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Despite the perception that there is little or no growth in Japan, our core portfolio holdings in the FSSA Japan Equity Fund have been able to adapt and grow despite economic headwinds, and have delivered sustainable earnings growth and attractive shareholder returns.
In this six-part series, we aim to address some of the most common investor concerns about Japan equities and highlight the opportunities for sustainable growth in this market.
We start with Part 1…
Part 1: Economic growth is not a requirement for corporate growth
Theoretically, a fast-growing economy bodes well for corporate earnings and stock prices, and vice versa. Because of this, investors often cite Japan’s weak economy and deflationary environment as reasons they have been reluctant to invest in Japan. However, the data suggests that these concerns may be unfounded. Although Japan’s nominal GDP has grown by just 4% since the late ‘90s peak, Japan Inc’s corporate profits have grown by 180% over the same period.
With our bottom-up and research-driven investment approach, we have found that Japan contains many “hidden gems” – companies that are able to grow strongly, despite the macro backdrop. How is this possible? Our research indicates that high-quality franchises that are dominant in niche sectors can sustain strong and consistent earnings growth without relying on leverage or macro conditions. Often, these companies incorporate some combination of the following characteristics: innovation, disruption, overseas expansion and a strong focus on return on invested capital.
Even in declining sectors, there are singular companies that have beaten the odds and delivered steady returns for investors. One such example is specialty furniture retailer Nitori, the largest furniture brand in Japan. Weak domestic consumption and deflationary price expectations might reasonably challenge any domestically-focused retailer. However, Nitori has continually innovated – from product design to new store formats – to secure new areas of growth.
Nitori’s vertically-integrated business model means that it manages the entire supply chain, with product sourcing from Southeast Asia, domestic distribution centres that cover every corner of Japan, and direct management of its bricks-and-mortar stores and its e-commerce business. This enables the company to offer high-quality furnishings that are much cheaper than peers and generates higher gross profit margins.
Nitori’s track record speaks for itself and by any standard measure, the company would be considered a remarkable success story. Book value and dividends per share have grown by more than 20x over the past two decades, while sales and profits have grown for 32 consecutive years – despite no growth in the furniture and home furnishings market in Japan. Long-term shareholders have been rewarded handsomely.
Fast Retailing is another example of a Japanese company that has delivered excellent compounded growth for investors. Despite Japan’s weak economy, Fast Retailing has delivered more than 20% compound annual profit growth over the past 20 years. The company behind UNIQLO, the casual-wear brand offering functional apparel and basic wardrobe staples, has turned deflation – a significant headwind for the retail industry – into a tailwind.
Fast Retailing provides high quality and functional yet low-cost unisex clothes, catering to all genders and age groups. Though its designs are simple and timeless, UNIQLO brings continual innovation to its product offering, making incremental improvements over time.
The company’s ethos is based on the guiding principles of its founder and president, Mr Tadashi Yanai, who believes that “God is in the details”. This reflects the Japanese conviction that skillful execution – with a sharp focus on perfecting the small things – should eventually accumulate into a leading competitive advantage over time.
As Akio Nitori, founder and chairman of Nitori, reportedly said, “Economic growth is never a part of our growth assumptions.” This supports our view that there are no sunset companies, only sunset industries. We believe that successful investing in Japan is about seeking out these “hidden gems” in a large and deep universe, rather than simply buying the index. As a highly under-researched market, we believe that Japan offers the perfect opportunity for bottom-up active investors to generate alpha.
We will continue to dispel some of the most common investor concerns through this weekly series.
This document has been prepared for informational purposes only and is only intended to provide a summary of the subject matter covered. It does not purport to be comprehensive. The views expressed are the views of the writer at the time of issue and may change over time. It does not constitute investment advice and/or a recommendation and should not be used as the basis of any investment decision. This document is not an offer document and does not constitute an offer or invitation or investment recommendation to distribute or purchase securities, shares, units or other interests or to enter into an investment agreement. No person should rely on the content and/or act on the basis of any material contained in this document.
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In the UK, issued by First Sentier Investors (UK) Funds Limited which is authorised and regulated by the Financial Conduct Authority (registration number 143359). Registered office Finsbury Circus House, 15 Finsbury Circus, London, EC2M 7EB number 2294743. Outside the UK, issued by First Sentier Investors International IM Limited which is authorised and regulated in the UK by the Financial Conduct Authority (registered number 122512). Registered office: 23 St. Andrew Square, Edinburgh, EH2 1BB number SCO79063.
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