Japan opportunity

[mhdousa]

Was emailed this by the manager of Denali, Kevin Byun. Curious what others think of his reasoning:

 

 

Japan is Unlocking the Greatest Opportunities in the World

by H. Kevin Byun

 

Japan has quietly unlocked the greatest opportunities in the world for value investors.

 

As a value and special situations investor, the April 1, 2017 tax reforms in Japan hit me like a lightning bolt. Yet there was, and still has been, no market appreciation to this seismic change. This tax reform, for the first time ever, allows Japanese companies to effectuate spinoffs in a tax-free manner. Until then, Japan was the only major market in the world in which tax-free spinoffs were not allowed. Japan boasts the largest field of the most deeply undervalued conglomerates in the world. More broadly, half of Japanese companies trade below book value. As of April 1 of this year, the stage is set for decades of value creation much like the US in the 1980s and 1990s.

 

Tax reform is part of the Three Arrows policy under the Abe Administration. The three arrows are monetary easing, fiscal stimulus, and structural reforms. Similarly, there are three reasons why Japanese equities are on the cusp of favorable performance. First, shareholder engagement and shareholder rights are increasingly influential. Importantly, the influence of the Bank of Japan, a substantial holder of Japanese equities, is already being felt. The BOJ is mandating the prioritization of shareholder interests and value creation for shareholders. Second, management and board engagement and incentives are modernizing and aligning with shareholders. The Tokyo Stock Exchange has mandated that boards must have two independent directors. Tax reform last year created tax advantaged issuance of restricted stock compensation and we can see an increase in insider ownership already taking place. Third, activism has gained acceptance and is increasingly effective in creating value for shareholders. Investors such as Third Point’s Dan Loeb (Sony, Seven & i, Fanuc, IHI, Suzuki) and Oasis Capital’s Seth Fischer (Nintendo, PanaHome, Toshiba Plant, Kyocera) have had a string of successes in Japan while effectively engaging with management.

 

Importantly, companies are focused on three key areas to increase shareholder value. First, an increased focus on return on equity. Japan has the world lowest ROE and a higher ROE would result in higher valuations. Second, the sale of non-core assets and businesses. Japanese companies are increasingly selling non-core assets such as cross-shareholdings and land to unlock value. Third, balance sheet optimization. Many Japanese companies have inefficient balance sheets with low returns and will benefit by returning excess capital to shareholders, further increasing returns.

 

For students of financial market history, one does not need to look far back in time to find precedents close to home. US conglomerates have created substantial value through spinoffs. The iconic conglomerate ITT completed a three part spinoff into New ITT Corp, ITT Hartford, and ITT Industries in 1995 as well as a three-part spinoff into New ITT Corp, Xylem, and Exelis in 2011. Another iconic conglomerate Tyco completed a three part spinoff into New Tyco, Covidien, and Tyco Electronics in 2007 as well as a three part spinoff into New Tyco, ADT, and Flow Control (via a Reverse Morris Trust with Pentair) in 2012. Also, one of the more well known examples is the 1988 LBO of RJR Nabisco, the food and tobacco conglomerate. RJR Nabisco was trading in the low $40s per share before the initial $75 offer from CEO Ross Johnson to the eventual $109 buyout by KKR. There are many ITT, Tyco, and RJR Nabisco equivalents of undervalued conglomerates in Japan.

 

As a value and special situations investor, I believe we are on the cusp of one of the greatest eras in the Japanese markets and look forward to capitalizing on the opportunities that will create value for all stakeholders.

[DTEJD1997]

This line of reasoning may be correct...the one big problem I see is that is great to have the rule in place, but will Japanese managers act on it?

 

They are NOTORIOUS for being conservative and hidebound.

 

Will management want to break up the conglomerates?  I don't know...

[eclecticvalue]

I think it creates an opportunity for activists to push for spinoffs.

[CorpRaider]

Interesting.  Seems like values might remain cheap if population trends (collapse) and deflation turn out as many project.  But maybe that is fully discounted in valuations.

[no_free_lunch]

I think it creates an opportunity for activists to push for spinoffs.

 

Agreed.  It seems it will create some very specific opportunities but I wouldn't expect the market at large to appreciate.

[saltybit]

Anything specific that you're looking at?

 

Starting at the list here http://realmoney.thestreet.com/articles/04/26/2017/japans-battered-trading-companies-get-double-boost

[Sergio8]

I do not know if there is a correlation there, but we can observe that since 2015, a significant number of companies trading below net cash started to buy-back shares. And when it is significant, it smells quite good, regardless of any laws.

 

It indeed feels like there are much less reasons today why such companies should trade well below their tangible and liquid assets. And indeed, the gaps have begun to close, or at least be reduced.

 

Nevertheless, I think that Japan remains one of the best markets (if not the very best) for Graham & Dood minded investors looking for cash generative businesses with rock solid balance sheets at great prices. Sometimes, you can even have businesses with 25-30 % return on unlevered assets trading below net cash and buying back shares in this country! This is unique in today's world in my opinion.

[eclecticvalue]

Sergio8 - Obviously there is value in Japan. Do you know the reason why the stocks haven't been bid up is due to the population not interested anymore? Is it due that the elderly Japanese citizens don't want to take the risk?

[Sergio8]

To be honest, I don't know for sure.

 

The few japanese people I talked to believe that investing in stocks is dangerous, based on the past losses they experienced.

 

I also read and heard that investors in Japan focus only on EPS and don't care a lot about net asset values. However, we probably all know that assets, when productive enough, are the generators of the companies' earning power.

 

That's why I don't really worry about the focus on earnings. We just have to pick the companies we like. At least, the well capitalized balance sheets give the managements great margin for errors, and the only thing these managements need to do is to prove that the cash really belongs to shareholders. And in that sense, what I am seing is mostly encouraging (at least going in the right direction).

 

Perhaps, disproportionate focus on earnings can partly be explained that around twenty / thirty years ago, a significant number of japanese managements used to buy derivative contrats and get their asset values wiped out. However, I am not sure this fear is still warranted today (as managements mostly became very cautious after learning from those mistakes).

[Spekulatius]

Good podcast here about Japanese stocks:

https://www.goldmansachs.com/intelligence/podcasts/episodes/07-11-23-kirk.html

 

New factors are

 

TSE encouraging companies which trade below book to do something

• Inflation starting to creep up (wages, goods)
• Slow motion restructuring of Japanese companies (governance, capital allocation, de-conglomerization etc). This has kicked off during the Abenomics phase and while slow moving seems to go in the right direction.
• Buffett bought Japan (via the trading houses).

 

The Abenomics boom from 2013-2017 sort of flamed out - the last post here in this thread came at the tail end of it, but maybe now it the time to take another look.

 

Disclosure: I own two japanese small/midcaps but very small in size.

[Xerxes]

I listed to this episode in my car this morning. A good one. 
 

I was looking at different options of funds our pension offers. (My employer)

 

There is a Canadian Fund, US Fund, Global Fund, there are bond funds etc and interestingly there is an “international fund” that as it happens happen to have +94% of its allocation to the Japanese stock market. 

[brobro777]

50 minutes ago, Spekulatius said:

Good podcast here about Japanese stocks:

https://www.goldmansachs.com/intelligence/podcasts/episodes/07-11-23-kirk.html

 

New factors are

 

TSE encouraging companies which trade below book to do something

• Inflation starting to creep up (wages, goods)
• Slow motion restructuring of Japanese companies (governance, capital allocation, de-conglomerization etc). This has kicked off during the Abenomics phase and while slow moving seems to go in the right direction.
• Buffett bought Japan (via the trading houses).

 

The Abenomics boom from 2013-2017 sort of flamed out - the last post here in this thread came at the tail end of it, but maybe now it the time to take another look.

 

Disclosure: I own two japanese small/midcaps but very small in size.

 

I think you're right. The zaitech losses from the bubble days are probably all cleared and gone and after years of dominance of software (led by the Americans), manufacturing (especially the high value kind that Japan and Europe tend to dominate) could become more important. Plus, Japanese companies appear to be becoming more shareholder friendly (e.g. Nintendo seems to be doing this). 

 

I'm too dumb and lazy to find individual winners so I'd probably buy a Nikkei 225 ETF or something

 

With all the current rage about AI and software, it would be pretty funny if manufacturing, Japan, and stuff like tobacco outperform during the next 10 years, haha

 

[UK]

https://www.wsj.com/finance/investing/japanese-companies-are-making-big-promises-to-boost-their-stock-prices-e7561645?mod=lead_feature_below_a_pos1

[Spekulatius]

More WSJ coverage on this matter:

https://www.wsj.com/finance/stocks/japan-has-a-long-history-of-disappointing-investors-why-this-rally-might-be-different-f3b36615?mod=series_stockmarket

 

I think there are some real changes happening on inflation as well as capital allocation that makes this rally different. I guess we will see.

[nwoodman]

17 minutes ago, Spekulatius said:

More WSJ coverage on this matter:

https://www.wsj.com/finance/stocks/japan-has-a-long-history-of-disappointing-investors-why-this-rally-might-be-different-f3b36615?mod=series_stockmarket

 

I think there are some real changes happening on inflation as well as capital allocation that makes this rally different. I guess we will see.

Corporate governance reforms too.  Earnings growth and a flicker of inflation is predominately due to the weaker yen. So not 100% convinced that a rising yen actually makes this market more attractive to US buyers as it may well tip it back into deflation.  What I am seeing though is  a shift from pure survival bias to something more positive and dare I say it competitive.   Certainly quality companies still  seem cheap on most metrics when compared to similar US equities.

[nwoodman]

Great thread by the way.  I should have paid more attention

[nwoodman]

 

Fascinating that this popped up on my youtube feed today too

 

[UK]

https://www.wsj.com/finance/investing/americas-billionaires-love-japanese-stocks-why-dont-the-japanese-f13ef087?mod=hp_lead_pos5

 

Japanese households put an average of just 11% of their savings into stocks and 54% in cash and bank deposits, according to Bank of Japan data released last month. That trails well behind the U.S., where households have about 39% of their money tied up in the market and only 13% in cash and bank deposits, according to Federal Reserve data.

...

“The Nikkei might hit 40,000, god knows when,” said Heihachiro “Hutch” Okamoto, foreign equity consultant at retail brokerage Monex. “But most of our investors prefer U.S. stocks.” To Okamoto’s point, the most popular names traded on Monex daily aren’t Japanese stock indexes like the Topix or Nikkei, brand-name companies like Sony or even the “sogo shosha”—the trading houses that Buffett has invested in. Instead, they are all American names: companies like Nvidia, Tesla, Apple and Amazon.com, as well as funds tracking the S&P 500 and the Nasdaq-100.

...

“Most people here think investing is very risky,” said Hidekazu Ishida, a special adviser at FinCity.Tokyo, which works with the government and the financial industry to try to boost investment in Tokyo. Being into finance comes off as “kakkowarui,” he added, referencing a word for uncool. Even some heads of companies are lukewarm about the idea of encouraging more individual investors to buy Japanese stocks. “I’m neutral about that,” said Takeshi Niinami, chief executive officer of whisky and beverage giant Suntory, when asked if he thought it would be a good idea for more Japanese people to invest in the market. Stock investing is risky, he said. And many Japanese people remain wary of participating in the market, because of the severity of prior downturns. “I think perhaps increasing interest rates is better for people,” he said.

[UK]

https://www.bloomberg.com/news/articles/2023-11-02/early-bets-on-nintendo-nidec-yield-big-gains-for-kyoto-bank?srnd=premium

 

As a result of these early bets, the bank is now sitting on vast paper gains. As of March, the bank held shares in 137 companies worth about 920 billion yen ($6 billion). The stakes were originally worth about 150 billion yen, according to the company. The portfolio exceeds the bank’s market value of about 660 billion yen.

[UK]

Interesting way of doing business: https://www.bloomberg.com/news/articles/2023-12-03/tsmc-intel-s-key-chip-materials-maker-goes-into-debt-rather-than-raise-prices?srnd=premium-europe

 

One of the chipmaking industry’s small but indispensable suppliers is sinking deeper in debt because it’s refusing to raise prices to cover mounting capex costs. Osaka-based Fuso Chemical Co. is bearing the cost to help churn out bigger volumes of sophisticated chips without asking customers for more. That’s despite holding a more than 90% share of the world’s silica used to polish silicon wafers and counting deep-pocketed heavyweights Taiwan Semiconductor Manufacturing Co., Samsung Electronics Co. and Intel Corp. as customers.

 

Edited December 4, 2023 by UK

[Spekulatius]

1 hour ago, UK said:

Interesting way of doing business: https://www.bloomberg.com/news/articles/2023-12-03/tsmc-intel-s-key-chip-materials-maker-goes-into-debt-rather-than-raise-prices?srnd=premium-europe

 

One of the chipmaking industry’s small but indispensable suppliers is sinking deeper in debt because it’s refusing to raise prices to cover mounting capex costs. Osaka-based Fuso Chemical Co. is bearing the cost to help churn out bigger volumes of sophisticated chips without asking customers for more. That’s despite holding a more than 90% share of the world’s silica used to polish silicon wafers and counting deep-pocketed heavyweights Taiwan Semiconductor Manufacturing Co., Samsung Electronics Co. and Intel Corp. as customers.

 

The article is a bit misleading. While they raised some debt (no doubt at very favorable terms), they still have more cash than debt on the balance sheet. They also generate 25% operating margins which is not too shabby.

 

Recently, the Bloomberg stories appear to get more and more distorted and resemble clickbait. When you look at FUSO chemicals financials it’s just does not seem to show the same picture than the article.

 

 

[UK]

1 hour ago, Spekulatius said:

The article is a bit misleading. While they raised some debt (no doubt at very favorable terms), they still have more cash than debt on the balance sheet. They also generate 25% operating margins which is not too shabby.

 

Recently, the Bloomberg stories appear to get more and more distorted and resemble clickbait. When you look at FUSO chemicals financials it’s just does not seem to show the same picture than the article.

 

 

 

Thanks for feedback.

[Spekulatius]

Looks like Fuso' Chemicals main business is Food additives and then the smaller business is Colloidal / nanocystalline Silica for polishing wafers.

https://fusokk.co.jp/eng/wp/wp-content/themes/fuso/images/ir/financialresults_en_231124.pdf

 

FWIW, looks like their profit margins for the semi business is roughly 33% and actually topped out at 45% profit margins last year which really isn't that shabby.

Edited December 4, 2023 by Spekulatius

[brobro777]

https://www.reuters.com/markets/asia/japans-nikkei-breaks-35000-first-time-since-feb-1990-2024-01-11/

 

First time since 1990!

 

[ArminvanBuyout]

I follow some Japanese investors on twitter. One of the prevailing themes recently has been how "not cheap" the Nikkei is anymore. I find it funny because regardless of where you're based, the one common theme is how the market is always too expensive haha

 

(I say this in jest as someone who's starting to ramp up exposure there)