Three Japanese growth stocks

published 3 July 2007

Every week, a professional investor tells MoneyWeek where he'd put his money now. This week: Simon Somerville, manager of Jupiter Japan Income Fund

Japan is quietly extending its longest period of economic growth since the end of World War II. This may be hard to believe for investors frustrated by the country's weak economic state following the asset bubble burst at the end of the 1980s. Although the rate of growth isn't as high as at the time of its Rapid Economic Growth' in the 1960s, many indicators show that the economy is gradually returning to full health. Unemployment has fallen to a nine-year low, while export growth remains strong.

Japan's government recently upgraded the first-quarter GDP growth rate to an annualised 3.3% from an initial estimate of 2.4% due largely to higher-than-expected business spending. Japanese companies on aggregate reported a 10% rise in recurring profits for the financial year ended 31 March 2007 and hiked dividends by about 20%.

In our Jupiter Japan Income portfolio, we are focusing on the strength of the domestic economy, rather than on exporters. Firms that rely on domestic demand should benefit from the improving labour and property markets. Moreover, consumer spending, which had been the main drag on the economy, recovered unexpectedly in the first quarter of 2007, which indicates that consumers may be becoming more optimistic albeit cautiously.

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Our portfolio has a large position in T&D Holdings (8795), the only listed life assurer in Japan, created by the merger of Taiyo Life and Daido Life in 2004. Earnings beat hopes for the year ended March 2007, helped by stronger-than-anticipated growth in investment income on the back of rising dividends from its equity holdings. In the current year, I expect T&D to benefit from higher investment income from its bond holdings.

I'm also positive about East Japan Railway (9020), a former Japan National Railways spin-off. It operates the rail network in the Tokyo metropolitan and surrounding areas and develops and manages retail and office properties on its land holdings near its railways. Earnings growth for East Japan for the year ended 31 March was better than expected, supported by rising sales at its core transport unit and cost cuts. With Tokyo's economy and land prices picking up, the company should benefit from increased economic activity in its operational territory.

Among my favoured smaller firms is Japan General (8878), a homebuilder based in Kanagawa, which is adjacent to Tokyo and includes residential cities such as Yokohama and Kamakura. The company has a number of development projects in the pipeline to take advantage of a robust recovery in Japan's property market. Land prices began to rise in most areas in 2006 and office rents continue to go up in the Tokyo metropolitan area. I believe Japan General will achieve strong earnings growth this year and next.