Source: Morningstar, Marten & Co

Why AVI Japan Opportunity?

Strong track record of absolute and relative returns achieved since launch, despite the underlying asset class being unloved

Since its launch in October 2018, AJOT has established a strong track record of outperformance of both its performance benchmark (MSCI Japan Small Cap Index) and its peer group, delivering an NAV return of 51.4% from launch to the end of June 2024 versus 16.0% for the benchmark. AJOT was launched to capitalise on the opportunities that can be unlocked through corporate activism in the Japanese small-cap market, by resolving key issues which have substantially hampered shareholder returns.

Key elements of the investment case are as follows:

The Japanese market is undervalued (see Figure 8 on page 5).

Smaller capitalisation stocks, AJOT’s hunting ground, have lagged larger-cap stocks by a significant margin (see Figure 5 on page 4).

AJOT is able to identify a deep pool of cash/asset-rich, good-quality companies whose valuations do not reflect these attributes.

AJOT is a beneficiary of a trend towards improved corporate governance and higher levels of corporate activity within Japan.

Demonstrably, its engagement activities are unlocking the latent value within the companies in its portfolio.

AJOT’s portfolio is relatively lowly valued

As an indication of the scale of the opportunity, at the end of June 2024, the portfolio was trading on 8.4x EV/EBIT versus 15.8x currently for the MSCI Japan Small Cap Index. In addition, as an indication of just how much excess cash was sitting on the balance sheets of portfolio companies at the end of June, on a weighted average basis 48.4% of the market cap of the portfolio was comprised of cash, investment securities (less capital gains tax) and the value of treasury shares less debt and net pension liabilities.

Figure 1: JPY versus GBP

Source: Bloomberg

In addition, any recovery in the yen could boost returns for AJOT shareholders. In our last note, we observed that AJOT’s returns and those of its benchmark were being held back by the weakness of the Japanese yen relative to sterling. In recent days, the yen has started to strengthen but could have a lot further to go (it remains about 34% off its peak in December 2011).

As an indication of the magnitude of this, had the yen held its own against sterling since AJOT’s launch, the NAV return would have been 112% rather than 51% to end June 2024. The managers note that at end March 2024, 83% of portfolio revenue was derived from sales into the domestic market – this is not a portfolio built on exporters.

Market backdrop

Japan now has positive interest rates

On 19 March, the Bank of Japan ended its negative interest rate policy, guiding the overnight interest rate to a range of zero to 0.1%. Then on 31 July, it raised them again to 0.25%. This rise came earlier than the market had expected. Figure 2 shows where it expects that rates will get to over time (based on interest rate swaps). In addition, in June, the Bank said it would scale back its quantitative easing, bond-buying programme.

This policy shift was made in response to rising inflation. Japan’s rate of inflation has been higher and more persistent than it has been for decades, and this is fuelling demand for wage rises. Wage increases negotiated this spring were the highest in 33 years, and this ought to be positive for consumer spending.

Figure 2: Japan interest rate market forecast

Source: Bloomberg, interest rate swap curve for TONA as at 5 August 2024

Figure 3:Japan CPI

Source: Bloomberg

Japan’s stock market has been buoyant; the large cap TOPIX hit at an all-time high on 11 July 2024, having finally surpassed a peak set in 1989, but yen strength and a wave of profit taking has driven a sharp fall in recent days such that the index has given up most of the ground it made over 2024.

Notwithstanding some modest outperformance during the recent sell-off, small caps continue to lag large caps and the degree of underperformance since the summer of 2020 is becoming extreme (this makes AJOT’s run of good returns all the more remarkable).

Figure 4: Japan wage rises

Source: Bloomberg, Japan Spring wage negotiation (Shuntou) monthly average wage increase rate

Figure 5: Japan small cap versus large cap

Source: Bloomberg. Note: 1) MSC Japan Small Cap/MSCI Japan.

The pace of corporate governance reform continues to accelerate. Figure 6 shows that the number of shareholder proposals put forward by constructivist investors to Japanese companies jumped significantly in 2022 and continues to increase. Well over half of those proposals put to shareholders in 2023 were for companies that had not previously been targeted.

The new rules are succeeding in their objectives. Around 600 Japanese companies were buying back shares in the 2023 financial year, a record. In addition, as Figure 7 shows, there has been around a 44% reduction in the numbers of shares held in strategic shareholdings, as cross-shareholdings are unwound.

Figure 6: Number of shareholder proposals by constructivist funds

Source: AVI Japan Opportunity Trust, based on data from Mizuho Securities Equity Research

Figure 7: Total strategic shareholdings (bn shares)

Source: AVI Japan Opportunity Trust, based on data from Mizuho Securities Equity Research

While corporate governance reform is often cited as a key driver of demand for Japanese stocks, another driver is valuation. Even after their sharp rise, Japanese stocks trade at a discount to global averages.

Figure 8: Valuation of various indices as at 31 July 2024

Source: MSCI

The remarkable thing in the table is the higher relative yield on Japanese stocks, perhaps evidence of progress on the clamour for higher pay-out ratios.

AJOT’s current campaigns

Engagement is becoming easier

Encouragingly, the manager says that engagement is becoming easier. AJOT’s previous successes and its critical but constructive approach mean that more boards are willing to listen. It is interesting that even the announcement of AJOT taking a stake in a company can be enough to have a positive impact on its share price (see Aoyama Zaisan Networks on page 9).

AJOT’s engagement activities are mostly behind the scenes. However, it is prepared to be vocal when necessary. Ahead of the June AGM season in Japan, AVI said it would vote against the re-election of Digital Garage’s directors after that company’s medium-term management plan (published in May 2023) failed to address the future of its 20% stake in Kakaku.com (which we discussed in our last note).

Figure 9: SK Kaken (JPY)

Source: Bloomberg

SK Kaken

SK Kaken has been a regular feature in our notes. On 5 June 2024, AVI announced that it was putting forward proposals to SK Kaken’s AGM. For the first time, two of AJOT’s directors were present in person and asking questions. This appeared to embolden another shareholder to challenge the company’s management too.

The number of individual investors on SK Kaken’s register has grown since AJOT first invested. The TSE has imposed a minimum of 400 shareholders below which a company should de-list. SK Kaken has successfully made efforts to comply with this but there is increasing investor scrutiny of the company.

This was the fourth occasion that AVI had submitted proposals. This time, it was calling for:

the cancellation of 90% of the 2,192,425 SK Kaken shares held in treasury. SK Kaken was holding 14% of outstanding shares in treasury and had not put forward any plans to use the shares to complete M&A or improve executive compensation. AVI feels that holding excess treasury shares creates a reissuance risk, which at the current share price would be value-destructive, and it is best practice to cancel excess treasury shares; and

an increase in the dividend from JPY135 per share to JPY290, representing a 50% pay-out ratio. AVI says that SK Kaken has hoarded earnings on its balance sheet, with cash and equivalents accounting for 71% of balance sheet assets.

Once again, AVI’s proposals were rejected, and the dividend remained at JPY135. Cash continues to accumulate on the company’s balance sheet, increasing the potential upside. You can read AVI’s views on SK Kaken here.

Figure 10: Aichi Corporation (JPY)

Source: Bloomberg

Aichi Corporation

Aichi Corporation (aichi-corp.co.jp/en), which makes aerial work platforms, is a listed subsidiary of Toyota Industries. Such arrangements have come under increased scrutiny in recent years and there is also attention being focused on Toyota’s corporate governance standards, which has helped to reinforce the attractions of this stock.

In May 2024, AVI launched a public campaign calling for one of the following:

Aichi buying back and cancelling all the 54% of its shares held by Toyota Industries;

inviting a capital partner to take Aichi private; or

Toyota Industries to acquire 100% of Aichi.

AVI highlighted that Aichi is already one of the most profitable companies in its field. However, it trades on almost half the rating of its listed peers. AVI feels that Aichi is failing to take advantage of opportunities to expand internationally, is simultaneously underinvested and over capitalised, and has poor shareholder communications and weak corporate governance.

AVI reckons that at 30 June 2024, Aichi was trading on 7.7x EV/EBIT and almost half of its market cap was accounted for by net cash and listed securities. You can read AVI’s views on Aichi here.

Figure 11: Nihon Kohden (JPY)

Source: Bloomberg

Nihon Kohden

As an example of the success that can be achieved behind the scenes, it is worth looking at progress with AJOT’s stake in Nihon Kohden.

Nihon Kohden (nihonkohden.com) is a medical equipment manufacturer, making equipment such as patient monitors, electrocardiographs, and defibrillators. At the end of June 2024, net cash and securities accounted for 18% of the company’s market cap. Despite the strong share price returns of the last couple of years, AVI still sees the potential for 100% upside in the share price.

The AVI team sent through a presentation to Nihon Kohden that made some suggestions as to how the company might achieve margins of 15% within three years. Pleasingly, the company has now adopted three-year targets for a 15% operating income margin (up from 8.8% for 2023), 5% CAGR of sales, 45% of sales coming from overseas (up from 35.9% for 2023), and an ROE of 12% (which compares to a current cost of capital of about 6%).

A corporate governance report published on 2 July 2024 promises – amongst other things – an improved gender diversity in its management structure, an annual re-examination of the rationale for cross-shareholdings (the company holds shares in 11 companies), and a target of a return of at least JPY28bn to shareholders (from forecast operating cashflows of JPY80bn).

Figure 12: NC Holdings (JPY)

Source: Bloomberg

NC Holdings

NC Holdings has been a position in AJOT’s portfolio since June 2021, and we first discussed it in our note of September 2022. It is a conglomerate with a rather odd mix of businesses – conveyor belts, management of multistorey car parks (3D parking equipment and mechanical parking equipment), renewable energy (solar power) and charging equipment for the electric vehicles. AJOT built up a 20%+ stake in the company and has engaged with it on several occasions, most notably proposing three successful resolutions at the company’s AGM in June 2023.

In June 2024, Miri Capital (a Boston-based investment firm) launched a tender offer at JPY2,208 per share, a 51% premium to the company’s share price as at end May 2024.

Ahead of the announcement, NC Holdings accounted for 3.9% of the portfolio. AVI says that following the tender offer, the investment in NC Holdings generated an IRR of 22% and an ROI of 47%.

Asset allocation

At the end of June 2024, there were 25 holdings in AJOT’s portfolio. The manager has increased gearing within the portfolio since we last published and at end June 2024 this stood at 5.2%.

The sector breakdown is very much the product of the manager’s stock selection rather than any deliberate attempt to over- or underweight particular parts of the Japanese economy. However, there has been a conscious effort to tilt the portfolio towards high-quality growing companies and away from potential value traps.

Figure 13: AJOT sector breakdown as at 30 June 2024

Source: AVI Japan Opportunity

Figure 14: AJOT portfolio split by market cap as at 30 June 2024

Source: AVI Japan Opportunity

The bias of the portfolio has shifted further down the small cap scale since we last published; again, this reflects the manager’s stock selection decisions as it seeks to take larger stakes so that it can have a greater influence.

10 largest holdings

The composition of the list of AJOT’s top 10 holdings has changed a fair bit since we last published – Beenos, Kurabo Industries, and Aoyama Zaisan Networks have entered the list, replacing Shin Etsu Polymer, DTS, and Wacom.

Figure 16: Beenos (JPY)

Source: Bloomberg

Beenos

Beenos (beenos.com/en) is a relatively small but fast-growing company. It offers an online marketplace and associated logistics service ‘buyee’ for overseas purchasers of Japanese merchandise. When AJOT first invested, it had cash/securities on its balance sheet equivalent to about 55% of its market cap.

Beenos share price jumped after AJOT declared its stake in the company. AJOT now owns around 10% of the company. Its initial stake was acquired from a venture capitalist backer that was looking for an exit.

AVI notes that Beenos has been growing its gross merchandise value by 31.3% per year over the past eight years. However, it was able to acquire its stake on a 2.9x EV/EBIT valuation. At the time, cash and listed securities accounted for 79% of its market cap. Frustrated shareholders had unsuccessfully attempted to remove the CEO.

Figure 17: Aoyama Zaisan Networks (JPY)

Source: Bloomberg

Aoyama Zaisan Networks

Aoyama Zaisan Networks (azn.co.jp/eng/) advises on inheritance tax planning. Japan’s ageing population underpins demand for its services, and it has been achieving double digit profit growth. AVI identified that it had excess cash on its balance sheet.

AJOT took a 5% stake in the company and Nikkei wrote an article on the back of it which triggered a jump in Aoyama Zaisan Networks’s share price (which might point to increasing recognition of AVI’s impact on the companies it targets). AVI does work with a PR firm in Japan, but this was not the source of the story.

Figure 18: Kurabo Industries (JPY)

Source: Bloomberg

Kurabo Industries

Kurabo Industries (kurabo.co.jp/english/) is a conglomerate with a wide variety of businesses. The historic core of the company is in textiles, but today it also has business segments in chemical products, advanced technology, food and services, and real estate.

AVI’s analysis revealed that 150% of the company’s market cap could be accounted for by cash, securities, and real estate on its balance sheet. The team was encouraged by actions that the company had started to take to address its undervaluation, including the sale of a subsidiary and a share buyback (almost 9% of its outstanding share capital, which was announced on 19 December 2023.

Performance

As Figures 19 and 20 show, over the past five years, AJOT has outperformed its benchmark by a wide margin, returning 50.3% in NAV terms and 39.2% in share price terms, which compares to 17.6% for the MSCI Japan Small Cap Index.

Figure 19: AJOT NAV total return performance relative to MSCI Japan Small Cap for the five years to 31 July 2024

Source: Morningstar, Marten & Co

AJOT has had an excellent run over 2024, building further on its long run of outperformance of both its MSCI Japan Small Cap benchmark and its Japanese smaller companies peer group.

Figure 20: Total return cumulative performance over various time periods to 31 July 2024

Source: Morningstar, Marten & Co. Note 1) the peer group is made up of Baillie Gifford Shin Nippon, JPMorgan Japan Small Cap Growth and Income, and Nippon Active Value

Performance attribution

AJOT’s manager observes that the trust’s returns are largely the product of its stock selection decisions rather than underlying market movements. Figure 21 shows the leading contributors and detractors to AJOT’s returns over the first six months of 2024.

Figure 21: Leading contributors and detractors from AJOT returns over H1 2024

Source: AVI Japan Opportunity

Alps Logistics

Figure 22: Alps Logistics (JPY)

Source: Bloomberg

In May 2024, Alps Logistics was bid for by a KKR-backed company, Logisteed. This was a stock that AJOT had held since 2018, and it was a 2.6% position at the end of 2023. It was a knock-out bid, at a 194% premium to the undisturbed share price. At the exit price, AJOT crystallised a 38% IRR and 306% ROI.

The manager notes that the deal highlights the gulf between depressed listed valuations and those of equivalent private companies.

We discussed Beenos and Kurabo Industries on pages 9 and 10. Eiken Chemical and TSI Holdings were featured in our last note (see page 14 for a list of these).

TSI

Figure 23: TSI (JPY)

Source: Bloomberg

TSI was also discussed in our last note, but to recap, it is an apparel company that owns several brands, ranging from street fashion to sports equipment. When we last published, AVI was hoping for news of initiatives aimed at boosting returns and the share price.

AJOT’s manager feels that TSI is capable of achieving margins of about 6%. The company announced a cost reduction programme in April with the ambition of hitting that 6% figure (up from about 1% currently) within about three years. TSI also said that it intended to adopt a policy of a 4% dividend on equity within the same timescale.

The share price has now tripled since AJOT’s first investment, helped by buybacks of around 8% of TSI’s outstanding stock each year. However, the AJOT team still sees the potential for 100% upside in TSI’s share price from here.

Jade Group

Figure 24: Jade Group (JPY)

Source: Bloomberg

Jade Group’s shares rose in February after it announced the acquisition of fashion ecommerce platform Magaseek. AVI said that the deal looked set to double Jade’s gross merchandise value and potentially double its profits by 2026.

AVI could not identify a fundamental trigger for Jade’s share price fall in April 2024. It took advantage of lower prices to add substantially to AJOT’s stake. The subsequent share price recovery in July reflects Jade’s announcement of a profit uplift related to the Magaseek deal. AVI sees the potential for considerable further upside in Jade’s share price.

Premium/(discount)

Over the 12 months ended 31 July 2024, AJOT’s shares traded between a 2.7% premium and a 7.4% discount. The average discount over the period was 2.5%. At 5 August 2024, AJOT was trading at a 4.8% discount.

AJOT’s discount has generally been range-bound between a 5% discount and a slight premium since mid-2022. AJOT’s attractive investment proposition, decent performance and the board’s discount management efforts have been the likely drivers of this. However, we feel that its performance and prospects are such that it should be trading at asset value and expanding.

The board recognises that it is in the interests of shareholders to maintain a mid-market price for the ordinary shares that is as close as possible to NAV, and will buy back stock if the average discount exceeds 5%. The discount should also be limited by the regular exit opportunity, the next of which is in October this year.

At the AGM held in May 2024, shareholders gave the directors authority to issue up to 20% of AJOT’s then share capital over the following 15 months (or up to the next AGM, whichever is the earlier). Shares will only be issued (or reissued from treasury) at a price equal to NAV plus a premium at least sufficient to cover the costs associated with issuing the shares.

The board was also granted permission to repurchase up to 14.99% of the ordinary shares. Shares repurchased may be held in treasury. If the four-month moving average discount is greater than 5%, the board will endeavour to reduce the discount by buying back shares. 135,000 shares have been repurchased over the course of 2024, so far.

Figure 25: AJOT premium/discount for the five years to 31 July 2024

Source: Morningstar, Marten & Co

Fund profile

More information is available at the fund’s website www.ajot.co.uk

AJOT is an investor in Japanese companies. Its focus is on good-quality small- and mid-cap listed companies that have a large portion of their market capitalisation in cash, listed securities or other realisable assets. AJOT’s manager takes a constructivist approach and seeks to engage proactively with these companies to unlock their value potential.

AJOT’s AIFM and investment manager is Asset Value Investors Limited (AVI). The lead manager working on AJOT’s portfolio is Joe Bauernfreund, one of a seven-strong team focused on Japan, one of whom is based permanently in Japan, and the majority of whom are Japanese-speakers.

AVI and its employees are aligned with shareholders

AVI was established in 1985 to manage what is now AVI Global Trust (AGT) and has AUM of about £1.3bn. AVI began investing in Japan over three decades ago and AJOT was launched in October 2018 to focus on the opportunities presented by that market. At the end of June 2024, AVI owned 1,640,000 shares in AJOT.

AJOT compares its performance to the MSCI Japan Small Cap Total Return Index, expressed in sterling terms. The index does not inform AJOT’s portfolio construction. AJOT will have a high active share relative to the performance benchmark.

Previous publications

Readers interested in further information about AJOT may wish to read our previous notes listed below. You can read them by clicking on the links in Figure 26 or by visiting our website.

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