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Dec 2007 LONG ONLY JAPANESE EQUITIES The market (TOPIX Index) ended the year badly, declining by 8.9% in the last two months of the year. Our strategy had proved resilient up to this point but succumbed to a fall in value by 6.3% over the same period. Unfortunately, we think this latest market decline portends an imminent downturn in corporate profits in Japan and indeed that may have already started. This should not be so surprising. After all, profits have expanded consistently for nearly five consecutive years and have reached a level higher than ever before as a percentage of GDP. Record high corporate margins have resulted from a combination of strong overseas sales, higher product prices, especially in the basic materials sector, and minimal if not negative wage inflation. Recently there has been a discernable weakening in consumption, particularly retail sales, and higher input cost following rises in commodity prices, notably oil. Added to that, weakening external demand is an ever present threat.This is probably bad news for significant parts of the market, especially those companies that have experienced a huge cyclical rise in margins over the last few years. Not only will these companies have to contend with a reversal but many will find cash flow disappears as the good profits of the last few years have lured managements into cash consumptive capital spending projects at a time when margins are falling. Even worse, the fall in margins tends to happen much faster than the rise which may act to deplete cash so quickly that borrowings may need to expand once again. We think the market will heavily punish companies that once again prove to be as cyclical as they have been in the past. In times of woe the dividend yield will be the main support to the share price now that most companies no longer have compliant cross-shareholders to support them. Today for such companies, not only are yields too low - offering little compensation to the investor for the cyclicality of the business - but in some cases there could be a threat of dividend cuts in the future as cash flows plummet. This could prove a toxic mix, and may result in significant falls in share prices from current levels. There is no doubt that if the scenario outlined eventuates, our companies will not be immune. Many of our businesses have economically sensitive parts to their operations that will be negatively affected. But compared to the type of company we describe above, our companies should be far better off. First, most of the businesses are exposed to consumer demand (a quarter of the strategy is invested in consumer franchises alone), which is relatively stable unlike corporate demand, which is far more fickle as capital spending budgets are slashed in bad times. Indeed, the businesses that are providers of essential goods and services may even be immune: for instance, the sales of pharmaceuticals, educational and utility services should continue to prosper even in bad times. Second, all of our companies are highly cash generative, selling products and services for higher than average margins and with relatively small capital spending requirements. As a result they can weather profits disappointment much better than the average company. Finally, the balance sheets of our companies are rock solid, with average net cash amounting currently to 23% of market capitalisation. This means there is much financial resource to support the current level of dividends and maybe enough to underpin further dividend rises even while profits temporarily stagnate. At the same time the cash backing provides extra support for valuations in difficult times. Canon is an example of a company we own that is economically sensitive and has thus fallen as much as 28% from its peak price in the summer. Its main products are office equipment such as printers and copiers. In a business downturn we would expect cutbacks in such office equipment expenditure. Profits are likely to fall as they did in 1999 and 1993. However, Canon profits are mainly dependent upon repeatable consumable sales of inks, toners and maintenance contracts that will probably continue however badly the downturn, shielding the company from the worst effects of such cutbacks. Also the company has decent operating profits margins of 17% and plentiful cash resources to tide over bad times, which should offer support, if not the ability to increase the dividend. The yield is already 2.3%, more than 50% higher than the market. Currently much of the recent demise in the share price is blamed on the strengthening Yen exchange rate. Sure, in the short term this has a negative effect, but over longer periods we believe such currency effects wash out in product pricing and what really matters is the utility of the product and the business model that lies behind the profit generation from its sale. Canon scores highly on both counts. Following such a sharp correction in the shares we are more tempted to add to our holding now that the valuation is cheaper than it has been over the last 15 years. Elsewhere we note that Astellas continues to put its abundant cash flow and cash savings to use. The company announced its second buyback programme this year, another 1.6% of outstanding equity. Also the company bought Agensys, a US based firm specialising in research into cancer therapy antibodies for a total price of no more thanY58bn, using 8% of its balance sheet net cash. The appeal of Agensys appears to be its core antibody production technology and its rich portfolio of target molecules. It should give Astellas access to several anti-cancer drugs in pre and early clinical trials. The deal makes sense from the perspective of increasing the company’s potential product line-up in future years and in terms of expanding into a promising new area of research in much the same way as Kirin Brewery did with its acquisition of Kyowa Hakko as reported in the November monthly. Michael Lindsell Dec 2007 10 Jan 2007 LTL 000-057-2 |
This document is intended for use by professional advisers, UK FSA authorised persons or those who meet the FSA intermediate investor classification. It is not intended for use by private individuals.
Opinions expressed whether in general or both on the performance of individual securities or funds and in a wider economic context represents the view of the fund manager at the time of preparation and may be subject to change without notice. It should not be interpreted as giving investment advice or an investment recommendation. This document is produced solely for information purposes only and may not be copied or distributed without expressed permission. Past performance is not a guide or guarantee to future performance. Investments are subject to risks and their value and income from them may go up as well as down. Investors may not get back the amount they originally invested. Issued by Lindsell Train Limited Authorised and regulated by the Financial Services Authority |
| 2008 | |||
| Jan | I Forgot More Than You'll Ever Know | Japan Eq | |
| Feb | Cash Hoarders & Debt Dependants | Japan Eq | |
| 2007 | |||
| Jan | Japan Eq | ||
| Feb | What's up in 2007 | Japan Eq | |
| Mar | Japan Eq | ||
| Apr | Japan Eq | ||
| May | Various thoughts on Japan | Japan Eq | |
| Jun | Idea Updates | Japan Eq | |
| Jul | The Bids | Japan Eq | |
| Aug | Japan Eq | ||
| Sep | Japan Eq | ||
| Oct | Japan Eq | ||
| Nov | On the Failure... | Japan Eq | |
| Nov | Is Japan a 'Buy'? | Japan Eq | |
| Dec | Japan Eq | ||
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