Japanese blue chips ‘on the cheap’

15 June 2009

Paul Chesson of Invesco Perpetual argues, against conventional wisdom, that there has never been a better time to buy “the world’s greatest manufacturing companies” at bargain prices.

There may never be a better time to buy the world’s greatest manufacturing companies at rock-bottom prices. Forget the fact that there has been a recent rally – the upside on many of the companies is still about 100%.
So where are these companies, and who is making such a confident prediction?

They are Honda, Murata, Nissan, Nitto Denko and TDK, and the manager who says investors have a once-in-a-generation opportunity to buy them on the cheap is Paul Chesson of Invesco Perpetual.

Hold on. Japan is an export economy, and we are in the midst of the biggest slump in global trade for half a century. Japanese GDP shrank by 3.8% in the first quarter of 2009, the largest ever quarterly decline in GDP recorded in Japan, and an annualised rate of 14.2%. An unprecedented drop in production saw exports fall by nearly 50%, with Japan last year posting its first current account deficit for 28 years.

But Chesson says you need to look underneath these ­figures. Japanese companies have vigorously attacked their inventories. We all know about the four-month shutdown at Honda in Swindon. Japanese firms have been doing the same at home, ruthlessly axing production and costs.

The hope is that the economy will soon start to rebound. Indeed, in the past couple of months there has been a rise, albeit small, in Japanese industrial production.

Chesson says Japanese companies were among the first to note the downturn in America and take ­evasive action. “Japan started to peter out in early 2006 because it’s an export economy. It has no domestic growth, for demographic reasons, and there’s not likely to be any.”

In other words, corporate Japan saw the writing on the wall, and started cutting back before Britain and Europe did. Yet investors here still regard it as a late-cycle story.

“Japan is cheap, fundamentally cheap,” says Chesson. “Japanese companies are trading on break-up value. The price of Japanese stocks already compensates you for the loss in profits. Stocks are cheap, at a time when we have passed the worst for the year-on-year fall in profitability.”

Most forecasts are still pretty grim on domestic demand, but there is confidence that exports will soon bounce back after inventories are run down. A government stimulus package is also likely to start coming through from the summer onwards, suggesting to many economists that GDP may start moving back into positive territory by the fourth quarter.

But have investors missed out after the recent rally?

Chesson says: “The market bottomed on March 12 at levels not seen since 1986. Since then it is up, but only by around 10% in sterling terms. And although I expect the yen to soften against sterling, it won’t go down by much.”
In the recent company reporting season, earnings were ­frequently ahead of broker forecasts. Chesson says it comes back to early action on inventories.

“Everybody is focusing on statistics such as the fact that car manufacturers reduced output by as much as 50%. But how much did car demand fall by? It was much closer to 25%. The car companies were, if anything, ahead of the market.”

So where does this take Chesson in portfolio terms? Last year it was all about defensive pharmaceutical and utility stocks. “I came out of them towards the end of last year. I sold maybe a month too early,” he says.

Since then he has rotated into the big blue-chip exporters. Some, such as Honda, have risen so far from their lows that he has already been trimming his position. The motor manufacturer has jumped from a low of ¥1,643 (£10) at the start of the year to about ¥2,875 today, a gain of 75%. “I still like Honda, and I still think it is 50% below where it could be. It’s just that there’s a lot of stocks there with a 100% upside.”

Most investors would be happy at the upside that Chesson has already delivered. The £200m fund is up 9% over the past year, against a 15% fall in the index, making Invesco Perpetual Japan the second best performer of 62 funds in the sector.

He is focusing on the high-tech end of Japanese manufacturing, where competition from the rest of Asia is muted. His biggest single holding is TDK, best known for making cassettes in the 1980s. Its main business now is the manufacture of pick-up heads for hard disk drives and making the capacitors that are the most numerous element in mobile phones.

Chesson is up-front about this being a deeply cyclical business. Profits are geared simply to the number of boxes shipped. And he’s convinced those numbers will soon be rising.

Last year TDK’s share price plunged from more than ¥7,400 to just ¥2,565 but it has since rebounded towards ¥4,500.
Apart from exporters, Chesson is keen on Japan’s brokers, holding Daiwa and Nomura. He acknowledges that Nomura earned a reputation for buying assets at the top and selling at the bottom, but says it has firmly shed that with some well-timed purchases of distressed assets during this recession.

Nomura bought Lehman’s Asian operations, but unlike earlier purchases, it has not installed Japanese management and methods, instead passing control to local talent.

Nomura’s share price collapse matched a lot of financial stocks in the West, falling from ¥2,000 to ¥400. It didn’t bottom out until March, but since then it has staged a remarkable recovery, doubling in just two months. “Nomura has never been so cheap and yet it has never been in a better position to take advantage of recovery,” says Chesson.

Chesson is on a mission to help investors avoid the mistakes they so often seem to make regarding the timing of Japanese investments.

“I’m more positive on Japan than I have been for a very long time,” he says. “I don’t want people to come up to me after the market has risen and ask why they weren’t told. Over my entire career I have seen foreign buyers buy Japan high and sell low. The last time was at the end of a bull run towards the end of 2005. It happens time and time again.

“Do you have nothing invested in Japan? If so, you are avoiding the world’s greatest manufacturing companies.”