2022 Opportunities in Japanese Equities
Portfolio Manager Masa Takeda discusses the new Prime Minister’s focus on growth, the effect of global supply chain issues and currency weakness on exporters, and how the Fund is currently positioned.
Masakazu Takeda, CFA, CMAPortfolio Manager
Would you please discuss new Prime Minister Fumio Kishida’s economic agenda?
In September 2021, Fumio Kishida replaced Yoshihide Suga as Prime Minister, and is expected to deploy similar economic measures with long-term growth remaining a key emphasis. To spur economic growth, Kishida recently announced a nearly $500 billion stimulus package that amounts to more than 10% of GDP.
Kishida may also bring a few new reforms. He has been promoting a new type of capitalism focused on the creation of wealth as well as its distribution. Depending on the policies introduced, there may be some short-term market repercussions. However, this new capitalism will shift the focus from a shareholder-first priority to sustainable growth.
Kishida may carry out additional reforms through the Corporate Governance Code, which was first introduced in Japan in 2015. Since then, there have been two revisions. In 2018, the Code recommended companies create clear management succession plans, greater diversity in the boardroom, and further reduction of core shareholders. Effective April 2022, companies will be required to have more independent board members, promote management diversity, and improve environmental exposures.
How have global supply chain issues affected the Fund’s export-oriented holdings?
Over the past few months, supply chain disruptions, rising commodity prices, chip shortages, and labor inflation have translated to worse-than-expected earnings for various Japanese companies.
We are pleased that many of the holdings in the Hennessy Japan Fund have successfully weathered the headwinds. One example is Sony, the tech conglomerate. Although Sony’s supply chain issues hit its electronics hardware business, the company managed to improve its profitability in a majority of its product offerings, which helped absorb the adverse impact of a higher costs. To address chip shortages, Sony invested in a joint venture with Taiwan’s PSMC for its first-ever chip manufacturing facility in Japan. We believe this venture should help alleviate sourcing concerns. Further, its entertainment businesses are expected to help offset short-term recent pressure on the hardware business.
Keyence, the factory automation sensor developer, also navigated the turbulence well. The company’s unique direct sales channel strategy allowed management to respond quickly to source parts while most of its competitors were unable to handle the shortage. As a result, Keyence’s operating profit increased 60% year-over-year in the last quarter and surpassed the previous record high in 2017 by 25%.
Would you please discuss the recent weakness in the Japanese yen against the U.S. dollar and how it affects exporters?
We believe a weaker yen reflects the economic differences between the U.S. and Japan. Even though corporate Japan has become more currency neutral since the 2008 financial crisis, a weaker yen remains a net positive for many exporters. Many holdings in the Hennessy Japan Fund are global exporters with foreign currency exposure. As such, the Fund should benefit from the improved yen-denominated revenue and earnings which we believe will translate to a higher share price.
As Japan’s economy continues to recover, what are your expectations for earnings growth and return on equity (ROE)?
In the current fiscal year ending in March 2022, the Tokyo Stock Price Index (TOPIX) earnings growth per share (EPS) will likely recover to 2017’s previous peak before the onset of the U.S.-China trade war. In addition, in the fiscal year ending in March 2023, the TOPIX EPS is expected to grow by another 15% as the economy reopens. This translates to a long-term average EPS growth rate of 10.3%.
With regard to return on equity (ROE), Japan’s unique corporate culture, such as permanent employment practice, slow adoption of technologies, and high-touch customer service, don’t necessarily translate to higher profits. However due to the Stewardship Code, ROE may rise above 10% to a longer-term range within the low to mid-teens. The Stewardship Code is a guideline for institutional investors to fulfill their responsibilities for sustainable growth and enhance the mid- to long-term investment return. It encourages investors to engage in constructive dialogue with listed companies on how to improve capital efficiency. We believe these institutional investors can be a driving force to improve productivity over the long run.
In a global inflationary environment, how is the Fund positioned?
Many companies that produce physical goods have come under pressure due to inflationary concerns. As a result, we have divided the Fund broadly into two groups. The first group contains high-quality companies whose competitive strengths are rooted in manufacturing excellence. These holdings include Nidec, Terumo, Shimano, Daikin, Rhoto, and Unicharm. We continue to view manufacturing excellence to be Japan’s reliable competitive advantage, and our holdings have excellent track records of navigating past recessions. We believe they have the ability to weather inflationary headwinds over time.
The second group contains businesses whose compelling economics reside in intangible assets, including Recruit, Sony, Keyence, Mercari, Hitachi, and SoftBank Group. These companies require little capital to grow and possess high returns on capital and high operating leverage, providing potential growth, even in an inflationary environment.
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