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Last week was my first visit to Japan of the new Reiwa era. Apart from the staff in the Tokyo BIC Camera store all wearing “Happy new Era” T-shirts, there was little evidence of any significant impact of the new imperial regime. However, President Trump was also in Tokyo, anxious to claim the prize of being the first foreign leader to meet the new Emperor and Empress. Despite some concern that the audience at the Grand Sumo Tournament he attended might show their disapproval in traditional fashion by throwing their seat cushions at him, the visit passed off uneventfully and the Japanese I spoke to tended to regard it with mild amusement.
I spent four days visiting companies in Tokyo and one day in Kyushu. The meetings were generally good and, although companies expressed concern about the impact of the US-China trade dispute on the global economy, most of them were largely dependent upon domestic demand and the actual impact on their businesses had been limited so far.
I saw two engineering outsourcing companies in Tokyo. Of all the companies I met during the week, these were probably the most likely to be affected by a slowing global economy, given their dependence upon the auto sector. However, the engineers being sent to the automakers are mostly being used in the R&D departments and, given the global trend towards the electrification of cars, neither company had seen any noticeable decline in demand from their clients. Technopro, an outsourcing company, which we own in the Japan Fund, told me that they had seen some engineers returned by clients from the technology sector, but that demand was so strong in other sectors that they had quickly been reassigned elsewhere. The 15% decline in its share price since the start of May seemed overdone.
Japan is working
Retailers were slightly concerned that consumer sentiment appeared to have deteriorated, although opinions about the forthcoming consumption tax increase were mixed. One retailer asserted that the impact this time would be limited, whilst another said that it expected the tax increase to be postponed yet again. Construction companies still have very full order books and are managing to pass on higher labour costs to their customers. The labour market tightness is really starting to be noticeable; in most of the companies I visited the reception desks, which were formerly staffed by “office ladies”, had been replaced by a phone, inviting visitors to dial their contact directly. Where meetings used to be interrupted by more office ladies bringing endless cups of green tea, now there were bottles of water placed on the table in the meeting room. And offices are much more pleasant working environments than they used to be; apparently this is becoming important in order to attract graduates, who can afford to be very picky about which companies they join. One company I visited, which a few years ago was reprimanded for treating its workers badly, was just unrolling the mats for its Wednesday evening yoga session when I left.
The government’s new workstyle reform legislation now limits overtime hours. Interestingly, this does not seem to have had a negative impact on margins. Rather most companies said that they had seen productivity improve as routine processes become more automated and workers complete their tasks in less time. Interest in automating production through AI and the Internet of Things is increasing all the time; I had a meeting with NS Solutions, a software company which we own in the Japan Fund. As a subsidiary of Nippon Steel, much of its work is with industrial companies and it was interesting to hear the company say that it believed that the demand it was seeing is structural, rather than cyclical. Certainly, Nippon Steel, regardless of the condition of the global steel industry, is intent upon using IT to improve productivity. Many other companies are doing the same.
I also attended the annual conference of Columbia Business School’s Centre for Japanese Economy and Business, at which Deputy Prime Minister (and Finance Minister) Taro Aso spoke. Given President Trump’s presence in Tokyo, it was perhaps unsurprising to hear him say that he was “long on America”, but he then went on to point out that Japanese companies have invested US$469bn in the US, employ 860,000 people and make 3.07m cars there, almost twice as many as they export from Japan. This is clearly the line that Prime Minister Abe has been taking with the US, in an attempt to ward off tariffs on exports of Japanese cars to the US. Mr Aso also made the case for the consumption tax hike. As head of the Ministry of Finance, this is his job, but he explained that the revenues from the tax hike are to be directed towards reducing the financial burden on families with children. The conference also included a session on shareholder engagement, during which a panel of “activist” investors discussed their experiences. This was a really interesting session for me as the speakers called upon investors to engage with companies in a proactive (and generally private) exchange of views on areas such as operational and asset efficiency, business strategy and capital allocation. We are very fortunate to secure regular meetings with the top management of some of the biggest companies in Japan, and this is the kind of activity we have been engaging in for years.
On the road
At the end of the week, I spent a day in Kyushu visiting companies in Fukuoka. This is slightly less well trodden ground by foreign investors and companies appeared pleased to see me and anxious to share as much information as possible. Indeed, in a couple of meetings, it was quite difficult to get a word in edgeways. We have been excited about the prospects for the Fukuoka economy for some time; it is the only Japanese prefecture outside of Tokyo which is seeing population growth. The main reason for going was to visit Nishi Nippon Railway, the local private railway company, which we own in the Japan Fund. In fact, it’s not really a railway company at all, as most of the transportation in Kyushu is by bus.
I stayed in one of their hotels, the Nishitetsu Croom Hakata hotel, which is located right behind the bus station. This is a business hotel, geared to the travelling Japanese businessman, which Nishi Nippon has refurbished recently in order to attract some of the increasing numbers of tourists to Fukuoka. For just under ¥12,000 (approximately £86) a night, I had a tiny but very well appointed room with a bed, desk, trouser press, massage chair (apparently an essential for the weary business traveller), Nespresso machine, free Wifi and bathroom. Downstairs was a hot spring bath. The hotel was very busy. Nishi Nippon is benefiting from the growth in the Fukuoka economy. It is part of the consortium which has just taken over the concession for Fukuoka Airport. This must be one of the most convenient airports in the world; it is a five-minute subway ride from central Fukuoka. The consortium plans to build a second runway and to upgrade the terminal facilities. This will free up capacity for LCCs (low cost carriers) to fly to Fukuoka from Asia. I could see that construction work had already begun. Nishi Nippon has also just begun redevelopment of its main real estate property, the Fukuoka Building, which is right in the centre of the city. The new building will be the highest spec building in a city which is seriously short of office space. Nishi Nippon is a great play on the buoyant Fukuoka economy and trades at a 30% discount to net asset value. Foreign investors own less than 9% of outstanding shares.
On my last day in Japan, I took the train from Fukuoka to Nagasaki. The first thing I noticed when I emerged from the station was the enormous cruise ship docked in the port. From this, guides were escorting hundreds of Chinese tourists to a fleet of waiting coaches in order to being their whistle-stop tour of Nagasaki.
My main reason for going to Nagasaki was to visit Hashima Island. Popularly known as Gunkanjima, (or battleship island), because of its appearance, this deserted island measures just 480m from North to South and, until 1974, housed a coal mining community working on the undersea coal seams and living on the island. This mine, formerly owned by the Mitsubishi Corporation, played a key role in Japan’s modernisation after the Meiji Restoration. Because the island is so small, housing was constructed as multi-storey reinforced concrete apartment blocks, and it was reportedly one of the most densely populated cities in the world at its peak. The conditions under which the miners worked were horrific: temperatures of up to 37 degrees and 95% humidity. During the war, Chinese and Korean forced labourers endured even worse conditions on the island, although the English language audio guide makes no more than an elliptical reference to this fact. As a part of Japan’s industrial heritage, this is a fascinating place to visit and it was designated a UNESCO World Heritage Site in 2015. Today, tourists travel by boat from Nagasaki on the 40-minute trip to the island, many of them motivated by its appearance as Silva’s island in the James Bond film “Skyfall”.
My last night in Tokyo was spent at the newly opened Hotel Zen Tokyo. This is a yet another modern take on the capsule hotel, which, according to the website, blends the “authentic with the modern”. The capsules are bigger than usual and the hotel offers lockers for luggage storage (as each capsule is divided from the outside world by just a curtain). I was somewhat sceptical of their claims to offer a “zen” environment, but the capsule area was really quiet, the bed very comfortable, the décor very zen, and I didn’t hear a noise from any of my fellow residents. At ¥4700 (£37) a night, I thought it was an absolute bargain.
Japan: the global trade play myth
I visited 17 companies over the course of my week in Tokyo. Almost without exception, the meetings were positive and the companies keen to engage with foreign shareholders. All were looking to maintain or raise their dividends and several, frustrated by their share prices, were clearly thinking of buying back shares, adding to what Bloomberg has described as the “buyback frenzy” in Japan. Recent foreign selling of the market appears to have been motivated by a view that the Japanese market is very exposed to the global economy. We believe that this view is outdated; corporate Japan has spent the past 20 years moving up the value-added scale, cutting costs and focusing on core businesses. The main Topix index currently trades on 12 times earnings, at book value, and yields 2.7%. Whilst investors remain focused on the global macro environment, it would be naïve to expect them to suddenly start to focus on the undervaluation of individual names. But the disconnect between the quality of individual companies and the valuation ascribed to them by the market is increasingly striking.
Source: JOHCM. Past performance is no guarantee of future performance. The value of investments and the income from them may go down as well as up and you may not get back your original investment. The information contained herein including any expression of opinion is for information purposes only and is given on the understanding that it is not a recommendation.
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