AVI Japan Opport.Tst - Annual Financial Report
16/03/2023 07:00
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RNS Number : 1370T AVI Japan Opportunity Trust PLC 16 March 2023
AVI JAPAN OPPORTUNITY TRUST PLC
ANNUAL REPORT 2022
LEI: 894500IJ5QQD7FPT3J73
Annual Financial Report for the year ended 31 December 2022
The Directors present the audited Annual Report for the year ended 31 December
2022.
Copies of the Annual Report can be obtained from the Company's website ("AJOT"
or the "Company") www.ajot.co.uk (http://www.ajot.co.uk) or by contacting the
Company Secretary by telephone on 07702 965 986.
AVI Japan Opportunity Trust plc ("AJOT" or "the Company") invests in a
focussed portfolio of quality small and mid-cap listed companies in Japan that
have a large portion of their market capitalisation in cash or realisable
assets.
Notice of Annual General Meeting
The Company's Annual General Meeting ("AGM") will be held at 11.30 am on
Tuesday, 2 May 2023 at the offices of Stephenson Harwood LLP, 1 Finsbury
Circus, London, EC2M 7SH. Shareholders will be able to submit questions to the
Board and the Investment Manager, Asset Value Investors Limited ("AVI") ahead
of the AGM and answers to these, as well as AVI's presentation, will be made
available on the Company's website. Please refer to the Notice of AGM for
further information and the resolutions which will be proposed at this
meeting.
Dividends
The Directors are proposing a final dividend of 0.80 pence per Share for the
year to 31 December 2022. Subject to the approval of Shareholders at the
forthcoming AGM, the proposed final ordinary dividend will be payable on 26
May 2023 to Shareholders on the register at the close of business on 28 April
2023. The ex-dividend date will be 27 April 2023.
Performance Summary
31 December 2022 31 December 2021
Net Asset Value* (£) 156,395,000 160,721,000
Net Asset Value per Share (total return) for the year -4.3% 12.3%
Share price total return for the year -4.5% 10.0%
Comparator Benchmark
MSCI Japan Small Cap Index (£ adjusted total return) -1.0% -1.4%
Portfolio Valuation
Net Cash as % of Market Cap 41.9% 39.9%
Net Financial Value as % of Market Cap 63.0% 75.9%
EV/EBIT 6.0x 5.1x
FCF Yield 6.0% 5.4%
Year to 31 December 2022 Year to 31 December 2021
Earnings and Dividends
(Loss)/profit before tax -£6.6m £17.9m
Investment income £3.7m £3.2m
Revenue earnings per share 1.69p 1.55p
Capital earnings per share -6.79p 11.89p
Total earnings per share -5.10p 13.44p
Ordinary dividends per share 1.55p 1.40p
Ongoing Charge
Management, marketing and other expenses
(as a percentage of average Shareholders' funds) 1.5% 1.5%
2022 Year's Highs/Lows High Low
Net asset value per share 120.7p 102.8p
Net asset value per share at 31 December 2022 114.11p
Share price at 31 December 2022 112.25p
Discount as at 31 December 2022 1.63%
(difference between share price and net asset value)
* For all Alternative Performance Measures, please refer to the definitions in
the Glossary in the Annual Report.
COMPANY OVERVIEW
Company Purpose
Discovering overlooked and under researched investment opportunities, and
utilising shareholder engagement to unlock long-term value.
Company Objectives and Strategy
AJOT aims to provide Shareholders with total returns in excess of the MSCI
Japan Small Cap Index in GBP ("MSCI Japan Small Cap"), through the active
management of a focused portfolio of equity investments listed or quoted in
Japan which have been identified by Asset Value Investors Limited as
undervalued and having a significant proportion of their market capitalisation
held in cash, listed securities and/or other realisable assets.
AVI seeks to unlock this value through proactive engagement with management
and taking advantage of the increased focus on corporate governance, balance
sheet efficiency, and returns to shareholders in Japan.
The companies in the portfolio are selected for their high quality, whether
having strong prospects for profit growth or economically resilient earnings.
By investing in companies whose corporate value should grow overtime, AVI can
be patient in its engagement to unlock value.
Benchmark
The MSCI Japan Small Cap Index.
Capital Structure
As at 31 December 2022, the Company's issued share capital comprised
137,461,702 Ordinary Shares of 1p each, of which 400,000 were held in treasury
and therefore total voting rights attached to Ordinary Shares in issue were
137,061,702. As at 10 March 2023 it comprised 140,361,702 Ordinary
Shares, none of which were held in treasury, and therefore total voting rights
attached to Ordinary Shares in issue were 140,361,702.
Investment Manager
The Company has appointed Asset Value Investors Limited ("AVI" or the
"Investment Manager") as its Alternative Investment Fund Manager.
The Association of Investment Companies ("The AIC")
The Company is a member of The AIC.
Website
The Company's website, which can be found at www.ajot.co.uk
(http://www.ajot.co.uk) , includes useful information on the Company, such as
price performance, news, monthly and quarterly reports as well as previous
annual and half year reports.
CHAIRMAN'S STATEMENT
"Four years since launch, your Company has performed well in the face of
multiple headwinds."
Overview of the Year
On behalf of the Board of Directors ("the Board") I am pleased to present the
Annual Report for 2022. This past year your Company has pursued its investment
objective with ever more conviction and has not been in any way unnerved by
the historic sell-off in bond and equity markets. I am truly appreciative of
our Shareholders continuing to validate the Board's confidence in our
investment approach. This confidence was demonstrated most clearly in October
2022 when Shareholders overwhelmingly decided not to take up the exit
opportunity to which they were entitled. I would like to thank our brokers,
Singer Capital Markets, for their efforts in canvassing opinion from
Shareholders representing a significant majority of the shares in issue, that
they did not wish to exit at this time - in so doing they have saved the
Company, and you, a substantial amount of money that would have been wasted on
the administrative expenses of putting an exit opportunity together. In
accordance with the terms of our Initial Public Offering ("IPO"), an exit
opportunity will continue to be offered on a biannual basis.
The war in Ukraine and other macroeconomic factors in the last 12 months have
created a challenging environment for all investors, and your Company was no
exception. Risk aversion has risen, and valuations have fallen, particularly
for growth assets.
In Japan specifically, the Bank of Japan's ("BoJ") ultra-low interest rate
policy has continued to weigh on the Japanese Yen, despite core inflation
reaching a 41-year high of 4% at the end of the year. The persistence of this
high inflation rate may have been the root cause for the BoJ's slight
modification to the 10-year Japanese Government Bond yield cap in December
2022, which increased from 0.25% to 0.5%. This small shift in policy could
indicate that the BoJ is moving away from its loose monetary stance, towards
further rate increases in 2023, which would benefit the Yen and have
implications for assets globally.
Despite the challenging environment, your Company ended the year -4.4% in GBP
terms in respect of net asset value, a less negative return than most global
equity markets. However, it was still below the -1.0% return of the official
comparator benchmark, the MSCI Japan Small Cap Index. Total net assets at the
year end stood at £156.4mn (31 December 2021: £160.7mn). Performance across
the portfolio was generally good but was dragged down by two large detractors,
Wacom and Pasona (as discussed in more detail below). Since inception,
however, AJOT has proven to be a source of resilience, with returns since
October 2018 of 21.4% versus 8.7% for the benchmark.
Year to date 2023, AJOT has returned +7.7% versus the benchmark's return of
+2.4%.
Your Company's bottom-up, deep research approach focuses on investing in
companies with solid fundamentals and attractive valuations. The portfolio has
63% of its market cap covered by net cash and investment securities, while
trading on a lowly 6.0x EV/EBIT multiple. This, coupled with continued
engagement, shielded us from the extreme re-pricing experienced in more highly
valued stocks, as rising interest rates exposed stretched valuations.
Your manager, AVI, has continued public campaigns at four portfolio companies
and sent letters or presentations in private to a further nine. AVI has
leveraged its expanded Japan team in the past 12 months to step up the level
and intensity of engagement. The team continues to build deep relationships
with management, having had numerous high-level meetings with Chairmen, CEOs
and outside directors of our portfolio companies. The preferred approach of
private engagement has led to notable successes, with a raft of
shareholder-friendly measures being introduced across multiple companies
without requiring public campaigns. This approach of constructive engagement
has helped the Company to navigate the challenging market conditions and
deliver strong results for our investors.
Dividend
As provided for in the Prospectus at the IPO, the Company intends to
distribute substantially all the net revenue arising from the portfolio. The
Company paid an interim dividend of 0.75p per share in November 2022, and the
Board has elected to propose a final dividend of 0.80p per share, bringing the
total dividend for the year ended 31 December 2022 to 1.55p per share (2021:
1.40p per share).
Investment Strategy
AJOT listed in October 2018 to take advantage of the highly attractive
opportunity to invest in under-valued, over-capitalised Japanese small-cap
equities with strong underlying business fundamentals. We believed - and still
do - that active engagement and corporate action will allow for the unlocking
of valuation anomalies unavailable in other global developed markets, with the
potential for attractive absolute and relative returns.
Four years since launch, your Company has performed well in the face of
multiple headwinds: lacklustre performance of small cap stocks (MSCI Small Cap
Japan has underperformed its larger MSCI Japan counterpart by almost 8%); a
notable sell-off in the Japanese Yen which has detracted 11% from GBP returns;
as well as a turbulent global environment. The Board remains confident AVI is
well placed to continue executing on the strategy and that there are still
plenty of mispriced investment opportunities.
Share Premium and Issuances
As at 31 December 2022, your Company's shares were trading at a discount of
-1.6% to NAV per share. The Board monitors the premium/discount carefully and
manages it by periodically issuing or buying back shares. During 2022, we
re-issued 250,000 shares from treasury and employed the Company's authorised
block listing facility to increase our shares in issue by 4,241,000. 400,000
shares were bought back during the year. As at 31 December 2022, 137,061,702
shares were in circulation, a pleasing increase from the 80,000,000 shares at
AJOT's launch.
Since the year end, the Company re-issued the 400,000 shares which had been
bought back during the year, as well as a further 2,900,000 shares using the
block listing facility. As a result, as at 10 March 2023, 140,361,702 shares
were in circulation.
The Directors believe that the performance of the Company since IPO should be
attractive to a larger pool of investors and are constantly exploring ways to
grow AJOT.
Debt Structure and Gearing
As described in the Prospectus, the Board supports the use of gearing to
enhance portfolio performance. The Company has in place a ¥4.33 billion debt
facility which was renewed on 2 February 2022. As at 31 December 2022, ¥2.47
billion of the facility had been drawn and net gearing stood at 5.1%.
Governance
The Directors firmly believe that greater diversity in the boardroom leads to
better decision-making and therefore higher returns for our Shareholders.
Needless to say, your Board meets or surpasses the various recommendations
issued by the Parker Review, the Hampton-Alexander Review and the New Listing
Rule 9.8.6 (9-11) for gender and ethnic diversity. However, the Board has even
greater and, I would argue, more directly relevant diversity within its ranks:
the diversity of social background, of education, of skills, of work
experience and of lived experience. Our diversity of gender and ethnicity is a
happy coincidence of constructing a Board with these broader attributes.
Ultimately, I believe that boards should be comprised of the best people for
the job, full stop. I am proud to confirm that for your Board these are the
very people that we do have in place.
Investment trusts are different from operating companies. We do not have CEOs
or CFOs which the FCA mentions in their recommendation for positive diversity
on boards. The Board has chosen not to appoint a Senior Independent Director
("SID"), one of the roles that the FCA believes should count towards diversity
targets. If a Board is functioning correctly then there should be no need for
a SID. The Directors of AJOT are strong, knowledgeable, professional
individuals who do not hesitate to inform me when I have made a mistake. It is
the Chairman's role to foster a culture where the independence of Directors
helps them serve as effective stewards of Shareholder wealth. This is how all
boards should operate. For investment trusts a much more important role than
that of the SID is filled by the Chair of the Audit Committee and we strongly
believe that the FCA should recognise the unusual position of investment
trusts and include the Chair of Audit role when looking at diversity
considerations. Your Board's Chair of the Audit Committee role is held by a
capable female Director.
The role of proxy advisors has increased over the past few years. This, I
believe, is to the detriment of the investment trust industry as a whole.
Proxy advisors seem to have little understanding of how investment trusts and
their boards operate, and unfortunately their decision-making process remains
opaque and final.
The use of a proxy advisor is understandable for an index fund charging
minimal fees, but those shareholders are in a minority, or non-existent, in
most investment trusts which are actively managed by their shareholders and
where investment manager decisions are subject to active board oversight.
While there are good reasons why the Board and the Investment Manager may make
certain decisions, there is no forum or opportunity for boards to explain the
rationale and circumstances for decisions to proxy advisors, who may then
advise a vote against particular resolutions.
Proxy advisors also have an obsession with succession planning. In order to
address this concern, the Board has formulated a succession plan which will
see new Directors join the Board and existing Directors resign as their duties
are handed over. However, I strongly believe that Shareholders should make the
ultimate decision on who represents them on the Board and over the coming
period I will be seeking Shareholders' views on the evolving composition of
the Board, rather than have it dictated by others with an imperfect
understanding on how the industry functions, let alone how specifically your
Board operates, all while using arbitrary metrics.
Outlook
Japan reopened its doors to tourists on 11 October 2022 and much of the APAC
region followed suit. As travel and tourism are set to resume across the
continent, the added economic boost that this brings is likely to continue to
drive inflation expectations upwards - a step-change from the long-entrenched
deflationary mindset of Japan. The possible impact of these and other factors
on BoJ and Japanese Government policy going forward has firmly returned this
long neglected country to the forefront of global investors' minds for the
first time in a generation.
Furthermore, the fundamental argument for Japanese equities remains
compelling, especially when compared to developed market alternatives. Not
only are we seeing continued improvements in capital management and corporate
governance, but at the end of December 2022, the TOPIX traded at 1x price to
book, lower than its long-term average, since 1993, of 2x. Similarly, the
TOPIX's trailing PE stood at 14x at the end of December, below its long-term
average of 21x (to 1993)*.
Predicting the future macroeconomic landscape is a difficult task. Instead,
your Investment Manager's focus remains on finding high-quality companies
trading at attractive valuations. AJOT's portfolio has become higher in
quality since its launch, and its level of engagement has intensified
materially. The current portfolio is well positioned with a concentrated yet
diverse collection of high-quality, lowly valued companies, with multiple
levers for re-rating. As a Board, we are confident that AJOT can continue
building on its successful track record of engagement with companies and
delivering overall attractive returns for investors.
In the coming weeks I shall be meeting any institutional investors who would
like to see me and I encourage as many Shareholders as possible to attend our
fourth AGM in May. The Investment Manager, your Board and I are respectful of
the workload of our investors. We remain available to all our Shareholders -
institutional and retail - who may wish to discuss an issue or ask a
question. As always, please feel free to reach out to me through our broker,
Singer Capital Markets, to arrange a meeting.
Norman Crighton
Chairman
15 March 2023
*Bloomberg as at 31 December 2022
OUR TOP 10 HOLDINGS
1. DTS Corp (8.0% of portfolio, 6.9x EV/EBIT)
DTS provides IT-related services to Japanese corporations. Its business is
expanding into Digital-transformation related ("DX") fields such as cloud,
robotics and IoT ("Internet of Things"). Japanese companies have underinvested
in their IT infrastructure, with antiquated processes and complex legacy
systems. With encouragement from the Government, we believe companies will
dramatically increase their IT expenditure - much to the benefit of DTS.
2. Nihon Kohden Corp (7.5% of portfolio, 9.3x EV/EBIT)
Nihon Kohden is a medical equipment manufacturer, with a product lineup of
patient monitors, defibrillators and ventilators. It has generated a 5.4%
20-year sales CAGR, with sales declining in only three of the past 37 years,
and has grown its overseas business to just over a third of sales. We expect
this growth to continue as the business benefits from increased global
healthcare expenditure and a shift to higher value-add digital solutions.
3. Konishi Co Ltd (7.0% of portfolio, 4.0x EV/EBIT)
Konishi is famed for its household glue brand BOND. It has a dominant market
share across the domestic adhesives market and successfully expanded its
business into infrastructure repair works. We believe Konishi has potential to
grow its adhesive offering into more industrial applications and to establish
itself overseas, which is not reflected in the lowly 4.0x EV/EBIT valuation.
4. NC Holdings Co Ltd (6.7% of portfolio, 7.4x EV/EBIT)
NC Holdings owns an eclectic mix of businesses, including solar panel
consulting, conveyor belts and - the most attractive - car parking systems.
Each standalone each business has its merits, but they have no synergies
combined. This is part of the reason why the business trades on 7.4x EV/EBIT
vs our fair value of over 10x.
5. Wacom Co Ltd (6.6% of portfolio, 9.4x EV/EBIT)
Wacom is a global leader in digital pen solutions. It is uniquely positioned
to benefit from the growing adoption of digital pens. Its dominant market
position allows Wacom to be at the forefront of technological innovation,
developing solutions that utilise big data, artificial intelligence and
virtual reality. Investors underappreciate the growth potential of Wacom's
technology, but under the leadership of the relatively new President and with
improved investor communication, we think this will change.
6. T Hasegawa Co Ltd (6.6% of portfolio, 9.8x EV/EBIT)
T Hasegawa is a top 10 global flavour and fragrance ("F&F") manufacturer.
Its products are used in a variety of products from tea to instant noodles.
The Company's motto is "a company founded on technology" and it has a rich
library of recipes. The F&F industry is appealing because of its high
barriers to entry and resilient pricing power, which explains why T Hasegawa's
global peers trade on an average EV/EBIT of over 20x.
7. Shin-Etsu Polymer Co Ltd (6.5% of portfolio, 3.5x EV/EBIT)
Shin-Etsu Polymer manufactures an assortment of devices, but its main product
is a container used to carry semiconductor silicon wafers. It is a listed
subsidiary of Shin-Etsu Chemical, and our base case is that Shin-Etsu Polymer
is taken over. The companies' business operations are intertwined, and the
management of both companies have made indications that they are open to
addressing the parent/child listing issue.
8. TSI Holdings Co Ltd (6.1% of portfolio, <0.0x EV/EBIT)
TSI Holdings owns a collection of diversified apparel brands. Its unique focus
on athleisure and outdoor wear sets it apart from competitors, but it trades
at a steep discount due to a bloated balance sheet. Net cash, investment
securities and real estate account for 176% of TSI's market cap, obscuring the
underlying business. Were TSI to trade in line with peers, there would be a
+150% upside to the current share price.
9. Fujitec Co Ltd (5.8% of portfolio, 18.3x EV/EBIT)
Fujitec is a global leader in manufacturing and servicing elevators and
escalators. It has a unique focus on Asian markets, which offer a compelling
growth opportunity. We launched a public campaign in May 2021, calling on
Fujitec to address decades of underperformance and its undervaluation. Fujitec
is the largest independent player left in a highly consolidated market, making
it an attractive acquisition target for competitors.
10. Digital Garage Inc (5.6% of portfolio, 7.2x EV/EBIT)
Digital Garage's three main business interests are card payment processing,
online marketing and venture investments. The real crown jewel is the
wholly-owned payment processing business, a beneficiary of shifting habits
towards cashless payments. Digital Garage's complex holding structure leads to
a large discount and we have been engaging with management on ways to rectify
this, including separating the payments business.
INVESTMENT MANAGER'S REPORT
"The portfolio trades at 6.0x EV/EBIT and is positioned for several potential
idiosyncratic events with upsides of 50-100%. Combined with a cheap Yen and an
increasingly supportive macro environment, we are optimistic about prospective
returns."
2022 was a year filled with challenges and volatility, with a war on European
soil and rising interest rates leading to a sell-off in both bonds and
equities. However, Japanese equities fared relatively well, with the MSCI
Japan Small Cap Index rising by +0.8% in JPY and declining by -1.0% in GBP.
This contrasts with the significant declines seen in other markets, such as
the Bloomberg UK Government All Bonds Total Return Index, which fell by
-25.1%, the MSCI AC World Index, which decreased by -8.1%, and the
growth-oriented NASDAQ Composite, which saw a drop of -24.1% (all in GBP). A
strong USD flattered these returns and in local currency they fared more
poorly.
Despite the challenging market conditions, your Company proved to be a source
of resilience, with a GBP NAV decline of -4.4%. This is a testament to the
strength of the portfolio and its low starting valuations. Performance across
the portfolio was generally good, with several stocks contributing positively
to the overall performance. Our three largest contributors, DTS, Fujitec and
Teikoku Electric, all benefited from shareholder engagement, leading to a
re-rating in their valuations. However, we experienced two large detractors,
Wacom and Pasona, which had an outsized impact on performance, reducing
returns by -6.4%.
Wacom suffered from a deterioration in its business environment while Pasona's
decline was driven by a broad sell-off in growth equities. We will discuss
both in more detail later, but the share price weakness has made their
investment cases more compelling and we still see upside.
Like much of the rest of the world, inflation continued to creep higher in
Japan, with the country's core CPI ending the year at 4.0%, the highest since
the late 1980s. Pressure from inflation and relatedly, a low approval rating
for Prime Minister Kishida, might have been the catalyst for the BoJ modifying
its 10-year Japan Government Bond yield target from 0% ±0.25% to 0% ±0.5% in
December 2022. Although only slight, it signalled a change in policy that
might pave the way for further rate increases in 2023. The effect was a
strengthening of the Yen against Sterling, which at the year low had weakened
by -8.8% but ended the year down only -1.9%.
Adjusting for portfolio weight changes, i.e. keeping the weights of the stocks
still held at the end of the period constant, the EV/EBIT multiple of the
portfolio increased modestly from 5.8x to 6.1x. This was entirely accounted
for by Fujitec's multiple rising from 8.6x to 18.3x, with the position
beginning the period as a 6.1% weight in the portfolio. Although Fujitec
suffered from a temporary decline in earnings driven by lockdowns in China,
its share price gained 22% on hopes of an increased chance of a
much-anticipated privatisation.
During the year we welcomed Shimpei Ochi to the Japan team. He joins us on a
nine-month internship, having advised the Ministry of Economy, Trade and
Industry in Japan on their M&A guidelines and subsequently completing a
Master of Law from Columbia Law School.
The backdrop for shareholder engagement is as supportive as ever.
Fifty-fivecompanies received shareholder proposals during the 2022 AGM season
(almost double last year's number), Uniden was taken private in what we
believe is the first successful friendly tender offer completed by a foreign
engagement fund, while EGMs were called at Fujisoft, Fujitec and Japan
Securities Finance.
Increased public engagement activity is helpful for our endeavours, reminding
management of our portfolio companies that they are accountable to
shareholders, and highlighting the risks of not listening to our suggestions.
Support from regulators is also helpful, and it was encouraging that the Japan
Stock Exchange continued discussing ways to improve corporate value of
companies listed on the TSE. Shortly after the end of 2022, they decided to
mandate companies to disclose policies and initiatives to address capital
efficiency and low valuations (specifically a price/book ratio below 1x).
Our engagement was mostly behind the scenes, sending 24 detailed letters or
presentations and holding 121 meetings with our 25 portfolio companies. This
led to notable successes at DTS when in May 2022 it announced a new mid-term
plan with a raft of shareholder-friendly measures, and Teikoku Electric when
management committed to paying out 100% of earnings to shareholders and
announced a 4.3% share buyback, the second in the space of nine months.
Our public engagement was limited to four companies, which were continuations
of prior campaigns. We submitted shareholder proposals to NS Solutions, SK
Kaken and Tokyo Radiator for the second year in a row, ranging from seeking
higher shareholder returns to greater board independence. While all companies
have controlling shareholders, we received good support from minority
shareholders. The fourth was Fujitec, where at the end of June 2022 we
released a public statement questioning whether Fujitec's independent
directors were acting in the best interests of shareholders. This followed
Fujitec's decision to retain the then President as Chairman, despite his
appointment not having been approved by shareholders at the AGM.
There are a number of exciting engagement campaigns developing amongst
portfolio companies. We intend to keep these discussions private and will only
pursue them in the public domain when our progress stalls and management fail
to accept our suggestions. Our lack of public activity this year is evidence
of the successes we are having privately and we hope that this continues next
year.
Portfolio Trading
Buying activity
Almost half of all purchases over the year were concentrated in two new
positions: TSI Holdings and Nihon Kohden. TSI Holdings owns a collection of
diversified apparel brands, with an attractive investment opportunity from a
more shareholder-friendly management team, upside from managing the brands
more efficiently and a bloated balance sheet, where net cash, investment
securities and real estate account for 176% of TSI's market cap. We believe
there is +150% upside to our fair value.
Nihon Kohden is a medical equipment manufacturer, with a product line-up
across patient monitors, defibrillators and ventilators. Net cash accounts for
28% of its market cap, trading on a 9.3x EV/EBIT multiple vs medical equipment
peers on 15.3x. Aside from the undervaluation, we believe the company is
underearning, with margins below peer average. We have identified several
improvement measures aimed at doubling the share price, something the
President agreed was achievable during a meeting.
We added to positions in Shin-Etsu Polymer (a potential takeover target by its
parent company Shin-Etsu Chemical), NC Holdings (where across our funds at
year-end, we held 21% of the votes), Konishi (open shareholder register and
trading on only a 4.0x EV/EBIT multiple), Wacom (on share price weakness), and
we continued building our position in LOCONDO.
Selling activity
In the four years since launching AVI Japan Opportunity Trust, we have built
up experience engaging with the management of our portfolio companies. Having
gone through three AGMs and holding numerous meetings, this was a year to
reflect on whether continued engagement at some companies was the best use of
our resources. Our frustration with a handful of companies tended to coincide
with companies where there was a high ratio of allegiant shareholders. We sold
positions in Kato Sangyo, Daiwa Industries, King Co, Kanaden and Sekisui
Jushi. The average % ownership of allegiant shareholders at our companies
which are not subsidiaries of parent companies fell from 27% to 21% over the
year.
The largest sale was Daibiru, which was subject to a takeover bid by its
parent company in 2021, followed by C Uyemura, where we took profits
surrounding concerns over a potential semiconductor slowdown and following an
+84% return on our investment. Other selling was modest; trimming a few
positions on valuation strength to fund purchases of new positions.
Contributors
DTS Corp
Contribution (GBP) 1.4%
% of net assets 8.0%
EV/EBIT 6.9x
NFV/Market Cap 44%
DTS, an IT system developer, was the largest contributor to returns with a
+22% share price increase, adding 140bps to performance.
We first invested in DTS in January 2020 premised on the appealing backdrop
for increased IT development demand and management's openness to engaging with
us on how to rectify the undervaluation. Across all AVI funds, we built a 10%
ownership stake, becoming the largest shareholder. Since then, we have sent 12
presentations and letters to management covering corporate governance,
employee remuneration, balance sheet efficiency and its growth strategy.
In May 2022 DTS responded to our suggestions and announced a new mid-term plan
that included a raft of shareholder-friendly policies. Beyond higher
shareholder returns which could see up to 35% of the market cap returned to
shareholders in the next three years, DTS announced a strategy to double
EBITDA by 2030, increase ROE to 16% and focus on high-value-added IT services.
We have been working closely with management and the board behind the scenes
on the mid-term plan, holding multiple meetings, including face-to-face
discussions in Japan. DTS' response to our engagement has been exemplary -
they allowed us frequent dialogue with senior board members and, aside from a
few minor points, actioned all our suggestions. The positive share price
performance, and significant outperformance vs the market is, we believe, a
testament to our efforts and clearly demonstrates the real value of AVI's
constructive activism - something that we hope will not have gone unnoticed by
our other investee companies, as well as other investors in the Japanese
markets.
DTS' share price sold off towards the end of the year, ending on an EV/EBIT
multiple of 6.9x vs peers' 13.5x. There remains considerable upside and, as
the largest shareholder, we will continue engaging with management to achieve
a higher share price.
Fujitec Co Ltd
Contribution (GBP) 1.3%
% of net assets 5.8%
EV/EBIT 18.3x
NFV/Market Cap 33%
Fujitec, the elevator and escalator company, was the second largest
contributor over the period, adding 126 bps to performance as its share price
increased +22%. The share price rise was driven by an increase in Fujitec's
EV/EBIT multiple from 8.6x to 18.3x.
It was a busy period for our engagement work, which followed on from our
public campaign in May 2020. At the end of 2021, Fujitec announced a mid-term
plan which we felt was strategically misguided, with confusing growth plans
and an unjustifiable capital allocation plan towards M&A. We responded by
sending a presentation to the company, showcasing the plan's flaws, putting
forward solutions and, importantly, threatening to take our grievances public.
To our delight, management responded to all eight of our recommendations and
released a supplementary plan at the start of March 2022.
Then in May 2022 Oasis, a Hong Kong-based activist investor, launched a
campaign calling for shareholders to vote against the reappointment of
President Takakazu Uchiyama, son of Fujitec's founder. Oasis highlighted
several related-party transactions dating back to 1989, and as recently as
2021, alleging that Mr Uchiyama has enriched himself at the expense of
shareholders.
Fujitec's response was troubling. Instead of admitting wrongdoing and
strengthening corporate governance, Fujitec embarked on a campaign of denial
and obfuscation. Fujitec's response omitted important details, the law firm
appointed to investigate the transactions was not independent and the board,
amazingly and despite ostensibly being 50% independent, unequivocally
concluded that not one of the related-party transactions posed a problem for
corporate governance.
When the AGM came around in June 2022, the motion to reappoint Mr Uchiyama as
President was withdrawn just one hour before, in what we believe was an effort
to conceal his low level of support. Then shortly after the AGM, Mr Uchiyama
was reappointed as Chairman without the approval of the shareholders.
Fujitec's disregard for shareholder rights and circumnavigation of the AGM
voting process was astounding. We released a public statement to that effect,
questioning whether Fujitec's outside directors were representing
shareholders' best interests.
After our public letter, Oasis continued their campaign and in November 2022
called an Extraordinary General Meeting ("EGM") seeking to replace all of
Fujitec's outside directors. The objective is to bring new elevator industry
experience, reform the governance structure and, ultimately, unlock trapped
value. Given the disgruntled shareholder base, we expect that the vote will be
close and put the board in an untenable position where nearly half of the
shareholder base does not support their appointment. We hope that the EGM will
draw a line in the sand and with an improved board allow the company to focus
on growing its business.
Since we established a position in 2018, we have achieved an +89% return.
While the valuation is not as compelling as it was when we initiated the
position, there is a higher probability that Fujitec could be subject to a
takeover bid from a long list of potential suitors.
Teikoku Electric MFG Co Ltd
Contribution (GBP) 1.2%
% of net assets 0.5%
EV/EBIT 7.0x
NFV/Market Cap 39%
Despite a short holding period of just over a year, our investment in the pump
manufacturer Teikoku Electric has been a resounding success, achieving a +51%
return, with management responding positively to our engagement efforts. We
identified Teikoku Electric as a company with an overcapitalised balance
sheet, a good globally recognised product and a presence of several engagement
funds on the register.
Shortly after we acquired a position, we sent a 51-slide presentation to
management with a particular focus on exiting a loss-making non-core business
and addressing the inefficient balance sheet. Since commencing our dialogue,
management's openness to considering a sale of their non-core business has
improved and they have taken aggressive steps towards rightsizing the balance
sheet. After committing to paying out 100% of earnings at the start of the
year, Teikoku Electric announced a buyback of 4.3% of its shares and a 110%
increase in the dividend. The buyback came shortly after another 4.2% buyback,
meaning in just under a year and a half Teikoku Electric will have bought back
8.5% of its shares while paying a 4.9% dividend yield.
Naturally, the more accommodating attitude towards shareholders, coupled with
a +52% upgrade to full-year profit guidance, buoyed the share price. Although
the EV/EBIT of 7.2x is below that of peers, the sustainability of the earnings
strength is a concern, and we decided to trim our position. Teikoku Electric
is still on our watchlist and, should the share price weaken, we might look to
rebuild the position.
NC Holdings
Contribution (GBP) 1.0%
% of net assets 6.7%
EV/EBIT 7.4x
NFV/Market Cap 42%
We started investing in NC Holdings ("NCHD") in June 2021 following an
acrimonious public dispute between NCHD and its then-largest shareholder TCS.
NCHD owns a collection of businesses, including solar panel consulting,
conveyor belts and, the most attractive, car parking systems. Collectively,
they trade on an EV/EBIT multiple of just 7.4x, with net cash and investment
securities covering 42% of the market cap.
After TCS failed to replace NCHD's board, NCHD repurchased their shares (c.32%
of outstanding) at ¥900, a hugely accretive acquisition with the shares
closing the year at ¥2,073. With growing confidence in the quality of NCHD's
business, the presence of a US-based investor on the shareholder register and
a compelling valuation, we have been slowly increasing our position. Over the
year we almost doubled our ownership and, at the end of the quarter, we owned
21% of the company across AVI's funds. We note the US investor has also been
increasing their ownership and now holds 25% of NCHD's shares.
Our engagement agenda has covered a wide variety of topics, from reviewing
NCHD's conglomerate structure to improving corporate governance and adopting a
more generous 100% total return pay-out ratio.
NCHD does not disclose a policy on shareholder returns and, excluding the
repurchase of shares from TCS, has only paid out about 20% of its net income
over the past three years. A 100% dividend pay-out ratio on next year's
earnings would amount to a respectable 4.5% dividend yield. So far in our
engagement we have not heard a convincing response from management as to why
the three assets it owns should be held under the same corporate structure.
We believe if management act on all our suggestions, then the share price
would be able to reach our target price of ¥2,700-¥3,000, or 30%-45% higher.
Detractors
Wacom Co Ltd
Contribution (GBP) -3.5%
% of net assets 6.6%
EV/EBIT 9.4x
NFV/Market Cap 24%
The largest detractor over the year was Wacom, who saw its share price decline
-35%. Starting the year with a 8.3% weight and being the largest position, the
decline had a meaningful impact, detracting 346bps from performance. Wacom is
the global leader in digital pen solutions and our investment was premised on
the increased adoption of digital drawing and writing. Wacom manufactures both
its own branded tablets and sells its technology to other electronic device
manufacturers. For example, the S22 Ultra smartphone which launched at the
start of 2022 has an embedded Wacom pen.
While we continue to believe that digital writing solutions will see strong
growth over the long term, inflationary cost pressures and diminished consumer
spending power have weighed on short-term profits. Encouragingly, Wacom's B2B
business has been resilient with a growing customer base and higher adoption
of digital pens, but the consumer business has suffered from a demand-led
slowdown. In October 2022, Wacom released a profit warning revising down its
full-year sales and profit guidance by -11% and -56% respectively. We have
been a little disappointed in Wacom's investor communications surrounding the
profit decline, with comments shortly before the profit warning now appearing
naively optimistic, and poor planning to control gross margins and Selling,
General and Administrative ("SG&A") expenses. We sent a letter during
November 2022 outlining seven actions we think management can take to aid the
situation. We recognise that the consumer environment is out of management's
control, but there are several self-help measures that we would like to see
implemented.
Our conviction in Wacom's technology and long-term growth potential is
unchanged, and the market's myopic focus presents an opportunity to take
advantage of the share price dislocation. Using normalised earnings, Wacom
trades on an EV/EBIT multiple of only 5.3x, a remarkably low valuation
considering Wacom's technology and structural growth tailwinds from the
increased adoption of digital writing solutions.
We increased our holding in Wacom by 24% over the year, adding to our position
on share price weakness. As a top three shareholder, we are working closely
with management to address the underperformance and ensure that efforts are
being made to maximise shareholder value. With a return to normalised profits,
our estimated potential upside to the current share price is in the order of
+100%.
Pasona Group Inc
Contribution (GBP) -2.9%
% of net assets 3.8%
EV/EBIT <0.0x
NFV/Market Cap 203%
Pasona was a large detractor, reducing returns by 294 bps to performance. The
shares returned -43% over the period, driven by a -60% decline in Benefit
One's share. Pasona is one of Japan's largest recruitment and outsourcing
companies, mainly operating through three business segments: HR, Life, and
Public Solutions. Pasona owns a 50% stake in Benefit One, which accounts for
202% of Pasona's market cap. Benefit One is a market leader in providing
outsourced HR services, from education and training to healthcare and employee
benefit options.
Benefit One's -60% fall was less driven by fundamentals but more by general
market concerns over higher valued companies. Benefit One's share price
strongly correlated with the MSCI Japan Growth Index which fell -16% over the
year vs a smaller fall of -4% for the MSCI Japan. While Pasona traded on a
large discount, Benefit One's valuation was on the richer side at the end of
last year. We reduced our position by -30% ahead of the fall, but did not
manage to exit entirely.
Pasona is making a greater effort this year to help realise the value in its
business portfolio. Over the year, it IPO'd Circlace, a 43% owned digital
experience consulting firm and Bewith, a business process outsourcing company.
It is encouraging to see Pasona's newfound proactivity, and we expect that as
the transparency of Pasona's businesses improves and the company continues to
grow earnings, we will see a narrowing of the discount to its valuation.
Benefit One has 11.3m captive members on its platform, about 19% of the 60m
employed workers in Japan, providing stable cash flows and an opportunity to
sell additional services. With Pasona's 69% discount coupled with a more
appealing Benefit One valuation, we see upside to Pasona's knocked down share
price.
Teikoku Sen-i
Contribution (GBP) -1.2%
% of net assets 2.1%
EV/EBIT 1.2x
NFV/Market Cap 85%
Teikoku Sen-I's share price fell -33%, reducing returns by 117bps. Teikoku
Sen-I is the leading manufacturer and distributor of disaster prevention
equipment in Japan, from fire hoses to airport firefighting trucks.
Geographically speaking, Japan is precariously placed and each year suffers
from typhoons, earthquakes, and flooding. The Government of Japan is devoting
significant resources to disaster prevention infrastructure as have private
companies (particularly nuclear power operators).
Teikoku Sen-I is well placed to benefit from this trend and has a fantastic
track record of diversifying into new business lines. However, the market has
difficulty understanding Teikoku Sen-I's business model as its earnings are
extremely seasonal, with over 100% of profits coming in the first and last
quarter of the calendar year. It means that investors must wait until the last
quarter to get a good handle on the financial situation and, during the year,
less sophisticated investors tend to extrapolate the weak Q2 and Q3 earnings.
As usual, profits were low in Q2 and Q3, but grew by +24% in Q1 and we are
encouraged by the overall positive trend for Teikoku Sen-I's fiscal year so
far. All the weakness over the period therefore came from a fall in the
valuation, from an already low EV/EBIT of 4.2x at the start of the year, to a
remarkable 1.1x.
We have been gradually reducing our position in Teikoku Sen-I, and trimmed it
by a further 10% in 2022. Teikoku Sen-I's business outlook is good and clearly
undervalued, trading on a 1.1x EV/EBIT, but the shareholder register is
littered with companies that are allegiant to management, frustrating our
engagement efforts. As we expect continued earnings growth, we are in no rush
to exit the position. Still, we are unlikely to allocate further to the
investment and it could be used as a source of capital for higher conviction
ideas.
LOCONDO
Contribution (GBP) -0.8%
% of net assets 4.2%
EV/EBIT 10.0x
NFV/Market Cap 29%
LOCONDO is a relatively new position in the portfolio. It runs a fashion
e-commerce platform in Japan, which was launched to provide shoe manufacturers
a venue to sell online. Importantly, it does not own the inventory of each
brand, it simply matches buyers and sellers, then manages the logistics -
storage, delivery and returns. This asset light business model is hugely
appealing, and its larger peer, ZOZO, trades on an EV/Sales of 5.4x vs
LOCONDO's 0.9x.
We were also attracted to LOCONDO's growth potential, with Japan's fashion
ecommerce penetration currently standing at only 19% but estimated to grow to
41% by 2030. LOCONDO is aiming to have a 3% market share by 2030 which implies
a nine year compound annual growth rate of +19%. After a -73% decline in the
share price from its peak in September 2020, we are able to own this fantastic
business on an EV/EBIT of just 9.7x and with net cash covering 29% of its
market cap. While the EV/EBIT multiple is higher than the average company in
AJOT's portfolio, this is more than compensated by its stronger growth
prospects, and this is not factored into the share price.
During the year, LOCONDO announced that it had gained the rights to manage the
Reebok brand in Japan, owning 66% alongside ITOCHU's 33%. The brand has been
poorly managed, owned by Adidas and deprioritised for fear of cannibalising
Adidas' sales. Reebok should be hugely accretive for LOCONDO, who only paid
for the inventory (at a highly reasonable price) and is a large contributing
factor behind management's confidence in growing profits by +75% next year.
We have built a near 10% stake in LOCONDO, making us the largest shareholder.
We do not believe that the current share price reflects LOCONDO's intrinsic
value and will be working with management on ways to rectify the
undervaluation.
Outlook
The performance of our portfolio in the wider context of weak global markets
is encouraging and shows that fundamentals and valuations do matter. The MSCI
Japan Small Cap's return of -1.0% (in GBP) for 2022 against steep declines in
other indices proves Japan's diversification value.
We are optimistic about the macro environment in Japan. The weak Yen makes
Japan highly cost-competitive, both for tourism and manufacturing. Inflation
has returned after a 40-year absence and, with wage growth and increased
spending, we could see a more rational allocation of capital and improved
productivity, which would bode well for your portfolio companies.
It is challenging to predict how 2023 will unfold, but we remain convinced
that valuations are important. Your Company's portfolio trades at a lowly 6.0x
EV/EBIT and is positioned for several potential idiosyncratic events with
upsides of 50-100%. The potential for a reversal of foreign outflows, a
stronger undervalued Yen, and a robust economic environment in the coming
years, gives us reason to be optimistic about the potential for attractive
absolute returns for our Company's portfolio.
Joe Bauernfreund
Asset Value Investors Limited
15 March 2023
PORTFOLIO CONSTRUCTION
The objective of AVI's portfolio construction is to create a concentrated
position in about 20-30 holdings, facilitating a clear monitoring process of
the entire portfolio.
AVI picks stocks that meet our investment criteria and once we decide to
invest, a minimum position size of approximately 2% of the portfolio is
initiated. In determining position sizes, AVI is mindful of liquidity and the
likely timing of any catalysts to unlock value. A key consideration is the
make-up of the shareholder register, a proxy for how receptive management
might be to our suggestions. The portfolio is diverse in the industries within
it, but we are sector agnostic and select investments based on quality and
value.
Portfolio value by sector
2022 2021
Materials 29% 28%
Capital Goods 19% 24%
Software and Services 18% 18%
Health Care Equipment and Services 7% 0%
Technology Hardware and Equipment 6% 8%
Consumer Durables and Apparel 6% 0%
Retailing 5% 7%
Automobiles and Components 4% 4%
Commercial and Professional Services 4% 5%
Transportation 2% 2%
Food and Staples Retailing 0% 4%
Equity portfolio value by market capitalisation
2022 2021
<£250mn 26% 14%
£250mn - £500mn 15% 14%
£500mn - £750mn 19% 27%
£750mn - £1bn 17% 20%
£1bn - £2.5bn 23% 23%
>£2.5bn 0% 2%
INVESTMENT PORTFOLIO
At 31 December 2022
% of % of investee company Market
Company Stock AJOT Cost value NFV/Market
Exchange Identifier net assets £'000* £'000 Capitalisation(1 ) EV/EBIT(1)
DTS TSE: 9682 8.0% 1.4 10,939 12,568 44% 6.9
Nihon Kohden TSE: 6849 7.5% 0.7 11,274 11,660 29% 9.3
Konishi TSE: 4956 7.0% 2.5 11,055 10,986 73% 4.0
NC Holdings TSE: 6236 6.7% 17.1 7,842 10,405 42% 7.4
Wacom TSE: 6727 6.6% 1.7 13,911 10,352 24% 9.4
T Hasegawa TSE: 4958 6.6% 1.3 8,275 10,295 29% 9.8
Shin Etsu Polymer TSE: 7970 6.5% 1.7 10,055 10,166 56% 3.5
TSI Holdings TSE: 3608 6.1% 3.6 8,733 9,545 133% <0.0
Fujitec TSE: 6406 5.8% 0.6 5,309 9,104 33% 18.3
Digital Garage TSE: 4819 5.6% 0.6 7,427 8,833 81% 7.2
Top ten investments 66.4% 94,820 103,914
NS Solutions TSE: 2327 5.1% 0.4 8,649 8,019 47% 5.1
SK Kaken TSE: 4628 4.8% 0.9 9,444 7,413 96% 1.3
Locondo TSE: 3558 4.2% 8.5 8,213 6,603 29% 9.7
Pasona TSE: 2168 3.8% 1.2 5,112 5,888 198% <0.0
A-One Seimitsu TSE: 6156 3.2% 8.0 4,571 4,977 86% 4.3
Toagosei TSE: 4045 3.0% 0.6 5,753 4,741 56% 3.8
C Uyemura TSE: 4966 2.9% 0.6 2,971 4,571 51% 3.9
Alps Logistics TSE: 9055 2.4% 1.4 2,989 3,680 46% 3.6
Teikoku Sen-i TSE: 3302 2.1% 1.3 5,580 3,334 85% 1.1
Tokyo Radiator MFG TSE: 7235 2.0% 4.9 4,250 3,075 92% 0.0
Top twenty investments 99.9% 152,352 156,215
Soft99 TSE: 4464 1.9% 1.9 2,811 2,954 100% <0.0
Aichi TSE: 6345 1.8% 0.8 2,789 2,803 77% 2.0
Papyless TSE: 3641 1.0% 2.5 2,141 1,543 18% <0.0
Teikoku Electric MFG TSE: 6333 0.5% 0.3 468 743 39% 7.0
ITFOR TSE: 4743 0.0% 0.1 62 65 49% 2.4
Total investments 105.1% 160,623 164,323
Other net assets and liabilities (5.1%) (7,928)
Net assets 100.0% 156,395
(*)Please refer to Glossary in the Annual Report.
(1) Estimates provided by AVI. For all Alternative Performance Measures,
please refer to the definitions in the Glossary in the Annual Report.
LEI: 894500IJ5QQD7FPT3J73
FURTHER INFORMATION
AVI Japan Opportunity Trust Plc's annual report and accounts for the year
ended 31 December 2022 and the notice of meeting for the Company's AGM will be
available today on www.ajot.co.uk (http://www.ajot.co.uk) .
It will also be submitted shortly in full unedited text to the Financial
Conduct Authority's National Storage Mechanism and will be available for
inspection at https://data.fca.org.uk/#/nsm/nationalstoragemechanism
(https://data.fca.org.uk/#/nsm/nationalstoragemechanism) in accordance with
DTR 6.3.5(1A) of the Financial Conduct Authority's Disclosure Guidance and
Transparency Rules.
Neither the contents of the Company's website nor the contents of any website
accessible from hyperlinks on the Company's website (or any other website) is
incorporated into, or forms part of this announcement.
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