The Cheap Japanese Basket: Year-End Portfolio Review and Reasons Why I Remain Bullish

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I initially began my cheap Japanese basket in March 2023 and now that 2023 has come to an end, let’s take a look at how everything worked out. But first, a quick summary of the themes in my basket and why I’m broadly still bullish on deep value Japan.

Within my basket of cheap Japanese companies, there are 3 broad themes: higher quality businesses with better RoEs and P/TBV closer to 0.7x, dirt cheap deep value net nets with P/TBV of 0.2-0.4x, and deeply discounted companies with underappreciated land assets. The net-net part of the basket is currently the largest and even the ‘higher quality’ names are dirt cheap by most metrics.

Two rules for companies I own are 1) No melting ice cubes. I don’t want to own any company that regularly reports losses. I like companies with consistent profits and a history of growing book value per share. 2) Some shareholder returns. Dividends are a requirement and buybacks are a big plus. I also don’t want to see the share count increase materially.

Besides dirt cheap fundamentals, here are some broad reasons why I’m bullish:

The Tokyo Stock exchange will begin publishing a list of companies which are complying with their requests to address discounts later this month, which should pressure compliance for management teams that want to maintain a good image. 

"There has been a sense of urgency brewing among companies" ahead of January, when the Tokyo Stock Exchange (TSE) starts publishing a list of companies that have disclosed action plans in line with its call to improve their use of capital, Kei Umeda, CEO of Mizuho Trust & Banking, said in an interview… Mizuho Trust's corporate finance consulting service has seen a surge in demand, having 60 to 100 client meetings every month to discuss how to boost price-to-book ratios, Umeda said.

Source: Reuters

Reuters reported that 85% of Japanese firms are seeing more listing-related burdens and 30% of those are re-examining the benefits of remaining listed. 14% of respondents that reported listing related burdens have considered going private. 

New NISA rules (Japanese 401k equivalent) doubled the amount investors can contribute annually.

New tax rules allow acquirers in M&A deals to deduct up to 100% of acquired company’s stock as an expense for tax purposes.

Disclosure requirements are increasing even further for listed subsidiaries, which could push parent companies to just buy out their listed subsidiaries. Lonseal (4224), Kinki Sharyo (7122), Kobelco (5660), Sanyu (5697), and Nichia Steel (5658) are all examples of listed subsidiares that I own.

Anyway, onto the Portfolio Review:

The Nikkei 225 index ended the year up 30%, but I didn’t begin my portfolio until it had already run up 10%. The Japanese basket was also a small ~10% weighting in my portfolio back then and has since grown to ~60%. The Nikkei basically peaked around June 16th, 2023 while I deployed most of my capital after that date. Still, my returns in USD terms have been quite good, despite the Nikkei remaining mostly steady since June.

Here’s the basket as it stands on January 1, 2024:

The biggest winners in the cheap Japanese basket have been slightly higher quality names like Fujii Sangyo (TYO 9906) and Narasaki Sangyo (TYO 8085), which are up 57% and 48% for the year. I’ve added to practically every one of these winners on the way up, which has brought up my cost basis.

Besides both having ‘Sangyo’ in their names, both are a bit higher quality in terms of RoE than the rest of the basket at ~11% RoE and trade at 0.6x and 0.7x p/tbv. Both have re-rated higher, as I initially purchased these names at 0.4x and 0.5x P/TBV.

Fuji Sangyo was a net-net when I first purchased it, but backing out net current assets, the market values the company at just $4.7m today vs a market cap of $143m. It’s still dirt cheap and remains a net-net if we include the $23m in investment securities as current assets. While Net income and revenues both continue to grow, I liked Fuji Sangyo a lot more when it traded at 0.4x p/tbv. Still, it’s cheap and I plan on holding it. P/E remains low at 6.24.

Narasaki Sangyo on the other hand is not a net-net, but remains inexpensive at 0.7x p/tbv and a P/E of 6.31.

Yamada Corporation (TYO 6392) has done extremely well for me, ending the year up 36%. This is another higher RoE name (12.8%) that trades at 0.7x P/TBV. While P/TBV multiple expanded a bit since I bought it, it remains extremely cheap. WinterGems on X wrote it up on their substack here for anyone interested in learning about the business. I like the business, but will not be adding to my position here.

Harima B.Stem (TYO 9780) has performed exceptionally well, up 46% for the year. The run up was mostly the stock rerating to 0.8x p/tbv. This one is extremely illiquid and not a name I would add to given its already re-rated higher without underlying earnings keeping up. Still, unlike many names in my portfolio, which are niche industrial companies, Harima B.Stem provides building maintenance and management services which should command better multiples. 

The best performing deep value net-net name in my portfolio that I have a sizable position in is Sanyo Industries (TYO 5958). With a P/TBV of 0.5 and P/E of 4.25 it remains absurdly cheap, especially given that net income hit a 30 year high. USD wise, the company’s market cap is just $62m. Backing out net current assets and the market values this business at -$9m. Add back investment securities and it's valued at -$15m. The best part? They’re actually buying back stock.

I’ve added a lot of extremely deep value names to the portfolio towards the end of 2023.

These include Nichia Steel (TYO 5658), Sanyu (TYO 5697), Marufuji Sheet Piling (TYO 8046), Kawagishi Bridge Works (TYO 5921) and Sanko (TYO 6964). While these names haven’t moved much since I bought them, I’m bullish.

Not every deep value name has performed well, as Nankai Plywood (TYO 7887) is down 1.8%. This is an extremely cheap (~0.2x p/tbv double net net name which I plan on holding onto. I also ended up selling Sapporo Clinical Laboratories (TYO 9776) and Taiyo Kisokogyo (TYO 1758) to take a tax loss. Neither of these names were large positions, but I do plan to repurchase my small position in 9776. I also sold off a few smaller positions in the portfolio to focus on better opportunities.

Another theme I’ve been interested in lately is dirt cheap companies with huge underappreciated land assets. My writeup on Asagami Corp (TYO 9311) illustrates just how undervalued land assets can be. I’ve purchased a decent sized position in Nippon Beet Sugar (TYO 2108) and a smaller position in Tohbu Network (TYO 9036) to make this bet. Keihin Co (TYO 9312), which I also wrote about, also owns valuable land assets and trades at just 0.5x P/TBV. While practically every company in my basket owns some land assets, land heavy names I highlighted above have land assets worth multiples of their market caps. I plan on increasing my exposure to this theme.

Conclusion: 

While this may come as no surprise, I remain bullish on deeply discounted Japanese equities. The portfolio has performed exceptionally well in 2023, especially since I deployed most of my capital after the Nikkei already ran up 30%.

Account wide I underperformed the S&P 500 in 2023 with my modest 19.85% gain, but my U.S. exposure fluctuated from net short 10% to net long 10% and I was net long account wide only 30-70% throughout the year, missing much of the U.S. rally and getting killed on my index shorts. The Japanese portfolio helped carry my performance last year.

While nothing in investing is guaranteed, the risk/reward in Japan seems favorable.

Happy New Year!

Worth reading: 

• Mizuho sees 'urgency' as Japan Inc scurries to improve capital use in line with TSE  

• Hiromi Yamaji: The Banker Turned Stock Exchange Boss Rattling Japan’s Listed Companies

• Can Japan’s legendary savers spark a stock market boom?

Disclosure: I own shares in all of the stocks mentioned in this article. Many of these stocks are extremely illiquid, so use limit orders and be careful if you’re considering building a position. None of this is investment advice. Do your own due dilligence.