The case for Japanese equities

Photo: Komatsu

Following the sharp setback in global equity markets it is important to reassess the case for Japanese equities within developed markets. Simply put, corporate margins continue to be improved through ongoing restructuring, cash flow generation is strong, balance sheets are liquid and in many cases debt-free and valuations are very low. The shareholder will progressively continue to get a better return going forward. The following example, courtesy of John Seagrim at CLSA succinctly makes the case.

KOMATSU (6301 JP) & CATERPILLAR (CAT US)

“Since 1st January 2013 Caterpillar has fished out $8bn of buy-backs and dished out $9bn of dividends. That makes a 5½ year return to shareholders of $17bn or 133% of Caterpillar’s $12.8bn in net earnings over the same period. The difference between what they’ve made and what they’ve dished and fished out is of course to be found on (or lost to) the balance sheet; since 2013 Caterpillar’s tangible book has fallen by $4bn to $6.5bn – equivalent today to just a twelfth of Caterpillar’s $76.5bn market capitalisation.

On the other hand, since April Fools day 2013, Komatsu has generated $7.5bn in Net Profit but has fished out a mere $270ml in buybacks and dished out just $2.93bn in dividends – that’s a 5¼ year return to shareholders of $3.2bn – or just 43% of net earnings. The upshot is Komastsu is currently swimming in $12.3bn of tangible book – equivalent to half its market cap. Just imagine if Komatsu thought that it could do with just half as much tangible book (it needn’t be anyway near as extreme as Caterpillar on a PTBR of 12x), then Komatsu would have $6bn plus, equivalent to 25% of its market cap, to spend on a buyback! Perhaps that’s what they are thinking right now – or perhaps not. But I know what Caterpillar are thinking – they’re thinking if only we still had a balance sheet like Komatsu… unfortunately Caterpillar, like the rest of non-financial America has virtually run out of tangible book – and with it the ability to prop up their share price with unwarranted buy backs.

Komatsu, which generates 11% plus operating margins and yields 3.3%, is trading on 12x earnings and 2x tangible book. Caterpillar, which generates high single digit operating margins and yields 2.9%, is trading on 11x earnings and a scary 12x tangible book.

I know which I’d rather buy.” What about you?

The objective of the Taiko Japanese equities strategy is to achieve long-term capital growth by investing in listed Japanese companies. The strategy seeks to profit from investment opportunities by identifying under-valued securities using a variety of fundamental analytical tools focusing upon growing cashflows and then employing qualitative screens to implement positions. The strategy has a concentrated portfolio, typically holding between 20 and 30 different positions at any given time but with diversification across multiple sectors. The strategy invests in companies throughout the capitalisation range but not below JPY 20bn.