Japanese companies have strength to deliver profits

BY MITSUHIRO YUASA

In October, the market declined due to rising interest rates in the US and increased fears about a future deterioration of the US and global economy. The market fell after the US market plummeted following the release of weak housing statistics amid a worrying quarterly earnings season.

During the month, the domestic market deteriorated on the back of the continuing trade war between the US and China. Further, the news of a bombing threat to a major media centre and various public figures of the Democratic Party inhibited major markets in October.

During the month, investors were tired about the currency hegemony war between the US and China, selling out of global equity markets. At the same time, certain Japanese companies announced a down-ward revision of earnings due to the global economic turmoil.

The Japanese currency, which had weakened against the dollar and supported the market during the previous month, suddenly strengthened as a safe-haven for global money flows. The hoarding of Japanese currency led to a deterioration of domestic exporters and dragged on the market in October. Small companies were sold heavily alongside large caps, which were sold for redemption needs. The market recovered slightly towards the end of the month, which was however too late and of a too small magnitude to offset the deterioration throughout the earlier part of the month.

COSMOS Pharmaceuticals (3349), which has been part of the Investment Adviser’s portfolio since inception, is operating drug stores based in Kyushu. The Company was founded by Mr. Uno in 1991 as a drug store that sells daily necessities such as medicines. Faced with severe competition in the retail sector, COSMOS further sells food items and alcoholic beverages along with cosmetics.

The Company currently operates 916 outlets spread across Japan, with 527 outlets located in the Kyushu area, the southern part of Japan. Contemplating its business model, there is more room for the Company to grow according to the Investment Adviser. During this fiscal year, COSMOS raised salaries for full- as well as part-time employees (which account for 3x the number of full-timers), promoting confidence among the workforce and fostering “back to basic ethics” in retail stores. The team believe that improved loyalty and a good business style which has attracted customers in the past, will trigger the Company’s growth further.The stock currently trades at P/E 24.5x, PBR 3.9x and ROE 17.1%.

In light of similar issues experienced in the late 1970s to early 1980s, the currency hegemony war between the US and China will not end soon in the Investment Adviser’s opinion. In the case of Japan, the US complained about an unfair trade environment between the two countries, accusing that the beef and orange markets in 1977 and later on the auto industry in 1980 were mostly closed to protect the domestic industry, eventually leading to the Plaza Accord agreement in 1985, in which Japan allowed its currency to appreciate against the dollar, losing power over its currency and Japan itself. Against this backdrop and in the team’s opinion, one should not expect the recent tradewar to end soon, but rather expect it to take several years to be settled.

The special diet of Japan began in October, starting talks about a consumption tax hike in October 2019 and associated relief measures. The additional 2% consumption tax will not apply to fresh foods but be levied upon alcohol and restaurant meals. The diet will also discuss the opening of certain industries which are in need of additional human resources, to foreign workers with a certain level of knowledge and skills.

The Investment Adviser believes that these two important bills will be processed smoothly to make a great start to 2019. The market declined sharply in October, but the team believe that companies still have the strength to produce good bottom line results, leading the Investment Adviser to maintain the current portfolio.

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The views and statements contained herein are those of Rheos Capital Works Inc in their capacity as Investment Adviser to the Fund as of 13/11/18 and are based on internal research and modelling.

Further insights

November 2018

October update - A preference for defensive portfolio positioning

The Strategic Europe Value Fund declined -4.24% in October, outperforming its index by 1.07 percentage points. The best performing sectors in terms of alpha were Materials and Industrials, due to strong stock selection. The Fund’s overweight to the Consumer Staples and Health Care sectors and its slightly higher cash position also helped.