There are “abnormally low valuations” to be found in Japanese stocks, with some quality businesses trading at about a quarter of the price of international peers, according to Joe Bauernfreund (pictured), manager of the AVI Japan Opportunity Trust.
Japan has long been out-of-favour among international investors ever since the boom of the 1980s gave way to a bust in the 1990s and 2000s. A previous study from FE Trustnet found that the IA Japan sector was still in negative territory more than 24 years after its December 1989 peak.
Headwinds for Japan continue to persist, most notably its ageing population and fears that it could once again fall back into deflation. However, numerous managers in the IT Japan and IT Japanese Smaller Companies sectors say the risks are more than priced in and with a 12x forward price-to-earnings ratio, the Topix looks undervalued compared with most other developed markets.
Bauernfreund said low valuations are one of the factors that led him to launch the AVI Japan Opportunity Trust.
“At AVI we look to invest in under-researched and misunderstood companies. This approach leads us in turn to small-cap Japanese companies, a segment of the market which is poorly covered,” he said.
“Of the 28 companies in our portfolio, only four are covered by more than one analyst and, as a result of investors’ general aversion to Japan, all are unloved. These factors have led to us finding abnormally low valuations in good-quality, highly cash-generative companies.”
To prove his point, Bauernfreund used the example of global lift manufacturer Fujitec, which has customers in China, south-east Asia, North America, Europe and Japan. He said the most appealing aspect of the business is the maintenance revenue it receives after installation.
“These maintenance contracts can last for decades, producing steady, recurring profit, which explains why Fujitec’s global peers trade on enterprise value to earnings before interest and tax multiples (EV/EBIT) approaching 20x,” he explained.
“However, Fujitec, which operates the same business model, is on a multiple of just 5x. Fujitec’s balance sheet is hugely overcapitalised, which means we are, in effect, investing 56 per cent of our capital in cash and listed securities while gaining exposure to a high-quality, profitable operating business at a low valuation – all the while receiving a 4 per cent dividend yield.”
Performance of trust vs sector since launch
Source: FE Analytics
Matthew Brett, manager of the Baillie Gifford Japan Trust, also pointed to the discounts available on Japanese stocks with prospects as good as those of “quality businesses listed anywhere in the world”.
The two biggest themes in his portfolio at the moment are internet and factory automation companies, which account for approximately 40 per cent of assets under management.
“For example, we are very enthusiastic about Softbank, which we believe has world-class assets, including a large investment in Alibaba, ARM and many exciting venture companies, trades at nearly a 50 per cent discount to the sum of these investments, and is managed by the extremely value-added Mr [Masayoshi Son] Son,” he explained.
“Also, we like FANUC, which is a leading global robotics company that has the potential to see accelerating growth as robotics expands to new industries and applications and where management have begun to return much more cash to shareholders.”
While most Japan managers accept the region is not without its challenges, Taeko Setaishi, lead adviser of the Atlantis Japan Growth fund, said this also brings opportunity. For example, she said rising productivity and greater workforce participation have to some degree offset the negative effects of depopulation.
“This development is already producing significant social change, particularly around public finances and welfare expenditure priorities,” she added.
“On the positive side of the ledger, Japan continues to run a significant current account surplus, is politically stable, and possesses a deep repository of patents available for monetisation.”
Nicholas Price, manager of the Fidelity Japan Trust, said that while Japan has suffered from the fallout of the US-China trade war, which has clouded the outlook for corporate earnings, the domestic economy remains stable. He added that while confidence among Japanese manufacturers has weakened, sentiment in the non-manufacturing sector is holding up.
Performance of indices over 10yrs
Source: FE Analytics
“Employment conditions remain tight, with the job-offers-to-applicants ratio at record levels,” the manager continued.
“Capital expenditure plans are supported by non-cyclical factors such as investment in labour saving technology and research and development. The Bank of Japan remains highly accommodative and extensive counter measures will be deployed to mitigate the effects of the October 2019 consumption tax hike from 8 per cent to 10 per cent.”
“From a valuation perspective, Japanese stocks priced in a significant level of risk in late 2018 and continue to look undervalued at around 12x forward earnings. With valuations testing historical lows in some parts of the market, there are opportunities to capitalise on disconnects between near-term sentiment and mid-term fundamentals.”
Nicholas Weindling, manager of the JPMorgan Japanese Investment Trust, added: “On the policy front, Japan continues to make progress in tourism, free trade and corporate governance. The market is likely to reward companies with improving governance policies overall, including shareholder returns, internal controls and disclosure.”