Our outlook for 2023 on the Japan can be summarized in 6 major trends:
- Further yen appreciation will follow further monetary policy changes.
- The domestic economy is likely to be supported by large scale capex and normalised auto production with a progressive full reopening of the economy and higher tourism.
- The stronger yen and the nuclear restart will lower cost-push inflation.
- Expect many but not all corporates to offset wage growth through cost-cutting.
- Corporate managements will maintain laser like focus on margins and cashflow and sustain shareholder returns.
- Japan will accelerate their enhanced defence spending plans.
Implications for the stock market
We do not expect the yen appreciation – more likely in the second half of 2023 – and the pathway to monetary policy normalisation to benefit all companies. Clear distinctions will arise between those with sustainable selling price control and the weaker companies. The latter will be pressured into discounts as input costs visibly decline. The financials, especially banks, remain likely beneficiaries of monetary tightening and our visit to the Chiba Bank – which we already owned – underlined the buoyant prospects for those banks with a fully functioning fintech model. For manufacturers, the lower domestic energy costs and the stronger yen will materially lower input costs although on a global basis the impact will be diluted, given lower yen revenues. Within many domestic industries, expect a slight overall recovery as the economy fully reopens and this will be more than offset by the acceleration in industry consolidation. During our Japan trip in December (updated market information May 2023), it was noticeable even in central Tokyo how many small retailers had been shuttered.
We remain hopeful that we can persuade more companies to adopt our 2 tier dividend proposals. Given potential annual dividend yields of close to 10% in some cases, the stock market reaction should be very positive. Again, this clearly suits our preferred investments that have very strong and sustainable cash flow generation.
The private equity activity shows no sign of abating and indeed is welcomed by corporate Japan as they are providing a pool of capital to purchase non-core assets. Full scale purchases such as Toshiba will prove a rarity as opposed to the norm. The more direct balance sheet asset stripping by activists will slow as opportunities become more limited but constructive pressure exerted in the boardrooms over strategy and returns will remain a constant feature.
Having conducted over 200 corporate meetings in 2022, we do not sense managements are in any way relaxing their focus on further operational return improvements and in that sense some yen appreciation will only further sharpen their focus. Over the coming years, we believe that the most striking improvement will emerge from higher labour productivity – driven in part by the current heavy technology-based initiatives – commonly referred to as the DX strategy.
In a troubled world, certain attributes such as non-leveraged, cash rich balance sheets afford Japanese companies options which are the envy of many companies in the Western World. This applies to the potential it has for investment and shareholder return decisions. Valuations for the most part remain low relative to other developed markets.
My favourite anecdote of such value in 2022 relates to a meeting with a domestic company, where we are shareholders. The president asked the first question, “Why Kimber-san are you buying our shares? “
“Well,” I replied, “You have 3 businesses with growth and consolidation prospects where you are the industry leader and generate high returns, your cashflow yield is over 10%, the balance sheet has high net cash levels and EV/EBITDA multiple is 2Xs!”
This is not a total guarantee to make money but such cases have a favourable absolute risk/reward profile. Whilst at the more extreme end of low valuations, this holding in the fund symbolises those companies we seek out for our portfolio and underscores our underlying optimism over future returns.