The Japanese stock market has long been one of the world's cheapest. Japanese companies have lagged their US counterparts, and inefficiency along with passive shareholders have dissuaded foreign investors from investing.
In order to make companies more competitive and revitalise the Japanese economy, Shinzo Abe's government introduced a Code of Good Practice in 2014 and a Corporate Governance Code in 2015, requiring companies to improve their capital allocation and act in a more shareholder friendly manner.
However, development is slow and has been hampered by lack of transparency and cross-ownership between companies, banks and insurance companies. The average age of companies' board members remains high, independent members are few and far between, and women are largely absent. Frequently, general meetings take place on the same day, making it difficult for shareholders to attend.
Investor push for development
Nonetheless, the pressure on companies is increasing. The Japanese Central Bank and state pension funds have started to invest in domestic stocks and shareholders in general have started to become more active. In order to speed up the developments, an increasing number of active investors are buying into Japanese companies. Together with asset managers and institutional investors, they are demanding greater transparency and a better return on their investments.
These developments have captured the interest of the value investors running the high concentration equity fund, SKAGEN Focus, which has significantly increased its exposure to the country over the past year.
"It is simply too cheap to ignore, both from an absolute and relative perspective. We think that it is just a matter of time before companies are forced to become more efficient in their capital management," says portfolio manager Jonas Edholm.
One of the latest additions to the SKAGEN Focus portfolio is Bank of Kyoto, a conservative regional bank with substantial net cash and a giant portfolio that includes companies such as Nintendo and Kyocera.
According to the portfolio managers' analysis, the market does not value the bank's portfolio correctly, however, and Bank of Kyoto is currently trading at 50 percent of its intrinsic value. A trigger that may make the share price rise to its correct value, would be if the bank were to start selling off its holdings and distributing capital to shareholders instead of continuing to build its own portfolio.
Re-rating for fire protection
SKAGEN Focus' most recent investment, Japanese Teikoku Sen-I, is a similar case. The company has its roots in the early twentieth century textile industry and today specialises in protective clothing and fire and counter terrorism equipment. The company has a major investment in the property company, Hulic, which is a good example of illogical Japanese cross-ownership.
If you calculate the value of the holding in Hulic, the core activity is worth almost nothing. In April this year, the Japanese activist investor Sparx increased its holding in the company significantly and demanded value-enhancing changes, including a plan to distribute dividends to shareholders.
Teikoku has reported good results over the past few quarters, which is also reflected in the share price. The SKAGEN Focus portfolio managers still see a 50 percent upside in the share, and have increased their holding in the summer, bringing it up to around one percent of the fund.
Upturn for cement
The cement company Taiheiyo is an exception among the fund's Japanese holdings. The company is indebted and has suffered from slow growth in a Japanese cement market that has been depressed for around a decade.
Thanks to a combination of a sharp increase in demand driven by the 2020 Tokyo Olympics and investors becoming aware of Taiheiyo's operations in the US, the share price has risen from 270 yen to 430 yen in the period since SKAGEN Focus initiated its position in August 2016. The portfolio managers are starting to scale back the position now that the target price has been reached.
Japan's extremely successful technology and telecoms conglomerate SoftBank, led by the genius founder Masayoshi Son, has been part of the SKAGEN Focus portfolio since the fund was launched in May 2015. SoftBank has been described as a venture capitalist, asset manager and private equity company. They have a large investment portfolio and are major shareholders in Chinese Alibaba's e-commerce business, amongst other things.
The company trades at less than 45 percent of the value of its aggregated assets. Here too, a possible catalyst for re-rating is that the company sells its assets and begins distributing dividends to shareholders.
"As extremely price-driven value investors, we see the price of Japanese companies relative to what they own as very appealing. Given the reforms sweeping through the company's stock market, we see the potential for share prices reaching new highs. As we see it, we are getting one euro for 50 cents," says Jonas Edholm.