In a world of excess capital, exuberant markets and high expectations for a strong post-pandemic recovery, it is difficult to find undervalued companies. But investors need look no further than Japan. Despite a muted impact from Covid-19 and a strong earnings recovery, the Topix has increased by just 18% in sterling terms over one year, compared to 33% for the MSCI World.
Time and again, value investors have held out much hope for Japan, only to be disappointed with false dawns and unmet expectations. However, attitudes towards shareholders are changing and we believe investing in Japan does not pose the same risks as it did a decade ago.
We look for high-quality businesses, which broadly speaking means companies that will generate a significant amount of shareholder value over three to five years. These are not hard to find – there are plenty of undiscovered wonderful firms in Japan, trading at amazing valuations. We engage constructively with management and offer ideas on how to rectify their share-price undervaluation. Low valuations, growing shareholder value and engagement is a potent combination for generating high returns.
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Elevating Fujitec
Fujitec (Tokyo: 6406) is a global lift manufacturer. Its maintenance contracts last for decades, producing steady recurring profit, which explains why Fujitec’s global peers trade on an average enterprise value to earnings before interest and tax (EV/ EBIT) multiple of 24. We put forward a public presentation last May outlining several improvement points, to which Fujitec reacted positively. Since then, it has discontinued its anti-takeover measures, increased the dividend payout, improved English-language disclosure and is taking steps to enhance its profit margins. These actions increased Fujitec’s EV/EBIT multiple from seven in May to 14 today, and we expect that re-rating to continue.
Japan’s IT revolution
Japan’s IT systems are outdated, inefficient and in much need of improvement. DTS (Tokyo: 9682) provides system solutions to companies, such as those that use more efficient cloud-based services. Due to its size and excess cash, DTS trades on an EV/EBIT multiple of just seven, compared with peers on 15. It has grown profits annually at 7% for the past five years and we expect that pace will continue. While at an early stage, we have built a strong relationship with the management team, who find DTS’s low valuation as perplexing as we do.
Cashing in on digital payments
Digital Garage (Tokyo: 4819) runs a payment-processing business that is well positioned to take advantage of Japan’s shift away from a cash culture. Non-cash payments account for only 16% of consumption in Japan, compared with 54% in the UK. The government wants non-cash payments to more than double to 40% by 2025. This would be a huge boon for Digital Garage, which is aiming to compound profits at 20% for the next five years. The tailwind is reflected in the valuation of a close peer, GMO Payment Gateway, which trades on a forward price/earnings (p/e) ratio of 107, but not in that of Digital Garage, whose complex structure and poor communication means it trades on an implied p/e multiple of 20. However, with a nudge from us, it has started to improve disclosure and we expect that valuation gap to narrow.
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