🥢Japan, found 3 gems in the rubble? 💎
🥢Japan, found 3 gems in the rubble? 💎
Stay frosty 😎
I was on vacation when I read about the fear of recession and the drop in the Nikkei Index.
I have to say, I always get giddy when this happens.
Great companies may also be getting oversold, and this could provide some buying opportunities.
Our goal is to react against a typical emotional response. Fear causes stress, and causes a fight or flight reaction and may entice you to push that sell button.
Fear leads to anger, anger leads to hate, hate leads to suffering
- Yoda
You want to be a holder or buyer in these times. The only reason to sell is if the underlying company is performing badly.
A brief look at the macro in Japan
Nikkei
Let’s take a quick look at the Nikkei Index.
It did recover a bit, but a 14% drop over the last month is not great. Now let’s see what happens when we start zooming out.
The Nikkei dropped 3% over the last 6 months:
It is up 9% over the past year:
And over the past 5 years, it is up almost 70%.
We have no idea what the future will bring.
However, based on historical performance, the world index will trend upward in the future. (Over the last 60 years, if you had been able to buy the MSCI World Index and hold it for over 15 years, you would have never lost money. Of course, if you bought at the worst moment in time, you would have been break even, but that’s what dollar cost averaging is all about).
But for a single country Index like the Nikkei, that future is a lot less certain.
There are 193 countries in the world. So let’s take a look at where Japan sits on certain indicators.
Debt level
As you probably know, Japan is number 1 when it comes to the level of debt as a percentage of GDP.
Here is the current top 10 according to data from worldpopulationreview.com. (surprisingly, I first wanted to get the data from the IMF, but there are almost 105 countries that had no data).
It always feels a bit weird to have the country with the highest GDP in the world, the United States, appear on this list.
If we look at the countries with the lowest debt to GDP in the world we get this:
As we know from analyzing businesses, more debt reduces optionality and can increase risk.
Let’s hope the US can get their debt level in check before interest payments become unsustainable.
But at the moment, countries like Japan, the US or the UK keep on seeing their debt levels increase:
Interest rates
Let’s repeat what we did before and look at the TOP 5 and BOTTOM 5 countries and their 10-year treasury yields.
The bottom 5 look like this:
And once more, Japan appears in the picture. We’ve added the current inflation rates to see what a fixed-income strategy would look like. Only China has a 10-year yield that surpasses the current inflation rate.
The highest yields you will get in the following countries:
Of course, the credit ratings are a lot lower. And someone with some cash in Kenya might be better off buying their treasury (However, there is extreme wealth inequality in Kenya: 0.1% of the population owns more than the bottom 99.9%)
The Buffett indicator
The basic idea is that production is meant to be consumed. Businesses produce for consumers and try to make a profit. These profits are eventually reflected in the total market cap (TMC) of all these companies.
So Gross Domestic Product (GDP) is an underlying force that drives profits and market cap.
The Buffett indicator is simply defined as:
Buffett uses this simple indicator to think about the markets as a whole. Here’s a great paragraph from a Gurufocus article that goes into detail on this topic.
Based on these factors, Warren Buffett has made a few market calls in the past.
In Nov. 1999, when the Dow was at 11,000, and just a few months before the burst of dotcom bubble, the stock market had gained 13% a year from 1981-1998. Warren Buffett said in a speech to friends and business leaders, “I'd like to argue that we can't come even remotely close to that 12.9... If you strip out the inflation component from this nominal return (which you would need to do however inflation fluctuates), that's 4% in real terms. And if 4% is wrong, I believe that the percentage is just as likely to be less as more.”
This is Buffett saying that the markets were overheated and could no longer be explained by the economic production of the United States.
So what does this mean for Japan?
Gurufocus, based on historical data, calculates how expensive the market in Japan looks at the moment. To be even more precise, they add the balance sheet of the central banks to the GDP. Here’s the final result:
On the 9th of August, a couple of days after the correction in the market:
So the Japanese market still looks overvalued as a whole.
The companies
Some macro can be useful, but in the end, it’s all about individual companies. I use the macro mainly to look at interest rates, and see what the opportunity cost is when investing in stocks.
If the current 10-year treasury yield sits at 4%, then you could ask for at least 6% as a threshold when investing in stocks.
I’ve set my hurdle rate at 15% to be ‘more picky’ on the stocks I buy.
Now let’s leave this discussion on the overall market behind us and see if we can find some gems inside the rubble.
We’re going to take a peek in 2 ways:
Look for Japanese companies that have dropped 50% or more in price over the last 12 months
Look for high-quality companies (high ROIC, low debt, etc) and see if some of them dropped by a significant percentage (at least more than the NIKKEI)
By using Unclestock.com and Finchat.io my eye fell on 3 companies in particular.
Here’s a short overview of all of them.
Macbee Planet (Ticker: 7095)
Here, we used unclestock.com and did the following:
Filter on companies in Japan
Look for companies that dropped more than 50% in price over the last 12 months
Take the highest quality one according to uncle-stocks quality metrics
One company in particular caught my eye because of this chart:
Revenue has increased and doubled in 2023. The peter lynch chart of 15 times EPS is increasing. The price of the stock is dropping to 2023 levels. Operating income continues to grow.
It has gross margins stable at about 20%, a 40B Yen market cap, 10B in cash, and 1.5B in long-term debt.
In addition, in the past 3 years, it boasts an ROIC higher than 40%.
What is going on here?
Is this company being thrown away with the bathwater or is there something amiss?
Well not exactly.
The sell-off in the company had nothing to do with this week’s sell-off (although it was sold once more). Shares have been sold over the entire year.
The revenue increase of 100% is not normal (acquisition). The company claims it should be able to achieve an organic growth rate of 20% in the future.
But how do they make money?
The easiest way to describe it is like this:
Macbee used data and tech to target the right people with internet ads. They are paid by the advertisers on a performance basis. Their view is that this type of performance-based market model will continue to gain share in the future. (as opposed to non-performance-based)
Forward earnings are set to grow at 20%. If we consider EBIT growth at this rate and take into account current enterprise value, then this company is trading at an EV/EBIT of about 5.5 or an EBIT yield of 18%.
That seems low for the quality metrics it shows.
From a capital allocation point of view:
55% of the company is held by insiders
They did for the first time pay a dividend in 2024
They have acquired several companies and plan on continuing their M&A strategy
Over the past year, they have issued shares with a 7% increase in average number of shares
Bear in mind this is a 150M USD market cap company. It is small.
I’ll need to do more digging, but I’m not familiar with internet marketing businesses. It certainly looks attractive from a valuation point of view.
Do you know this company?
Now let’s use Finchat, and see if some quality companies have entered some sort of buying zone.
Remember the criteria used in the Buffett checklist ⬇️
We’ll use some of them in the following screen:
EPS has to grow
The ROIC has to be bigger than 20%
We do not want to pay more than a forward P/E of 15 just like Buffett
The price in the market experienced a significant drop in the last week
We’ve added the PEG ratio into the mix to include future growth projections
We want top-line growth, over the last 3 years and over the last year -> rev cagr
Here’s a screenshot of the criteria we used.
Within Japan, Finchat gives us a list of only 10 companies:
These all had a significant drawdown over the past week. There are 2 of them that caught my eye.
Let’s go through them.
Sankyo (Ticker: 4568)
Sankyo manufactures Pachinko machines.
Pachinko what?
First introduced in 1920, it’s one of the most popular games in Japan. It’s something in between a pinball and a slot machine.
Here’s a great video explaining the pachinko gaming phenomenon:
Is there a secular trend?
There was, but it seems the popularity of pachinko is falling. The number of pachinko parlors has gone from 18,000 in the 1990s to 7,700 in 2021.
COVID was a blow to the industry and since pachinko is related to the elderly population (especially men), the rise of mobile gaming and stricter laws in Japan on gambling does not bode well for the industry.
Growth metrics
The decline in the industry is not showing in the overall numbers of Sankyo, with solid revenue and EPS growth over the last 5 years.
However, on August 7th they released their quarterly results, and those paint a different picture:
Sankyo acknowledges that the pachinko market is sluggish, however, their sales in the Pachislot segment have increased (+84%) significantly year over year.
Pachislot is your typical slot machine but integrates a digital display based on popular franchises or games in Japan like Evangelion or Gundam wing.
We can find a confirmation of the secular decline when looking at the number of parlors:
Where the number of outlets keeps on decreasing.
Their gross margins are on average about 55% which is surprising for a device manufacturer.
Financial Strength
The company has no debt and 205B Yen in cash on its balance sheet. About 10% is owned by insiders.
Ownership and Capital Allocation
They have been using their cash to buy back shares. Sankyo has been paying a dividend steadily over the past years. They have made small M&A acquisitions over the past years.
Summary
This is a small-cap company, a leader in the pachinko industry, and the industry itself is in slow decline.
The company keeps on generating cash and has used it strategically to buy back shares. Management is giving back the cash to its shareholders through these buybacks and dividends.
Their stock dipped along with the rest of the Nikkei but has already seen a recovery.
I think this is an interesting one.
If the company can increase its market share even in a slowly declining industry and keeps giving back cash to its shareholders through buybacks and dividends, this could still be a great investment, a the right price of course.
Rorze Corporation (Ticker: 6323)
Rorze manufacturers circuit boards, and equipment to the semiconductor industry.
Although they sell to a couple of sectors (life sciences, analysis devices), their revenue is dominated by the semiconductor space.
Growth
Their sales have significantly started to increase about a year ago, showing a more than doubling in revenue growth in the last quarter compared to a year before.
Most of their sales are going towards the Chinese semiconductor industry:
Their order backlog has decreased a bit but is still at a high level:
The business forecasts about 25% in sales growth compared to last year.
Financial Strength
The company has a solid cash position, low long-term debt, and a very high interest coverage rate.
Ownership and capital allocation
The founder still manages the company and has about 35% ownership. Total number of shares is stable. The company does not pay a dividend. When we look at capital allocation in 2023:
Operations: CFO: 15.5B Yen
Investing: CFI: 5.9B Yen
2.8B in MNT CAPEX
1.8B in acquisitions
1.3B in other Growth CAPEX
Financing: CFF: 2.3B paid in dividends
In other words, the semiconductor boost has enriched their balance sheet with cash. That cash will continue to come in in the coming years.
It’s not clear how they are planning to deploy it. Their cash position has grown at a 5Y CAGR of 28% and now sits at 40B Yen.
Valuation
Although the price has come down significantly over the last month (a 50% drop!) we’re still looking at an EBIT yield of 7-8%. That’s too low for my taste.
Summary
It’s an interesting company, but it will flow with the cyclicality of the semiconductor industry. Lots of CAPEX is being spent at the moment. I find it difficult to time these ones right. How long will this CAPEX cycle continue? The only indication we have is the backlog, and based on their orders and sales volume, they’re good for about 2 years of the same level of performance. After that, who knows?
Conclusion
I hope you’ve found some value in this screening of the Japanese market and how I look at fear and market corrections.
There are some interesting companies to discover within the rubble of a market drawdown. If a bigger crash were on the horizon, I would do a similar exercise to search for solid companies that have been sold disregarding quality factors.
Have you been buying lately? How do you feel about the current markets?
As always, may the markets be with you!
Kevin
P.S. I’ve been buying into a new position lately. I’ll publish a more detailed look at what I did next week.
I was familiar with one of the three names. I will check the other two. Thanks.
I have not bought anything. Need to see blood in the streets before I start buying. Valuations are too high and recession is long overdue. 30 year olds can't buy homes in this environment with prices high and interest rates at 6/7%. Something has to give. A one day or one week drop is just a wake up call. Not a reason to part with any cash in my opinion. The Bull Market is over. After the election we will get a more true direction and confirmation.