OPTIMAL JAPAN ABSOLUTE LONG FUND
Optimal Japan Absolute Long Fund (‘OJAL’) invests in the Japanese equity market with the objective of maximising investor returns. This includes hedging the portfolio. Although the Fund’s NAV is denominated in USD, the underlying investments are in Japanese Yen securities and the Investment Manager does hedge this exposure to the Yen by using forward contracts.
|NAV PER UNIT US$17.444|
|As at 31 August 2018|
|As at 31 August 2018||1 year||3 years||5 Years||10 years||Inception*|
|*Since inception (start date 1 September 2004). Data provided by Apex Fund Services.|
|As at 31 March 2018||OJAL||Topix Index|
|Number of Holdings||26||830|
Value of US$10,000 INVESTED
Source: Apex Fund Services
A little Chinese gold dust goes a long way – for some
China is a massive country with a big impact in many areas, not all of which is welcomed by those impacted. The US government of Donald Trump is hoping to reduce what they see as a negative impact from China’s trade policies and other governments (like Australia’s) are seeking to reduce the risk of political damage from information gathering by barring Chinese telecoms companies from tendering for government contracts for telco network infrastructure. The real impact of China’s actions is more nuanced and only the passing of time will allow us to judge whether these actions helped or hurt.
The impact of Chinese demand, be it real, projected or imaginary, is definitely felt in equities markets and fortunately it is often in association with higher prices. We, like most people, like higher share prices. In this letter we will mention a few companies (Japanese and Chinese) which are all definitely affected by Chinese demand and dreams, and will show how the associated market gold dust is not distributed evenly or, in our view, fairly on every stock.
We have mentioned Tokai Carbon in a previous letter. It has been one of our best investments over the past year. This is a low profile but successful maker of carbon black (it goes into auto tires), fine carbon and graphite electrodes – which is where China comes in. But first, some basic facts relating to Tokai Carbon as an investment: the market cap is US$4bn, and the shares trade on a PER for the current year of 6x. The company’s return on assets (RoA) is 28% this year, the RoE is 42%, while the PBR is 2.3x. Some might explain the cheap valuation by the fact that this is a company in a cyclical business so at times of high profitability, it only commands a lowly rating because profits will fall with the next economic down cycle. That is partly true, but the fact that the Chinese government wants a cleaner steel industry with more modern, electric-arc furnace steel production will create demand for Tokai Carbon’s graphite electrodes and keep pricing high. It will reduce the cyclicality of Tokai Carbon’s profits and provide a cushion to earnings in the years ahead. A sixfold rise in this year’s operating profits notwithstanding, precious little investment gold dust remains on the shares now, but with Chinese demand real and sustainable, we believe it will attract more and expect the shares to perform well.
Another Japanese company that we like and which has done a fantastic job selling to Chinese consumers is Pigeon. Pigeon is Japan’s leading maker of milk bottles for babies as well as other items related to feeding. The company has a market cap of US$6bn, and its shares trade on a PER of 42x. Over the past six years, the shares have risen ninefold, the company’s operating profits have grown from Y5bn to Y20bn and the OP margin has jumped from 8.2% to 20%. The rise in profits and profitability is impressive (the RoA is 21%), but simple arithmetic tells us that the shares have been significantly re-rated with the price rise overshadowing the increase in profits. We admire the company and think they have done, and continue to do, a great job in positioning themselves as the producer for loving, aspiring parents who want the best for their baby. Chinese sales have grown rapidly over the past few years and this year will account for about 35% of the company’s total – exceeding their Japan sales for the first time. They also have meaningful sales in Singapore and in the US (after an acquisition) and with perfect hindsight, we wish we had been prepared to pay 20 times that the shares used to trade at before the Chinese gold dust landed in 2013 and took the shares to PER levels of more than 40x that we now see. While the shares seem over-valued to us, we can’t deny that the China impact has been real and very positive.
The third example of China’s gold dust effect is Shiseido. In this instance, we remain very dubious of the valuation as it factors in many future years of projected benefits from Chinese demand in spite of this being a company which has had a peak Operating Profit Margin (OPM) of only 8.4% over the past 20 years and has actually lost money at the operating level in 5 of those years. Admittedly, they are projected to achieve a record 11% OPM in the current year, but for all that, the shares (with a market cap of US$27bn) trade on 39x PER, 6.5x PBR and with a return on assets of only 9.3%. By the standards of most companies, an RoA of 9% is good, but most companies do not sell for 39 times their profits. The share of sales going to China is estimated at not quite 17% in the current year, rising to 18% in 2020. As for Operating Profits, China will represent almost 20% of the company total this year and remain steady at that level in the coming two years. Sales growth in China is solid without being spectacular and profitability is good (13%) but well below the level that they get from sales in Japan. With competition from the global cosmetics giants, Japanese rivals (like Pola Orbis and Kanebo) and local Chinese makers, we are doubtful if the rosy sales and profit forecasts will be met and believe the shares are over-priced.
At the absolute extreme of the gold dust rainbow is the Chinese company Meituan Dianping. This company will list in Hong Kong soon (September 20th) and using the indicative price range expected for the IPO, it will be valued at almost US$55bn. The company, described as an online food delivery-to-ticketing platform, aims to help consumers “eat better, live better”. After the astounding business and share market success of companies such as Amazon, TenCent, Alibaba, Facebook, Uber and many others, it would be foolish to think that Meituan Dianping’s shares are destined to disappoint, but with an operating loss forecast for this year of RMB 11bn (US$1.6bn), an assumption of a near tripling of sales over the coming three years and an operating profit of only RMB23.6bn(US$3.5bn) in 2021, it is clear that the IPO’s underwriters are wearing rose coloured glasses. The gold dust is thick on the ground around this one.
There is great dispersion among stocks now with many investors willing to trade ecommerce and disruptive technologies at almost any valuation while cyclical or value stocks get cheaper regardless of their profits and prospects. As we saw in 1999, these market dispersions can go to crazy extremes, and we do not see the same insanity today that was evident then, but eventually bubbles burst, the tide goes out, we realise that the emperor wears no clothes and prices adjust.
We just have to make sure we catch the next Pigeon before the gold dust has arrived.
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|Strategy||Long Only Equity|
|Net Asset Value (NAV)||US$17.444|
|Trustee||Optimal Fund Management Pty Limited|
|Launch Date||September 2004|
|Performance Fee||20%*||*the fee is levied on the investment’s positive excess returns above the return on the Topix index (in USD terms) with a high watermark.|