Itochu: Warren Buffett's Top-Performing Japanese Stock With Untapped Value

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ITOCHU Corporation, a key player in the Berkshire Hathaway portfolio, excels in diversified trading and investments, contributing to its robust performance.Year-to-date, ITOCHU has demonstrated strong...

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In fact, I ran a comparative analysis on the CAGR that Berkshire must have realized by simply buying 5% of each of the 5 largest Japanese trading houses and letting it ride til today [the original purchase allocation]. In a previous article covering this group, I went through the backtest by determining the market cap of each of these in 2020 and then predicted what an $8 Billion portfolio would look like year to date at a 5% purchase of each market cap. I came up with the following percentages: PORTFOLIOVISUALIZER The results were striking. In an ultra-flat Japanese stock market with a quickly depreciating currency [remember, these ADRs have an underlying value denominated in their local currency], this basket of trading houses weighted in a similar fashion to Berkshire Hathaway's first purchase resulted in a CAGR of 23.15% per year versus 14.46% for the S&P 500. This portfolio also had no down years in this period, when we experienced Covid lockdowns and the 2022 tech crash. Please note, this backtest period is from Jan 1 2020 until August of 2024: PORTFOLIOVISUALIZER As someone who now sees international diversification as a logical proposition, Japan has been my go-to hunting ground for cheap stocks that have desirable attributes in the land of the rising sun. My local market, the US, now trades at FWD multiples above 20 times earnings while countries like Japan, who have very reliable and similar accounting practices to U.S. GAAP policies, have very high-quality companies trading at 10-15 X FWD earnings. ITOCHU is the current king of Japanese trading companies that control vast, diversified divisions of wholly and partially owned business interests both in Japan and worldwide. The problem with investing in Japan, the counter-argument if you will, is that they are, a graying population in a stagnant economy. In the case of the trading companies, however, we get holdings companies with international exposure that apply shrewd Japanese business acumen and philosophy. ITOCHU relentlessly emphasizes their method of bolting on incremental value, cutting costs, and preventing capital outflow while ultimately trying to lower capital costs before and after a new consummation. They engage heavily in buybacks and return of capital to shareholders with a unique capital payout plan that I will cover later in the article. This company is a buy in my opinion, as are the rest of the trading houses. There are some tricks in evaluating data here as these all trade as ADRs, I believe I've done my best in my assessments to iron out all the corners. What ITOCHU does and who they are ITOCHU Integrated Report 2024 ITOCHU has more revenue segments here than reported business divisions, but we can see clearly the largest profit generators for the company are food followed by their machinery division with energy and chemicals rounding out the top 3. ITOCHU Integrated Report 2024 The company has consistently been able to produce a return on equity higher than the TOPIX 500 [the Japanese version of the S&P 500] which has been consistently below 10% for the past decade. This is a reason why the Japanese government has been trying to light a fire under the tail of the listed companies in Japan that are not particularly shareholder-friendly. They are customer first and take a little risk with leverage, missing out on a lot of opportunities when borrowing in Japan is as cheap as it gets. These trading houses operate contrary to the Japanese market, focusing on profit, cost-cutting and capital return through buybacks and dividends. We can see that shareholder's equity has steadily grown over the last decade for ITOCHU, which is the primary measure of success for a holdings company like a Berkshire Hathaway, increasing book value through successful reinvestment and new investment of profits and borrowed capital. ITOCHU 2024 integrated report Speaking of return on capital, the ITOCHU \"Brand-new Deal\" has a goal of a payout ratio of 40% or more with a baseline of higher of 30% of profits or 200 Yen per share. So at minimum, the dividend per share is being set to $1.32 per share based on the current exchange rate. Since each ITOCY ADR is a 2:1 ratio [2 Japanese shares for every 1 US ADR], then our base dividend going forward is $2.62 a share, roughly 2.67%. Let's also remember that this is paid in Yen. If the dollar continues to depreciate against International currencies as we go into a cutting cycle, this amount will inflate with the ascension of the Japanese Yen if you are buying the USD face value ADR shares. The 8 Divisions of ITOCHU ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report ITOCHU 2024 integrated report Division analysis With food, machinery and chemicals being the company's highest profit generators, those are the most worthy of examination. The food division has 80% exposure to the Japanese economy, which I like. Japanese tastes are unique, and outside food brands don't have much of a chance. They also have Chinese packaged food partnerships with Long Rong and Aneka Tuna Indonesia. They own Fuji Oil, which has the top cooking oil market share in the Japanese market. Fresh Foods also includes a controlling share of Dole Asia. In machinery, they have everything covered. They produce machines to help build airplanes, wind turbines, waste management facilities [a personal favorite], desalinization plants, and auto parts machinery. This segment only has 50% exposure to Japan and may be one of their most diversified businesses with the highest CAGR [22%] of all of their businesses. Rounding out the top 3 profit producers, Energy & Chemicals have a 70% exposure to Japan and have a fully integrated oil business that spans the globe [Azerbaijan, China, Iraq, Siberia, Qatar, Oman] to produce oil and petrochemicals primarily for the Japanese market. It also has a renewable energy component that deals with solar and industrial grid battery solutions [like Tesla]. These 3 of the 8 segments are the primary drivers of ITOCHU's cash flows. Here is a link to the excellent resource used throughout this article. It contains so much information it will make your head spin. Year to date performance Data by YCharts Even with the recent pullback in the Japanese market, ITOCHU has been a market beater for most of the year. If the Japanese market itself doesn't take it to a market beating performance by year's end, the currency return might do the trick if the Yen can appreciate. Performance versus the S&P 500 trailing 10 years Data by YCharts Although Buffett only bought the stock in 2020, this stock has been performing well much earlier than Berkshire's holding time frame. Looking at a longer-term view, ITOCHU has even beaten the Nasdaq (QQQ) on a total return basis in the last decade. Again, this is all in a putrid Japanese stock market that just recently surpassed its 1989 highs [and quickly dipped back down]. This is impressive, and I am convinced it is because they are one of the few Japanese companies that continues to harp shareholder returns. Thesis on the Japanese Yen I recently wrote an article regarding Japanese ADRs and their currency return proposition, here were some notes:  Most of the major currencies in the world have been instituting rate hikes to curb inflation, whereas a few like Japan have not. Finding the disconnect between two major economies where one is about to hike while we cut could present some currency appreciation opportunities. Since the benefit and detriment of buying ADRs is the total return being appreciation + currency exchange rate, this is a nice area of the market that should be rate sensitive and positive for those that hold USD accounts as the USD weakens. Dividends are another factor in trading ADRs or OTC stocks denominated in dollars. The dividends will be paid in Japanese Yen but could also appreciate net of exchange rate fees when paid to the holder. The TTM Dividends are paid based on the Yen as paid to investors on the Tokyo Stock Exchange. As long as the companies do not cut their dividends, the yield should increase if the Yen continues to strengthen.  Valuation When looking at ADRs, the first step is to find the ADR issuer on Google perhaps, and find the ordinary to depository share ratio if you are buying the ADR versus pink sheet version. ADRs usually have a Y after their ticker, and OTC shares normally represent a 1-to-1 price per share and will have an F at the end. The Y shares normally have higher trading volume and liquidity. Today, 10-24-24, the Y versus F shares trading hands are about 16 to 1 in volume. So for the Y shares, we have a 2 to 1 ratio. This means a lot of metrics you will see on Seeking Alpha and other data importers will need to be multiplied X 2. Citi Depository Receipts Graham Number As Berkshire Hathaway, other holding companies and financials are well assessed based on their book value growth over time, the Graham Number is the most appropriate valuation model for these companies. It takes into account both earnings and book value, where Graham thought a good deal was when the price-to-book X the price-to-earnings did not exceed his magic number of 22.5. The equation is Square root (BV X EPS X 22.5)= Graham fair value. Here we will utilize YCharts to get the most accurate pro rata EPS and book value numbers as book value and EPS may not have a 100% correlation between the movement of Japanese shares and ADRs. Data by YChartsData by YCharts Equation: Square root (BV X EPS X 22.5)    BV 49.84   TTM EPS 7.64   Graham Number 92.56   Click to enlarge Currently trading above its Graham Number by about $7, I still believe it is a good value when I consider this being the highest quality of the Japanese trading houses and still being very close to a dirt cheap value stock like an AT&T or a bank stock here in the US. Add in possible currency return going forward, and I'm still a buyer, with forward GAAP P/E estimated under 15 X. Balance sheet ITOCHU 2024 integrated reportData by YCharts Firstly, credit quality is amongst the highest in Japan for this company at a Moody's A2 Stable rating. As this is a company that constantly bolts on and expands, they emphasize their cheap access to capital as one of their pillars of strength. With so many Japanese companies afraid of debt, highlighting borrowing capacity is very bullish in my opinion for a Japanese stock. Looking at the balance sheet, all things I like to see. Net debt falling and shares outstanding falling at the same time. Net long-term debt is less than 2 X EBITDA, one of the primary indicators of good credit quality is a low LT debt to EBITDA ratio. Great balance sheet. Risks and summary I hope to do a series on all 5 of these Japanese trading houses:  Mitsui & Co. (OTCPK:MITSY) Sumitomo Corp. (OTCPK:SSUMY) Marubeni Corp. (OTCPK:MARUY) Mitsubishi Corp. (OTCPK:MSBHF) ITOCHU  Each is its own labyrinth of information. I own all 5 trading hoses equally weighted, but ITOCHU has been my best performer so far. Risks are mostly tied up in currency here. As with any ADR, the depreciation of the underlying currency can give you headwinds, while appreciation gives you tailwinds. It can move either way, but I'm betting tailwind going forward. ITOCHU is a buy.  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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