Japanese stocks: The return of durable brands

The value of an investment, and any income from it, can fall as well as rise and investors may not get back the amount invested.

Serena Williams and Roger Federer have won 43 major titles between them in careers spanning over 20 years. Both still feature among the world’s top tennis players and still attract sell-out crowds. Such consistency and durability should be celebrated.

It should be no different when it comes to investment.

Rapid growth stocks, notably those with disruptive business models, have gained most of the airtime for growth investors of late and have featured most prominently among the Japan Team’s most successful investments. In contrast, steady growth businesses have been conspicuously absent from the headlines and from our recent winners.

This can partly be explained by Japan’s unfavourable demographics, its deflationary mindset and the poor standards of corporate governance weighing on shareholder returns. High starting valuations for ‘pedestrian growth’ have been an additional headwind.

We remain well disposed to our high growth internet disruptors and global leading automation stocks alike, seeing much potential growth ahead. We’ve paid more attention to durable franchises in recent stock and portfolio discussions, however. Businesses quickly discounted in the past are now looking attractive and some are in the portfolio already. What changed?

First, burgeoning Chinese wealth has transformed the opportunity for several Japanese consumer franchises. The domestic market only offers low-single-digit growth, but China’s growing middle class has an appetite for high quality, premium Japanese goods. In skincare, Japanese brand Pola Orbis is held in high regard and enjoys profitable growth. Personal care and sanitary products maker Unicharm also benefits from rising wealth in China, with high-margin incontinence and feminine care products selling well there. Chinese consumers are willing to pay up for quality and reliability, playing into the hands of the established Japanese brands. A rise in inbound tourism – which we expect to resume once Covid-19 is behind us – has created a new growth market for many Japanese retailers, as well as increasing brand awareness among Chinese consumers. Given the size and wealth of the Chinese market, high demand for premium Japanese brands seem likely to last decades.

Second, improving attitudes towards corporate governance have increased scrutiny on returns generated by many Japanese companies and underpinned enthusiasm for self-help, most notably among longstanding inefficient franchises. Tyre-maker Bridgestone, which benefits from a leading position in electric vehicles, construction and aeroplane tyres, recently sold its non-core building products brand Firestone, and consolidated its facilities. Beauty care and household goods specialist Kao has slashed its product range from 49 items in 2019 to 19 today.

Japan’s ongoing digital transformation has not escaped the attention of its major consumer brands. Kao has developed a new digital creation centre which aims to digitise marketing activities and product development. This reduces costs and shortens the time from product development to commercialisation but also uses artificial intelligence to optimise inventory and procurement management.

In a recession, durable businesses with high market shares and franchise characteristics tend to fare better. This is reflected in share price performance. This was the case in the financial crisis of 2008–2009 and now our holdings in steady, resilient growth areas such as telecoms, consumer goods and transport served us well. By mid-2021, things looked very different. With home confinement and social distancing measures, internet platforms flourished, while manufacturers and traditional retailers suffered, affecting previously dependable earners from tyre-makers to cosmetics companies.

This led to a third dynamic: Consumer franchises with durable growth prospects have seen profits and share prices plunge to their lowest valuations in years. Despite opening up and signs of a recovery, these franchises appear to have been overlooked so far, with investors allocating more funds to lower-quality cyclicals to benefit from normalisation after Covid. Bridgestone and Kao have derated to their lowest earnings multiples in many years, despite undergoing self-help and benefiting from an improving industry backdrop. These businesses will enjoy a snap back in earnings as the word returns to normal, while delivering profitable earnings growth for years to come in a variety of conditions – apart from another global pandemic.

Like those great sports icons, great companies persist through challenging times, and by constantly improving, they can continue to deliver for many years.

Risk Factors

The views expressed in this article are those of Andrew Brown and should not be considered as advice or a recommendation to buy, sell or hold a particular investment. They reflect personal opinion and should not be taken as statements of fact nor should any reliance be placed on them when making investment decisions.  

This communication was produced and approved in September 2021 and has not been updated subsequently. It represents views held at the time of writing and may not reflect current thinking. 

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