A professional investor tells us where he’d put his money. This week: Joe Bauernfreund of the AVI Japan Opportunity Trust selects three cheap Japanese shares.
We seek out companies that are overlooked, unloved or ignored by mainstream investors. These stocks have been marked down as a result of particular circumstances that we think are unlikely to persist. Asset Value Investors (AVI) has a global focus but we have a very strong belief in Japan. Last year we launched a dedicated Japan fund, AVI Japan Opportunity Trust (AJOT).
Japanese companies have an abundance of cash, driven by strong profit growth and historically low payout ratios. However, the culture of locking cash away and ignoring shareholders has been changing since the introduction of the Corporate Governance Code in 2015. Companies are unwinding cross-shareholdings, buying back record numbers of shares and raising dividends. Yet, despite the clear progress, valuations are still depressed. There are many opportunities in high-quality, cash-rich, small Japanese companies that the market is unfairly neglecting. Here are three examples.
SK Kaken: painting a pretty picture
SK Kaken (Tokyo: 4628) produces highly specialised construction paints with the majority of sales coming from refurbishment works. Despite anaemically low inflation and the perception that Japanese companies do not grow, SK Kaken has increased profits at an annual rate of 7% for the past 20 years. It now has a 52% market share in the domestic construction paints market. Despite SK Kaken’s impressive record, the market values the company at just 4.7 times EV/EBIT (see page 15 for a full explanation of this valuation measure), with net cash covering 64% of the market cap. While the dividend payout ratio is low (11% income for a 0.7% yield) the company generates 6% of its market cap in cash each year. We are being paid to wait.
Secom Joshinetsu: alarmingly cheap
Secom Joshinetsu (Tokyo: 4342) is a subsidiary of the global security and alarms company Secom, which owns 51% of it. It has the exclusive right to operate Secom’s business across three prefectures in Japan. The business is stable, charging recurring service fees to its customers to guard and monitor their buildings. It boasts a renewal rate of close to 100% and during the recession revenues only fell 6%. Secom Joshinetsu’s 1.4 times EV/EBIT valuation compared to its parent’s ten times leaves 76% upside. The investment case is all the more compelling considering Secom Joshinetsu’s 7% free cash flow yield, while 80% of the market value is covered by cash.
Fujitec lift maker in bargain basement
Fujitec (Tokyo: 6406) is a global lift manufacturer with sales in Japan, China, Southeast Asia, North America and Europe. The most appealing aspect of the business is lift maintenance contracts. These last for decades, producing steady, recurring profits, which explains why Fujitec’s global peers trade on EV/EBIT multiples approaching 18 times. However, Fujitec, which operates the same business model, is on a multiple of just seven. Fujitec’s balance sheet is hugely overcapitalised, which means we are, in effect, investing 53% of our capital in cash and listed securities and gaining exposure to a high-quality, profitable operating business at a low valuation – all the while receiving a 3% dividend yield.