Japan has been a market where investors have been buying growth at all costs, and the opportunity set remains limited from a valuation perspective, in our view. However, the Invesco International and Global Growth team has been able to identify select opportunities so far this year. Invesco International Growth Fund remains underweight Japan, but we added to our exposure in the second quarter in companies that meet our Earnings, Quality and Valuation (EQV) criteria.
To begin, let’s put the valuation picture in perspective. The top-contributing stocks for the MSCI All Country World ex-U.S. Growth Index include Japanese companies Shiseido, Fast Retailing and Recruit, which have forward price-to-earnings (P/E) ratios of 40x, 31x and 30x, respectively.1 (None of these are fund holdings as of June 30, 2018). Throughout Japan, large-cap companies that have a return on equity (ROE) of 15% or better are trading at an average next-12-months (NTM) P/E of 25x, whereas our two recent initiations came with NTM P/Es of less than 17x.2
A new opportunity in Japan
In the second quarter, we initiated a position in Hoya Corp., a global leader in technology components such as photomask blanks for semiconductors and glass disks for hard disk drives, as well as eyeglass lenses. (1.48% of Invesco International Growth Fund as of June 30, 2018).
This is a business that has generated ROE in the high teens, despite having 10% of the market cap in net cash, yet we were able to begin accumulating shares at an attractive valuation with an ex-cash NTM P/E of 16x.3
Hoya holds a dominant No. 1 position with more than 50% market share, and in some cases, they are the monopoly provider for their products.4 Their board structure consists of only one insider, which is almost unheard of in Japan, and they have a history of returning free cash flow to shareholders through buybacks and dividends.
Building on existing opportunities
In addition, we continued to build our position in Asahi Group, a global beer, spirits, soft drinks and food company (1.57% of Invesco International Growth Fund as of June 30, 2018). We initiated this holding in the first quarter of 2018 at a forward P/E of less than 17x.3
In the past, we considered Asahi to be a prime example of the inefficiencies we often find within Japanese businesses. So, what led us to buy a former poster child of inefficiency?
- In general, the Japanese beer industry has undergone structural changes. With the help of government initiatives and enforcement, the industry has shifted away from volume rebates and promotional spending. Pricing has risen for the first time in many years. Simply put, the industry has recently been prioritizing profitability over market share.
- Specific to Asahi, they have sold off their non-operational assets, thus improving balance sheet efficiency. Operating margins have been rising, ROE has risen to the mid-teens, and both have scope for further improvement, in our view.
Over the coming years, we believe Asahi may benefit from upcoming changes in the beer tax structure — the majority of their volumes are expected to experience a tax decrease as the high tax rate on full malt beer normalizes to a lower level. At the same time, we expect competitor volumes to experience a tax increase as the tax rates rise for low-priced beer alternatives.
Investors in Japan have tended to gravitate toward growth at the expense of valuation. But we believe that our focus on quality growth companies at attractive prices is key to long-term performance. Despite a limited pool of companies that meet our requirements in Japan, we have been able to uncover a few opportunities that fit with our approach.
1 Sources: MSCI, Bloomberg, L.P., as of June 30, 2018
2 Sources: FactSet Research Systems, Bloomberg, L.P., as of June 30, 2018
3 Source: Bloomberg, L.P., as of June 30, 2018
4 Source: Hoya Corp.
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The MSCI All Country World ex-U.S. Growth Index is an unmanaged index considered representative of growth stocks across developed and emerging markets, excluding the United States. The index is computed using the net return, which withholds applicable taxes for nonresident investors.
Forward price-to-earnings ratio is a variant of a company’s price-to-earnings ratio, and is calculated by dividing the company’s current share price by its expected earnings, usually for the next 12 months or next full fiscal year. In the case of the former, this is also known as next-12-months (NTM) price-to-earnings.
Return on equity (ROE) is a measure of profitability, calculated as net income as a percentage of shareholders’ equity.
Holdings are subject to change and are not buy/sell recommendations.
The risks of investing in securities of foreign issuers, including emerging market issuers, can include fluctuations in foreign currencies, political and economic instability, and foreign taxation issues.
The performance of an investment concentrated in issuers of a certain region or country is expected to be closely tied to conditions within that region and to be more volatile than more geographically diversified investments.
Growth stocks tend to be more sensitive to changes in their earnings and can be more volatile.
The fund is subject to certain other risks. Please see the prospectus for more information regarding the risks associated with an investment in the fund.