The Japanese yen has been rising steadily against the dollar for a quarter of a century now. The trend started in 1985 when Japan agreed, in an international accord signed at New York’s Plaza Hotel, to intervene in currency markets to arrest what seemed at the time as an excessive U.S. trade deficit aggravated by the strength of the dollar.
While most economic commentators portray the strong yen as a fundamental problem for Japan, portfolio manager Drew Edwards of Advisory Research (ARI) Funds says the Japanese have proven themselves adept at adjusting to a stronger currency. The yen has appreciated over 50% against the dollar in just the past five years.
In an interview with AdvisorOne, Edwards said it is true that Japan is a global exporter and as such can be adversely impacted by a strong yen. But that’s not the whole story. “Seventy percent of Japanese GDP is based on domestic consumption,” he says. “Domestic consumers benefit from this.”
Another key beneficiary of a strong yen is investors, Edwards (left) adds. “Most of the companies we invest in are usually net cash. They have strong balance sheets with a lot of cash. What they’re doing with it increasingly is invest outside of Japan. The yen is so strong that they’re able to buy foreign assets at a great discount.”
The result, he says, is a significant pick-up in corporate M&A. When his Advisory Research team visits companies, “We ask what they’ll spend their cash on; that’s what they say.”
Edwards emphasizes that his team members are bottom-up investors, so they’re not focusing their search specifically on companies that are takeover targets. “We’re buying companies that are asset rich, trading at a discount to net asset value.” But he says it is precisely those stocks that are cheap relative to NAV and out of favor that are often attractive as acquisitions.
Edwards says that the energy sector particularly is a “space where we’re seeing a lot of Japanese interest.” Because Japan imports nearly all of its energy resources, the Japanese are keenly interested in the new fracking technologies that can extract abundant natural gas in friendly allied countries like the U.S. and Canada, he adds. And he notes that the strong yen helps Japanese companies importing energy and raw materials used in production, though he acknowledges that Japanese companies on an aggregate basis will be hurt by the yen’s strength.
In any event, most of Advisory Research companies are net cash, and consequently store their financial assets in a rich currency, giving them a strong advantage as investors.
Though the firm does not make its investment decisions on macroeconomic criteria, most of the international stocks they are buying tend to be in Asia and Japan and not in Europe or the U.K. “We’re just not finding that the valuations [of European companies] are cheap enough to justify the macro-level risk in the region,” Edwards says.
Two of Edwards’ current favorites are Chugoku Marine Paints (TYO:4617) and Maruichi Steel Tube (TYO:5463). Chugoku a $500 million market-cap, Tokyo-based industrial paint manufacturer with a leading position in the market for paints used on ships and containers. Edwards calls it a play on emerging-markets growth since most of the company’s revenue stems from rapidly growing Asian markets like China, South Korea and Vietnam. Edwards says its current P/E is 6.3; its price-to-book is just 0.75 despite a consistent 13% return on equity.
Maruichi Steel Tube is a $2 billion market-cap, Osaka-based manufacturer of welded steel tubes and pipes. The company has no debt, pays a 2.8% dividend and has a price-to-book ratio of just 0.7 and a P/E of 13.9. Edwards says its low valuation is due to a perception that the construction market has matured, but he says this overlooks the fact that “Maruichi has invested significantly in growing overseas markets, such as Vietnam and India.” Edwards says shareholders will benefit from rapid revenue growth and improved return on earnings as the firm leverages its strong balance sheet.
Advisory Research, which targets institutional and high-net-worth investors and investment advisors, manages four funds: the All-Cap Value Fund (ADVGX); Global Value Fund (ADVWX); International Small-Cap Value Fund (ADVIX); and the International All-Cap Value Fund (ADVEX).