Japan Market Comment & Outlook
The Japanese stock markets have recovered after the brief but sharp correction, with losses of around 9% from mid-September to the end of the first week of October, and are now up 4.4% from their lowest point.
The turbulence in the Chinese real estate sector, caused by the heavily indebted Evergrande Group (3333 HK) and the negative headlines surrounding missed interest payments by Fantasia Holdings (1777 HK), has faded into the background. The focus is increasingly on third-quarter earnings reports, the upcoming elections (parliamentary election on October 31), and the details of the announced stimulus package, which are eagerly awaited. The general sentiment was certainly boosted by the likely agreement in the U.S. Congress regarding the debt ceiling increase. The Nikkei 225 managed to break above the 200-day moving average again and seems poised for higher levels. Looking at the quarterly results, we see that Takashimaya (8233 JT), one of Japan’s major department stores, was a major disappointment, revising its forecast for first-half operating profit from ¥2 billion to now expecting a loss of the same magnitude. Similarly disappointing was the announcement from Fast Retailing (9983 JT), which owns the UNIQLO brand, expecting an operating profit of ¥270 billion, significantly below expectations, which ranged between ¥300 billion and ¥345 billion. On the other hand, SBI Holdings (8473) raised its pre-tax profit forecast by 100%.
The 200-day moving average has proven to be a very good support level for the third time this year. The March high was also slightly exceeded in today’s trading session. The trading range is open up to 2,200 points, implying a possible 10% advance. If the majority of third-quarter earnings reports are favorable, higher prices could be targeted.
Topix vs. Nikkei 225: The Nikkei 225 is generally used as the market barometer. However, similar to the Dow Jones Industrial in the U.S., this index is somewhat of a relic that doesn’t reflect the overall market well. It includes only 225 stocks and is price-weighted. The four largest index constituents—Fast Retailing (9983 JT), Tokyo Electron (8035 JT), Softbank (9984 JT), and Daikin Industries (6367 JT)—together account for over 20% of the index. The Nikkei 225 was first published in 1949. In contrast, the Topix, currently comprising 2,180 stocks, represents the overall market much better. It is also market-cap weighted. The top five holdings—Toyota Motor (7203 JT), Sony (6758 JT), Keyence (6861 JT), Recruit Holding (6098), and Softbank (9984 JT)—account for 12% of the index. Additionally, the Topix is divided into 33 industry sub-indices. Therefore, it makes sense to use the Topix as a barometer for the Japanese market.
The sector picture hasn’t fundamentally changed; Marine Transport and Mining are still at the top. Electric Power had an exceptionally poor period, down 5.5% since the last report. The sub-index heavyweight Kansai Electric Power (9503 JT) had to take a reactor offline to carry out anti-terrorism upgrades. This reactor is expected to be reconnected in October 2022. Non-Ferrous Metals performed very well, advancing by about 8%, primarily driven by the sub-index heavyweight Sumitomo Metal Mining (5713 JT), which has a 28% index weight and rose over 11% after positive news about a stake in a Chilean mine.
Digital Garage (4819 JT): Digital Garage is an internet solutions provider. The company offers strategic planning for e-commerce tools, web design, and consulting in the online advertising market. The headquarters is in Tokyo, with a branch in San Francisco. With Japan’s digitalization still in its infancy, Digital Garage is operating in the "right" sector, as reflected in its fundamental data. The gross profit margin is high at 70%, and the net profit margin is 30%. Digital Garage has an outstanding convertible bond worth ¥25 billion, maturing in September 2023. The parity is at 92% with a premium of 20%, and it is currently trading at 111%. The stock looks very attractive, sitting in the middle of its trading range, with potential up to ¥5,600 (from the current ¥5,140). At this stock price, the convertible bond would have a fair value of 118%, with an increase in delta from the current 0.54 to 0.65.
Fancl (4921 JT): Fancl is a manufacturer of cosmetic products and toiletries. Fancl supplies, among others, Costco Wholesale Corp (COST US) in the United States. Its main competitors in Japan are Kao Corp (4452 JT) and Shiseido (4911 JT), as well as L'Occitane Int'l (973 HK). The company’s net profit margin has averaged 7% over several years. The company is debt-free, except for an outstanding ¥10 billion convertible bond maturing in April 2024. The parity stands at 96% with a modest premium of 18%. The convertible bond has a put option in April 2022 and is currently trading at 113%. The stock has broken above its 200-day moving average today, and the next target is the red resistance line at around ¥3,900 (a 5% advance). Breaking through this resistance could pave the way to ¥4,150. For the convertible bond, this would mean a 5% increase in fair value (compared to the put) and a 9% increase (calculated to maturity).
Disclaimer: The opinions expressed in this market commentary reflect solely the author’s view and are in no way intended as recommendations to buy or sell. Holinger Asset Management disclaims any liability for losses arising from trading in stocks, indices, convertible bonds, or other financial instruments mentioned in this market commentary.