Discovering overlooked and under researched investment opportunities to unlock long term value.
Investing in the Japanese market for over two decades, with a dedicated team in London and Tokyo
|Software and Services||14.2%|
|Commercial and Professional Services||10.4%|
|Foods and Staples Retailing||5%|
|Automobiles and Components||4%|
|Health Care Equipment and Services||2.9%|
|Media and Entertainment||0.4%|
Since the launch of AJOT in October 2018 we have argued that the continued existence of parent-child subsidiary structures in Japan would be unlikely to survive the corporate governance revolution. Such arrangements are advantageous to the parent company, but abusive of minority shareholders. The corporate governance code challenges their existence, and we believe their days are numbered.
We wanted to provide this mid-month update as we have launched three public campaigns. As we commented in our April newsletter, we submitted shareholder proposals to seven companies ahead of their June 2021 AGMs. Since then, we have withdrawn proposals from three, are still in discussions with one (where we have a meeting with the President and its parent company at the end of the month) and three remain active, of which we highlight details below.
We formally submitted shareholder proposals to seven of our portfolio companies in April. We say formally, as we have been informally putting forward the same suggestions to management persistently since we first invested in each company. The submission of the shareholder proposals came as no surprise to management, as in the preceding months we have taken the time to explain, at great lengths, the reasonings for our actions. In fact, the shareholder proposals have allowed us to have more frequent and meaningful dialogue with our investee companies which has fostered closer relationships.
Over the first quarter, AJOT’s NAV declined by a modest -0.6%. The strength of the Pound against the Yen, which detracted 7.5% from returns, masked an otherwise respectable quarter.
The most important feature of our portfolio is that the overall corporate value of our 28 investee companies is increasing, whether that be through cash generation, earnings growth or a higher justifiable multiple due to improved business quality. In February and March, our companies reported earnings results, showing a solid recovery in profitability after the disruption from the pandemic with the weighted profits of the portfolio increasing by 16% year-on-year.
Our companies finished reporting their earnings for a hugely important quarter which we had hoped would prove to the market the quality of our portfolio and continue the V-shaped earnings recovery. It is fair to say we have been pleasantly surprised by the strength of the earnings recovery. 19 of 27 companies reported year-on-year profit growth while 20 reported quarter-on-quarter growth for an average growth rate of 27% and 23% respectively.
Our companies have started to report post-COVID earnings, a hugely important quarter which we hope will prove to the market the quality of our portfolio and continue the V-shaped earnings recovery. So far so good. At the time of writing 13 companies announced results, with 9 seeing not only profits returning to pre-COVID levels but growing.
Alps Logistics was the standout performer, both in terms of contribution and earnings performance. Despite starting the period with a relatively small 2.5% weight, Alps Logistics contributed 55bps to performance, following a +24% share price return. Alps Logistics’ share price benefitted from an upgrade to the 1st section of the Tokyo Stock Exchange and strong results, with YoY sales and profits growing +8% and +44%, following an uptick in electronic part shipments and continued growth in its ecommerce delivery business.
Despite improving earnings, increasing levels of corporate activity and buoyant markets, small-cap companies in Japan have been largely ignored by stock market investors. For the quarter ending 31st Dec 2020, the MSCI Japan Small Cap Index, in GBP, returned 2.2% while its larger counterpart, MSCI Japan, returned 9.0%. Foreign capital flows into Japan were positive in November and December – a rare occurrence over the past five years. For the time being much of that capital appears to be going into large cap names, although in time, we expect this to broaden out to include smaller companies too. AJOT’s return of 1.0% over the quarter is disappointing considering the very strong earnings recovery reported by portfolio companies, as well as the encouraging backdrop of a recovery in global economic activity.
By November all the companies in our portfolio had reported quarterly earnings, giving us greater insight into the pace of the recovery. As we commented last month, our companies reported a V shaped bounce in earnings. Although profits for the quarter were down -22% year-on-year, they bounced by +42% compared to the last quarter; based on management’s conservative guidance, profits should be up another +29% by next quarter. Remarkably, this has not been reflected in the share prices of our companies.
“Corporate governance reform is key in raising the value of Japanese companies.” These were the words of Japan’s new Prime Minister Suga at a policy speech given at the end of October. His speech was laden with mention of reform, including digitalisation, and attacking bureaucratic decision making and the notorious habit of following past precedents.
At the end of August Japan’s longest serving prime minister, Shinzo Abe, resigned on health grounds. As the driver and key promoter of reforms to improve corporate efficiency, it naturally raises the question – does his resignation mark the end of the policies that have collectively become known as “Abenomics” and within that the so called “third arrow” that focuses on structural reform that has led to a corporate governance revolution in recent years?
AVI Japan Opportunity Trust p.l.c is referred to as ‘AJOT’ throughout the website. AJOT’s investment managers, Asset Value Investors are referred to as ‘AVI’