Each week, a professional investor tells MoneyWeek where he’d put his money now. This week: Paul Chesson, head of Japanese equities, Invesco Perpetual.
Japan’s economy has recovered more rapidly from the Tohoku earthquake than almost anyone expected. Disruption to supply chains has been overcome more quickly than forecast, industrial production has bounced back, domestic consumption has been robust and corporate earnings revisions in the first quarter have been largely positive. The very low valuation levels of Japanese equities don’t reflect this. Stock prices are being driven by external news, such as the sovereign debt crisis in the eurozone or stalling growth in developed markets. This has damaged sentiment towards Japanese firms and the strong yen has done little to help. Japan’s Topix index is now barely higher than it was after the collapse of Lehman Brothers three years ago, despite the economic and profit recovery seen since then.
In my view the global economy is unlikely to be weak enough to inflict any more damage on Japanese corporate profits than share prices are already discounting. China will continue to lead growth in Asia and the region will remain a key contributor to global growth, which would be positive for Japanese firms. Bottom-up analysis forms the basis of my investment process: for me, valuation determines whether or not a stock is attractive. I’m looking for firms whose earnings potential isn’t reflected in their valuations. Several Japanese stocks fit the bill.
Japan’s real-estate market has seen encouraging signs of improvement. Vacancy rates in Tokyo peaked in March and have been gradually declining since. Rents seem to be stabilising. This is supportive of Japan’s large listed real-estate companies, such as Mitsubishi Estate (JP: 8802), which is focused on leasing prime central Tokyo office buildings. Its extremely high-quality buildings are attractive for tenants seeking good locations, including in the heart of Tokyo’s financial district. As a result, its vacancy rate is around half of the Tokyo average. The firm’s land values look cheap relative to sales that have been taking place in the market and against a more robust demand outlook.
Some quality businesses have reached historically low valuation levels, presenting interesting opportunities. One is Hoya (JP: 7741), a specialist in high-quality glass products, ranging from eyeglass lenses to key technology components, areas in which the group has the dominant market share. Hoya has also been diversifying its earnings into new areas, such as endoscopes. Hoya is a business with high and defendable margins, stable earnings from its eyeglass and contact lens business, a promising medical business, and exposure to a recovery in the electronics industry.
Tokyo Electron
(JP: 8035), a manufacturer of semiconductor production equipment, is another example of an industry-leading company that has seen its shares de-rated. The shares have been under pressure from declining capital expenditure among electronics manufacturers as the macro-economic outlook has become less clear. However, this is a cyclical industry that can experience strong upward trends. The increasing popularity of smartphones and tablet computers is driving a succession of new product launches. Against this backdrop, a new period of investment by the company’s key customers is likely. With the stock trading around the value of its net assets and on an undemanding earnings multiple, the shares have already discounted a bleak outlook.