Japan's Market in General
The Nikkei Index is now down 8.5% from pre-disaster levels. Barron's put out an article that was very bullish. "Buy Japan Now" it proclaimed over the weekend. Warren Buffett and Bill Gross have made bullish comments on Japan as well. (Bill Gross calls his a "tactical" position in Japan, that is, he is just trading it for the short term). Toyota shut its plants, but only until March 26th, 4 days from today. Both the Japanese government and the Bank of Japan have announced multiple monetary and fiscal stimulus packages to come, so it does seem likey that this will be more of a one or two quarter "blip" in Japan as opposed to a long drawn out recession. That is, as long as Japan avoids a nuclear disaster. I have no clue how to handicap that one.
However, after the Kobe quake in 1996, the market fell 25% before rebounding entirely over the next six months. According to the World Bank, this quake will cost $235BB, almost double the impact of the Kobe quake. Today, with the broader Japanese market down only 8.5%, I guess I am not that excited. "Be greedy when others are fearful" is a great Buffett quote, but I am not sure people are that fearful here.
Regarding particular ETFs or stocks in Japan, the obvious way to play Japan is via EWJ. It holds all the big cap and mega cap Japanese companies, including:
Toyota
Honda
Mitsubishi Financial
Canon
Sumitomo
Mizuho
Takedo Pharmaceutical
etc etc
I am even more surprised by the performance of EWJ however. After initially falling 16.5%, EWJ has recovered to the point where today it's only down 6.5%. The US market is still down 3%, so I would say that it doesn't seem that compelling to me. Investors are taking a lot of risk now for a mere 3.5% underperformance vs the US market. Even the XLU, an ETF of US utilities, is still down 4.5% from pre-quake levels. More on that later.
As far as valuations, I am sure that there are cheap Japanese stocks, but the market as a whole is trading at around 14.8x earnings, about inline with the US market. (this is also before downward revisions which are pretty likely). To me, if you were nimble enough to buy at the lows last week, then I would say that it was obviously a good trade, and maybe there is a little room left, but not enough to make me buy anything now. Have people forgotton that Sendai, a major port city, was just about wiped off the map?
What is even more surprising is that EWJ now trades at the largest premium ever to its NAV. The 4.5% premium I assume is a result of investors rushing to get long Japan as quickly as possible, and perhaps some BOJ stimulus money flowing into equities too. Since January 2010, the range of premiums/discounts to NAV has been -3% to +2%. I don't recommend buying this when it's at any premium to NAV.
The final problem with buying Japanese equities right now is that G-7 Central Banks are coordinating efforts to depress the Yen. The Yen rallied initially after the quakes, but bankers will ensure the Yen goes lower. That is negative for any dollar-based investor buying Japanese equities or ETFs. Sure, you benefit by owning stocks that export goods to foreign countries. A lower Yen makes their goods cheaper. But a lower yen means that when you translate that back to dollars, you lose. Finally, given that only 12.5% of GDP in Japan is exports, net net you are much more long the Yen than short it via export-driven equities.
Next I comment on utilities and tech, as they got pretty crushed last week.
Utilities
The nuclear meltdown potential has caused concern among US utility investors. Are nuclear plants in the US now likely to face additional regulatory scrutiny? What about ones that reside in earthquake prone areas? PG&E (ticker PCG) has a nuclear plant called Diablo Canyon in coastal California. Its license doesn't expire until 2024 however, so I suspect its a safe bet as a stock to pick up on the cheap. It's down 11% ytd, trades at 11.7x 2011 earnings, and its stock yields 4.2%. They did $3.42 in EPS last year, so at $43.75 its 13x trailing earnings, also pretty reasonable. There was an unfortunate gas pipeline explosion last year, but they have reserved for this and I wonder how much more unexpected bad news is out there to push the stock lower.
With the stock down $2.15, from $46 bucks a share, its lost almost $900mm of market value. I can't imagine that the FERC can dream up almost $1BB of costs to extend their license in 2024. Already Diablo Canyon can safely operate during a 7.5 magnitude quake, that is if you believe the company. Supposedly, the area can only produce quakes of up to 6.5 magnitude. The entire plant is probably worth $4-5BB, as nuclear plants today are probably worth $2000 per MW. (its a 2k MW plant). So the market has already dinged them for 20% of the total value of the plant. Probably overdone.
The supply chain in Japan is likely to cause some delays in producing products like the iPad2, which news crushed Apple. I still think AAPL is a buy at $325, that's where I plan to add, but it didn't quite get there. Hewlett Packard supposedly has little exposure to Japan, and suffered less. However, the bigger picture is that tech is a terrible performer this year, especially in big cap land. Value investors will start sniffing though eventually. Below I copied a blurb from Barron's that appropriately excludes cash from P/E calculations. The huge surplus of excess cash that these guys generate eventually will get noticed by some big, edgy, activist hedge funds. And they will take them on to encourage distributing more of that cash.
Barron's Excerpt
Tight-fisted technology companies are loosening up a little with dividend policies, but industry payouts generally remain small or nonexistent.
Cisco Systems announced its first dividend on Friday, saying it will pay six cents a share quarterly, while Hewlett-Packard (ticker: HPQ) last week increased its quarterly dividend by 50% to 12 cents a share.
The problem is that neither company's dividend is substantial. Cisco's yield is 1.4%, while HP's is 1.1%. Most techs resist paying the 3%-plus dividends that might attract investors to their depressed stocks, pressured lately by concerns about supply disruptions from the Japanese earthquake and nuclear crisis.
Apple, Google and Dell still pay no dividends. Intel is the most generous among major U.S. techs, with a 3.7% yield, while Microsoft's dividend is 2.6%.
Barron's has argued, most recently in "Time for a Change in Techland" (Feb. 21), that tech companies ought to pay ample dividends. In that story, we highlighted many cash- and earnings-rich techs that could substantially boost payouts. The industry has favored stock buybacks and acquisitions, but that has done little for their shares. Cisco had been a prime offender, buying back more than $69 billion of stock in the past decade while paying no dividend.
Generous dividends could boost tech stocks by attracting income-oriented investors. Legg Mason fund manager Bill Miller has written that major techs ought to pay out 70% of profits and that such a move could substantially boost their stocks. We've argued a 40% payout ratio is justified and more realistic.
Note: Includes Investments. E=Estimate. 1. Fiscal Year ending in Sept. 2.Fiscal Year ending in June. 3. Fiscal Year ending in July.
Sources: Thomson Reuters; Bloomberg; Company reports
Tech price/earnings ratios generally are low, and many are below 10 when net cash is stripped away. Microsoft, at 25, trades for less than 10 times estimated fiscal 2011 profit of $2.55 a share and has a P/E of just eight when its $3-plus a share in net cash and securities is stripped away. Cisco's P/E drops from about 11 to eight when cash is stripped out. Cisco shares, at 17, are down 16% this year amid growing concerns about its profit outlook.
Based on fiscal 2011 profit, even mighty Apple trades for a P/E of around 12 when its industry-leading cash hoard of almost $60 billion is stripped away.
Analysts still view most major techs as growth companies, but they're being valued as if their businesses are going away. Credit Suisse analyst Philip Winslow wrote last week that Microsoft trades at a 30% discount to the S&P 500, and investors are undervaluing its "sustainable revenue growth and defensive competitive characteristics." He sees $3-plus per share in profit in fiscal 2013 and carries a $36 price target.
Credit Suisse analyst Kulbinder Garcha began coverage of Apple with a $500 price target last week, arguing the company has an additional $10 a share of earnings power above the $23 that it is expected to produce for its September fiscal year.
Hewlett-Packard, at 42, trades for just eight times projected profit of $5.24 for its fiscal year ending in October, and for six times the company's fiscal 2014 goal of $7 a share. One reason HP trades so cheaply is that it pays a miserly dividend equal to less than 10% of its earnings and talks about making more acquisitions—which generally have destroyed value in the tech world.
Tech valuations have rarely been lower. Managements can continue their practices of the past—doing deals and buying back stock—or they can get serious about dividends. Our view is that ample dividends are the correct approach and would play well with yield-starved investors.
-- Andrew Bary
Conclusion
I am just waiting for the Keynesian economists out there to say something like, "This is good for Japan. Think of all the additional spending that will come from rebuilding their infrastructure." Sure, spending might go up short term, but the capital has to come from somewhere, and also there is the opportunity cost of spending. Replacing highways and plants isn't generating new capacity or increasing productivity. In fact it's displacing a lot of that spending. It's net net a negative to their economy. The stock market SHOULD be lower, earnings will be lower in Japan, period.
Spending, as I have argued in the past, (and contrary to what our country's fiscal and monetary leaders think), isn't a positive in and of itself. Spending to improve capacity, products, or productivity IS a good use of capital. Spending without generating return is a waste, as anyone with half a brain knows.
Finally, we are seeing more unrest in the Middle East. Today Yemen's generals are revolting against their president. My only general comment is that, contrary to what our Western media is reporting, these revolts aren't necessarily people rising up against evil dictators in hopes of attaining freedom & democracy. Much of it is that these are countries that have leaders in bed with the US, and they are making a statement about who they want their leaders to align themselves with.
If this spreads to Saudi Arabia, a country with massive oil production and our best ally in the Middle East, then oil could go up much much more. Add in Japan's need for oil to rebuild, and the bull case there likely stays intact. And, with more uncertaintly, I would bet that this enhances the case for QE3, or at least prevents the Fed from raising rates anytime soon. Keep your commodities, tech still looks very cheap, and perhaps add a little XLU or PCG.
Barron's Excerpt
Tight-fisted technology companies are loosening up a little with dividend policies, but industry payouts generally remain small or nonexistent.
Cisco Systems announced its first dividend on Friday, saying it will pay six cents a share quarterly, while Hewlett-Packard (ticker: HPQ) last week increased its quarterly dividend by 50% to 12 cents a share.
The problem is that neither company's dividend is substantial. Cisco's yield is 1.4%, while HP's is 1.1%. Most techs resist paying the 3%-plus dividends that might attract investors to their depressed stocks, pressured lately by concerns about supply disruptions from the Japanese earthquake and nuclear crisis.
Apple, Google and Dell still pay no dividends. Intel is the most generous among major U.S. techs, with a 3.7% yield, while Microsoft's dividend is 2.6%.
Barron's has argued, most recently in "Time for a Change in Techland" (Feb. 21), that tech companies ought to pay ample dividends. In that story, we highlighted many cash- and earnings-rich techs that could substantially boost payouts. The industry has favored stock buybacks and acquisitions, but that has done little for their shares. Cisco had been a prime offender, buying back more than $69 billion of stock in the past decade while paying no dividend.
Generous dividends could boost tech stocks by attracting income-oriented investors. Legg Mason fund manager Bill Miller has written that major techs ought to pay out 70% of profits and that such a move could substantially boost their stocks. We've argued a 40% payout ratio is justified and more realistic.
Techland Tightwads
These companies' price/earnings ratios are generally low, and higher dividends would probably help.| 2011 E | Net Cash | |||||||
| Recent | P/E ex | Total | Per | % Of Shr | Div | |||
| Company/Ticker | Price | EPS | P/E | Net Cash | (bil) | Share | Price | Yld |
| Apple / AAPL1 | $334.64 | $22.98 | 14.6 | 11.8 | $59.7 | $63.98 | 19% | 0.0% |
| Microsoft / MSFT2 | 24.78 | 2.55 | 9.7 | 8.3 | 31.6 | 3.69 | 15 | 2.6 |
| Google / GOOG | 561.36 | 34.54 | 16.3 | 13.4 | 31.5 | 97.80 | 17 | 0.0 |
| Cisco / CSCO3 | 17.00 | 1.59 | 10.7 | 7.9 | 25.0 | 4.46 | 26 | 1.4 |
| Intel / INTC | 19.90 | 2.04 | 9.8 | 8.1 | 19.8 | 3.47 | 17 | 3.7 |
| Dell / DELL | 14.11 | 1.70 | 8.3 | 5.8 | 8.4 | 4.28 | 30 | 0.0 |
| Nokia / NOK | 8.02 | 0.73 | 11.0 | 7.2 | 10.2 | 2.76 | 34 | 6.8 |
| Yahoo! / YHOO | 15.86 | 0.75 | 21.1 | 17.5 | 3.6 | 2.77 | 17 | 0.0 |
Sources: Thomson Reuters; Bloomberg; Company reports
Based on fiscal 2011 profit, even mighty Apple trades for a P/E of around 12 when its industry-leading cash hoard of almost $60 billion is stripped away.
Analysts still view most major techs as growth companies, but they're being valued as if their businesses are going away. Credit Suisse analyst Philip Winslow wrote last week that Microsoft trades at a 30% discount to the S&P 500, and investors are undervaluing its "sustainable revenue growth and defensive competitive characteristics." He sees $3-plus per share in profit in fiscal 2013 and carries a $36 price target.
Credit Suisse analyst Kulbinder Garcha began coverage of Apple with a $500 price target last week, arguing the company has an additional $10 a share of earnings power above the $23 that it is expected to produce for its September fiscal year.
Hewlett-Packard, at 42, trades for just eight times projected profit of $5.24 for its fiscal year ending in October, and for six times the company's fiscal 2014 goal of $7 a share. One reason HP trades so cheaply is that it pays a miserly dividend equal to less than 10% of its earnings and talks about making more acquisitions—which generally have destroyed value in the tech world.
Tech valuations have rarely been lower. Managements can continue their practices of the past—doing deals and buying back stock—or they can get serious about dividends. Our view is that ample dividends are the correct approach and would play well with yield-starved investors.
-- Andrew Bary
Conclusion
I am just waiting for the Keynesian economists out there to say something like, "This is good for Japan. Think of all the additional spending that will come from rebuilding their infrastructure." Sure, spending might go up short term, but the capital has to come from somewhere, and also there is the opportunity cost of spending. Replacing highways and plants isn't generating new capacity or increasing productivity. In fact it's displacing a lot of that spending. It's net net a negative to their economy. The stock market SHOULD be lower, earnings will be lower in Japan, period.
Spending, as I have argued in the past, (and contrary to what our country's fiscal and monetary leaders think), isn't a positive in and of itself. Spending to improve capacity, products, or productivity IS a good use of capital. Spending without generating return is a waste, as anyone with half a brain knows.
Finally, we are seeing more unrest in the Middle East. Today Yemen's generals are revolting against their president. My only general comment is that, contrary to what our Western media is reporting, these revolts aren't necessarily people rising up against evil dictators in hopes of attaining freedom & democracy. Much of it is that these are countries that have leaders in bed with the US, and they are making a statement about who they want their leaders to align themselves with.
If this spreads to Saudi Arabia, a country with massive oil production and our best ally in the Middle East, then oil could go up much much more. Add in Japan's need for oil to rebuild, and the bull case there likely stays intact. And, with more uncertaintly, I would bet that this enhances the case for QE3, or at least prevents the Fed from raising rates anytime soon. Keep your commodities, tech still looks very cheap, and perhaps add a little XLU or PCG.
Hi, very nice blog I just found here. Keep on writing about Teva please. Best of investment luck to you /Peter
ReplyDeleteYou are very wrong about Japan though. Their profits are not at all at their full potential atm. US has got very extreme profit margins atm.
ReplyDeleteP/E10 in Japan is 14.5.
P/E10 in USA is 23,5.
P/B and P/S are akso half in Japan.
If you factor in a comparison with alt yield it gets more extreme.
Based on the 10Y bond in both countrys, Japan has a FED-model rate of 5.82 % and US has a rate of 0.71 %.
Thanks Peter. yes profit margins are back to all time highs in the US. are your P/Es using normalized profit margins then? Do you have any thoughts on the yen? I question the yen's ability to strengthen however in the next 6-12 months, esp given the G7 countries commitments to keeping the yen weak. Makes Japan a tougher investment right now.
ReplyDeleteI use the Shiller smoothed PE, also known as the PE10 method.
ReplyDeletehttp://www.multpl.com/
I fully agree that the Yen will weaken. Will make profits much better in Japan.
The best trade will be long Japaneese stocks and short the Yen/USD.
In a comparison between bonds in Japan and USA, it seems crazy to me to short the US bonds, and not the Japaneese ones. The 30Y US rate is very very high in comparison.
Its funny to me that the largest short bonds etfs in US target the 20+ bonds, and not the shorter ones.
Yep long japan short the yen could be a good trade. I think TBF is still good (short us treasuries) as we rely so much on external foreign funding and monetization. japan is 95% internally financed. but i agree, JGB's are a great short too, the risk being more in a short squeeze from quants/other hedge funds in a liquidity squeeze.
ReplyDelete