Resilient Japan ripe for investment

Global Outlook

Just as a virulent pandemic is preventing overseas visitors from attending Tokyo’s games in the coming weeks, so it’s likely discouraging international investors from seeking opportunities in Japan.

Yet the act of staging this quadrennial sporting showpiece in the face of such adversity epitomises a characteristic of modern Japan that investors would do well to take more notice of: resilience.

Despite downbeat sentiment surrounding the curtailed games, now appears an opportune time to invest in Japan. Data indicate its economy is recovering, with manufacturing activity picking up as economies globally start to reopen from pandemic-enforced shutdowns.

Japan’s exports to China are surging, while exports to the US and Europe have also rebounded from the lows of last year1. This serves as a timely reminder that Japanese companies are highly leveraged to recovery in the global economy, across industries from autos to semiconductor-making equipment.

Decades of economic hardship at home have driven Japan’s leading firms to build their brands overseas in search of growth and inspired a bold approach to innovation. Today, Japan is a global pioneer in automation technologies, notably robotics. Manufacturing automation remains key in China to saving on labour costs and improving product quality.

The recovery in global consumption amid vaccination roll-outs is trickling down into the earnings outlooks of Japanese firms.

The recovery in global consumption this year amid vaccination roll-outs is trickling down into the earnings outlooks of Japanese firms, many of which posted strong first-quarter results.

The following companies are selected for illustrative purposes only to demonstrate the investment management style described herein and not as an investment recommendation or indication of future performance.

Amada, for example, which makes machines for processing sheet metal, has seen a robust recovery in orders. So, too, auto-lighting specialist Ichikoh Industries has raised its full-year profit guidance, while semiconductor-manufacturer Sanken Electric is enjoying a rebound in sales growth.

Domestic consumer spending is also improving. Shrinking demographics ensure unemployment remains low in Japan, while labour market institutions provide protection to household incomes. These factors provide a job security – and support for spending – that few countries can count on.

Covid-19 infection rates have largely plateaued in the major cities of Tokyo and Osaka, while Japanese authorities are accelerating their vaccination programme at speed.

With precautionary savings high among the local population as a result of the pandemic, even a partial unwinding of restrictions is likely to give a further lift to consumer spending.

Haircare specialist Milbon has seen visits to hair salons return to pre-pandemic levels, while luxury hotels operator Resorttrust is in line to benefit from pent-up demand for leisure and travel activities.

Another key factor for investors is that, by necessity, Japanese businesses have built strong capital positions to counter domestic economic difficulties. Non-financial firms hold more than 20% of their market cap in cash, on average, versus less than 10% in the US2.

This enables them to capture opportunities as conditions improve. Now we are seeing a broad-based pick-up in corporate spending as businesses that had put expansion plans on hold amid the pandemic look to invest in their own growth. This is designed to drive profitability, which is likely to be positive for share-price performance over time.

Contrary to common external perceptions, Japan offers a rich source of investment opportunities. Of more than 2,000 stocks in the Topix, over 40% are not covered by analysts. This allows active investors to unearth hidden value, especially among the many smaller, less-well-known firms.

One in seven Japanese stocks rose by 500% or more in the decade to September 20203, underlining how company performance doesn’t necessarily reflect weakness in the domestic economy.

We see promising areas of structural growth such as digital transformation, interconnectivity and health technology. Japan’s social care bill is rising at a time when its working population is shrinking. But innovative medical equipment firms continue to invest in R&D to maintain a competitive edge.

We also see new trends emerging as economies worldwide adopt policies to address environmental sustainability. A number of Japanese firms offer cutting-edge technology to bridge the transition to green energy.

Examples include Takuma, a leading biomass power and waste incineration plant provider whose products help cut carbon dioxide emissions; and Sanken Electric, which makes energy-saving chips that reduce CO2 emissions for white goods.

Environmental, social and governance (ESG) standards are another potential growth area for investors. These are not only essential to managing risks, but also can help to enhance the value of businesses.

We have found management and product assurance at Japanese firms to be world class, yet many are not disclosing this to the market. We discovered an auto company keeping its stringent processes for maintaining quality and safety standards a secret. Disclosing this could broaden investor understanding about its competitive strengths and potentially drive up its share price.

Similarly, we found a baby products firm making praiseworthy progress on carbon emissions and sustainable sourcing, but again this was going unrecognised. Disclosing processes for selecting raw materials can be a good selling point for products.

Overall we see a brightening outlook for Japanese firms as beneficiaries of the reopening of economies worldwide. At the same time, investors might anticipate a rebound in domestic spending as vaccinations gather pace and Japan’s economy reopens for business.

 

1 Bank of Japan data, May 2021

2 Bloomberg, 31 December 2019

3 Bloomberg, 13 November 2020

 

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