Oakmark's David Herro Says Unloved Japanese Stocks a `Steal,' Time to Buy
By Charles Stein - Feb 4, 2011
Japan’s stock market is more than 70 percent off its 1989 record high and last month the country’s debt was downgraded for the first time in nine years. Time to buy Japanese equities, says David Herro.
“At these prices Japanese stocks are a steal,” said Herro, 50, manager of the $6.9 billion Oakmark International Fund, which is almost a quarter invested in Japan.
Already comparatively cheap, Japanese stocks should become even more attractive as exporters increase trade with China and companies start returning cash to shareholders, said Herro, Morningstar’s international manager of the decade.
Herro and others bullish on Japan, including strategists at Goldman Sachs Group Inc. and Deutsche Bank AG, are bucking a wave of skepticism spawned by a generation of dismal stock market and economic results. In a January Bloomberg global investor poll, 23 percent of respondents named Japan as the market that would perform the worst in 2011. Only the European Union was less popular.
“They have too much debt and they’ve suffered from bouts of deflation,” Michael Mullaney said in a telephone interview, explaining why he holds fewer Japanese stocks than the MSCI EAFE Index, a common international benchmark. Mullaney helps oversee $9.5 billion as a portfolio manager at Boston-based Fiduciary Trust Co.
Political Gridlock
Japan’s credit rating was cut for the first time since 2002 last week by Standard & Poor’s as persistent deflation and political gridlock undermine efforts to reduce an $11 trillion debt. The government’s ratio of debt to gross domestic product will peak in the mid-2020s, the S&P report said.
Twenty-four percent of Herro’s equity holdings are Japanese companies, compared with the 16 percent average for international funds, according to Chicago-based Morningstar. His Oakmark colleague, Clyde McGregor, whose $2.4 billion Oakmark Global Fund beat 99 percent of rivals over the past decade, has 21 percent of his equity assets in Japan. The $12.2 billion First Eagle Overseas Fund, which beat 89 percent of peers over the same stretch, has a 42 percent allocation, Morningstar data show.
“People hate Japan,” Herro said in a telephone interview from Chicago. That attitude has caused investors to overlook the market’s strengths, including low prices, said Herro, who outperformed 97 percent of peers over the last decade.
Piles of Cash
The Topix, also known as the Tokyo Stock Price Index, trades at a price-to-book value of 1.1, about half the level it reached in 2006, according to data compiled by Bloomberg. The comparable ratio for the Standard & Poor’s 500 Index is 2.3. Price-to-book value is a measure of a company’s price compared with the worth of its assets.
Companies in Japan look even cheaper when cash on balance sheets is considered, Herro said. One of Herro’s holdings, Rohm Co., a Kyoto-based chipmaker, has cash and long-term investments equal to more than 50 percent of the stock’s market value, Robert Taylor, co-manager on two of Oakmark’s international funds, said in a telephone interview.
Corporate profits in Japan this year will approach 2007 highs, adding to record levels of cash, New York-based Goldman Sachs said in a Dec. 1 report. The firm predicted the Nikkei 225 Index could reach 12,000 this year, up from 10,543.52 at the close today. In a January report, Frankfurt-based Deutsche Bank said Japanese stocks could produce returns of more than 20 percent in the first half of 2011.
China Exports
In a December letter to shareholders, Matthew McLennan and Abhay Deshpande, portfolio managers of New York-based First Eagle, wrote that many of their Japanese holdings were doing well, including Fanuc Ltd., the world’s largest producer of controls that run machine tools. The Yamanashi-based firm is positioned to take advantage of expanding globalization, they said.
“We think for China and India to go through high-end industrialization they will need the equipment Fanuc makes,” McLennan said in a September interview with Bloomberg television.
McLennan declined to comment on Japan, according to an e- mail from Tom Pinto, a First Eagle spokesman.
Fanuc’s founder, Seiuemon Inaba, said in a January interview with Bloomberg that the firm wanted to capitalize on China’s automation boom. “Everything comes down to China,” he said. “That’s where the growth is.”
China passed the U.S. as Japan’s largest export market for the first time in 2009, according to the Japanese Ministry of Finance.
Stock Buybacks
Charles de Vaulx, who joined New York-based International Value Advisers LLC in 2008 after 20 years at First Eagle, said Japanese firms historically have kept too much cash, refusing to give it back to investors in the form of dividends or buybacks.
“Over time, investors have grown sick and tired of the fact that companies in Japan aren’t managed for shareholders,” said de Vaulx, who co-manages the $1.8 billion IVA International Fund, which has 40 percent of its equity assets in Japan, Morningstar data show.
That is starting to change, de Vaulx said.
One of the stocks he owns, KDDI Corp., Japan’s second- largest mobile-phone operator, rose the most in almost two years in Tokyo trading after the company said in October it will spend as much as $1.2 billion buying back shares.
Canon Inc., the world’s largest camera maker, rose 5.6 percent Sept. 10 when the firm said it would buy back as much as 1.2 percent of its shares. Herro owns shares in the Tokyo-based company.
Debt Burden
The change isn’t happening quickly enough for some investors. In June 2009, Rohm shareholders defeated a proposal by Brandes Investment Partners LP to buy back more stock after the San Diego-based firm argued that Rohm’s cash position was excessive.
Rohm management is still committed to buybacks and dividends, Oakmark’s Taylor said in an e-mail.
The Nikkei 225 Index has fallen 73 percent since it peaked at almost 39,000 in December 1989. In the 25 years ended Dec. 31, the index lost 1 percent a year, according to data compiled by Bloomberg.
The Japanese economy grew an average of 1 percent a year in the 20 years through 2009, according to IHS Global Insight, a Lexington, Massachusetts-based consulting firm. The U.S. averaged 2.5 percent a year growth in the same period.
Weakening Yen
“Japan has frustrated investors for years,” said Jack Ablin, chief investment officer at Chicago-based Harris Private Bank, where he helps oversee $55 billion.
When Japanese stocks do rise, Ablin said, the gains for outside investors are often wiped out by declines in the yen. Forecasters surveyed by Bloomberg expect the yen to weaken against the dollar in 2011.
Even fans of Japanese stocks like Herro have suffered as some bets failed to pay off. Shares of Daiwa Securities Group Inc., a Tokyo-based investment bank and Herro’s largest holding, fell 19 percent annually in the five years ended Dec. 31, according to data compiled by Bloomberg.
Herro, who has owned Daiwa since 2001, said investors don’t fully appreciate the firm’s strengths, including its asset- management business. “I will continue to wait it out,” he said.
‘Lack of Exuberance’
Investors in Japan need to look past the gloomy macroeconomic picture, Taylor said. “We are not saying we love falling birth rates, deflation or the fact that they have had so many different prime ministers in the past few years,” he said, referring to the June election of Naoto Kan, the fifth Japanese leader in four years.
Japan’s stock market has rallied repeatedly over the past 25 years, de Vaulx said, even as the economy has plodded along. Many individual stocks have thrived, especially in periods when the yen weakened against the dollar, a plus for Japanese exporters.
“Japan is a market that suffers from an irrational lack of exuberance,” de Vaulx said.
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