Fidelity Japanese Values delivered an NAV total return of 20.5% for the year ended 31 December 2016, marginally underperforming its benchmark but beating the rest of its peer group. The share price also went up, but only by 17.0% per share to 101.50 pence, as the discount to NAV widened to 17.1%.
Over the year, key holdings in companies with strong global franchises in the chemicals, pharmaceuticals and transportation equipment sectors were the principal drivers of the Company’s absolute returns. The large active position in Nissan Chemical Industries made a material contribution to returns. Smaller holdings in automaker Yamaha Motor and confectionary company Kotobuki Spirits also added significant value. Meanwhile, the underweight stance in the banking sector, which was negatively impacted by the introduction of negative interest rates in Japan, also paid off.
Conversely, holdings in non-bank financials and services companies detracted most heavily from returns. As investors became increasingly risk averse amid the downturn in the market, financial stocks underperformed in the first half of 2016. At the same time, global cyclical stocks struggled against currency and macroeconomic headwinds. In the second half of the year, domestic and defensive growth names fell out of favour as the market rotated sharply in favour of larger value stocks.
Principal Contributors
Nissan Chemical Industries, established as Japan’s first manufacturer of chemical fertilisers, is today a leading producer of basic and advanced chemical products, as well as agrochemicals and veterinary pharmaceuticals. The company reported solid financial results at both the full-year (fiscal 2015) and interim (fiscal 2016) stage. Earnings increased on growth in agricultural chemicals, which saw strong shipments of external anti-parasite drugs for animals (dogs and more recently cats) and herbicides for wet-rice farming, as well as the improved performance of its chemicals business amid lower oil prices. The company also continued to actively buy back its shares and maintained a total payout ratio target of 70%.
Yamaha Motor develops and manufactures motorcycles and other motor-powered products globally. Motorbikes and outboard engines for recreational watercraft are the company’s primary sources of profit growth. The stock suffered in the first half of the year given the currency headwinds that accompanied increased levels of macroeconomic uncertainty globally. However, this trend afforded the Portfolio Manager the opportunity to buy Yamaha Motor’s shares at a more attractive price as he gained conviction in its earnings growth potential. The holding in the stock moved to overweight versus the index in March 2016, after which it started to recover as sentiment improved and the yen reversed course. Yamaha Motor’s highly-profitable marine business in the US and motorcycle operations in emerging countries are expected to drive double-digit growth in earnings over the next one to two years.
Kotobuki Spirits is a relatively under-researched confectionary company that blends regional cultures and traditions into high-quality Japanese sweets and cakes that are distributed across the country for use as souvenirs. The firm generated brisk growth in earnings supported by its strong product development capability and price increases, as well as the expansion of its sales network to include Tokyo central station and international airports. The expansion of the souvenir market in Japan driven by the increase in foreign visitors is expected to support the company’s growth over the mid-to-long term.
Ono Pharmaceutical follows a compound-oriented research and development strategy, which enables it to identify compounds that are effective against disease and develop first-in-class treatments. Shares in Ono Pharmaceutical advanced as global sales of Opdivo, an anti-cancer treatment jointly developed with Bristol-Myers Squibb, expanded and clinical testing for the extended indications of the drug progressed. As the stock approached fair value, the holding was actively reduced, before being closed in April 2016. Thereafter, the stock relinquished its gains as uncertainty surrounding drug repricing in Japan diminished confidence in the company’s earnings outlook.
Yonex is a world leader in badminton, tennis and golf equipment. The company announced strong full-year results, supported by the growth of its badminton equipment business in Asia. Sales in China expanded rapidly, aided by the strength of its brand and its shift from the use of sales agents to direct sales by subsidiaries. Despite some concerns about a slowdown in consumer activity post the Olympics, Yonex continued to report strong earnings, driven by sales in China and the rest of Asia. The company is well positioned to benefit from growth in the Asian badminton market and rising demand for mid-range products as average income levels increase.
Principal Detractors
AEON Financial Service is a credit card provider and its shares reacted negatively to the below-consensus results of its parent company AEON at the start of the year and the renewed strength of the yen, which raised concerns about the risk to its earnings generated overseas. The company’s announcement of an unexpected capital increase in late August exacerbated the downturn in its shares. The financing will be used for future growth and the company remains well positioned to capture the growth of credit card usage in Japan and other parts of Asia. The scale of investment is likely to limit its ability to increase profits in the near term and the position was therefore reduced between September and November 2016. However, it remains a top 20 holding in the portfolio as the company’s rate of profit growth is expected to reaccelerate from fiscal year 2018.
Orix, a diversified financial services company, reported solid results and increased its payout to shareholders. However, its relatively high foreign ownership ratio meant that it was susceptible to the sharp deterioration in risk sentiment and accompanying sell-off in global financial markets that occurred during the first half of the year. The negative contribution sustained in the April-June quarter, when the stock occupied a relatively large position in the portfolio, outweighed the subsequent recovery. Towards the end of the review period, the allocation to non-bank financials that tend to underperform in a rising interest rate environment was reduced and the position in Orix was sold in November 2016.
Rohm, a leading producer of custom integrated circuits and semiconductor devices, was favoured as a highly profitable beneficiary of automobile electrification. However, shares in the company fell sharply in early 2016 as signs of a slowdown in end-demand (particularly in the mobile and audio-visual areas) became more apparent. Higher fixed costs and a stronger yen also appeared to limit the scope for a recovery in earnings. The stock looked attractive at below book value, but potential upside appeared limited amid further declines in consensus forecasts. As a result, the position was sold in April 2016.
Kose, a leading cosmetics company, was added to the portfolio at the start of the year based on its strong fundamentals (market share gains in Japan and global evolution of domestic brands), long term growth prospects and improving shareholder returns. However, increased marketing costs, including sponsorships and global promotions, meant that profits fell short of expectations despite strong growth in sales. Concerns about slower inbound tourist demand also weighed on the stock. In light of an upturn in interest rates globally and the renewed weakness of the yen towards the end of the year, the position in Kose was sold in order to fund the purchase of cyclical and financial stocks with more attractive upside.
Kubota is a leading producer of agricultural machinery. The market’s negative reaction to the company’s recent earnings results appeared excessive and seemed to be guided primarily by volatile currency movements. The position was reduced due to the effects of intensifying competition in the North American tractor market and periods of yen strength on the company’s near term earnings. However, Kubota remains well positioned to benefit from the mechanisation of farms in emerging Asia over the long term, as well as housing and infrastructure investment in the US. Its share price is at the lower end of its historical valuation range and offers attractive upside potential.
FJV : Fidelity Japanese Values tops peer group for 2016