AVI Japan Opport.Tst - Annual Financial Report
14/03/2024 07:00
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RNS Number : 7813G AVI Japan Opportunity Trust PLC 14 March 2024
AVI JAPAN OPPORTUNITY TRUST PLC
ANNUAL REPORT 2023
LEI: 894500IJ5QQD7FPT3J73
Annual Financial Report for the year ended 31 December 2023
The Directors present the audited Annual Report for the year ended 31 December
2023.
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 focused
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 a.m. on
Wednesday, 1 May 2024, at the offices of the Association of Investment
Companies (the "AIC"), 9(th) Floor, 24 Chiswell Street, London, EC1Y 4YY.
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.
Dividend
The Directors are proposing a final dividend of 0.85 pence per Share for the
year to 31 December 2023. Subject to the approval of Shareholders at the
forthcoming AGM, the proposed final ordinary dividend will be payable on 24
May 2024 to Shareholders on the register at the close of business on 26 April
2024. The ex-dividend date will be 25 April 2024.
Performance Summary
31 December 2023 31 December 2022
Net Asset Value* £182,943,000 £156,395,000
Net Asset Value per Share (total return) for the year 15.8% -4.3%
Share price total return for the year* 14.8% -4.5%
Comparator Benchmark
MSCI Japan Small-Cap Index (£ adjusted total return) 6.9% -1.0%
Portfolio Valuation*
Net Cash as % of Market Cap 35.8% 41.9%
Net Financial Value as % of Market Cap 49.6% 63.0%
EV/EBIT 8.7x 6.0x
FCF Yield 4.4% 6.0%
Year to 31 December 2023 Year to 31 December 2022
Earnings and Dividends
Profit/(loss)before tax £25.2m -£6.6m
Investment income £4.0m £3.7m
Revenue earnings per share 1.76p 1.69p
Capital earnings per share 15.89p -6.79p
Total earnings per share 17.65p -5.10p
Ordinary dividends per share 1.70p 1.55p
Ongoing Charge
Management, marketing and other expenses
(as a percentage of average Shareholders' funds) 1.5% 1.5%
2023 Year's Highs/Lows High Low
Net asset value per share 130.3p 110.1p
31 December 31 December 2022
2023
Net asset value per share 130.3p 114.1p
Share price 127.0p 112.3p
Discount (difference between share price and net asset value) 2.5% 1.6%
* 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,
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 typically have 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 capitalising on 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 2023, the Company's issued share capital comprised
140,836,702 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
140,436,702. As at 13 March 2024 it comprised 140,836,702 Ordinary Shares,
400,000 of which were held in treasury, and therefore total voting rights
attached to Ordinary Shares in issue were 140,436,702.
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
"The portfolio is well positioned with a concentrated, yet diverse, collection
of high-quality, lowly valued companies, with multiple levers for re-ratings.
As a Board, we are confident that AJOT can build on its successful track
record of engagement and will continue to deliver attractive returns for
investors."
Overview of the Year
On behalf of the Board of Directors ("the Board") I am pleased to present the
Annual Report for 2023 for AVI Japan Opportunity Trust plc. The Company was
launched in 2018 to take advantage of the rich opportunity set in Japan,
believing that the corporate governance reform agenda first espoused in 2013
had gained critical momentum, and that a sea change was imminent. This was not
a consensus view, with Japan considered by most to be a perennially cheap and
largely irrelevant market for global investors.
2023 then was a year in which (other) investors' enthusiasm for Japanese
equities grew and scepticism waned. The strong economic backdrop, ultra-loose
monetary policy, low relative valuations, weak yen, and unabated progress on
corporate governance reform drew global attention. Notably, at the start of
the year the Tokyo Stock Exchange ("TSE") announced it would require companies
to disclose capital efficiency improvement plans, particularly by those
trading below 1x book value.
Japanese equity markets were buoyant, with the MSCI Japan returning +28.6%
over 2023 (in JPY) and the Nikkei seeing its largest one-year rise since 1989,
up at +31.0%. This rally, however, was mostly limited to larger cap names,
which outperformed their small-cap counterparts by +7.5%.
In this context, it is pleasing to report that your Company ended the year
+15.8% in GBP terms, outperforming its official comparator benchmark, the MSCI
Japan Small Cap Index, which returned +6.9%. Since its inception, AJOT has
delivered returns of +40.5% versus +16.2% for the benchmark. In JPY terms,
since inception, returns are significantly higher, at +73.7% vs +43.6% for the
benchmark.
Your manager, AVI, has continued constructively engaging with portfolio
companies to unlock value. The Board got a first-hand look at their efforts
this year, as 2023 marked the first time that we travelled together to Japan.
The enthusiastic response from market participants and investee companies
alike to our visit was testament to the high regard in which AVI is held and
coupled with the unique benefits of the investment trust structure that your
Company enjoys, we are more positive than ever on our future prospects. AVI's
investment team builds deep relationships with the management of every
portfolio company, holding a great number of meetings with senior executives
and board directors. This approach has led to numerous shareholder-friendly
measures being introduced across multiple companies without requiring public
campaigns which has delivered strong results for our investors.
The preferred approach of private engagement has led to notable successes,
with detailed letters or presentations sent to nine portfolio companies over
the year. Three portfolio companies were the subject of public engagement,
including NC Holdings, where three of our shareholder resolutions were
successfully adopted.
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 0.85p per share in November 2023, and the
Board has elected to propose a final dividend of 0.85p per share, bringing
total dividends for the year ended 31 December 2023 to 1.70p per share (2022:
1.55p 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. Active engagement and
corporate action are the key to unlocking valuation anomalies and AJOT's
track-record has demonstrated the potential absolute and relative returns this
approach can deliver.
Over five 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 brethren by almost 16%); a
marked depreciation of the Japanese Yen which has detracted -33% from GBP
returns, and a turbulent global environment encompassing a pandemic, rapidly
rising interest rates and multiple geopolitical events. The Board remains
confident that AVI is well placed to continue executing on the strategy and
that there are still plenty of mis-priced investment opportunities.
Share Premium and Issuances
As at 31 December 2023, your Company's shares were trading at a discount of
-2.5% to NAV per share. The Board monitors the premium/discount and carefully
manages it by periodically issuing or buying back shares. During 2023, we
employed the Company's authorised block listing facility to increase our
shares in issue by 3,375,000 while 985,000 shares were bought back during the
period. As of 31 December 2023, 140,436,702 shares were in circulation, a
pleasing increase from the 80,000,000 shares at AJOT's launch.
The Directors believe that the performance of the Company since IPO should be
attractive to a larger pool of investors and are constantly exploring avenues
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 ¥2.9 billion debt
facility, which was renewed on 2 February 2022 and subsequently extended to 5
April 2024 on the same terms while renewal terms are being agreed. As at 31
December 2023, ¥2.93 billion (£16.3 million) of the facility had been drawn
and net gearing stood at 1.6%.
Board Trip to Japan
In September the Board travelled to Japan for its first visit. Meeting with a
variety of advisors, market participants, lawyers and the Tokyo Stock
Exchange, it provided Directors with a deeper understanding of the opportunity
set and of how the Company can be best positioned to benefit. The Board had
the opportunity to meet with six portfolio companies, including a laboratory
tour and tasting experience at T Hasegawa's R&D facilities outside Tokyo.
In Osaka, it was a great privilege when Konishi, your Company's 4(th) largest
position, invited the Board to their historic headquarters built in 1903. This
was the first time a foreign company had been invited to the site and it was
pleasing to see the depth of the ties AVI has built with the company.
The Board left encouraged with the changes underway in Japan and the evident
success of AVI's engagement efforts. Overall, it was a highly fruitful visit,
which confirmed that this time really is different in Japan.
Outlook
At the end of November, news broke that Toyota Motors - one of Japan's last
holdouts to reform its balance sheet - will partially unwind its cross
shareholding in parts maker Denso. In December, the TSE announced that it
would add further pressure by calling on 1,000 plus companies that have
parent-subsidiary relationships or that have listed or equity affiliates to
increase disclosure around their rationale for having listed subsidiaries and
their efforts to ensure their independence. Just after the end of the year in
January, the TSE then released the names of 1,115 companies that disclosed
information regarding actions to implement policies conscious of cost of
capital and share price, shaming the 2,160 that did not.
The mounting pressure for corporate reform will not subside in 2024. AJOT's
focus on finding attractively valued, durable companies and using active
engagement to unlock value holds it in good stead to benefit from the changing
tide. The portfolio is well positioned with a concentrated, yet diverse,
collection of high-quality, lowly valued companies, with multiple levers for
re-ratings. As a Board, we are confident that AJOT can build on its successful
track record of engagement and will continue to deliver attractive returns for
investors. The portfolio as at the year end had 49% of its market cap covered
by net cash and investment securities and traded at an 8.7x EV/EBIT multiple.
In the coming weeks I shall be meeting any institutional investors who would
like to sit down with me, and I hope to see as many Shareholders as possible
at our AGM in May. The Board and I 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 directly
(norman.crighton@ajot.co.uk (mailto:norman.crighton@ajot.co.uk) ) or contact
our broker, Singer Capital Markets, to arrange a meeting.
Norman Crighton
Chairman
13 March 2024
OUR TOP 10 HOLDINGS
1. Nihon Kohden (9.7% of portfolio, 15.3x EV/EBIT)
Nihon Kohden is a medical equipment manufacturer. It has compounded sales over
the past 20 years at 4.9%, with sales declining in only four of the past 38
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.
2. TSI Holdings (8.7% of portfolio, 4.9x EV/EBIT)
TSI Holdings owns a portfolio 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 92% of TSI's market cap, obscuring the
underlying business. Were TSI to trade in line with peers, there would be a
+100% upside to the current share price.
3. Takuma Co (8.6% of portfolio, 6.7x EV/EBIT)
Takuma builds waste treatment plants for municipalities in Japan, and with a
labour shortage, there is increasing demand for companies to operate these
plants after construction. Our strong conviction lies in Takuma's shifting
business model, towards recurring maintenance and operation contracts, which
we don't think is reflected in Takuma's 3.9x EV/EBIT multiple at present.
4. Konishi (8.5% of portfolio, 5.4x 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 5.4x EV/EBIT valuation.
5. Shin-Etsu Polymer (7.4% of portfolio, 7.3x 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.
6. DTS Corp (7.4% of portfolio, 9.9x 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.
7. Eiken Chemical (6.5% of portfolio, 7.9x EV/EBIT)
Eiken Chemical is a manufacturer of medical diagnostics equipment, operating a
high-quality business with a proven track record of growing sales. Eiken
Chemical holds a dominant market position in Colon Cancer Screening, with an
overwhelming global market share in excess of 70%. Furthermore, Eiken Chemical
is set to experience structural growth from the ageing population and is a
vulnerable takeover target with an open shareholder register. Our engagement
will focus on capital allocation, operational improvement, and shareholder
communication.
8. Wacom (5.6% of portfolio, 20.0x 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.
9. Jade Group (5.5% of portfolio, 13.1x EV/EBIT)
JADE GROUP (formerly LOCONDO) operates a fast-growing, capital light, fashion
e-commerce business. In 2022, JADE GROUP acquired a stake in Reebok Japan
which it has flawlessly integrated into its logistics network. There is a long
growth runway for e-commerce in Japan and JADE GROUP is well positioned to
benefit.
10. NC Holdings (4.9% of portfolio, 7.0x 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 business has its merits, but they have no synergies combined.
This partly explains why the business trades on 7.0x EV/EBIT vs our fair value
of over 10.0x.
INVESTMENT MANAGER'S REPORT
"At the time of writing, we are building positions in five new names, which,
on average, trade on an EV/EBIT multiple of 4.0x, with 106% of their market
cap covered by cash, securities and rental real estate. In each of these
positions, we see an avenue to upsides in the order of 50 - 100% and the
potential for us to become large shareholders."
Dear AJOT Shareholders,
During the period from 1 January to 31 December 2023, your Company returned
+15.8% in GBP. This compares with a return for the benchmark, the MSCI Japan
Small Cap Index, of +6.9%. Over the course of the period, the Yen depreciated
by -11.5% against the Pound, which has been a headwind to Sterling-based
returns. In Yen, AJOT's NAV has increased by +31.0% over the period and +73.7%
since launch.
It was a pleasing end to your Company's fifth anniversary year. In a year that
strongly favoured large-cap value stocks, where AJOT has little exposure, the
continued outperformance of the portfolio is a testament to the strategy of
generating idiosyncratic returns from a concentrated portfolio of
high-quality, overcapitalised, undervalued companies. Driving returns were TSI
Holdings (share price +68% in Yen), Konishi (+65%) and JADE GROUP (+96%). TSI
Holdings saw its share price rerate following the disclosure of management
initiatives to address the low valuation, while Konishi benefitted from +35%
earnings growth over the past 12 months, with JADE GROUP on track to grow its
operating profits by +76% this year.
The Japanese Yen weakness was driven by a more cautious approach to moderating
Yield Curve Control ("YCC") from Kazuo Ueda, the newly appointed Bank of Japan
("BoJ") governor. With core inflation expected to stabilise around the BoJ's
2% goal, the BoJ are in no rush to adjust loose monetary policy. With the real
effective exchange rate of the Yen trading at the cheapest level since the
1970s, on balance, we believe the chances of Yen strength outweigh the risk of
further weakness. This, however, is not a prediction, and it doesn't factor
into our investment allocation. If the Yen were to strengthen it could be a
helpful reversal of the headwind we have faced over the past years.
Setting aside the weak Yen, in local currency terms, it was a remarkable
period for the Japanese stock market, as the TOPIX gained +28.3% (JPY). This
outpaced the S&P 500's +25.7% gain (USD), the MSCI Europe Index's +15.8%
gain (EUR) and the FTSE All Share's +7.9% gain (GBP). Investors appeared
buoyed by the Tokyo Stock Exchange ("TSE")'s announcement requiring companies
to disclose actions aimed at improving corporate value, particularly those
trading at a price-to-book ratio of less than 1x. This marked the first time
the TSE had explicitly focused on a valuation metric, which clearly resonated
with investors.
Adding further pressure on corporate reform, the Ministry of Economy Trade
& Industry ("METI") finalised its guidelines for corporate takeovers. The
guidelines contained encouraging wording that we believe might pave the way
for more unsolicited takeover approaches. The Financial Services Agency
("FSA") is currently reviewing the tender offer rule and concert party
regulation, aiming to simplify current regulation. In December, the TSE
announced its intention to call on the over 1,000 companies in
parent-subsidiary relationships or that have listed equity affiliates to
enhance disclosure regarding the rationale for having listed subsidiaries.
Although not a regulatory change, Toyota Motors, one of Japan's last holdouts
to reform its balance sheet, announced in November that it will partially
unwind its cross shareholding in Denso. The direction of travel is clear, with
shareholders, regulators and the Government all pushing in the same direction.
In August, we welcomed Shuntaro Shimizu, our newest addition to the Japan
team. Shuntaro, joined from Bain & Company's Tokyo office, brings valuable
financial experience gained at the Bank of Japan and holds an MBA from
Stanford School of Business. He concentrates on applying his consulting
expertise to engage with our portfolio companies and research new ideas.
The EV/EBIT of the portfolio increased from 6.0x to 8.7x over the year. This
was in part driven by the strong portfolio performance but also from a
conscious effort to invest in higher quality companies where we discern
greater opportunity for business growth. Due to the concentrated nature of the
portfolio, Nihon Kohden and Wacom, trading on EV/EBIT multiples of 15.3x and
20.0x, respectively, had an outsized effect on the aggregate portfolio
valuation, with the median EV/EBIT of the portfolio being a more modest 6.9x.
The strong markets have not diminished the opportunity set and there continue
to be pockets of deeply mispriced companies. At the time of writing, we are
building positions in five new names, which, on average, trade on an EV/EBIT
multiple of 4.0x, with 106% of their market cap covered by cash, securities
and rental real estate. In each of these positions, we see an avenue to
upsides in the order of 50-100% and the potential for us to become large
shareholders.
AVI Shareholder Engagement
Shareholder engagement in Japan continues its rise unabated, with one broker
noting that Japan is undergoing its third activist investor boom. The number
of shareholder proposals from engagement funds grew from just under 60 last
year to a record-high 82 this year and more shareholders expressed their
disappointment with poor management, with support for incumbent Presidents
falling.
We contributed to the 82 shareholder proposals this year by filing shareholder
proposals at SK Kaken and NC Holdings. In the case of SK Kaken, this is the
third consecutive year in which we have submitted proposals to the AGM.
Although we have achieved some success, such as the company disclosing Scope 1
and 2 greenhouse gas emissions, increasing the number of outside directors,
and conducting a 5-for-1 stock split, the company has refused to improve
shareholder returns. Despite gaining 35% support, which, considering the
founding family's nearly 50% control, represents a majority of minorities, SK
Kaken persists in maintaining a measly 12% dividend pay-out ratio, resulting
in cash accumulating each year. So long as we are shareholders, we will
continue to apply pressure on the family to improve the situation.
At NC Holdings ("NCHD"), in a notable first for AVI and a very rare occurrence
at Japanese AGMs in general, we had three shareholder proposals successfully
passed, with a further three receiving majority shareholder support. Two
dividend-related resolutions were approved, including an increase in the
dividend pay-out ratio to 70%, and the establishment of a stock-compensation
plan tied to achieving a three-year total share price return of over 50% and
an average three-year ROIC of over 10%.
While we are pleased with this success, we are disappointed that our
shareholder proposals to appoint two highly qualified outside directors did
not pass. In addition to largely ignoring shareholder views for the past two
years, the board opposed six resolutions that achieved majority shareholder
support, engaged in intimidation and baseless threats related to purported
concert party issues, targeted our investment team members by name in both
their public and private rebuttals, and even attempted, unsuccessfully, to
claim that NCHD's business was of national interest to evade scrutiny at the
AGM. We will continue to engage with management and seek solutions to improve
NCHD's corporate value over the coming year.
Towards the end of the year, after almost five years of private engagement, we
released a public statement expressing our opposition to Digital Garage's
board of directors and their misguided strategy. Critiquing the ill-fated
midterm plan released in May 2023, we announced our intention to vote against
all directors at the upcoming AGM. We believe our statement was well received
and contributed to raising awareness among other investors about the necessary
actions Digital Garage needs to take to address its undervaluation.
Our private engagement accounts for most of our work, and over the period, we
sent 8 presentations and 17 letters to portfolio companies. In our private
engagements, we cover more topics than shareholder proposals allow, with a
strong emphasis on operational improvement, including strategies for margin
enhancement and growth. Our engagement is tailored and specific to each
company, with our in-depth understanding highly appreciated by management. We
perceive ourselves as providing a service akin to investment consultants.
At the heart of our shareholder engagement is a long-term approach, and while
improvements might not be reflected straight away, we believe that through our
suggestions we are helping management create better businesses, ultimately
leading to higher returns for all shareholders. In all cases, a track record
demonstrating our readiness to make our concerns public significantly enhances
our credibility in interactions with boards and management.
While we can't discuss all the details of our private engagement, it was a
busy period, and there are several situations which we see coming to a head in
2024, whether that be shareholder proposals, mid-term plans or potential
privatisation events. We believe the potential for alpha generation through
engagement has never been higher, and we are excited by the abundant
opportunities in the year ahead.
PORTFOLIO TRADING
Buying Activity
The largest purchase over the period was Takuma, the waste treatment plant
builder and operator, which entered the portfolio in April. Having observed
Takuma from the sidelines for several years, we witnessed the share price boom
+150% higher in an ESG-fuelled bubble in 2021, only to decline by -46% to the
price at which we started buying. Given its open shareholder register (32%
foreign ownership), a structural tailwind, and a shifting business model to
more recurring maintenance work (already 50%), we believe that Takuma's lowly
6.7x EV/EBIT valuation multiple is entirely unjustified. Almost half of
Takuma's balance sheet assets are held in cash and listed securities,
accounting for just over 60% of the market cap. We plan to start engaging with
management on solutions to address the undervaluation in advance of next
year's mid-term plan.
The second largest purchase was Eiken Chemical, a diagnostics company
specialising in the manufacture of medical chemicals that react with body
samples to provide a diagnosis for cancer, disease or infection. The market is
attractive, with high regulatory barriers to entry, a razor/razor blade style
business model and stable growth driven by increased diagnostics healthcare
expenditure. Eiken Chemical has produced a number of niche products, with the
most exciting being its Colon Cancer screening test, called FIT (Faecal
Immunochemical Test), which accounts for around 40% of sales.
While generating low margins from the sale of its analyser, Eiken Chemical
earns high-margin recurring income from the subsequent sales of bottles and
solutions, providing recurring sticky income. Eiken Chemical's global
dominance is driven by its testing accuracy and consistency, proprietary
technology in its buffer solution, and the recognition of the OC-Sensor in
over 100 journals, enhancing brand recognition and trust with healthcare
providers.
The appeal of the diagnostics business is not lost on investors, with a set of
peers, both domestic and global, trading on an EV/EBIT of 26x vs Eiken's 8x.
We believe the disparity, in part, is driven by a misunderstanding of its
niche business model, the roll-off from high margin COVID-related reagents,
and a bloated balance sheet (32% of assets in net cash). We see almost +100%
upside to the current share price, and if the company achieves its 2030 plan,
possible with the successful launch of a DNA based stool test, over +200%
upside.
Selling Activity
The largest sale was our long-standing position Fujitec, where we generated a
+111% ROI and a +32% IRR over our almost five-year holding period. This
tremendous success was driven by shareholder engagement, starting from the
release of our public presentation in May 2020, and culminating with the
recent overhaul of the board of directors and ousting of the founding family
President. When we first invested in Fujitec, it was trading on a 4.7x EV/EBIT
multiple, a significant discount compared to its peers trading on 16.8x. Over
the life of the investment, that radically changed, and at the time of
selling, Fujitec was trading on a 23.3x EV/EBIT multiple, a premium to peers'
20.4x. We took the difficult decision to sell the position based on valuation
grounds, believing that the exciting prospects for value creation under the
new board were reflected in the higher valuation.
We sold our position in C Uyemura, which we had been reducing for some time,
generating an 87% ROI and 21% IRR over the life of our investment. We sold the
last of our stake in Teikoku Electric, following a strong appreciation in the
share price. Although it was only in the portfolio for a year, we generated a
52% ROI, amounting to a 92% IRR.
As has been the case for a few years, our tolerance for companies with
intransigent and entrenched management who refuse to listen to shareholder
voices has diminished. This explains our exits from Papyless, Pasona, Tokyo
Radiator and NS Solutions, as well as the reduction of our stakes in two other
small positions. AVI's approach is one of cooperative rather than
confrontational engagement, in contrast to some other activist approaches.
There are too many well-run and undervalued companies in Japan, with
management teams who want to create value for shareholders, to waste our time
with uncooperative companies that show little interest in shareholder
concerns.
Contributors
TSI Holdings
Contribution (GBP) 3.3%
% of net assets 8.7%
EV/EBIT 4.9x
NFV/Market Cap 82%
TSI Holdings ("TSI"), one of the largest listed apparel companies in Japan,
was the leading contributor in 2023, with its 68% share price increase adding
335bps to performance. TSI entered the portfolio in July 2022, and has
generated a return on investment of 44%.
TSI's strong performance can be partly attributed to the TSE's initiative to
pressure companies to address poor capital efficiency. As a follow-up to the
2022 TSE market classification review, in March 2023, the TSE requested listed
companies to raise awareness around their corporate value, particularly if
their shares were trading at a price-to-book ratio ("PBR") below 1.0x. TSI
holds a large amount of non-core business assets such as cash and deposits,
investment securities and rental real estate, and remarkably, its PBR remains
at c. 0.5x.
We believe the business side of TSI has also attracted investor interest. TSI,
along with other Japanese apparel companies, faced challenges stemming from
the impacts of COVID-19. Nevertheless, consumer sentiment recovered strongly
in 2023, with the economy further stimulated by inbound demand from
surrounding Asian countries acting as a tailwind.
In addition to the supportive macroeconomic trends, TSI is implementing
operational changes to improve its efficiency. Specifically, TSI focused on
revitalising its historically strong but currently underperforming brands,
such as nano universe, through a rebranding initiative and reform that
involved strengthening senior frontline members. Consequently, nano universe,
whose performance had been on a downward trend over the past few years, began
to exhibit signs of recovery in 2023. Furthermore, the company has been
working towards delivering higher margins, targeting 4.3% operating margins by
2025 compared to the current lowly 0.9%.
In terms of engagement, we have deepened our constructive dialogue on
operational improvement and capital policy. As highlighted earlier, TSI
remains significantly undervalued, with a PBR of 0.5x, and we believe there is
still substantial upside to be unlocked through our supportive engagement
efforts.
Konishi
Contribution (GBP) 3.2%
% of net assets 8.5%
EV/EBIT 5.4x
NFV/Market Cap 47%
Konishi, a company engaged in manufacturing of adhesives and civil
engineering, achieved a share price return of +65% over the period, adding
320bps to performance. Following intense private engagement with Konishi's
senior management, the company released a mid-term plan in May 2023, pledging
to either invest or return to shareholders all cash generated over the next
three years. The plan also outlined a three-year EBITDA growth target of +35%
(of which +19% growth is forecast to be achieved in the first year).
This marked the first time Konishi had disclosed a capital allocation plan and
its first commitment to buying back shares. A few weeks after the mid-term
plan, Konishi announced an 8.5% share buyback which sent the share price +10%
higher, and has been increasing further since. Aside from greater market
recognition following the mid-term plan, earnings growth has buoyed the share
price. Profits grew +71% over the six-month period to 30 September 2023
(Konishi's interim), driven by price increases coupled with softening raw
material prices.
Despite the +65% share price growth, Konishi's EV/EBIT multiple increased only
modestly from 4.0x to 5.4x. While Konishi have shown discipline in their
capital allocation for the next three years, they have not addressed the
current large cash pile, which, including listed securities, accounts for 47%
of Konishi's market cap. We will continue to engage with the company on
improving capital allocation, amongst other operational measures, and foresee
a bright future for the company and its share price.
JADE GROUP
Contribution (GBP) 3.1%
% of net assets 5.5%
EV/EBIT 13.1x
NFV/Market Cap 17%
JADE GROUP (formerly LOCONDO) ("JADE"), an apparel ecommerce company, achieved
a near doubling of its share price, up +96% and adding 179bps to performance.
Full-year profits in February 2023 came in above forecasts (¥991m vs.
¥900m), but it was the company's +33% sales and +76% profit growth forecast
for the year ending February 2024 that propelled the share price. By the
9-month mark at the end of December, operating profits had grown +99.9%.
JADE had been heavily investing in logistics infrastructure, leading to
ballooning fixed costs weighing on profits and resulting in unutilised
warehouse capacity. Last year it won the right to manage the Reebok brand in
Japan through a joint venture with Itochu. Having already made the warehouse
capacity investments, the company benefited from the power of operating
leverage, with Reebok's incremental sales flowing straight to the bottom line.
This year's profit guidance is in line with the mid-term plan, and management
estimate that with further accretive acquisitions, they can grow profits by
another 34% next year.
Alongside these results, JADE announced a 3.6% share buyback, which was well
received. CEO Yusuke Tanaka's insightful 14-page shareholder letter detailed
the company's history, what management have learned and management's growth
strategy. He made a compelling argument as to why JADE justifies a ¥30bn-50bn
market cap, much higher than the current ¥23bn market cap. While it will
require flawless execution of the plan to achieve the higher end of that
range, we do not think it is entirely unrealistic.
Across AVI funds, we are JADE's largest shareholder, owning just under 10% of
the shares, and have maintained regular engagement with the company. We are
optimistic about the company's growth prospects, which we don't think are
being fully reflected in its 13x EV/EBIT multiple.
After the year end in February 2024, JADE announced the acquisition of
Magaseek, which will see Gross Merchandise Value ("GMV") double and, although
not yet confirmed by the Company, double its profits over the coming years. At
the time of writing, JADE's share price is up +29% after the year end.
Shin-Etsu Polymer
Contribution (GBP) 2.2%
% of net assets 7.4%
EV/EBIT 7.3x
NFV/Market Cap 37%
Shin-Etsu Polymer, a semiconductor wafer case manufacturing company, saw its
share price increase by +53%, adding 220bps to performance. The strong return
was propelled by increased scrutiny from the TSE on the archaic practice of
listed parent/subsidiary structures. Despite the challenging business
environment this year for Shin-Etsu Polymer, with wafer manufacturers
adjusting their inventory weighing on the demand for wafer carrier cases, the
business performed resiliently and has forecast modest sales and profit growth
of +2.5% and +2.0% respectively.
Trading on an EV/EBIT of just 7.6x, with net cash amounting to about 33% of
the market cap at the year end, Shin-Etsu Polymer is still undervalued, owing
to its parent/subsidiary structure with Shin-Etsu Chemical, who own over 50%
of the shares. With Shin-Etsu Chemical being both a customer and supplier of
Shin-Etsu Polymer, there are potential conflicts of interest. The absence of a
majority independent board, coupled with the presence of former Shin-Etsu
Chemical employees as directors, raises governance concerns. While we
appreciate that management have made modest improvements, we believe these
measures do not adequately address key issues enough to rectify the company's
undervaluation.
We have put forward proposals to both Shin-Etsu Polymer and Shin-Etsu Chemical
in private, seeking to achieve a majority independent board and to dissolve
the listed structure entirely. We hope both companies will recognise the
current shortcomings and take further action to grow corporate value and
protect shareholders' interests. Pressure from the TSE, shareholders and wider
stakeholders to address conflicts from parent/subsidiary structures will not
wane.
Nihon Kohden
Contribution (GBP) 2.0%
% of net assets 9.7%
EV/EBIT 15.3x
NFV/Market Cap 17%
Nihon Kohden, was the 5th largest contributor, adding 200bps to performance
with a +42% share price return. Nihon Kohden is a global leader in medical
equipment manufacturing, renowned for launching the world's first AC-powered
EEG machine. The company is now diversified across patient monitors,
ventilators and defibrillators.
Earnings over the year were respectable, with Nihon Kohden continuing to
benefit from overseas growth and increased healthcare expenditure. As
management work towards a refreshed strategy with their May 2024 mid-term
plan, there has been a distinct absence of market-moving announcements from
the company. Rather, it was the disclosure from a well-known US activist fund
that it had purchased 5% of Nihon Kohden's shares that drove the share price
higher. We have admired this fund's engagement with Nihon Kohden's peer,
Olympus (a large-cap Japanese company not held in the portfolio) and
referenced the success of Olympus' transformation plan in our engagement to
Nihon Kohden.
Although Nihon Kohden's discount to peers has narrowed since we initiated our
position, currently trading on an EV/EBIT multiple of 15x compared to peers'
20x, we believe this doesn't fully capture the substantial potential we
envision for the business. Under the leadership of President Ogino, the
Grandson of Nihon Kohden's founder, we see a pathway for the business to
improve operating margins from 10% to 15% and transition its focus from lumpy
medical equipment sales to recurring digital services. Coupled with 5%
projected annual sales growth, we estimate that over the next five years
operating profits have the potential to nearly double.
Although the transformation is still in its early stages, we are confident it
can be achieved. It is encouraging to see another activist investor recognise
the potential, and we look forward to continuing our engagement ahead of the
May 2024 mid-term plan. We still see over +100% upside to the prevailing share
price.
Detractors
Digital Garage
Contribution (GBP) -2.2%
% of net assets 4.5%
EV/EBIT 10.3x
NFV/Market Cap 60%
Digital Garage, which operates one of Japan's largest payment settlement
businesses, was the leading detractor from performance in 2023, with a -19%
fall in its share price reducing performance by 216bps.
The weak share price can be attributed, in no small part, to the release of a
profoundly disappointing mid-term plan in May. Leading up to the release of
the mid-term plan, AVI had been engaging with Digital Garage extensively,
having sent a letter to the Board advocating for all strategic options to be
considered. This year, we submitted a 72-page presentation as part of our
ongoing engagement, addressing matters such as shareholder communication,
group strategy and the inefficient holding structure.
Rather than listening to our concerns, as well as those publicly raised by
another shareholder, management persisted with its suboptimal strategy. The
mid-term plan fell short of addressing the holding structure and the
questionable 20% stake in listed Kakaku.com, nor did it make a convincing case
as to how, without change, the performance of the payment business would
improve. The negative share price reaction demonstrated that we were not alone
in our disappointment.
After careful consideration, in November 2023 we issued a press release aiming
to spur management into action. The release conveyed concerns regarding
Digital Garage's corporate governance and the credibility of its directors,
whilst also announcing our intention to vote against their re-election at the
June 2024 AGM.
Unfortunately, at the end of the year, defiant to the trend of reducing
cross-shareholdings, Digital Garage issued 5.25% of its treasury shares to
Resona HD, with Resona HD committed to purchasing an additional 4.75% in the
market. In return, Digital Garage intends to hold discussions regarding the
acquisition of shares in a Resona HD subsidiary and setting up a venture fund
together. We are perplexed as to what led management to believe that issuing
deeply undervalued shares in such a convoluted manner would create value for
shareholders. The lack of concrete tie-ups with Resona HD suggests a hastily
executed deal, where it appears the primary beneficiaries are the advisors and
management focused on protecting themselves from shareholder accountability.
Digital Garage has been in the portfolio since inception, and despite
initially being a strong performer, its returns have eroded, leading us with a
rather underwhelming return on investment of +6.2% and an IRR of +2.6% over
the holding period. Over the past three years, Digital Garage's share price
has declined by -1.8%, in contrast to the TOPIX, which has returned +41.1%.
Over longer periods the relative performance has fared no better.
With the current leadership and status quo strategy, we would not be surprised
if Digital Garage continues to erode shareholder value. Despite our lack of
faith in management's ability to drive shareholder value, the shares do trade
at a significant undervaluation. Overtime, we anticipate reallocating the
position to more attractive opportunities.
NC Holdings
Contribution (GBP) -1.5%
% of net assets 4.9%
EV/EBIT 7.0x
NFV/Market Cap 65%
NC Holdings was the second largest detractor in 2023, reducing returns by -151
bps. NC Holdings primarily operates multi-storey parking and conveyor belt
businesses in Japan. AJOT initiated its position in NC Holdings in June 2021,
and has experienced a total return of -3.5% in GBP or +12.7% in Japanese Yen
over the period.
During the AGM season in June 2023, we submitted shareholder proposals to NC
Holdings regarding the revision of stock-based remuneration and dividends.
Notably, three proposals were successfully passed, including a special
resolution.
NC Holdings had previously encountered challenges in adequately disclosing the
company's mid-long-term management policy for enhancing corporate value. NC
Holdings neither conducts financial results briefing meetings nor publishes
supplemental IR presentations. However, following the period of our public
campaign, NC Holdings announced in June 2023 that it is committed to
disclosing information on the management direction that the board of directors
intends to pursue in order to improve its enterprise value, including the
specific measures that they plan to implement. We await the disclosure with
great interest, eager to see how NC Holdings will communicate concrete growth
strategies, investment plans, capital efficiency improvement policy and
business portfolio strategies in the near future.
In terms of business, we understand that potential growth areas include the
expansion of the free line conveyor business, which is the business of
conveying earth and sand by conveyor for civil engineering works in general,
and the expansion of sales to local municipalities. We have engaged in
constructive dialogue with management regarding the implementation of a shift
away from dependence on non-growth domains, such as coal-fired power plants.
We believe that the company's medium- to long-term commitment to growing these
businesses will contribute to a better understanding by the market of the
potential value of the company.
We expect to realise the upside through ongoing constructive dialogue,
addressing business management, capital policy and investor relations
disclosure.
SK Kaken
Contribution (GBP) -0.7%
% of net assets 3.2%
EV/EBIT <0.0x
NFV/Market Cap 105%
SK Kaken, a manufacturer of construction coating paints, was the third largest
detractor, reducing performance by 70bps as its share price drifted -10% lower
over the course of the year.
We continued our public engagement initiative, 'Painting a better SK Kaken',
and for the third consecutive year we submitted shareholder proposals to SK
Kaken's AGM. Our engagement has broadly focused on capital allocation,
liquidity enhancement, corporate governance and shareholder communications. At
this year's AGM, we campaigned for the return of the excess cash accumulated
on the balance sheet to shareholders via dividends, along with the
cancellation of treasury shares. While we achieved majority support from
minority shareholders, the resolution was not passed, primarily due to the
founding family's significant ownership stake.
On a more positive note, despite repeatedly resisting our suggestions for the
past four years, management finally took steps in the right direction, as they
conducted a 5-for-1 stock split, reduced the director tenure and transitioned
to a company with an audit and supervisory committee, greater board
independence and improved disclosure of ESG performance and quarterly results.
Although we are pleased with the progress on these points, further action is
needed to rectify the undervaluation, with SK Kaken currently trading on a
negative EV/EBIT multiple, underscored by net cash covering 103% of the market
cap.
SK Kaken has been in the portfolio since inception, and despite our engagement
efforts has been a poor performer, yielding a return on investment of -18.4%,
with an IRR of -4.4%. With a remarkably cheap valuation and stable business,
we still see significant upside, albeit the timing of realising this upside is
in the hands of the family.
Outlook
The cascade of regulatory improvements in 2023 is, in our view, a seminal
moment in the long and winding road to unlocking the enormous value trapped in
Japanese companies. We see abundant opportunities to exploit mispriced
companies in a highly inefficient market. The concentrated nature of our
portfolio and large upsides leaves us excited about the potential to generate
significant alpha. This was evidenced by Alps Logistics and JADE GROUP, who,
at the time of writing have seen their share prices appreciate by +51% and
+29% respectively in 2024.
Joe Bauernfreund
Asset Value Investors Limited
13 March 2024
PORTFOLIO CONSTRUCTION
The objective of AVI's portfolio construction is to create a concentrated
position in about 15-25 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
2023 2022
Materials 23% 29%
Capital Goods 19% 19%
Health Care Equipment and Services 16% 7%
Software and Services 12% 18%
Consumer Durables and Apparel 10% 6%
Technology Hardware and Equipment 5% 6%
Consumer Discretionary Distribution and Retail 5% 0%
Banks 4% 0%
Transportation 3% 2%
Automobiles and Components 2% 4%
Food, Beverage and Tobacco 1% 0%
Equity portfolio value by market capitalisation
2023 2022
<£250m 17% 26%
£250m - £500m 21% 15%
£500m - £750m 21% 19%
£750m - £1bn 29% 17%
£1bn - £2.5bn 11% 23%
>£2.5bn 1% 0%
INVESTMENT PORTFOLIO
% of Cost Market % of investee company
Company Stock AJOT £'000* value NFV/Market
Exchange Identifier net £'000 capitalisation(1) EV/EBIT(1)
assets
Nihon Kohden TSE: 6849 9.7% 14,230 17,735 0.8% 17% 15.3
TSI Holdings TSE: 3608 8.7% 11,146 15,983 4.5% 82% 4.9
Takuma TSE: 6013 8.6% 13,281 15,802 1.9% 51% 6.7
Konishi TSE: 4956 8.5% 11,065 15,600 3.0% 47% 5.4
Shin Etsu Polymer TSE: 7970 7.4% 10,298 13,555 1.8% 37% 7.3
DTS TSE: 9682 7.4% 11,452 13,488 1.5% 43% 9.9
Eiken Chemical TSE: 4549 6.5% 10,755 11,896 3.1% 40% 7.9
Wacom TSE: 6727 5.6% 13,911 10,254 1.8% 14% 20.0
JADE GROUP TSE: 3558 5.5% 7,013 10,005 7.4% 17% 13.1
NC Holdings TSE: 6236 4.9% 8,613 8,998 18.4% 65% 7.0
Top ten investments 72.8% 111,764 133,316
Digital Garage TSE: 4819 4.5% 9,982 8,176 0.8% 60% 10.3
T Hasegawa TSE: 4958 4.4% 6,799 7,942 1.1% 30% 10.5
SK Kaken TSE: 4628 3.2% 9,445 5,836 0.9% 105% <0.0
Aichi TSE: 6345 3.0% 4,728 5,580 1.2% 54% 5.1
A-One Seimitsu TSE: 6156 2.8% 4,571 5,189 9.1% 70% 15.1
Alps Logistics TSE: 9055 2.6% 3,067 4,787 1.5% 31% 6.1
Soft99 TSE: 4464 1.8% 2,811 3,249 1.9% 78% 2.2
Kyoto Financial Group TSE: 5844 1.5% 2,226 2,732 0.1% 85% 2.4
Shiga Bank TSE: 8366 1.5% 2,410 2,685 0.3% 110% <0.0
Hachijuni Bank TSE: 8359 1.4% 2,198 2,567 0.1% 82% 2.2
Top twenty investments 99.5% 160,001 182,059
Yaizu Suisankagaku Industry TSE: 2812 1.1% 1,806 1,918 2.5% 70% 17.3
Daidoh TSE: 3205 1.0% 1,602 1,880 2.3% 185% <0.0
Total investments 101.6% 163,409 185,857
Portfolio median 57% 6.9x
Portfolio weighted average 50% 8.7x
Other net assets and liabilities (1.6%) (2,914)
Net assets 100.0% 182,943
(*)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 2023 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.
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