Japan was not alone in facing significant market volatility over the first half of 2020. As markets around the world came to grips with COVID-19, the Japan equity market experienced an indiscriminate sell-off across all sectors.
There was little differentiation between the higher quality, well-managed companies that we own and their less attractive peers. This created both challenges and opportunities for our portfolio.
As bottom-up investors, we have taken the crisis as an opportunity to look at the behaviours of consumers and corporations and how this will affect the companies we invest in.
As a result, we have been able to increase our position in conviction stocks at attractive prices – some of which we will highlight in this article.
Solid fundamentals and technology trends
A number of factors underpin the success of the portfolio in times of both growth and contraction.
Strong cash position - One of the key strengths of our investment approach is that we are inherently conservative, and more than 80% of our portfolio companies have a secure net cash position.
Revenue transparency - A large portion of the portfolio is invested in purely domestic companies with higher visibility with regards to demand.
Market dominance - Among our portfolio holdings with high overseas exposure, we have invested in leading Asian consumer franchises, with dominant market share in their respective niche industries.
Beyond these fundamentals, however, are the accelerating trends driven by technology in a post-pandemic world.
As we adapt to the new norms of social distancing measures and travel restrictions, the use of e-commerce, digital payments, telemedicine, cloud services, virtual and online entertainment, and online education platforms have accelerated – and are likely here to stay.
For example, the percentage of workers equipped with remote-working capabilities in Japan is currently below 20%1 and we expect this will rise, leading to higher expenditure on technology-related goods and services.
When we evaluated our portfolio holdings to increase exposure to attractively priced stocks on our watchlist, technology was a key theme. Some of these are listed below.
MonotaRO, Japan’s largest maintenance, repair and operations (MRO) e-commerce platform. We believe it still has a long runway of growth ahead, as it continues to gain market share in the fragmented MRO industry. Compared to 30% e-commerce penetration in the overall business-to-business (B2B) market, e-commerce penetration in the MRO segment is only 10%1. We believe the pandemic will accelerate the shift towards online purchases.
OBIC, Japan’s largest enterprise resource planning (ERP) systems provider, which has been resilient in the current market environment and has performed steadily in previous downturns. Operating profit has grown consistently for the last 22 years, including the GFC2 and the Tōhoku earthquake periods. With more people working from home, we expect cloud-based services to become an increasingly larger business.
GMO Payment Gateway, the largest online payment processing company in Japan. E-commerce penetration in Japan is only 7%3 of retail sales so with more offline retailers and consumer brand companies launching e-commerce portals, we believe the company is well-positioned to capture the market, due to its extensive experience and track record in the payments industry. Japan’s cashless payment penetration is relatively low at 18%4 compared to countries such as South Korea (95%), the UK (67%) and the US (44%).
The recent market volatility also allowed us to buy high quality stocks on our watch list that we had followed for some time, but were too expensively valued in the past.
Hoya, a leading manufacturer of lenses and related optical products. Having observed its performance over time, we increasingly appreciated its corporate philosophy of being a “big fish in a small pond” and its strong focus on corporate governance and shareholder returns. Unusual in a Japan context, Hoya has a strong profit-centric culture and its track record has been consistently good.
Olympus, the largest medical equipment company in Japan with 70% global market share in gastrointestinal endoscopes5. Olympus is investing in China, where the overall penetration of gastrointestinal endoscopy is low, by increasing its training programs to resolve the bottleneck of insufficiently qualified doctors (China has only 22 endoscopists per million people, compared to 250 per million in Japan6). Chinese government policies to promote endoscopic diagnosis support its penetration into mid-tier hospitals, which should increase demand for Olympus’ products exponentially.
The top contributors to performance year-to-date are the same companies that we had added to during the sell-off, including MonotaRO, GMO and OBIC. Though they were sold off along with the market, they subsequently rebounded, as investors realised there should be little negative fallout from the coronavirus.
Technology is a key differentiator for such companies, but they also need quality management and solid financial fundamentals. We are focused on these types of companies and have taken advantage of this year’s volatility to invest for the future.
1 Ministry of Economy, Trade and Industry: 2018 Infrastructure Development for a Data-Driven Society in Japan (Market Research on Electronic Commerce)
2 Global Financial Crisis
3 GMO Payment Gateway, February 2020
4 GMO Payment Gateway, February 2020
5 Olympus, November 2019
6 Olympus, November 2019
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