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Write-down risks loom for Sumitomo's nickel, tire ops

Analysts seek chance of Japanese trading house taking hefty impairment losses

Sumitomo has fallen to fourth place in profit among Japan's big trading houses.

TOKYO -- Stock market watchers are starting to worry about impairment risks facing Sumitomo Corp. on its nickel-mining and tire businesses, which may upset the Japanese trading house's forecast for profit growth this fiscal year.

Both the Ambatovy nickel development project in Madagascar and U.S. tire retail subsidiary TBC are stuck in an earnings slump despite aggressive investments.

Polina Diyachkina, research analyst at Macquarie Capital Securities (Japan), said impairment charges on the Ambatovy mine are unavoidable, given that its long-term nickel price forecast remains at a very high level. Sumitomo owns a 47.7% stake in the Ambatovy joint venture, with its total exposure to the project standing at $1.7 billion, including debt and equity, according to Diyachkina, who estimates the fair market value of the joint venture's assets at around 40 billion yen ($355 million).

Even if Sumitomo avoids writing down its Ambatovy investment this fiscal year, Diyachkina said, it will need to do so eventually.

Ambatovy, one of the world's largest nickel projects, also involves Canadian nickel refiner Sherritt International and South Korean state-owned Korea Resources. Work on the project began in 2007, and it has an integrated production process encompassing all stages from extracting to refining of nickel as well as cobalt. The joint venture expects to report a net loss of 17.8 billion yen in fiscal 2017 owing to maintenance expenses and a low operating rate caused by equipment trouble.

Ambatovy's output has recovered to roughly 80% of its capacity, according to Sumitomo Chief Financial Officer Koichi Takahata. But the trading house remains exposed to the mine's uncertain profit outlook.

Flat tires

Market participants largely agree that TBC is more likely than the Ambatovy project to trigger additional impairment losses. TBC has performed poorly since Sumitomo acquired the U.S. distributor of replacement auto tires for around 120 billion yen in 2005. Although the tire retailer is expected to return to the black in fiscal 2017 after a year-earlier 1.8 billion yen net loss, profit is seen coming in at a slim 800 million yen or so. Tire sales in the U.S. market are growing in volume terms, but TBC's unit prices keep falling.

Sumitomo took a roughly 20 billion yen write-down on TBC in the year ended March 2015. An analyst at a domestic brokerage said: "Retail is a sector where companies need to accurately grasp consumers' ever-changing needs, and this is hardly a strong suit for Sumitomo." Downsizing its tire business and bringing in retail partners could become an option for changing its strategy.

Sumitomo forecasts a 35% increase in group net profit to 230 billion yen for the year ending March 2018 under International Financial Reporting Standards. On the bright side, the current prices of nonferrous metals such as nickel and copper remain above the company's initial projections. Demand for steel pipe used in oil well casings and other structures is also picking up, mainly in North America. Excluding Ambatovy and TBC, Sumitomo's performance has been mostly solid.

That said, Sumitomo used to rank among Japan's big three trading houses by profit but has been leapfrogged by rival Itochu and fallen to fourth place. It is now crafting a new medium-term business plan for the next three years, set for release next spring. Without a strong commitment to turning these two struggling operations around, Sumitomo will be hard-pressed to make an earnings comeback.

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