Charles Edwardes-Ker, vice-president and director, investment management, at TD Asset Management Inc., says that the Japanese economy is proving to be more resilient in the wake of its recent disasters than was initially expected.
A specialist in Japan, Edwardes-Ker has spent 25 years investing in the Japanese equity market. "The March 11 Tohoku earthquake, the tsunami that followed and the subsequent Fukushima Daiichi nuclear power-plant meltdown, have taken their toll on the Japanese economy."
The Bank of Japan, he says, has reduced its estimate of GDP (gross domestic product) growth for 2011 to 0.6% from 1.6%. It has raised its GDP growth estimate for the country for 2012 to 2.9% from 2%. But he notes that despite the reduced growth prospects for 2011, certain problems are not as extensive as they were thought to be back in March.
Firstly, he says, the expected energy shortfall this summer for eastern Japan is roughly half of the initial estimates. But, he adds: "There will still be a need for strict conservation." Consumers and businesses will have to cut back on their use of electricity, he says. "Peak usage tends to be during the Japanese summer, when there is a high demand for power to run air-conditioning units."
Another positive, he says, is that East Japan Railway Co. has repaired all its lines in the earthquake-hit area, well ahead of schedule. "This has restored the transportation infrastructure and also provided a symbolic boost to the nation."
Lastly, the disruption in the global supply chain from the destruction of the manufacturing facilities of Japanese electronics and auto-parts companies will not be as prolonged as was first feared, he says. "Some of these companies will be able restart their production, albeit on a partial basis, this summer."
The estimated damage from the March earthquake and its aftermath is about US$300 billion or 4% of Japan's gross domestic product, says Edwardes-Ker. So far, he says, the government has committed some US$48 billion to the necessary reconstruction. "There is more to come."
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This will further increase Japan's already hefty fiscal deficit, he says. There will be a need for the government to look to boost its revenues. "One possibility is an increase in sales tax, which is currently 5%." Given this prospect, Edwardes-Ker says he is cautious on the outlook for Japanese consumer-related stocks.
At TD Asset Management (assets $189.1 billion), Edwardes-Ker, who has been at the firm since October 2001, is responsible for TD Japanese Growth (assets $21 million). This fund is an above-average performer in its category, based on its three-, five- and 10-year track records.
The fund's benchmark is the Topix Index (Tokyo Stock Price Index). The index currently trades at a price-earnings multiple of 14 times, which compares favourably with P/E multiples globally, Edwardes-Ker says." It is a much more reasonable valuation than in the '80s, when the Japanese equity market traded at extremely lofty multiples, he says, before the bubble burst.
| Japan has been a global market laggard | ||||||||
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| 1Y | 2Y | 3Y | 5Y | 10Y | ||||
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| Japan TOPIX (C$) | -4.5 | 1.0 | -7.0 | -8.5 | -3.9 | |||
| MSCI World Index (C$) | 11.4 | 14.4 | -2.0 | -0.5 | -0.5 | |||
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| Returns include reinvested dividends Source: TD Asset Management Inc. |
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TD Japanese Growth holds 65 names, of which some 20% are in the smaller-cap space. "The small caps offer better relative value than their big cap counterparts."
Edwardes-Ker is a growth-at-a-reasonable-price manager. His goal, he says, is to construct a portfolio of companies that have higher earnings growth and lower leverage on their balance sheets than the index as a whole. The portfolio of stocks should also, he says, trade at a P/E multiple below that of the index.
TD Japanese Growth, says Edwardes-Ker is underweight in the banks. "Japanese banks have a history of diluting shareholders' equity."
Instead, he is emphasizing non-bank financials. An example is Osaka Securities Exchange Co. Ltd., (market capitalization $1.3 billion), the second largest stock exchange in Japan and a specialist in derivatives. "There is strong growth in derivatives trading."
Osaka Securities has a high return on equity and a strong balance sheet with no debt, Edwardes-Ker says. In addition, it has a good history of corporate governance, "sometimes a challenge in Japan." It is also one of the cheapest stocks in the stock- exchange business in Asia, he says.
Finally, the Tokyo Stock Exchange Group Inc., which runs the world's second largest equity market could merge with its smaller Japanese counterpart, "which could be good for Osaka Securities Exchange Co. shareholders."
Turning to other sectors, TD Japanese Growth is overweight in industrials, which constituted almost one third of the portfolio at the end of March.
A top-10 holding is FANUC Ltd. (market capitalization $38 billion), a "global leader in the manufacture of factory automation products and robotics." China is a big customer, says Edwardes-Ker. "The country is seeing wage increases in its manufacturing sector, so there is likely to be increased demand for automation."
FANUC has exceptional earnings growth, he says and a strong balance sheet. The stock trades at a slight premium to the market, "but this is warranted, given the quality of the company and its global reach."
Another sector overweight is energy. INPEX Corp., an exploration and production company, is among the fund's top 10 holdings. The company has more than 70 projects around the world.
Two significant undertakings in the INPEX pipeline, says Edwardes-Ker, are its Ichthys LNG (liquefied natural gas) project with the gas field offshore Western Australia in the Timor Sea and the Abadi LNG project with the gas field offshore from the eastern part of Indonesia in the Arafura Sea.
"Japan will be rethinking its energy mix and likely increase its use of LNG." The stock trades at 1.1 times book value per share.
Tokyo Electric Power Co., which owns the troubled Fukushima nuclear power station, is not a holding in the portfolio, Edwardes-Ker says. "In the 25 years I have been managing Japanese stocks, I have never owned a nuclear-power utility."
Finally, TD Japanese Growth has a maintained a "strong" overweight position in the home-building industry, which will benefit from the need to rebuild homes in the wake of the March devastation. These stocks have been doing well, says Edwardes-Ker. Misawa Homes Co., Ltd. is a top-10 holding in the fund. "I have taken some profits in this stock, he says, but continue to be enthusiastic about this company."
