Better-than-expected corporate earnings support market


Fund Commentary
29 Aug 2017


Q1 earnings of Japanese corporations were better than expected, leading investors to increase their confidence in companies that exceeded initial earnings estimates. According to a report by Mizuho Securities, earnings of manufacturing companies were especially strong and rose 31% YoY in the first quarter, whilst that of non-manufacturing companies declined 7% YoY during the same period.

The popularity of Prime Minister Abe deteriorated after the LDP lost major seats in the Metropolitan assembly election in July. Even worse, Ms. Inada, Minister of Defense and right hand to Prime Minister Abe, resigned over a military cover-up. Meanwhile, the leader of DPJ also resigned without apparent reason. Corporate earnings were better than expected and supported the market. However, political instability and geopolitical threats such as North Korea’s missile launch capped the overall market in July.

Political instability continues, forcing the LDP and Komei’s coalition government to talk about the series of scandals within Abe’s cabinet. Prime Minister Abe reshuffled his cabinet which is not new to the Investment Adviser. If a snap election is called for prior to the scheduled end of term, deliberation of several important policies may stop temporarily, negatively impacting the economy. Furthermore, geopolitical threats prevail and may cap the economy and domestic market.

The latest survey by the Development Bank of Japan expects capital expenditures on the part of large companies (with paid-in capital of 1bn yen or above) to grow 11.2% YoY for the FY 2017. Manufacturers expect a 14.2% YoY rise in capex, whilst non-manufacturers expect a 9.5% YoY increase compared to FY 2016. IT-related investment rose 7.0% YoY in FY 2016 and is expected to grow 27.6% YoY in FY 2017. This indicates that Japanese companies are seeking to grow, using their excess cash to improve their ROE and ROA. The Investment Adviser is looking for companies that can grow regardless of the macro environment and thinks that there are potential candidates in the domestic market. The team will continue to search for companies which are generating profit and incorporate them in the portfolio.

Seria (2782), the Fund’s largest holding at the end of July, operates 100yen chain stores in Japan under the brand name of “Seria” and “Color the days”. Furthermore, the Company also operates franchise businesses. Its main product line includes household goods and snacks. Current President Eiji Kawai started his career at a bank in Japan and developed a company scoring model to fit the bank’s lending business, before joining Seria in 2003 and becoming its President in 2013. Since joining the Company, he has been developing internal product scoring models to check product sales. The Company’s POS system runs 100 million calculations on a daily basis to check sales and inventory levels of 19,000 items at nearly 1,300 shops all over Japan. The Company is still improving its overall productivity by introducing an in-house supply system. As of 31st July, the Company traded at a P/E of 38x, a PBR of 8.2x and a ROE of 23.8%.


The views and statements contained herein are those of Rheos Capital Works Inc in their capacity as Investment Adviser to the Fund as of 10/08/17 and are based on internal research and modelling.