Unlike Mitsubishi Estate, which on May 14 removed its poison pill, Sumitomo Realty announced on May 16 that it decided to renew its takeover defense plan for three more years. It is one of only three companies among the 2,000 listed on the Tokyo Stock Exchange First Section lacking even one outside board director at present.

Sumitomo Realty also released the outline of its midterm plan, whose targets are broadly in line with our forecasts.

We slightly lift our fair value estimate from JPY 4,120 to JPY 4,230 as we roll forward our model by a year and retain our no-moat rating.

Under its Eighth Management Plan, Sumitomo Realty is targeting total revenue of JPY 3.1 trillion over the next three fiscal years, representing a 2.4% CAGR and total operating profit for the three years of JPY 740 billion, a 6.4% CAGR compared with the total of the past three years. It plans to spend around JPY 200 billion per year to develop around 250,000 square meters of floor space annually compared with the 230,000 square meters per year it added during its Seventh Management Plan. The spending amount is in line with our forecasts. Unlike some of its rivals, where nearly the entire development pipeline is visible in disclosure materials, in Sumitomo Realty’s case we do not know the location of every new building to be developed over the next three years, though this presumably includes the former Dentsu headquarters in Tsukiji and a building at the Fudanotsuji intersection near JR East’s large Shinagawa redevelopment project. By segment, it is forecasting operating profit CAGR of 8.5% for leasing, zero growth in operating profit from condo sales, and 12% CAGR in the housing construction segment that includes its Sokkurisan remodeling business. We think the leasing segment operating profit target looks slightly aggressive if the market weakens, but this may be offset by the company's cautious outlook for condo sales over the next three years.