Nomura shares fell around 16% Monday after the firm said it is exposed to a huge loss from transactions with an undisclosed U.S. client against which Nomura has claims of about US$2 billion based on market prices as of March 26. Given that this is a net rather than a gross exposure, we believe it almost certainly means Nomura will recognize a bottom-line loss in its fiscal fourth quarter ending March 31. However, considering the strong earnings Nomura reported for April-December 2020, we expect it will have remained profitable for the full fiscal year even if the losses prove to be larger than estimated at present. A loss as large as $2 billion would be 7.7% of book value as of December 2020 and around 10% of Nomura’s market cap.
Our fair value estimate for Nomura remains JPY 570 per share and US$5.45 per ADR, about 5% below the current share price and 18% below the ADR price on Friday before the news was disclosed. Our fair value estimate is based on our forecasts for long-term cash flows and is lower than price targets of most sell-side analysts at present. In some sense, our existing view incorporates the risk of this kind of loss taking place, as the nature of Nomura’s overseas business, particularly in New York, leads it to sometimes generating very large profits and sometimes significant losses when adverse events occur. The volatility of Nomura’s earnings due to its larger presence in trading businesses overseas is the reason we have favored Daiwa Securities as an investment over Nomura since we began coverage of the two stocks in 2018.
We think the unexpected loss may end the relative honeymoon new CEO Kentaro Okuda has enjoyed since assuming the top post last April. Unlike his two predecessors Kenichi Watanabe and Koji Nagai, who presided over losses in 2008 and soft earnings in 2012, respectively, when they took the reins, Okuda’s term so far had shown a remarkable turnaround from losses in 2019 to very strong earnings in 2020 thanks to its U.S. operation.
On a strategic level, we don’t think the loss will result in a major change at Nomura. The firm is likely to maintain its large U.S. operation while continuing to focus on business areas where it has a clear advantage or niche, such as mortgage-backed securities or cross-border M&A involving Japanese buyers acquiring U.S. targets. However, the firm may tighten its willingness to take risk in some areas where it has recently been aggressive, such as U.S.-listed equity options, in our view, if it concludes that potential downside risks are larger than it previously estimated. We await Nomura’s Investor Day on May 12 after its next earnings announcement for a clearer picture on how this incident may affect its strategic decisions going forward.
