Investing in Japan: late to the party

There has been a lot of coverage of Japanese stocks on a number of value blogs the past two years. Guys like Nate from Oddball Stocks and Geoff Gannon have been investing in Japan and posting their thoughts and some of their picks.

The Japanese market has rallied quite a bit since the end of 2012. So, an investor might ask, are there still bargains left in Japan? After running some screens and checking out a number of companies I believe the answer is yes. There are still a great number of bargains to be found in Japan. I ended up buying my first Japanese stock about a week ago. I will discuss the stock later on in this post, but first I wanted to post some of my thoughts on investing in Japan and about my timing.

Why did I invest in Japan and why now?

I am late to the party when it comes to investing in Japan. I have been reading Geoff’s and Nate’s posts about Japanese stocks and only now did I decide to buy, so why now? I don’t have a very good answer. The best answer I can give you is that I gradually got comfortable about the idea of owning a few Japanese companies in my portfolio and that the rising US stock market also helped.

Initially I just couldn’t understand how stocks could get so cheap and stay so cheap for such a long time. I had read about the bursting of Japan’s bubble and the deflation that has been plaguing them, but it was only after reading Richard Koo’s book The Holy Grail of Macroeconomics: Lessons from Japan’s Great Recession that I realized the full impact of the bursting of the bubble on Japanese citizens and corporations. Koo’s book is mostly about macroeconomics and the concept of balance sheet recessions, but it also discusses the psychological aspects of these types of recessions. Some of the balance sheets of Japanese companies can only be understood with these psychological effects of the long recession in mind. A lot of companies have become allergic to debt and are paying down debt balances that were very modest to begin with. Some companies are hoarding cash to levels that just seem absurd. Reading Koo helped me understand why this is happening and also convinced me that this is not a permanent situation. I believe eventually Japanese companies will become a little more rational about debt and cash levels. It probably won’t change drastically, but a minor improvement in capital allocation or investor sentiment can do wonders for a net-net or a cheap stock.

Currency risk was not much of a concern for me. I will make the Japanese stocks a fairly small portion of my portfolio and I am willing to bear the currency risk. As a European I have been investing primarily in the US for the last few years and I saw some currency swings in my own portfolio. I don’t have an opinion on the relative values of currencies. The main thing I try to do is to diversify my holdings so I don’t get ‘unlucky’ owning too much of a currency that manages to depreciate the most.

The main thing that has made me look harder at other markets is the rising US market. It has become more difficult to find cheap stocks in the US. This past year I have sold some positions that appreciated and recently I also abandoned a position. I have reinvested some of the proceeds in French small caps, but have found few cheap stocks in other European markets. The Japanese market however still has plenty of bargains.

Ok, now to the stock I bought. I want to mention in advance that the information I have been able to retrieve on most Japanese stocks is very limited. With the Japanese stocks I’m betting mainly on the statistical cheapness of the stocks. I have used Google Translate to piece together some info in the Japanese financial statements, but this is far from ideal. Still, as a group (I plan to buy perhaps 2-3 more stocks) I think they will do well.

Maruzen Co Ltd (JP:5982)

Maruzen Co Ltd manufactures and sells commercial kitchen equipment. This is professional equipment that is used by restaurants and other places in the home-meal replacement market like nursing homes. The company owns three plants where it manufactures the equipment. Maruzen has around 90 sales offices covering Japan.

Their main product lines are:

The company also manufactures bakery equipment. I believe this segment is still relatively new and therefore small. Maruzen wants to grow its market share to 10%. The final segment is the Building Leasing segment. The company manages a few properties. From what I understand this segment is basically utilizing real estate the company currently owns and the company does not seem to be actively purchasing properties for the development of this segment at this time.

The restaurant market has been pretty weak in Japan since the recession in 2008. Maruzen’s sales have remained stable from 2008 to 2011. It seems like business has picked up a little in recent quarters.

These are the main things that attract me to Maruzen:

– At the current price of ¥676 Maruzen has a market cap of ¥12.62 billion (based on outstanding shares of 18.67 million, thus excluding treasury stock, the websites of MSN Money, FT and Bloomberg seem to use issued shares (19.78 million) for their calculations). Book value on 11/30/2012 was ¥21.16 billion, for a price-to-book ratio of 0.60. Cash & Short Term Investments were ¥10.57 billion and have grown from ¥3.28 billion in 2008. PP&E is a substantial part of book value though at ¥14.58 billion.

– The current P/E ratio is a little below 7. ROE has been in the 7-9% range over the last five years, which is good for a firm with excess cash and very low debt.

– The company is generating a lot of cash. In 2008 the company built a new distribution center and plant, this explains the large capital expenditures for that year. Recent years show capital expenditures that have been well below depreciation. It is probably a good idea to assume that capex will be substantially higher than in recent years, perhaps ¥800-900 million is a better estimate for future years. Even then we should get a decent FCF yield that lies comfortably above 10%. Maruzen’s cash flows have been very consistent.

– Maruzen still has a little bit of debt on the balance sheet (around ¥ 2.2 billion), but this is less than half of what it was in 2008. Like many other Japanese companies, Maruzen has continued to reduce its debt.

A negative point about this stock is that the minimum lot size for Maruzen is 1000 shares.

One other thing I noticed is that the Fidelity Low-Priced Stock Fund owns roughly 10% of the outstanding shares of Maruzen. Since this investment is a minuscule part of their portfolio this fact is probably meaningless, but it is nice to know that this stock belongs to their group of Japanese investments.

Why Maruzen?

I chose Maruzen above other, perhaps even cheaper looking cash-box type stocks like Tsutsumi Jewelry. What I hope is that Maruzen will be better at allocating capital than some of the true net-nets out there. A company like Tsutsumi just seems to be piling up the cash year after year and paying a very small dividend. I’m not confident that a company like Tsutsumi will change their ways soon.

The management of Maruzen offers more hope in this regard, I think. In 2011 the company repurchased about 1 million shares, although these shares have not been cancelled. The company also pays a small dividend, the stock currently yields about 2.5%. If the cash keeps streaming in and the little debt that remains is further reduced, they will have to make a decision whether to keep piling up the cash, make acquisitions (or real estate investments) or to return more of the cash to the shareholders in the form of a larger dividend or the repurchasing of shares. My hope is they will choose to increase the cash spent on the latter option. To be clear: I don’t think investing strictly in Japanese net-nets is a bad idea. I think that will do very well. I just prefer companies that in my view have a better chance of redirecting their cash flows to dividends and repurchases.

Disclosure: long Maruzen (5982)

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