Taking a new look at Japan

Taking a new look at Japan
By Judith Rehak International Herald Tribune
THURSDAY, SEPTEMBER 1, 2005

It has been difficult for investors to ignore Japan in the past few weeks. But instead of the usual bad news about its flagging economy, depressed real estate and struggling banks, the headlines have featured improving economic data and growing confidence among global investors. Those have propelled the Nikkei 225-stock index to a four-year high.

For international investors, Japan's prolonged economic downturn has made it a country to avoid. But veteran Japan investors say that after many false starts, the deflation that has held back recovery is easing. Corporate restructuring is finally paying off, and with unemployment down to 4.2 percent, more Japanese people are working and spending.

"And what is different this time is that we have a banking system back to health," said David Warren, president of T. Rowe Price International and a Japan specialist.

Even the sudden scheduling of a general election on Sept. 11 - in which the prime minister, Junichiro Koizumi, is challenging the old guard that voted down his plan to privatize Japan's postal savings system - has not scared off global investors. They are betting Koizumi will win, gaining a mandate for more changes in the economy.

One of the sectors that looks most attractive to Warren is banking, which has led the sharp rally in the Nikkei. "If we're escaping from deflation, domestic demand will pick up, so we're big on banks," he said.

Among the holdings in the U.S.-listed T. Rowe Price Japan Fund, he singled out Sumitomo Mitsui Financial Group, one of the biggest banking groups in Japan. Warren described it as more entrepreneurial than its peers and as taking steps to increase fee income. Resona, a smaller regional bank that is focused on activities in the suburbs of Osaka and Tokyo, like mortgage lending, is another pick.

The portfolio includes familiar large-cap names, like Toyota and Canon. But Warren is enthusiastic about small to medium-size domestic companies, especially retailers. "One thing happening in Japan is that there are a lot of new companies that are really challenging old-line retailers and growing rapidly," he said.

An example, and one of the fund's largest positions, is Culture Convenience Club, a DVD rental specialist that recently bought the Japanese operation of Virgin Megastore. Warren also favors Livedoor and Rakuten, which offer online services including shopping as well as brokerage accounts.

Not everyone is ready for a pure play on Japan, though, and another approach is an Asia regional fund with a large stake there. David Linehan, the manager of the Excelsior Asia Pacific Fund, recently had a hefty 56 percent of his portfolio in Japan. "That's more than in a long time," he said. His low, in 2002, was 16 percent.

Linehan looks for companies with a catalyst that will strengthen profit and improve cash flow. He, too, likes retailers, although he emphasizes those that offer value. "There were periods in the past when Japanese consumers were spendthrifts, but that is long gone," he said. "They really want value for money." Among his picks are Don Quijote, a discount chain, and Ninety-nine Plus, which sells low-cost produce and household goods.

He does not share Warren's enthusiasm for banks, however. "I believe Japanese banks have gotten ahead of themselves," he said. His reason is that he sees little loan growth ahead, as companies have strong balance sheets and do not need much new borrowing, even at low rates.

Linehan has not abandoned Japan's global companies. His largest holding is Chiyoda, a construction company that is benefiting from increased spending on liquefied natural gas facilities as demand and prices for liquid natural gas have soared.

The portfolio also includes what he calls some "closeted" plays on technology, like Nidec, which makes motors for hard disk drives for Apple Computer's iPod, instead of going "whole hog into riskier sectors like semiconductors."

But what if the wave of upbeat economic news turns sour and Japan disappoints again? Warren said he would lean more toward global names like Toyota and Canon, which are less expensive and have more downside protection, or less vulnerable domestic sectors like pharmaceuticals and food stocks.

Linehan could go elsewhere in Asia, although he appears to be in no hurry. He said he would lighten his Japan holdings if the Nikkei index rose to around 15,000, or an additional 25 percent. "But as long as the economy reflects further strengthening, there might not be a need to lighten up," he said.