Aberdeen Japan dips into revenue reserves to deliver 15p dividend – Aberdeen Japan (AJIT) has released its annual results to 31 March 2021 which saw it deliver a total NAV return of 33.5% in sterling terms, ahead of the Topix, which returned 24.8% over the year. The return to shareholders was 35.2% while it ended the year trading on a discount of 9.9%, which had narrowed from a discount of 10.9% the previous year. The company bought back £3.4million worth of shares during the year to manage discount volatility. Its revenue return per share was 6.57p and the board has announced a total dividend of 15p, in line with the trust’s enhanced dividend policy which was introduced last year. This comprises 6.5p revenue return, 3p from revenue reserves and 5.5p from capital reserves.
During what was a difficult year for many, at the height of the global coronavirus pandemic, Aberdeen Japan continued to take advantage of its ability to gear, and renewed its loan facility with ING Bank in January 2021. The board continues to monitor the level of gearing and considers a gearing level of around 10% to be appropriate although, with market fluctuations, this may range between 5% and 15%.
ESG was a key focus for the company during 2020 as it encouraged greater transparency in terms of disclosure, with companies more willing to engage with investors and the composition of boards growing more inclusive and diverse. The management team has been working with several companies to encourage them to track key metrics, such as carbon emissions and carbon intensity, and to disclose this information regularly with other important information on supply chain management and health and safety. Relevant achievements include persuading a major carmaker to increase transparency and improve how it is perceived by the market; encouraging a mid-sized property firm to scale back its less profitable operations in order to allow its core business to thrive; and pressing an equipment maker to create a better framework to enhance returns.
Since the change of mandate to a Japan-only equities strategy in October 2013, Aberdeen Japan has delivered a NAV total return of 133%, compared to a benchmark total return of 105.2%.
Statement from the investment manager:
Overview
In what was a challenging year for investors, Japanese equities recorded a double-digit gain in the year under review, but there were two distinct halves. In the first six months, with a lack of clarity over the Covid-19, the market was more risk averse and favoured quality stocks, at a time of uncertainty in the face of a global pandemic. This benefited your Company’s portfolio, which outpaced the benchmark by a substantial margin. The latter half saw optimism that the development and rollout of vaccines would accelerate an end to social and work restrictions and facilitate global economic recovery. This lifted more cyclical parts of the market, with an accompanying increase in risk appetite that favoured the lower quality names that we tend to avoid.
The Japanese market reflected global trends: digitally-enabled companies initially gained the upper hand over analogue and valuations of the former group became increasingly extended, while those of the latter languished. As the year progressed, however, it became evident that the early prognosis of the pandemic’s impact was harsher than the actual effects. With the approval and rollout of Covid-19 vaccines in the latter half, albeit slowly in Japan compared with other developed countries, the bifurcation across markets started to reverse. We have been taking stock of the new trends, assessing their effect on the portfolio’s underlying holdings and evaluating opportunities.
Portfolio review
The ongoing pandemic has had far-reaching effects on all businesses. In this environment, the Company’s focus on well-run companies, which adapted quickly to changes in the market and which continue to find ways to create value, contributed to the outperformance. Importantly, we have observed positive trends in ESG initiatives across the Company’s holdings. These reflect long-term contacts and dialogue initiated by your Manager, who is committed to maintaining this approach. The discussions we have had with portfolio companies include proposals to raise disclosure standards on their initiatives, to create frameworks for a better assessment of risk and to improve returns, and to promote more significant restructuring.
In terms of stock performance, shares of Sanken Electric rose following the successful listing of its US subsidiary Allegro Microsystems. This is another positive step towards unlocking the company’s value, a subject which we had discussed with the company in the past as it moves from a restructuring phase to the pursuit of growth. Separately, the company also received a tender offer from an activist hedge fund, highlighting the value that remains inherent in the company. Speciality chemicals company Shin-Etsu Chemical saw its shares climb on expectations of brighter prospects for both its silicon wafer and polyvinyl-chloride manufacturing businesses. The former is the primary raw material required to make semiconductors used in most electronic devices, for which we expect the demand-supply balance to tighten over the medium term.
Meanwhile, fintech firm WealthNavi responded positively as investors continued to buy into the growth potential of its robo-advisory business, which targets the expanding segment of tech-savvy young consumers looking to invest their savings in an ultra-low interest rate environment. We initiated a holding in the company through its initial public offering in December.
Elsewhere, factory automation solutions provider Nabtesco advanced on hopes for increased capital expenditure as economic conditions improved. Most recently, the company sold its stake in affiliate Harmonic Drive Systems and dissolved the business partnership between the two companies. The proceeds are to be used for share buybacks, debt repayment and growth investments. Capital allocation is a topic that we often discuss with the company, and we had questioned the lack of synergy from this partnership. Nabtesco is a global leader in producing reduction gears for use in mid-to larger-sized industrial robots, while Harmonic Drive focuses on smaller robots – and Nabtesco has the technology to expand its business into Harmonic Drive’s domain independently.
The gains from these companies more than offset those that fared less well. These included Tokio Marine, whose shares were weighed down by concerns over its exposure to policies related to business interruption insurance, but which we believe is manageable as the company has astutely diversified its business risks over the years; mobile network operator KDDI, which came under government pressure to cut tariffs, but which has expanded outside its core business and remains committed to earnings growth and shareholder returns; and drugstore operator Welcia Holdings, which performed well in the initial months of the pandemic and has seen a subsequent decline in growth rate, but which retains the dominant market position and is seen as a consolidator in a fragmented industry. We remain confident in the longer-term prospects for these businesses, which remain buffered by resilient balance sheets.
In other activity, we exited several holdings. Among these were retail conglomerate Seven & i Holdings, clinical-testing device maker Sysmex, IT-services providers SCSK and Fujisoft, control equipment provider Azbil, industrial refrigerator manufacturer Daiwa Industries, and pharmaceutical firm Shionogi & Co.
We exited Seven & i due to slow progress on restructuring of non-performing businesses in spite of our continued engagement. We initially invested in the company with the view that its core-convenience store business would drive sustained growth, offsetting weakness from non-core businesses such as department stores. However, even the core business has faced increasing competition from drugstores and other retailers. We were also disappointed by the management’s decision to conduct large-scale overseas M&A, instead of tackling issues at home in spite of our engagement efforts. We exited Sysmex after the stock re-rated sharply in 2020, partly due to the company’s newly developed antigen-based Covid-19 testing kit. We assessed that the company’s antigen-based tests could face challenges given their inferior accuracy rates and longer preparation time required compared to some of its competing products. While we were still confident on the company’s ability to build upon its dominant positioning in haematology testing, we could no longer justify the share’s high valuations.
Our assessment on Azbil was similar to that of Sysmex as we felt that investors were overly optimistic on the company’s prospects to develop and market a specialised air ventilation system to prevent the spread of COVID inside buildings. We believed that the technology would be too expensive for landlords to install, especially as the office space market was softening as more companies were adopting work-from-home technologies. While we remained optimistic on the company’s ability to grow sales of ventilation control systems, we could no longer justify the stock’s high valuation after the stock nearly doubled in 2020.
We also exited SCSK in light of better opportunities elsewhere. While we remained optimistic on the company’s ability to benefit from rising demand for IT services, we believed that it was fully priced in by the market. At the same time, we identified other more attractive IT solution businesses with the client base and track record to capture structural growth opportunities such as digital government and local 5G.
These exits allowed us to establish positions in more attractive opportunities across several businesses, including leading IT solutions provider NEC Corp., which we believe is well-positioned to benefit from the build-out of Japan’s 5G network and the government’s digitalisation efforts. The company is also poised to expand its business abroad through a partnership with Samsung Electronics on 5G mobile network systems, as well as providing a lower-cost solution for telecommunications providers in the implementation of the new global wireless standard. Similarly, Murata Manufacturing was another new introduction. Murata is one of the few electronic component manufacturers in Japan to reinvest efficiently in its business and grow its margins, which has translated into the company’s leading edge research and manufacturing capability. We also established a holding in Jeol, a world-leading maker of multi-beam semiconductor mask-writers, which are crucial in the production of high-end semiconductors. In addition to the lucrative mask-writers business, management is keen to boost profitability by expanding its sales of scientific instruments to the semiconductor and medical sectors.
We also participated in the initial public offers of both Coconala and Appier due to their relatively attractive valuations when compared with their longer-term growth outlooks. Coconala provides an online-based matching platform for knowledge, skills and services. The company is entering a virtuous cycle, whereby more transactions lead to more reviews, leading to clearer visualisation of sellers’ skills and buyers’ needs. Appier is an artificial intelligence-based marketing support tool provider, enabling its clients to improve data-driven decision making in digital marketing. Its proprietary algorithms help identify valuable customers, enabling more targeted ads and coupons to enhance customer conversion rates.
Outlook
Looking ahead, favourable fundamentals and a recovery in global trade should provide some tailwinds for Japanese equities, while improving governance should drive greater shareholder value. Some trends during the pandemic are likely to remain; for example, the move to increased working from home, and the increasing shift of retail to online models. This is clear when we look across the Asia Pacific region where economies have reopened and social and business activities have resumed, although some habits formed during shutdowns persist.
Businesses that have delayed expansion plans seem to be making up for lost time, resulting in a broad based pick-up in corporate capital expenditure; there is pent-up demand not only from last year’s business disruption, but also from the geopolitical uncertainty witnessed in the year before due to US/Chinese trade tensions. There are, however, risks in this scenario: valuation disparities have widened amid rising imported cost inflation; geopolitical tensions remain a challenge; and the anticipated global recovery is likely to be uneven, given the sharp disparities between countries in Covid-19 vaccination rates and the consequent ability to control the social and economic impact of high levels of virus transmission.
The Japanese Prime Minister Yoshihide Suga has maintained his predecessor Shinzo Abe’s economic policies, but has seen his own popularity wane over the past six months. His low-key public persona, lost by-elections, slow and over-bureaucratic vaccination processes as further waves have gathered momentum, and the unpopularity of plans to go ahead with the Olympics (due to start on 23 July) have all been factors. Despite this, the continuity of economic management and stability of government remains.
From an investment perspective, we have kept our focus on and commitment to improving your Company’s portfolio through these turbulent times. This includes our continued focus on well run businesses that are leaders in their segments, and that are linked to longer-term structural changes in society. Our diligence in carrying out proprietary research and our continued discussions around improving governance and good ESG credentials has, to date, yielded success; the results of many of the underlying companies held in the Company reaffirm our investment choices, which should position your company well for a global economy which may well be on the cusp of recovery.
AJIT : Aberdeen Japan dips into revenue reserves to deliver 15p dividend