Emma Wall: Hello, and welcome to Morningstar. I'm Emma Wall, and here with me today to give three sectors to watch in Japan is Andrew Rose, Schroder's Manager of the Tokyo Fund.
Hello, Andrew.
Andrew Rose: Good morning.
Wall: So what is the first sector to watch then?
Rose: Well, one interesting sector in Japan is a fairly uniquely Japanese sector which is called trading companies. And trading companies, obviously, trade machinery, cars, food, et cetera. But they also have quite substantial overseas exposure to commodities like iron ore, coking coal. And it's interesting to me because stocks are extremely cheap, they are undervalued, and they are undervalued because commodity prices have been weak. So, commodity prices are down and the stocks are cheap, and I think that makes them quite sensitive to any type of rebound in commodity prices.
But also significant is, there is an element now of self-help. So, in the past they've continually invested in new types of commodity asset. Increasingly, what we've seen is these companies began to focus on ROEs, target ROEs, and if they can achieve that, be it via top line profitability or by shareholder efficiency, balance sheet efficiency, then I think the valuations will go higher. So, in other words, it will be rerated. The moment the price to book ratio is about 0.7, if it achieve their ROEs, you can see that move to, say, 1. So, that's one interesting sector for me.
Wall: And from the naive point of view, you'd imagine that anybody in the import/export business will be very sensitive to currency movement, is that the case? Because the yen has moved quite a lot over the last year, is that a problem?
Rose: Yeah. When the import and export and the currency exposure is not straightforward, because it's not just the yen/dollar, it's also yen/Australian dollar or Indonesian rupiah or whatever. For me, I think what's more key for trading company share prices is, certainly what happens to commodity prices, but also as to whether they actually work through their commitment to boosting ROEs, so that will be what drives the share prices, rather than the currency.
Wall: Okay and what's the second sector?
Rose: An unusual, maybe might think – I'm thinking of the insurance sector is being interesting. And I say unusual because, Japan has a declining population, so why would you want to invest in insurance companies when there are fewer people to buy insurance, frankly.
And for me the reason is that, it's been a sector that's been undervalued for a long time, but it’s lacked the catalyst for the undervaluation to be wound, if you like. But what you've got now is two things; one is premium rates are going up. We've seen a lot of rationalisation within the insurance sector – the premium rates are going up and loss ratios are going down. So, the sort of top line of the insurance company sector is growing in a way it hasn't for a long time. So you've had the undervaluation there for a long time, there is not a catalyst to unlock that. And I think it's now pretty interesting here to be exposed to.
Wall: I mean, when you think about insurance, it falls into two categories; there's general insurers, who I would expect have been hugely impacted by the, not that long ago, tsunami, and then there is the life insurance business with an aging population like Japan, you think that that would be difficult. I mean, how do you marry those macro pressures with profitability?
Rose: Yeah. Now, I like them both, but my comments were more towards the, what I call the non-life, the casualty insurers. And again, you might say, would you want to have an insurance company in Japan when you got threats of earthquakes and tsunami? And in fact, you can't really insure earthquake or tsunami; it's mainly a government risk, so that's less, but something to be concerned about.
Wall: Okay. And then what's the third and final sector?
Rose: I think an export sector, particularly the car sector, which last year was a very strong performer for much of the year, not so recently when it sold off. And it's a sector which clearly does benefit from a weak currency and from growth in U.S. market and Asian markets. And I like this sector now because, as I said, has sold off, valuations are low and they've come out with conservative forecast for this year.
So I think as we move through the year, probably you'll see upward revisions to those forecasts. So you have a sector which has underperformed, is undervalued and the news flow from here should be positive. So, within the export-related sectors, the car industry would be my favorite.
Wall: The car industry, I'd imagine is very dependent on the sort of global economy. Obviously, we are having rumours of interest rate rise in this country, which hugely impacts the consumer and the amount of disposable income they have; not so much in the U.S. but it is on the sort of medium-term horizon. How much then does the economy and sort of Western consumers and their ability to buy those cars, how much does that affect the stock?
Rose: You're right. I mean, sharply higher interest rates would be a negative for consumer demand and for auto demand. And the main risk, I guess, is the U.S.; sadly, the U.K. isn't that key for Japanese car companies. U.S. is the key risk. And whilst tapering's taking place, it's not on the radar; you don't have very sharply higher interest rate.
So, it's a risk worth bearing in mind, but it doesn't seem one to be too concerned about, and at the moment, I think the outlook for consumer spending in the U.S. is reasonably good.
Wall: Andrew, thank you very much.
Rose: Thank you.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
