Stock prices in Japan were weak even before the devastating earthquake struck. On March 10, the last day of trading before the 9.0 shock, the Nikkei average of 225 stocks stood at 10,544.13, well below the level of 10,563.92, just one year prior. And of course, the index was nowhere near its closing price of 38,915.87 in late 1989.
Japanese stocks, already trading at a steep discount to other major markets, plunged as news of the earthquake, tsunami and nuclear meltdown spread. During the first two trading sessions after the quake, the Nikkei fell nearly 17 percent, trading at just 1.1 times book value. That is less than half of what markets in the US typically trade.
While the Nikkei has recovered some of those losses, it was trading at just 9,718.99 on April 4. That is 7.8 percent below its pre-quake level of March 10.
The crisis in Japan has created a moment of truth for value investors who have taken an interest in Japanese companies during the last few years. The disaster has forced them to make a decision: stay the course and possibly look for more exposure to Japan, or walk away from what could be a major value trap.
Brandes Investment Partners in San Diego found itself in just such a position. The money manager had been overweight Japanese companies since late last year, when about about 28 percent of its $23 billion international equity portfolios and 15 percent of its $15 billion global equity strategy were in Japanese stocks.
“Since Friday after the disaster happened, we have been going through every company in our portfolios to try to understand how they were affected by the quake itself and the aftermath, and to understand what it means for their businesses,” said Brent, a voting member of the Brandes large cap investment committee.
They have concluded that the earnings of many companies in Japan will take a hit over the next three to nine months. “But two to four years from now, people are going to look back and say Japan got through this crisis, and got through it pretty well,” Woods said.
As companies in Japan announce hits to their earnings over the next six to 12 months, Woods says Brandes will be on the lookout for buying opportunities. “We are looking for undervalued companies in an undervalued market,” he says. “Our job is to look behind the earnings over the next several quarters. The real value of companies in Japan is what they do over the next 20 years.”
Investors will need to apply fundamental analysis to understand how particular companies are likely to fair. They will have to differentiate among businesses, not just sectors.
For example, Toyota does a lot of design and production work outside of Japan, so its may be able to operate relatively well despite conditions in Japan, according to Phillip Phan, a professor and executive vice dean at Johns Hopkins’ Carey Business School. “Honda is relatively centralized,” he notes.
Overall, he says that large cap companies in Japan are relatively well positioned. “The midsized and regional companies in Japan may be most at risk,” he says.
The catastrophe in Japan may compel companies there to accelerate the process of globalization, diversifying their geographical risk. That process has been under way for some time, as Japanese companies look to reduce manufacturing costs and operate closer to their end markets, just the way companies from the U.S. do.
Sony has said it will outsource 55 percent of television set production by 2012, up from 5 percent in 2010. Toyota intends to reduce domestic production by 15 percent over six years, expanding its manufacturing operations in the U.S., China and Brazil, according to a press release.
There is a risk that that customers of partners of companies based in Japan could ramp up that process in reverse, moving business away from Japan to diversify their own geographic risk. Investors will need to be alert to such challenges during the next few quarters.
The cheap yen--driven down by a massive currency intervention by the Bank of Japan and the G7 nation--will help Japan’s many export-oriented companies. While they drive the nation’s economy, there are plenty of importers, too. “Japan is a major importer of wheat,” Phan notes. Those companies will be vulnerable to currency risk. And if their costs rise to far, they may need to pass costs along to consumers.
That could help reverse decades of deflationary pressure in Japan, possibly creating a new wave of inflationary pressure. As prices rise at home, they may work their way into the export markets as well, adding to a host of inflationary pressures such as rising energy costs.
Such changes will cut both ways for companies in Japan, depending upon on range of factors such as exports, diversification and global reach. But to a great extent, many companies in Japan will have the resources to withstand the historic shock.
