Japan: New Market, New Opportunities

Intro

eToro recently added Japanese stocks to the platform, and it’s opened up some names I’ve been following for a while but never had access to. The Japanese market is often overlooked, once a booming economy dominated by tech. These days investors think about the huge national debt, aging population, and an extremely weak currency.

This all being said, I still think Japan has some great businesses worthy of investment.

New Market

Back in around 2019/2020, eToro asked me at an event which markets or assets I would most like to see added to the platform. At the time, I was deep into researching the EV, Electrical Hardware and Heat pump/HVAC markets as part of my broader core theme: Electrification.

EVs were still dominated by Tesla, but China was ramping rapidly, so they were a consideration. I identified Hyundai and Kia as better options though, putting South Korea on my wish-list. They came up again for Heat pumps/HVACs with Samsung and LG, but Japan topped this list with $6367.T and $6503.T - the two biggest players in Heat pumps globally.

In Electrification, both South Korea and Japan came up again, the former still growing into the market, but Japan is the established name, with $6501.T positioned as a global leader in grid infrastructure and $6503.T positioned well too.

My response to eToro: “Please add Japan and South Korea as soon as you can!”

New Risks

As mentioned in the introduction though, the Japanese market comes with some risks and downsides. The biggest by far is currency risk. The Japanese Yen is known for being weak, originally it was a deliberate method of fighting deflation. Recent attempts to raise interest rates by the Bank of Japan resulted in market turmoil because of “Carry Trades”.

Investors borrowed Yen, converted to different currencies and invested it, with the plan to pay it back at near-zero interest. When rates increased the currency strengthened, making it more expensive to pay back and in many cases there would be additional interest. This has essentially left the Bank of Japan trapped, they need to increase very slowly, or they could cause huge issues in financial markets.

The end result is that even if a Japanese stock is up 25% in a year, a lot of it will be offset if the value of the Yen has fallen by 10% against major currencies.

Japanese companies also tend to be huge sprawling monsters. Nissan, Mitsubishi, Toyota, etc have such vast businesses with a huge range of products that it’s hard to get exposure to just 1 core theme. The structure of the companies is often complex, and ownership is even worse, with companies owning major stakes in rivals creating a web of systemic and contagion risk. The picture has been improving for a few years now, but it’s something to be aware of when looking at Japanese companies.

New Opportunities: Daikin $6367.T

Daikin has been on my watchlist for years. They’re the world’s largest HVAC manufacturer, and importantly they are a pure-play investment. I’ve written before about how Electrification is leading to gas boilers being replaced by Heat pumps, aided further by advanced building material science improving efficiency. On top of that, global extreme weather events are pushing more people to invest in air conditioning, a trend I expect to see accelerate.

From 2013 to 2020, Daikin offered consistent growth, with around 400% growth (in USD) during those 7 years, or around 26% per year - outperforming both the Nasdaq 100 and S&P500. In 2020/2021 it carried an ESG premium, growing another 80% before interest rates helped pop the bubble as homeowners spending declined. This was further compounded by weaker Heat pump incentives in Europe hitting demand again.

The ongoing gas shortages caused by the situation in the Middle East and high pricing for $NATGAS is now acting as an additional tailwind for European Heat pump adoption, and governments are starting to push adoption again.

On top of this, Daikin is pushing into the datacenter cooling market with strategic acquisitions in the space last year and a new business unit.

In terms of fundamentals, everything looks ok. Revenue is still growing and is starting to accelerate again. Margins are low because they invested in European capacity just before things turned against them, but they are now growing back into it, so margins should improve. Debt is slowly falling from an already reasonable amount.

The stock is still trading at 2020 levels, despite the improving picture, and I see Daikin as a promising long-term compounder.

New Opportunities: Hitachi $6501.T

Hitachi was historically a huge company, but has streamlined itself. The core segments are:

Energy

Grid infrastructure, with a huge presence in High Voltage Direct Current. There is a lot of overlap with other portfolio positions like Schneider Electric, ABB.

Connective Industries

This is a broad category so I’ll try and break it down.

The major sub-category is Building Systems, mostly elevators and escalators. It has struggled since the Chinese construction boom collapsed.

The more exciting sub-category is High-Tech, which includes a lot of high-end products used in life sciences, but most interestingly, important semiconductor equipment for plasma etching silicon and for measurement and analysis, where they have a dominant market position. This is obviously in high demand currently as customers including Samsung, Intel and TSMC all use Hitachi tools in their fabrication facilities for the latest chips.

This gives Hitachi significant exposure to semiconductor demand.

Digital Systems & Services

IT infrastructure used widely across Japan by organizations of all shapes and sizes, supported by a legacy Enterprise Storage business that they are actively looking to sell.

Mobility

Rail signalling systems, Trains and Transit systems make up the bulk of the mobility segment. Another theme I’m more than happy to have exposure to, with some overlap with ABB.

Hitachi is a difficult company to talk about concisely, but they have a very important strategic position in Grid Infrastructure, Industrial Automation and Modern Transit, with a semiconductor equipment business on the side as a bonus. This of course means it is far from a pure play investment, but their well-established leaders in these areas and management are continuing to consolidate the business to focus on growth opportunities.

Their growth over the past 3 years is over 175% with some stagnation over the past year. I see this as a good value proposition with exposure to major growth industries. Another compelling reason to invest is their order backlog of $58 Billion - up 76% YoY and representing nearly 3x their annual revenue. This highlights strong demand growth and provides great forward visibility on future revenue.

Investor day takes place in a couple of weeks which should help highlight the growth opportunities and broad direction management intends to take the company.

Closing Comments

Japan remains a market that requires caution, but I’m happy with the two companies I’ve selected and am thrilled that eToro have given us all access to the opportunities that might be being overlooked.

Have you identified any opportunities in Japan? Do you have reservations about investing there? Let me know in the comments.

As always thank you all for taking the time to read this, thanks for copying me if you do. If you don’t, please consider following me here and on social media if you enjoyed the post, and check out my portfolio to see if copying me aligns with your investment goals.