OREANDA-NEWS. S&P Global Ratings today said it has revised the outlook on its long-term corporate credit rating on Japan-based general trading and investment company ITOCHU Corp. to stable from negative. At the same time, we have affirmed our 'A-' long-term corporate credit and senior unsecured ratings on ITOCHU and affirmed our 'A-2' short-term corporate credit ratings on the company. The outlook revision reflects our view that after achieving stable profits in fiscal 2015 (ended March 31, 2016) relative to those of its peers, ITOCHU will likely increase its net profit in fiscal 2016 (ending March 31, 2017) and maintain its profitability and capital adequacy at levels commensurate with our ratings on the company. We hold these expectations even after incorporating the burden of its upfront investment in China-based industrial and financial conglomerate CITIC Ltd., despite persistently low resource prices and stagnant economic growth in Asia.

The large investment in CITIC and a severe business environment hurt ITOCHU's capital adequacy--defined as adjusted capital to risk-based capital (risk assets)--to a certain degree in fiscal 2015. In our opinion, the company's profitability remains sensitive to the external environment in fiscal 2016, given persistently low resource prices, increased uncertainties over the global economy, and fluctuations in other factors, such as foreign exchange and equities. Nevertheless, we expect the company's risk-asset margin--defined as pretax net profit to risk-based capital (risk assets)--to continue to exceed 10%. That's at the lower end of the range commensurate with our adequate assessment for profitability. Accordingly, we believe the company will maintain its capital adequacy at a level commensurate with our current assessment.

ITOCHU has strengths in textile, machinery, and a wide range of consumer-related businesses, including food, forest products and general merchandise, and information and communications technology (ICT). In addition, the company has been shifting its focus from resource businesses, which are highly volatile in terms of profit, to nonresource businesses, which generate relatively stable profits. The company has reduced resource investments in the past few years. After investing in CITIC in 2015, ITOCHU has prioritized generating synergy effects from collaborating with CITIC, reduced new investments, and accelerated sales of assets of low profitability. We believe ITOCHU will be able to secure positive free cash flow in the next one to two years.

Under our base-case scenario, we expect ITOCHU to book a net profit of about ?300 billion in fiscal 2016 and to maintain an improving trend in the following years. We also expect the company's free cash flow to become positive in the next one to two years, owing to reduction in new investments and acceleration of asset sales. Although its investment in CITIC carries concentration risk, we expect profit contributions from the Chinese company to be relatively stable without sudden increases. We assume that ITOCHU will not increase its exposure to joint initiatives with CITIC aggressively, even though the company may increase collaboration with CITIC in resource businesses. When it invested in CITIC, ITOCHU provided a loan to its partner in the deal, which is Thailand-based agribusiness company Charoen Pokphand Group (CP Group). In our analysis, we removed from ITOCHU's risk assets most of the liabilities related to the loan because the loan has largely matured.

We maintain our assessment of ITOCHU's business risk profile as strong. We believe ITOCHU will keep its competitive advantage, mainly in the textile, machinery, and consumer-related businesses, and maintain stable profits relative to its peers. Meanwhile, we maintain our assessment of the company's financial risk profile as intermediate. We maintain our anchor for ITOCHU at 'a-', which is the higher of the possible dual 'a-/bbb+' outcomes from the combination of its business and financial risk profiles. The anchor reflects stable net profits generated by its well-balanced trading and investment business portfolios in comparison with those of its peers. Other modifiers have no impact on the anchor.

The stable outlook reflects our view that ITOCHU will continue to generate relatively stable profits, even though the company is exposed to volatility risk in resource prices and uncertainties in the global economy. We hold this view because the company has been generating stable net profits in comparison with those of its peers amid a deteriorating business environment. The outlook also takes into account the company's reductions in new investments after investing in CITIC. However, we believe the burden of ITOCHU's investment in CITIC will continue to constrain improvements in the company's capital adequacy.

We would consider an upgrade if ITOCHU's capital adequacy improves steadily. This could occur if it improves its net profit at a faster pace than our assumptions, maintains positive free cash flow by a large degree, and keeps its risk assets from increasing significantly in fiscal 2016 and beyond. Specifically, we would consider an upgrade if we come to a stronger view that ITOCHU's adjusted capital is likely to sustainably exceed the amount of risk-based capital required under our 'A' stress scenario.

Conversely, we would consider a downgrade if we come to the view that ITOCHU's profitability is likely to decline by a larger extent than our current assumption, which could happen because of a material decrease in profit contribution from CITIC or substantial deterioration in the macro economy. We would also consider a downgrade if we come to a stronger view that ITOCHU's free cash flow will remain negative by a large degree.