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Resource price crash devastates Japan's trading houses

Mitsui's investments in copper, such as at this mine in Chile, have resulted in major impairment losses due to a collapse in resource prices.

TOKYO -- Crashing natural resource prices have ravaged the bottom lines of Japan's trading giants, causing two long-established houses to sink into the red for the first time in the postwar era.

Something unheard of happened at Mitsubishi Corp. and Mitsui & Co. recently: They reported a group net loss for the year through March 2016. 

The collapse of the prices of copper, iron ore and other natural resources triggered by weakening demand in China has decimated the profits of Japan's top trading companies. They are getting burned for making massive investments in assets such as copper and iron ore mines made during the resources boom that began in the late 2000s.

The five leading trading companies, which also include Itochu, Marubeni and Sumitomo Corp., have booked combined impairment losses totaling nearly 2 trillion yen ($18.2 billion) in the past two years.

"Our business structure has become excessively focused on natural resources," lamented a top executive at a major trading company.

Alarmed by the unprecedented loss, Mitsui President and CEO Tatsuo Yasunaga has declared that he will overhaul the company.

During a March 23 board meeting, Yasunaga began an unplanned speech after a financial director briefed members on the dismal earnings results for fiscal 2015. "We will change the company," Yasunaga said, explaining his plan to transfer manpower from natural resource businesses to areas such as health care, agriculture and electric power.

Mitsui, the core of the Mitsui group of companies, reported impairment losses totaling 350 billion yen for the year, mainly because of the nosedive of copper prices in January when they fell below the low end of the price range forecast by the company.

Just three months ago, Yasunaga reassured investors that there would be no more asset impairments for the fiscal year. But a copper mine the company acquired in 2012 suffered a depreciation in market value in excess of its book value, ensuring a huge net loss for the year.

Downward trajectory

Mitsui, Japan's first general trading house, is a victim of its own success. The trading juggernaut, whose history dates back to the 19th century, has built up a reputation for its highly competitive resources development business, especially in iron ore. As a result, the company has earned the sobriquet of resources trading house.

The malaise has been in the making since 2002, when the company's president at the time was forced to resign amid a bid-rigging scandal concerning a Japan-funded diesel power plant project on the Russian-held island of Kunashiri.

In 2004, Mitsui became enmeshed in another scandal, this time concerning falsification of emissions data on diesel particulate filters manufactured by a subsidiary.

These scandals prompted the company to reform its organization and business operations, in a move it described as business process re-engineering. One change the company introduced was a program for personnel transfers between different sections to prevent collusion with business partners. Mitsui also divested many small businesses, mainly in Japan, to ensure strict oversight over all operations. 

These steps led to an outflow of human resources and the loss of valuable human connections. Mitsui then focused on its natural resources businesses, and over the years it became increasingly more dependent on these sections for earnings. 

Mistaken projections

Mitsubishi, Mitsui's archrival, has also been making big bets on natural resources. In 2011, in the middle of the resource bubble, Mitsubishi acquired a 24.5% stake in Anglo American's copper mining unit in Chile. Copper prices have since tanked, and Mitsubishi booked an impairment loss of 426 billion yen for the year that ended in March.

The long-term perspective of the investment did not pay off. "We didn't expect the investment to start yielding profits for about 20 years," said then Mitsubishi President Ken Kobayashi. 

But the Chilean copper mine had once been an investment target of Mitsui. Mitsubishi's investment decision was apparently influenced by its rivalry with Mitsui.

During a March 24 teleconference with shareholders, Mitsubishi was criticized for blaming its disastrous earnings results on "changes in the business environment." The company said the impairment losses were caused by price falls, but it failed to offer shareholders any convincing explanation for why it failed to formulate quick and effective responses to the trend shift. 

Marubeni also logged large impairment losses -- 162.5 billion yen -- mainly on gas fields and iron ore. "We came under strong pressure to investment more in natural resources while their prices kept rising," said the company's president, Fumiya Kokubu.

Steering the ship

Companies as large as these trading giants cannot easily change course.

Trading houses had good reason to focus their investments on natural resources over the past several years. The strategy paid off in hefty returns during the boom, and as profits jumped, funds for new investments opened up. But they often paid too much for assets that were generating profits, said Yasuhiro Narita, a senior analyst at Nomura Securities.

One big question is whether in-house monitoring committees and outside directors at these companies properly performed their roles of examining and assessing the profitability of investments in natural resources whose prices tend to fluctuate wildly.

Mitsubishi's new chief executive, Takehiko Kakiuchi, who took over on April 1, has pledged to ensure the company's growth by boosting the value of corporate partners it has a stake in.

Kakiuchi plans to pour human and financial resources into retailers and other domestic consumption-oriented companies to increase Mitsubishi's income from dividends and other investment-related gains. This strategy is less vulnerable to market fluctuations, but requires more time to generate profits.

The profit structures of the major trading houses became similar during the natural resource boom years, but now they are starting to diverge as the companies pursue different strategies for reviving their bottom lines. 

Some have already started making moves to carve out new futures. Itochu, for instance, has invested 600 billion yen in China's largest state-owned conglomerate, while Marubeni has pivoted toward electricity. Sumitomo is ramping up its stakes in media businesses.

The end of the investment frenzy in natural resources will sorely test the strategic acumen of Japan's heavy hitters in the trading industry. 

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