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Buffett takes contrarian path with Japan resource trader stakes

Pandemic spurs Berkshire Hathaway to diversify US-centric portfolio

Warren Buffett said he hopes for "opportunities of mutual benefit" with this rare overseas investment by Berkshire Hathaway.   © Reuters

NEW YORK -- Warren Buffett's Berkshire Hathaway has bucked the trend of socially responsible investing by acquiring 5%-plus stakes in five Japanese trading houses deeply involved in fossil-fuel-linked businesses.

Buffett's contrarian bets sent shares in the five companies -- Itochu, Marubeni, Mitsubishi Corp., Mitsui & Co., and Sumitomo Corp. -- soaring in the Tokyo market on Monday, even though their earnings have been languishing amid low resource prices.

Marubeni and Sumitomo rose 9% from their Friday closings. Berkshire's statement signaling the possibility of boosting the stakes to 9.9% drew buying from surprised investors.

Many are puzzled by Buffett's bullish $6 billion-plus investments in the sector. But Hathaway's recent investment decisions suggest this is all part of a broader strategy. Some are hopeful that this will spur other foreign investors to take another look at Japanese stocks.

"Japan's general trading houses have long been shunned by foreign investors because of their unique business model," a source affiliated with Mitsubishi said. 

"Investing in five companies in the same industry is quite unusual," said a source at an asset management company.

Japan's major trading houses are huge, highly diversified companies that invest and deal in products ranging from food to textiles to energy, operating at many different points of the supply chain.

But Buffett was making his moves based on a time-tested strategy.

In early July, Berkshire acquired the gas transmission and storage business of Dominion Energy, which decided to unload the assets under pressure from ESG investors.

Instead of embracing environmental, social, and governance investing, Buffett tries to go for undervalued businesses based on their cash flow. Natural gas pipelines and storage facilities generate stable revenues and are protected by high barriers to entry. They are among his favorite investment targets.

The grim outlook for natural resources due to the coronavirus pandemic and the trend of ESG investing are the double whammy hitting Japanese trading houses. For Buffett, they likely presented a buying opportunity.

Berkshire also seeks to diversify a portfolio that now consists largely of American companies. Four U.S. businesses, including Apple and Bank of America, account for roughly 70% of its holdings of publicly traded shares by value.

Its overseas investments have been limited to a handful of companies, such as BYD, China's largest maker of electric vehicles.

Berkshire recently unloaded all its shares in U.S. airlines and slashed its stakes in American banks, with the exception of Bank of America.

Its cash hoard has swelled to a record $146.5 billion, and at Berkshire's annual shareholders meeting in May, Buffett touched on a dearth of investment opportunities as the pandemic drags on.

With U.S. stocks hovering in all-time-high territory, Japanese stocks may have stood out as a good place to park excess cash.

The price-to-book-value ratios of the five big trading houses stand at around 0.7 to 0.8, with the exception of Itochu, which is less exposed to resources than its peers. All five reported deteriorating earnings last fiscal year.

And Kei Okamura at Neuberger Berman attributes their poor stock market showing partly to the rise of ESG investing.

"The trading houses have performed the function of procuring resources to serve Japan's national interest," Okamura said. "They won't change easily, so it's difficult to invest in them." Buffett's decision to do so stems from not only their low price relative to their profit-generating capabilities, but also the possibility of partnerships with businesses in the Berkshire group, particularly in energy.

Investing via joint ventures in the trading houses' projects in developing economies would help correct Berkshire's U.S. tilt. The announcement of the new stakes on Sunday U.S. time -- Buffett's 90th birthday -- lends the move extra significance.

"The fact that one of the world's leading investors showed interest in lagging Japanese stocks, and particularly in trading houses, is positive news for the Japanese market as a whole," said Itochu Chairman and CEO Masahiro Okafuji.

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