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Morningstar | Mitsui’s 2Q Earnings Driven by Higher Energy Prices; Raising FVE to JPY 1,530; Shares Overvalued

There was no major surprise in Mitsui’s first-half fiscal 2019 (ending March) results, with net profit down 6% year over year to JPY 223 billion, largely due to the absence of one-off gains. After incorporating our latest commodity price deck to reflect higher near-term prices, we raise our fiscal 2019-20 earnings forecasts by 8%-15% and increase our fair value estimate to JPY 1,530 from JPY 1,460. We think the shares are overvalued given its high exposure to energy and mining businesses, as our below-consensus midcycle commodity price assumptions will weigh on Mitsui’s long-term profitability.

Earnings from the mineral & metal resources division were affected by lower contributions from Australia’s iron ore operations due to a decline in sales price and absence of valuation gain on Valepar’s restructuring. This was partly mitigated by improved performance of lifestyle (aided by reversal of provisions from Multigrain) and energy (higher oil and gas prices, lower costs and increased dividend from LNG business) segments. Despite the lower net profit, first half’s operating cash flow was up 4% year over and management has raised full-year dividend guidance to JPY 80 per share from JPY 70. This translates to a decent dividend yield of more than 4% for fiscal 2019.

While we have seen efforts by management to grow its nonresources businesses, such as investing in healthcare (supplement business), nutrition and agriculture (agricultural distribution and sugar businesses), and retail and services (senior living property business), the firm’s earnings are still highly concentrated in its resources and energy segments, which contributed about 56% of the total net profit in the first half.

We think this is not sustainable and expect contribution from the energy and mining businesses to fall below 40% of total earnings by the end of our explicit forecast due to our "lower for longer" price assumptions.

For example, our midcycle key commodity price forecasts in fiscal 2023 are USD 39 per tonne for iron ore, USD 89 per tonne for metallurgical coking coal, USD 74 per tonne for thermal coal, USD 2.34 per pound for copper, and USD 55 per barrel for WTI crude oil (all in nominal terms). These indicate downside of about 18%-58% from current levels.