Japan Equities–Sector picks

With the relief rally in global equities over the past month, Japan equities recovered some lost ground from May's sell-off but gains continued to trail world equities year-to-date, presenting several select opportunities.

Recent share buyback announcements, undemanding valuations versus global peers and light investor positioning should provide some support to Japanese equity markets. Given our preference for bottom up stock picks with medium-term growth prospects which offer attractive valuations and are relatively more sheltered from trade worries, we revisited Morningstar's coverage of the Technology, Consumer and Financials space in order to provide universe of preferred Japan stock picks Key sector picks include: Nintendo Co. (7974 JP), Nidec Corp (6594 JP), Sumitomo Mitsui Financial Group (8316 JP), Seven & I Holdings (3382 JP) and Yakult Honsha (2267 JP).

Key sector highlights

1. Japan Information Technology

  • Historical trends--PMI new orders and Japan's electronic components valuations tend to move together positively. Recent trends indicate that electronic indicators may be approaching the bottom of the cycle.

  • Trade risks remain a concern, but medium term structural trends looki ntact -5G to drive digitalisation in various industries through demand for faster speed, richer data contents on smartphone, cloud storage, smart appliances, robots, cloud gaming and autonomous driving.

  • Key sector picks maintained in Murata Manufacturing, TDK, Nidec, Nintendo.

Murata Manufacturing (6981 JP)

  • A beneficiary of 5G and auto-digitalization trends as more components are needed for 5G smartphones, some potential to replace US competitors on RF modules for Huawei.

  • Murata's multi-layer ceramic capacitors (MLCC) global market share (2017) is estimated at 40%, with SEMCO as nos. 2 (est. market share of 20%). Suppliers for MLCCs are limited, androbust demand is expected to continue. Estimated demand growth rates: MLCC growth/smartphone +10%/year, MLCC demand for 5G base stations +20%/year, MLCC growth per auto +20%/year.

Source: Morningstar

TDK Corp (6762 JP)

  • Leading supplier of rechargeable batteries,beneficiary of MLCCs and sensors demand growth.

  • Senors and polymer batteries needed in wearables and IoT.

  • Impact of Huawei ban looks mostly priced.

Nidec Corp (6594 JP)

  • Massive motor demand from autos, robots and white appliances.

  • More requirements for power efficient motors due to environmental regulations which is supportive of potential increase in demand for Nidec.

  • Undergoing restructuring to improve operations.

Nintendo (7974 JP)

  • Positive outlook on new Switch version to be launched, which should enable longer lifespan. Portable consoles have longer life spans than home consoles, as well as a later peak (3rdor 4thyear as compared to1st/2ndyear for home consoles)

  • Attractive pipeline can be maintained through efficient use of its resources.

  • Strong first-party software implies it could be less affected by the threat of cloud gaming (e.g. Stadia by Google). Stadia is not a subscription service: it also charges by the number of games you buy. Companies such as Nintendo and Sony may lose out because additional console costs are incurred for consumers.

  • Nintendo can provide more attractive games by consolidating two consoles in order to focus resources on one platform. The company generates most of its profits from first-party games so impact is likely to be less severe. In addition, it has the option to sell its games on other platforms, with 85% of Nintendo's software revenue from first party games versus Sony (20% of software revenue from own games). Sony generates most of its profits from third party games and thus it has a larger risk of losing to Stadia.

  • Hardware sale contributes to 40-50% of revenue, but it does not generate much profit as most profit is derived from its games.

2. Japanese Financials and Property

  • Due to a tough operating environment, bank sector valuations have declined and currently look attractive for long term investors (e.g. MUFG trades at about 0.4x p/b).

  • Banks and securities are in secular decline. However, even with flat earnings, we can expect dividend growth. Preferred pick: Sumitomo Mitsui Financial Group (8316 JP). Capital ratios are quite high;stronger earnings trend as compared to other banks. Also, SMFG is cheap because interest rates on bank loans have been decreasing, but flat earnings growth domestically (growth mostly derived from overseas markets).

  • Japan insurers are deploying excess capital both on mergers and acquisitions and increased shareholder returns. Sector estimated dividend yields of about 5.5-6% (Tokio Marine's dividend yield is improving)

  • Segment wise, Japanese life insurance markets are larger than non-life. Non-life insurance market consolidated to 3 major companies with 85% of market share. Both life and non-life insurance markets expanded overseas recently. US accounts for 1/3of Tokio Marine's non-life insurance profits

  • Non-life insurance is the preferred investment but autonomous driving technology could be potentially disruptive to non-life insurance

  • Commercial land prices (Osaka, Fukuoka, etc) have benefited from the ongoing tourism boom in Japan, supported by direct flights within Asia. Top 3 prefectures with highest commercial land prices:1. Kyoto 2. Tokyo 3. Osaka.

3. Japan consumer

  • Key consumer sector picks are Seven & I Holdings (3382 JP), given it is unlikely they will change their 24-hour operation business model in the short term) and Yakult Japan's ageing population and rising health consciousness are suitable fits for Yakult's products).

  • Tokyo summer Olympics may also provide a boost for the Japan consumer market.

#japan #investing #ICT #consumer

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