» In an uncertain macro economic environment, more investors become less willing to pay for growth.
» “Growth in disguise” companies may offer the best of both worlds in the current environment.
» Investors can capture Japanese “growth” opportunities with “value-priced” companies.
» A few examples include Tokio Marine, ORIX, and Hitachi.
Often investors are attracted to growth-oriented companies because of their above-average growth potential. As a result, they are often willing to pay a premium for their shares. Yet, as the macro environment becomes increasingly uncertain due to rising interest rates and global inflation, more investors become less willing to pay a premium for growth. Instead, companies with share buyback plans and dividend payouts have become more attractive. We believe companies trading like “value” companies or “growth in disguise” hold more near-term opportunity than growth companies that are solely reliant on revenue and earnings expansion.
For more price conscious investors, growth businesses priced at a discount to earnings or book value—“growth in disguise” companies—could yield big opportunity.
“Growth in Disguise” Stocks
Typically, many growth companies in Japan offer higher expected earnings growth rates but have negligible share buybacks and meager dividend yields. On the other hand, some Japanese “value” stocks, defined by low price to earnings (P/E) are discounted due to the inherent low growth outlook.
“Growth in disguise” companies may offer the best of both worlds in the current environment: These Japanese companies offer higher growth potential, participate in share buybacks, and pay dividends yet are priced at a discount to our view of intrinsic value.
A few examples highlighted below include Tokyo Marine, ORIX, and Hitachi.
Tokio Marine is Japan’s largest general insurance group with a solid track record in the domestic market and an expanding overseas business.
Insurance businesses are generally regarded as mundane and mature in Japan. While this is true to some extent, the insurance industry has been growing faster than Japan’s GDP and has become dominated by a few key players due to industry consolidation.
Furthermore, Tokio Marine’s sizable overseas underwriting businesses are driving its overall net premium growth rate to the mid-single digit range.
Tokio Marine is one of three mega-insurance companies in Japan that controls nearly 90% of the domestic underwriting business, allowing them to generate abundant cash flows. All three companies own “strategic equity holdings” worth tens of billions of dollars. These holdings used to be the target of shareholder criticism as under-utilized assets but now are considered as an opportunity to create shareholder value.
While we believe Tokio Marine’s outlook looks bright, due to the market’s misperception of the insurance industry, the stock has been trading at a lower valuation than the overall Japanese market. We believe Tokio Marine has a sustainable growth rate of 4% to 7% over the next few years. Given healthy cash flow, the company can buy back shares, thereby raising earnings per share. Its dividend yield as of November 30, 2022 was 3.5%. When combining these key financial metrics, we believe Tokio Marine can generate a 10%-plus shareholder return over time.
ORIX is Japan’s largest non-bank, comprehensive financial services company. It was established in 1964 as a leasing company, but has diversified into a broad range of business lines including aircraft leasing, property development, asset management, banking, life insurance, private equity, venture capital, renewable energy investment, and airport concessions. Approximately 50% of its earnings is generated from outside of Japan.
From a valuation perspective, ORIX has grown at 7-10% per annum over the last five and 10 years on a book value basis. Management is committed to a 33% dividend payout ratio, which equates to a dividend yield of 3.9% as of November 30, 2022. In addition, the company has been buying back shares and boosting earnings per share. In fact, over the past three years, outstanding shares have decreased at a rate of 2-3%, augmenting the earnings growth rate on a per share basis.
We believe ORIX remains undervalued with a current valuation of 9.2x forward P/E with a price to book (P/B) of 0.7x compared to the Tokyo Stock Price Index’s P/E of 8.7 and P/B of 1.2.
Hitachi is one of Japan’s largest industrial manufacturing conglomerates which produces industrial equipment, heavy machinery, home appliances, consumer electronics, and diagnostic equipment.
Since 2016, the company has transitioned from a pure manufacturing-centric business model to a software-based, asset-light, consulting business model. Now, Hitachi sells hardware to industrial customers along with software services, maintenance, aftersales support, operational outsourcing, and monitoring services.
The company has a return on equity (ROE) of 14.8%, substantially higher than the average Japanese company. This is even more impressive given that Hitachi has yet to complete its transition to a more profitable industrial data analytics-based hardware/software turnkey solution provider.
Management also unveiled a three-year business plan which projected an earnings per share (EPS) compound annual growth rate of 10-14% and an adjusted earnings target of $9.4 billion in FY2024. Furthermore, the plan also highlights a cumulative free cashflow estimate of $10.2 billion from operating businesses and $7 billion from additional non-core asset sales. Of this, $5.5 billion will be used toward dividends and share buybacks. It should be noted that the amount of shareholder returns equates to over 10% of the current market cap.
In our view, at only 11x forward earnings, Hitachi is a “growth stock in disguise,” with above-average growth prospects trading at valuation multiples more commonplace with value-oriented stocks.
An Opportunity to Benefit
We believe there are many high-quality Japanese companies that have these “growth in disguise” qualities. As economic growth appears uncertain, these types of companies look more attractive compared to growth companies that do not engage in share buybacks or pay dividends and must rely on earnings growth and multiple expansion.
As an actively managed portfolio, the Hennessy Japan Fund features a concentrated portfolio of globally oriented Japanese companies, many of which have compelling growth prospects but are trading at what we believe are attractive valuations.