The efficiency and profitability improvements mentioned in the previous article "Investing in Japan - Automation for the people", have been mainly implemented in the export-oriented manufacturing industry. However, such improvements are few and far between in non-manufacturing industry segments. For us as investors, this means that there are many business segments in Japan in which it is difficult to identify profitable companies that could be considered as long-term investment candidates.
In this context, at one of the recent conferences, I had an interesting discussion with a sell-side analyst covering Japanese stocks. To illustrate the differences in efficiency between some manufacturing companies and businesses in non-manufacturing sectors, he used an illustrative, and somehow anecdotic example: "When visiting Fanuc's (the robotics company) domestic factories, I am always impressed by the high degree of sophistication and their fully automated production process. In contrast, if you were to go into one of the Tokyo branches of a Japanese bank to transfer money to Luxembourg (or any other European country), you will probably be stuck there for at least one hour, the time I think it will take to complete the transaction" So much for the differences in efficiency!
A new breed of domestic retailers
After the banking sector, the domestic retail segment serves as another example of this lack of efficiency. Since the collapse of the asset-inflated bubble at the beginning of the 1990s, retailers have had to endure avery difficult operating environment, with intermittent periods of deflation putting constant downward pressure on prices and dragging down sales for extended periods of time. Many traditional supermarkets, department stores or small mom and pop stores have been devastated by this environment, as they have not been able (or were not willing to) make the necessary changes to their business model to adapt to this environment. As a result profitability for these companies has constantly been very low.
It is in this environment that a new breed of retailers has emerged, companies with a focus on customer needs and strong commitment to growth and profitability. These new companies were ready to adapt their business model to the tough environment and grow their businesses by increasing turnover and by opening new stores. It's among these businesses that we find interesting investment candidates. Companies likeABC-Mart, Don Quijote and Nitori have a similar approach to business: they are obsessive about profitability, focused on efficient execution, very strict on cost control, conscious about fashion and design and readily adapt to customer needs and desires. Forbes Magazine summarized it very well in a story about Akio Nitori, the founder of Nitori Holdings : "these companies are the new face of Japanese retail".
In still highly fragmented markets, they are constantly gaining market share at the expense of weaker competitors, such as small local shops or large general merchandise stores less focused on a specific business activity.
ABC-Mart - The shoe fits
ABC-Mart is one of the biggest shoe retailers in Japan and by far the most profitable. It generates high operating margins as a result of good management of its inventories, good positioning of its stores at strategic locations, and a range of high quality shoes at attractive prices. Half of its sales are generated by own-brand shoes with high margins, produced in countries with low labour costs. With these brands, the company is also present in South Korea and Taiwan via local retailers. ABC-Mart has managed to position these brands successfully and promote them through extensive advertising campaigns.
Nitori Holdings - Furnishing Japan
Nitori is a low-cost provider of inexpensive furniture (comparable to IKEA) and the only major national furniture chain in Japan. Nitori stands out from the competition thanks to an innovative business model that integrates the whole furniture distribution chain from production to marketing of its own brands. The company's business model and the fact that all its factories are situated in countries with lower labour costs, gives it a valuable competitive advantage. Unlike IKEA, which currently only operates 7 stores in Japan, Nitori also offers delivery, assembly and setting services free of charge, which adds to its user-friendly appeal in a country experiencing an ageing of its population and used to receiving meticulous service.
Don Quijote - Tilting at windmills
Don Quijote is a mass-market discount retailer, selling almost everything, from groceries to cosmetics over electronic appliances to fashion items like watches or apparel. Just like its famous eponym, who was fighting against windmills that he imagined to be giants, Don Quijote set forth to challenge the well-established retailers with a revolutionary store concept. Special displays, late-night opening hours, discount prices and an enjoyable shopping experience, coupled with its know-how in low-cost operations enables the retailer to significantly differentiate itself from the competition. This unique store concept is summed up in its last annual report: " Stores operated by Don Quijote are intended to be spaces for amusement that transform the typically routine chore of shopping into an entertaining experience through unique presentations." When looking at market share evolution over the past, this concept is definitely a success. So, unlike the knight-errand in Miguel de Cervantes novel, this Don Quijote actually seems to be winning its battles.
Another thing these companies have in common, is that their founders still own large amounts of company stock and are still involved in company management.
- Masahiro Miki (Founder and former Chairman of ABC-Mart) owns more than 30 % of the company
- Takao Yasuda (Founder & Chairman Don Quijote) owns 14% of the company
- Akio Nitori (Founder & President of Nitori Holdings) and his family own more than 20 % of the company
This alignment of management interests with shareholder interests is rather rare in Japan, where large owner-run companies are scarce and where pursuit of shareholder value is not always a high priority.
Wrapping it up
The article at hand and my previous post give a snapshot about our investment approach to Japanese equities and draw a picture about the kind of Japanese companies that correspond to our investment methodology. All the companies mentioned are holdings of BL-Equities Japan1. For us, the key to successful investing is to identify quality companies with a tangible competitive advantage that is resilient to short-term economic news and developments. Factory automation, smartphone fabrication and retailing are just a few of the segments in Japan where we can identify attractive long-term investment candidates.
1 BL-Equities Japan is an equity fund that invests in Japanese companies. The investment philosophy of the fund is based on the principles of "business-like investing". This approach implies that the fund manager considers every investment like a stake in a business with a long-term investment horizon. This means that he is on the look-out for quality companies with a tangible competitive advantage that results in high levels of profitability and strong potential for free cash flow generation. Great importance is also attached to company valuation.
| Share Class | A | B | H1 (Euro hedged) |
| Currency | JPY | JPY | EUR |
| Cap/Dis | Dis | Cap | Cap |
| ISIN | LU0578147992 | LU0578148453 | LU0887931292 |
