Asset Strategies in a “New Era for the Sogo Shosha”

Asset Strategies in a “New Era for the Sogo Shosha” The “Brand-new Deal 2017” medium-term management plan (FYE 2016–2018) clearly sets out ITOCHU’s strategic focus on the non-resource sector in China and Asia, where the Company has strengths. In addition, with an eye toward the target of consistently maintaining ROE of more than 13% while continuing to bolster shareholders’ equity, we are accelerating asset replacement and implementing stringent cash flow management to strengthen our financial position and to further increase asset quality and efficiency. This special feature section explains ITOCHU’s asset strategies, with a focus on the “New Era for the Sogo Shosha.”

ITOCHU’s Business Model

Maximizing Earnings from Trade and Return on Investment

Leveraging of Enhanced Management Resources to Expand Business While Increasing the Probability of Success Enhancement of Management Resources

1 2

Creating Implementing Added Value Asset Str ategies

Brand management Investment in areas where Coordination we have strengths Trading company functions Risk management Management know-how Pursuit of asset efficiency

3 Management Resources Internal External

Financial base, human resources, traditional functions of a general trading company Client assets (customers / suppliers) Business know-how, various strengths of Group Partner assets companies, organizational assets

Corporate Governance

38 ITOCHU CORPORATION ANNUAL REPORT 2016 SPECIAL FEATURE 1 Investing in Areas Where We Have Strengths ITOCHU’s China and Asia strategy— Centered on strategic business alliance and capital participation with CITIC Limited and Charoen Pokphand Group Company Limited Page 40

SPECIAL FEATURE 2 Pursuing Risk Management and Asset Efficiency Asset Replacement and Cash Flow Management in the “New Era for the Sogo Shosha” Page 43

ITOCHU CORPORATION ANNUAL REPORT 2016 39 SPECIAL FEATURE 1

To Lead A New Era Investing in Areas Where We Have Strengths ITOCHU’s China and Asia strategy—Centered on strategic business alliance and capital participation with CITIC Limited and Charoen Pokphand Group Company Limited

We have determined our strategic emphasis in the “New Era for the Sogo Shosha.” We will focus on the non-resource sector, centered on consumer-related businesses, where we are the strongest company in the industry. Together with the most appropriate partners, we will develop operations in China and Asia, where we have strengths that we have reinforced over many years.

Significant Potential in the general products in China and Asia. of the middle class has led to dramatic Markets for Textiles, Food, and In China, there is an ongoing transi- changes in lifestyles, and consequently General Products in China and tion in the economic growth model. consumption behavior has shifted from Asia There is a shift from government-led quantity to quality. In this setting, Real GDP growth in China is slowing growth that is dependent on public demand for Japan’s safe, secure prod- to 6% to 7%. However, ITOCHU is not investment and focused on heavy ucts has shown notable growth, as pessimistic about the future of eco- industry toward stable growth led by the seen in the large volumes of expensive nomic conditions, including those in private sector and consumer spending. products and daily items purchased by China, because the primary objective of The vigorous consumer spending has visitors to Japan. It is clear that there our strategic business alliance and cap- not declined even though there was an will be major business opportunities if ital participation with the CITIC Group, adjustment of excessive investment, people are able to purchase Japanese China’s largest conglomerate, and the overproduction, and excessive credit products more easily in China. Looking CP Group, Thailand’s leading conglom- created by the 4 trillion yuan (approxi- toward the future, there will be further erate and one of the leading conglom- mately ¥5.3 trillion applied exchange significant opportunities. Per-capita erates worldwide, is to address the rate at that time), equivalent to 13% of GDP in China is expected to increase significant medium to long term poten- GDP economic stimulus plan during the from approximately US$8,000 in 2015 tial in the markets for textiles, food, and 2008 global financial crisis. An increase to approximately US$11,400 in 2020.

Per-Person Spending by Chinese Visitors to Japan Private-Sector Consumption as a Percentage of GDP

Average for Chinese visitors to Japan

Average for foreign visitors to Japan Approx. China: Approx. Up to 40% ¥280,000 Japan: ¥ Approx. 180,000 There is latent strength in consumer spending. 60%

Source: Japan Tourism Agency, Consumption Trend Survey for Foreigners Visiting Japan, 2015 Sources: Japan: Cabinet Office. China: National Bureau of Statistics

40 ITOCHU CORPORATION ANNUAL REPORT 2016 Currently, private-sector consumption accounts for up to 40% of China’s Investing in Areas Where GDP, which is low in comparison with the level in Japan of approximately We Have Strengths 60%. In conjunction with the emphasis of economic policies, it is easy to envision a scenario in which this potential becomes the driving force of Financial services CITIC has economic growth. Resources and energy top-ranked companies in a variety of industries Investing in Fields Where Two Manufacturing in China • Trust Company • Securities Company Strengths Overlap Engineering contracting • Alloy Wheel Manufacturer ITOCHU and the CP Group have • Mining and Construction Real estate invested in CITIC, a state-owned com- • Equipment Manufacturer pany in which the Chinese government Other • Special Steel Producer effectively owns a majority through the CITIC Group. As one pillar of its reforms of state-owned enterprises, the Chinese government is advancing the “mixed ownership model,” which pro- motes the acceptance of private-sector capital, including capital from overseas, Focus and accelerates the absorption of management know-how and the imple- mentation of international development. Although government is promoting the policy, it is extremely unusual for foreign of this agreement is that two of further extend the Company’s lead as companies to acquire 20% of the our strengths cultivated over many one of the strongest general trading shares of a government-owned asset. years—in “China” and in “consumer- companies in China. For a general In 1972, when China had just started related businesses”—will lead to new trading company, information is an to follow a course of reform and opening opportunities, and our strengths will be extremely important factor to launch up, ITOCHU became the first Japanese further reinforced by the new business business rapidly and guide them to general trading company to be ratified opportunities. steady success. Through the CITIC to resume trade between Japan and Group, which has a close relationship China. In 1979, we established a repre- Real-time Information that with the central government, ITOCHU sentative office in Beijing, and since Raises our Competitive now has access to real-time information that time we have stayed ahead of Edge to a New Level that it was not able to obtain in the past. other Japanese general trading com This section introduces an example of For example, we are now acquiring panies and accumulated management how ITOCHU’s competitive edge will detailed information about such matters resources, such as business infrastructure, human networks, and personnel with expertise in the Chinese language The CP Group’s Strengths in China and culture. The CP Group, which One of China’s largest poultry exporters became the first foreign company to Has established business foundation in 29 of 31 provinces enter China in 1979, has built a founda- Business initiatives implemented by more than 300 companies tion in local markets throughout China, Has earned the strong trust of the government centered on such products as poultry, Chia Tai brand has widespread name recognition swine, and eggs. This capital participation is unprecedented in China and was made possible by the expectation that the two leading corporate groups would make a contribution to the provision of abundant textiles, food, and general products for the people of China in the future, the same as in the past. For ITOCHU, the significance

ITOCHU CORPORATION ANNUAL REPORT 2016 41 as the policy direction of the Chinese We will carefully implement economy, human networks, and the major initiatives with a view potential of various projects. Together toward achieving the greatest with the overseas Chinese network of possible increase in the corpo- the CP Group, the intangible competi- rate value of CITIC, a large tive advantage obtained through this corporate group. strategic business alliance and capital Senior Managing Executive Officer Yuji Fukuda, participation has advanced ITOCHU’s who advanced the alliance negotiations China strategy to a new level. CEO for Asia & Oceania Bloc; President & CEO, ITOCHU Singapore Pte Ltd.; Executive Advisory Officer for CP & CITIC Operations Major Initiatives with an Impact on CITIC’s Corporate Value the CITIC Group and the CP Group and rush forward in a hurry to achieve bene- In this strategic business alliance and strive to expand earnings and market fits from the tie-up. Rather, we will take capital participation, ITOCHU and the capitalization. a careful approach to projects from a CP Group invested a combined total Financial Service Business accounts long-term viewpoint. of about ¥1,200.0 billion in CITIC on a for 80% of CITIC’s earnings. Through 50:50 basis. The CP Group owns 4.7% growth in non-finance businesses, cen- Generating Synergies over the of ITOCHU’s stock, making the CP tered on consumer-related businesses, Long Term with a Commitment Group one of our major shareholders. ITOCHU can contribute to the reform to Sampo Yoshi ITOCHU holds 25% of the stock of of CITIC’s earnings structure. This will We are moving forward with dispatches C.P. Pokphand Co. Ltd., which is the have a major impact on the corporate and exchanges of personnel from both core company in the CP Group and has value of the CITIC Group. Synergies short-term and long-term perspectives. feed, livestock, aquaculture, and food can be created in an extremely wide Through meetings of the Strategic processing businesses in China and range of fields, such as retail, processed Cooperation Committee, the top man- Vietnam. All three parties share the foods, livestock, grains and other foods, agement of ITOCHU, CITIC, and the CP same destiny. brands and other apparel-related areas, Group coordinate the direction of coop- ITOCHU invested ¥600.0 billion, communications, and medicine. On the erative initiatives. Moreover, manage- the largest single investment in the other hand, CITIC, a large corporate ment collaboration meetings are also Company’s history. To obtain a return group with assets of about ¥110 trillion, conducted at the senior management commensurate with that level of invest- generated net profit of about ¥800.0 level, where detailed discussions are held ment we need to not only participate in billion in FYE 2015. Major initiatives to foster the generation of full-scale the flow of commercial distribution and suitable for this large scale will be synergies. The key to generating sus- expand trade but also do our utmost to required to influence CITIC’s earnings tained synergies over the long term is help increase the corporate values of structure. Accordingly, ITOCHU will not the cultivation of relationships of trust at the level of the middle-rank employees, Expanding the Non-finance Business of the CITIC Group through the who will support the future. In addition Generation of Synergies to rigorous employee selection, we are creating opportunities for detailed discussions in a wide range of areas, such as mutual understanding of manage- FYE 2015 Results ment policies, values, history, and princi- 80% of earnings Consolidated Approx. pal businesses as well as the potential from finance Total Assets ¥110 trillion for generating synergies. In this way, the three corporate groups share the con- Consolidated Approx. cept of working to increase each other’s Net Profit ¥650.0 billion corporate value with a future orientation. Moody’s Rating A3 We believe that sustained growth in profits for ITOCHU will result from efforts to give concrete expression to Expanding non-finance businesses sampo yoshi (Good for the seller, Good for the buyer, and Good for the society), which is the foundation of our business. Through these efforts, we will work to benefit all of our partners, including CITIC and the CP Group, and contribute to abundance for the people of China and Asia.

42 ITOCHU CORPORATION ANNUAL REPORT 2016 SPECIAL FEATURE 2

To Lead A New Era Pursuing Risk Management and Asset Efficiency Asset Replacement and Cash Flow Management in the “New Era for the Sogo Shosha”

In FYE 2016, ITOCHU moved quickly to replace low efficient assets and further strengthened its cash flow management. In addition, we conducted detailed analyses in both the non-resource and resource sectors and took a thorough approach to recording losses in order to reduce future risks. The purpose of those initiatives was to build a more solid foundation that will be able to withstand changes in the economic environment in order to lead in the “New Era for the Sogo Shosha.”

Increasing Asset Quality In addition to the resource sector, additional impairment for the entire through the Strengthening of we also conducted detailed analyses of amount of goodwill and a portion of Our Financial Position asset values in the non-resource sector, intangible assets. For ETEL, a tire ITOCHU has continually taken steps where we have a competitive edge, and wholesaler and retailer in Europe, we from an early stage to address future worked to clear away concerns about conservatively took into consideration potential risks. In FYE 2016, we deter- the future. For example, at LeSportsac, the forecast for tire demand over the mined uncertainty in the economic which earns nearly 15% of the trade- medium to long term and recorded environment was increasing, and we mark rights value in the textile business, impairment losses of ¥31.0 billion on decided to record approximately ¥90.0 we recognized impairment losses when goodwill. The various types of impair- billion in losses. we implemented replacement to intro- ment loss processing that we imple- In the resources sector, we rigor- duce products with higher added value. mented in FYE 2016 were one facet of ously selected businesses, and we In addition, we decided to withdraw our efforts to “strengthen our financial decided to sell certain coal interests in from Bramhope, a major UK-based position,” a basic policy of the medium- Australia. In addition, we conservatively manufacturer and wholesaler of term management plan. revised our outlook for commodity apparel. Moreover, for Dole, where The next section introduces exam- prices over the long term, and recorded impairment losses were anticipated due ples of asset replacement that were impairment losses at IMEA and a North to insufficient harvests, we conserva- implemented from the viewpoint of Sea crude oil project. tively reevaluated the uncertainty of corporate value that is suitable for the agricultural products and recognized “New Era for the Sogo Shosha.”

Loss Processing Implemented in FYE 2016 Textile Bramhope exit approx. –¥6.0 billion WIDP (impairment) approx. –¥18.0 billion approx. –¥17.0 IMEA coal (impairment) approx. –¥18.0 billion billion Java/LeSportsac (impairment) approx. –¥8.5 billion, etc. • One facet of efforts to Dole (impairment) approx. –¥6.0 billion IMEA/sale of certain coal interests approx. –¥17.0 billion “strengthen our finan- Metals & Minerals cial position” approx. –¥22.0 Indonesia coal loss approx. –¥2.5 billion, etc. Total approx. –¥42.0 billion billion IMEA coal (impairment) (additional) approx. –¥2.5 billion • Reducing factors that will affect earnings in Food Dole (impairment) (additional) approx. –¥11.5 billion Total amount of approx. –¥14.5 the future billion Dole Australia exit approx. –¥2.0 billion, etc. additional losses • Increasing asset quality approx. –¥90.0 billion Forest Products and General Merchandise ETEL (impairment) approx. –¥31.0 billion approx. –¥31.0 billion Others: Approx. –¥5.5 billion ITOCHU CORPORATION ANNUAL REPORT 2016 43 Integration of Brazilian Iron Ore Related Assets Nacional Minérios S.A. (NAMISA), an iron ore production and sales company Acquisition of assets that are among in Brazil, operates a project in the state of Minas Gerais in Brazil that was the world’s most competitive and acquired in December 2008, in the collection of US$700 million in cash middle of the resource boom, through a consortium that ITOCHU established in collaboration with five large domestic iron and steel companies and POSCO, of South Korea. Competitive strength in the iron ore mine business is determined not only by high-quality iron ore mines but also Merger & by infrastructure assets, including rail- way and port facilities. NAMISA was a project that had limitations on the use of infrastructure under a long-term contract with Companhia Siderúrgica Nacional (CSN). Also, CSN’s neighbor- Cash-In ing Casa de Pedra (CdP) Mine has min- able reserves of more than 3.0 billion tons (probable reserves of more than Simultaneously Transitioning Sale of Shares of PrimeSource, 6.5 billion tons), about 10 times to Superior Resource Assets a Superior Asset NAMISA’s reserves. The investment and Strengthening Cash Flow In March 2015, ITOCHU and ITOCHU in NAMISA was initially made with a Management International Inc. (hereinafter, “III”), con- view toward a management integration In November 2015, the merger was cluded an agreement with Platinum with the CdP mine, one of the most concluded after eight years of effort. Equity, LLC (United States) for the sale competitive mines in the world. ITOCHU’s share in the newly merged of their entire holdings of shares of In June 2011, a new business plan company is 7.6%, compared with PrimeSource Building Products, Inc. was concluded with CSN and the 21.95% in NAMISA. The merged com- (hereinafter “PrimeSource”), a building generation of synergies among the two pany is a mining company with signifi- material company in the U.S. and Canada. mines was commenced. Full-scale cant strengths that are competitive, not The sale was concluded in May 2015. negotiations started from 2012. Internally, only within Brazil but on a global basis, The “niche / low-tech / domination centered on the Metals & Mineral in such areas as iron ore resources, strategy,” which aims at the achieve- Resources Division (currently, the quality, production scale, and infrastruc- ment of No. 1 positions in specific Mineral Resources Division), we formed ture. For ITOCHU, this means that a fields, is one part of the basic strategy Team ITOCHU NAMISA, comprising up major earnings pillar has been estab- of the Forest Products & General to 50 professionals from all business lished in Brazil, on a par with the iron Merchandise Division. In accordance areas, including ITOCHU Brasil S.A., ore mines in Western Australia, among with this strategy, ITOCHU worked to NAMISA, ITOCHU Mineral Resources the largest in the world, where we work raise the value of PrimeSource, which Development Corporation, and the together with BHP Billiton to conduct III acquired in 1998 for $50 million legal, finance, accounting, and tax development and production. Through (approximately ¥6.5 billion). departments from headquarters. With this merger, ITOCHU collected US$700 In FYE 2016, the company had a iron ore prices declining, we focused million in cash, and in addition we took dominant position, with net sales of our Companywide comprehensive a major step forward in the establish- approximately US$1.3 billion (approxi- strengths on the management integra- ment of a higher quality resource asset mately ¥156.0 billion), 1,300 employ- tion project, which involved obtaining portfolio that will be less susceptible to ees, and 42 distribution bases in the favorable terms while controlling risk. future resource price fluctuations. United States. In particular, PrimeSource

44 ITOCHU CORPORATION ANNUAL REPORT 2016 earned an overwhelming top share of the M&A market were increasing. and reached a conclusion at a price that the U.S. market for nail and screw distri- In consideration of the need for new was basically in line with the initial man- bution, and its share of nails imported ownership for further reinforcement of dates. The deal was closed in May into the United States reached 27.4%. PrimeSource’s competitiveness, 2015. ITOCHU’s aggregate earnings from ITOCHU decided that it was a good time Through the completion of this proj- PrimeSource reached a total of approxi- to replace this asset and thus began to ect, ITOCHU obtained economic mately ¥75.0 billion and dividends were take steps toward the divestiture. returns—cash of approximately ¥110.0 approximately ¥45.0 billion. PrimeSource billion, net profit on sale of approxi- made a large contribution to cumulative Returns—Cash Recovery and mately ¥20.0 billion, and aggregate consolidated profit after tax for the Practical Know-how earnings and dividends of approxi- Forest Products & General Merchandise In November 2014, ITOCHU mately ¥100.0 billion—as well as intan- Division over the same period. approached 60 potential buyers, and gible returns through the process. Thanks to the booming economy after management presentations, due This project is an example of recov- and monetary easing around the world, diligence was conducted for four com- ering cash with a view to utilizing the the North American M&A market was panies. In March 2015, final bids were cash for asset replacement in a strate- active around 2014, when ITOCHU submitted by three companies, and the gic area by selling the company while began to consider selling its contract negotiations were subse- the corporate value was increasing PrimeSource shares. The housing and quently started with one of these three, instead of withdrawing from the building products market was recording Platinum Equity. ITOCHU first identified business due to a marked decline in steady growth, and the valuations of the its mandates, and subsequently, performance. companies similar to PrimeSource in persistent negotiations were continued

ReplacementFYE 2016 Amount of sale: Approx. ¥110.0 billion Aggregate dividends: Approx. ¥45.0 billion

Deciding to Replace Asset while Corporate Value was Increasing 1998 Investment of approx. ¥6.5 billion

ITOCHU CORPORATION ANNUAL REPORT 2016 45