Smartkarma Research Team, Smartkarma

Smartkarma Research

Smartkarma Research Team

Smartkarma

Smartkarma unites the fragmented investment industry, connecting institutional investors, independent research providers, and corporates within a single network.

Research Reinvented

Thematic (Sector/Industry)

<p>On our next Webinar, we are thrilled to welcome back Insight Provider <a href="https://www.smartkarma.com/profiles/scott-foster" target="_blank" data-smartkarma-citation="accounts:1134" rel="noopener">Scott Foster</a>, who will present his hand-picked ideas in Japan's IT sector. </p>
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<h3>The webinar will be hosted on Wednesday, 27 October 2021, 17:00 SGT/HKT.</h3>
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<h2><a href="https://share.hsforms.com/1H9pFZOB-RF2J00kbvMmxcw2c5gj?zoom_webinar_id=85198859426" target="_blank" rel="noopener">Register for the Webinar here</a></h2>
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<p>Scott Foster is a securities analyst who has been covering electronics, precision equipment &amp; robotics, engineering, construction, transport, and other sectors for more than 25 years in Japan and 3 years in Korea.</p>
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On our next Webinar, we are thrilled to welcome back Insight Provider Scott Foster, who will present his hand-picked ideas in Japan's IT sector. 

The webinar will be hosted on Wednesday, 27 October 2021, 17:00 SGT/HKT.

Register for the Webinar here




Scott Foster is a securities analyst who has been covering electronics, precision equipment &amp; robotics, engineering, construction, transport, and other sectors for more than 25 years in Japan and 3 years in Korea.



Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

Pan-Asia Catalysts/Events

Quiddity Advisors

Event-Driven

<p>Every year (usually in the beginning of September), the Nikkei Inc Index team conducts an annual review of the major price-weighted Nikkei indices - the most important being the Nikkei 225 Average - and adds and subtracts constituents according to the Rules.</p>
<p>Today, they announced the 2021 version of the changes (<a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210906E_1.pdf" target="_blank" rel="noopener">announcement</a>, <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210906E_3.pdf" target="_blank" rel="noopener">PAF changes</a>).</p>
<p><em>Below is <strong>Some Background</strong>. If you want to skip ahead to the juicy analysis, you can jump ahead to the <strong>Changes Announced</strong> section just below, and then more below the fold.</em></p>
<h3>Some Background</h3>
<p>The Nikkei 225, well-known globally as "the Nikkei" is a price-weighted index, originally started nearly 70 years ago as an average of a selected number of stocks listed on the TSE First Section. Later, it became 225 members. </p>
<p>Because it is price-weighted, and because for a long time it made no divisor adjustments for stock splits (so when a stock split 2:1 its weight fell by half because price fell by half and trackers had to sell half their shares in that stock), and the price multiplier was determined by the par value of a company, then they later they started adjusting for splits, stocks which are old, never split, AND have a high price end up having a high weight in the index. </p>
<p>There was a huge reshuffle in April 2000 when the Nikkei decided that the system needed rebalancing to include more tech, so they changed the Rules. They pushed 30 names out and 30 names in, <em>and the 30 names added were 50% of the new index</em>. </p>
<p>Twenty one years after the prior change in methodology, this past May 10 the Nikkei Inc Index Team announced new changes to the Rules. There was a <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210510E_1.pdf" target="_blank" rel="noopener">proposal</a>, with an <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210510E_3.pdf" target="_blank" rel="noopener">FAQ</a>, and <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210510E_2.pdf" target="_blank" rel="noopener">supplemental data</a>. On 5 July, the Nikkei confirmed the proposal with a new <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210705E_1.pdf" target="_blank" rel="noopener">Guidebook</a>.</p>
<p>When I wrote about this on 10 May in <em><a href="https://www.smartkarma.com/insights/after-20yrs-nikkei-225-proposes-minor-impact-rule-changes-nintendo-disappointment" target="_blank" data-smartkarma-citation="insights:51277" rel="noopener">After 20yrs, Nikkei 225 Proposes Minor Impact Rule Changes (Nintendo Disappointment?)</a></em> I said I thought the changes disappointing. There are real problems with the index and this did not do much; <em>the changes are evolutionary rather than revolutionary</em>, with the only interesting change being that constituents are added with a weight no greater than 1%. If the normal price adjustment factor would allow a constituent to enter at a weight <em>greater</em> than 1%, the Price Adjustment Factor (base 1) is lowered in increments of 0.1 so that the deemed inclusion weight on Base Date (end of July) is no more than 1%. There is no change to the idea that the Nikkei Index Team can override their rankings at any time as they see fit.</p>
<p>Because the Nikkei Index Team had let the sector balances and rankings slide quite a bit over the years (not adding "obvious" names and not deleting names which should probably have been deleted, and not rebalancing the sectors as the rules say they should), the possibility was that some names like <a href="https://www.smartkarma.com/entities/nintendo-co-ltd" target="_blank" data-smartkarma-citation="entities:5415:1" rel="noopener">Nintendo Co Ltd (7974 JP)</a> and similar high-price-low-share-count names which "deserved" to be included were not simply because their very high price would create undue impact (it was undue impact and the lack of incremental float for high-weight low-share-count names which caused the BOJ to lower, then eventually cease their buying of Nikkei 225 ETFs). This rule on capping inclusions at 1% would go a ways to mitigating that problem so that would allow the Nikkei to add previously un-addable names. Expectations were high on a group of names, with <a href="https://www.smartkarma.com/entities/nintendo-co-ltd" target="_blank" data-smartkarma-citation="entities:5415:1" rel="noopener">Nintendo Co Ltd (7974 JP)</a>, <a href="https://www.smartkarma.com/entities/keyence-corp" target="_blank" data-smartkarma-citation="entities:3077:1" rel="noopener">Keyence Corp (6861 JP)</a>, <a href="https://www.smartkarma.com/entities/zozo-inc" target="_blank" data-smartkarma-citation="entities:18379:1" rel="noopener">ZOZO Inc (3092 JP)</a>, and probably <a href="https://www.smartkarma.com/entities/oriental-land-co-ltd" target="_blank" data-smartkarma-citation="entities:13517:1" rel="noopener">Oriental Land (4661 JP)</a>, with the latter two likely to create some real froth if actually selected. </p>
<h2>The Changes Announced</h2>
<p>Today after the close, the Nikkei Index Team announced the following changes to the Nikkei 225 Average as a result of the Annual Review:</p>
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<p>The changes will be made on the last trading day of September, at the close. I expect to see $10bn trade on that day.</p>
<p>The new rules allow the Nikkei Index team to not do a lot to the sector mix if the additions are made because of "High Liquidity" because while the sector mix would normally mean more than three deleted, the new rules cap changes at 3 per annual rebalance (which is not enough).</p>
<p>As noted above, <a href="https://www.smartkarma.com/entities/zozo-inc" target="_blank" data-smartkarma-citation="entities:18379:1" rel="noopener">ZOZO Inc (3092 JP)</a> and <a href="https://www.smartkarma.com/entities/oriental-land-co-ltd" target="_blank" data-smartkarma-citation="entities:13517:1" rel="noopener">Oriental Land (4661 JP)</a> were among names which were expected as possible inclusions and therefore a certain amount of pre-positioning may be in place. They may get somewhat hurt tomorrow.</p>
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<p>There are a LOT of moving parts here. There are 3 ADDs, 3 DELETIONS, 1 Price Adjustment Factor moved sharply <em>higher</em> and one moved somewhat <em>lower</em> (a list of all the PAFs announced by the Nikkei is <a href="https://indexes.nikkei.co.jp/nkave/archives/news/20210906E_3.pdf" target="_blank" rel="noopener">here</a>), then there are another 220 stocks which will see selling on 30 September at the rebalance. </p>
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<p>For more detailed analysis of the stocks, their positioning, how much to buy, etc, please read on.</p>
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<p><em>For more about passive tracking in Japan, please refer to <a href="https://www.smartkarma.com/insights/japan-passive-who-owns-what-2021" target="_blank" data-smartkarma-citation="insights:55008" rel="noopener">JAPAN PASSIVE: Who Owns What 2021?</a> </em></p>

Every year (usually in the beginning of September), the Nikkei Inc Index team conducts an annual review of the major price-weighted Nikkei indices - the most important being the Nikkei 225 Average - and adds and subtracts constituents according to the Rules.
Today, they announced the 2021 version of the changes (announcement, PAF changes).
Below is Some Background. If you want to skip ahead to the juicy analysis, you can jump ahead to the Changes Announced section just below, and then more below the fold.
Some Background
The Nikkei 225, well-known globally as "the Nikkei" is a price-weighted index, originally started nearly 70 years ago as an average of a selected number of stocks listed on the TSE First Section. Later, it became 225 members. 
Because it is price-weighted, and because for a long time it made no divisor adjustments for stock splits (so when a stock split 2:1 its weight fell by half because price fell by half and trackers had to sell half their shares in that stock), and the price multiplier was determined by the par value of a company, then they later they started adjusting for splits, stocks which are old, never split, AND have a high price end up having a high weight in the index. 
There was a huge reshuffle in April 2000 when the Nikkei decided that the system needed rebalancing to include more tech, so they changed the Rules. They pushed 30 names out and 30 names in, and the 30 names added were 50% of the new index. 
Twenty one years after the prior change in methodology, this past May 10 the Nikkei Inc Index Team announced new changes to the Rules. There was a proposal, with an FAQ, and supplemental data. On 5 July, the Nikkei confirmed the proposal with a new Guidebook.
When I wrote about this on 10 May in After 20yrs, Nikkei 225 Proposes Minor Impact Rule Changes (Nintendo Disappointment?) I said I thought the changes disappointing. There are real problems with the index and this did not do much; the changes are evolutionary rather than revolutionary, with the only interesting change being that constituents are added with a weight no greater than 1%. If the normal price adjustment factor would allow a constituent to enter at a weight greater than 1%, the Price Adjustment Factor (base 1) is lowered in increments of 0.1 so that the deemed inclusion weight on Base Date (end of July) is no more than 1%. There is no change to the idea that the Nikkei Index Team can override their rankings at any time as they see fit.
Because the Nikkei Index Team had let the sector balances and rankings slide quite a bit over the years (not adding "obvious" names and not deleting names which should probably have been deleted, and not rebalancing the sectors as the rules say they should), the possibility was that some names like Nintendo Co Ltd (7974 JP) and similar high-price-low-share-count names which "deserved" to be included were not simply because their very high price would create undue impact (it was undue impact and the lack of incremental float for high-weight low-share-count names which caused the BOJ to lower, then eventually cease their buying of Nikkei 225 ETFs). This rule on capping inclusions at 1% would go a ways to mitigating that problem so that would allow the Nikkei to add previously un-addable names. Expectations were high on a group of names, with Nintendo Co Ltd (7974 JP), Keyence Corp (6861 JP), ZOZO Inc (3092 JP), and probably Oriental Land (4661 JP), with the latter two likely to create some real froth if actually selected. 
The Changes Announced
Today after the close, the Nikkei Index Team announced the following changes to the Nikkei 225 Average as a result of the Annual Review:







The changes will be made on the last trading day of September, at the close. I expect to see $10bn trade on that day.
The new rules allow the Nikkei Index team to not do a lot to the sector mix if the additions are made because of "High Liquidity" because while the sector mix would normally mean more than three deleted, the new rules cap changes at 3 per annual rebalance (which is not enough).
As noted above, ZOZO Inc (3092 JP) and Oriental Land (4661 JP) were among names which were expected as possible inclusions and therefore a certain amount of pre-positioning may be in place. They may get somewhat hurt tomorrow.

There are a LOT of moving parts here. There are 3 ADDs, 3 DELETIONS, 1 Price Adjustment Factor moved sharply higher and one moved somewhat lower (a list of all the PAFs announced by the Nikkei is here), then there are another 220 stocks which will see selling on 30 September at the rebalance. 

For more detailed analysis of the stocks, their positioning, how much to buy, etc, please read on.

For more about passive tracking in Japan, please refer to JAPAN PASSIVE: Who Owns What 2021? 

2021 Nikkei 225 Rebalance: Nintendo, Murata, Keyence IN; Nisshinbo, Toyo Seikan, 'Skupper' OUT

Senior Technology Analyst, Japanese Equities, LightStream Research

Scott Foster

Senior Technology Analyst, Japanese Equities

Long-Short Analysis on Japan, Asia and the World

LightStream Research

LightStream conducts quantitatively rigorous and data-driven analysis with a focus on Japan and Asia.

We consistently cover the Tech, Consumer and Industrial sectors, and provide ECM and Events coverage more broadly.

We supplement traditional qualitative insights from company relationships with a robust quantitative foundation that examines as much historical data as is available.
We further refine the accuracy of our insights and calls through the use of alternative data to flesh out current trends, and through a valuation framework that emphasises non-superficial peer group selection and a proper attempt to understand the metrics and changes that have driven security valuations in the past.

Equity Bottom-Up

<p>Nidec's share price jumped 2.4% to ¥1,300 on Wednesday, July 21 - the last trading day before Japan's national holidays, when the company announced results for 1Q of FY Mar-22 - but fell back 3.2% to ¥12,580 today.</p><p>This reflects the positives and negatives facing the company as it ramps up production of EV motors and drive systems.</p><p>Results for the three months to June looked good, with operating profit up 60% year-on-year on a 33% increase in sales. 1Q sales, operating profit and net profit were all about 56% of 1H guidance.</p><p>On top of that, Nidec and Hon Hai announced plans to establish a joint venture to develop Nidec E-axle traction motor systems for EVs made by Hon Hai subsidiary Foxtron Vehicle Technologies.</p><p>However, competitor Hitachi (6501 JP) announced plans to build EV component factories in Japan China and the U.S. to expand capacity by about 6 times; and price competition in China is severe.</p><p>At 53x management's EPS guidance and 50x our own EPS estimate for FY Mar-22, and 40x our estimate for FY Mar-24, a lot of potential growth is already in the price.</p><p>We reiterate our previous conclusion: Guidance is probably conservative, but the shares are still overvalued.</p>

Nidec's share price jumped 2.4% to ¥1,300 on Wednesday, July 21 - the last trading day before Japan's national holidays, when the company announced results for 1Q of FY Mar-22 - but fell back 3.2% to ¥12,580 today.This reflects the positives and negatives facing the company as it ramps up production of EV motors and drive systems.Results for the three months to June looked good, with operating profit up 60% year-on-year on a 33% increase in sales. 1Q sales, operating profit and net profit were all about 56% of 1H guidance.On top of that, Nidec and Hon Hai announced plans to establish a joint venture to develop Nidec E-axle traction motor systems for EVs made by Hon Hai subsidiary Foxtron Vehicle Technologies.However, competitor Hitachi (6501 JP) announced plans to build EV component factories in Japan China and the U.S. to expand capacity by about 6 times; and price competition in China is severe.At 53x management's EPS guidance and 50x our own EPS estimate for FY Mar-22, and 40x our estimate for FY Mar-24, a lot of potential growth is already in the price.We reiterate our previous conclusion: Guidance is probably conservative, but the shares are still overvalued.

Nidec (6594 JP): Good 1Q, but EV Motors Face Tough Competition and Severe Pricing

<p>On Thursday, April 22, Nidec announced FY Mar-21 results. On Friday, the shares dropped 5.1%. Why? Possible reasons include:</p><ul>
<li>Nidec founder Shigenobu Nagamori, age 76, will give up the role of  CEO to current president and COO Jun Seki in June. Nagamori will remain Chairman, but his era is drawing to a close and the "Nagamori Premium" may already be evaporating.</li>
<li>FY Mar-21 results were good, but not stellar, and management is guiding for modest growth in FY Mar-22.</li>
<li>Progress is being made with EV motors, robot components and other products, but there is no new growth story. </li>
<li>Management expects EV power trains to become cheaper than internal combustion engine power trains "after 2024." In the meantime, R&amp;D and investment in new capacity are likely to be a drag on margins.</li>
<li>Valuations remain high. Even on what we regard as a reasonably optimistic forecast, with sales exceeding management's ¥2 trillion target in FY Mar-24 and EPS rising by more than 50% by then, the shares are selling at more than 40x earnings.</li>
</ul><p>On January 27, following 3Q results, we wrote "Take profits." We maintain that view.</p>

On Thursday, April 22, Nidec announced FY Mar-21 results. On Friday, the shares dropped 5.1%. Why? Possible reasons include:
Nidec founder Shigenobu Nagamori, age 76, will give up the role of  CEO to current president and COO Jun Seki in June. Nagamori will remain Chairman, but his era is drawing to a close and the "Nagamori Premium" may already be evaporating.
FY Mar-21 results were good, but not stellar, and management is guiding for modest growth in FY Mar-22.
Progress is being made with EV motors, robot components and other products, but there is no new growth story. 
Management expects EV power trains to become cheaper than internal combustion engine power trains "after 2024." In the meantime, R&amp;D and investment in new capacity are likely to be a drag on margins.
Valuations remain high. Even on what we regard as a reasonably optimistic forecast, with sales exceeding management's ¥2 trillion target in FY Mar-24 and EPS rising by more than 50% by then, the shares are selling at more than 40x earnings.
On January 27, following 3Q results, we wrote "Take profits." We maintain that view.

Nidec (6594 JP): Guidance Probably Conservative, but Still Overvalued

<p>On January 10, we wrote that demand for semiconductor equipment could exceed SEMI's growth forecast for 2021, that Tokyo Electron's guidance for FY Mar-21 was probably conservative, and that<em> Investors in Tokyo Electron (TEL)</em><em>... should benefit, even if the shares appear to be overbought.</em> (see<em><a href="https://www.smartkarma.com/insights/tokyo-electron-8035-jp-semiconductor-shortage-points-to-stronger-year-ahead" target="_blank" data-smartkarma-citation="insights:46893" rel="noopener">Tokyo Electron (8035 JP): Semiconductor Shortage Points to Stronger Year Ahead </a></em> ).  </p><p>Since then, TEL has raised guidance, Intel and TSMC have announced big new capital spending plans, SEMI has raised its forecast of semiconductor equipment demand, and TEL's share price has risen by 24%. How much more upside is there?</p><p>The shares are now selling at 34x management's EPS guidance for FY Mar-21 and 31x our estimate for FY Mar-22. These multiples are not high compared with those of other first-rate Japanese  precision manufacturing companies, but they are double what they were two or three years ago. </p><p>It is tempting to say that valuations are extended in what remains a cyclical industry, but the greater risk to earnings growth, in our estimation, is high and rising depreciation and R&amp;D expenses as the company expands capacity and develops technology for the 2 nanometer node and beyond (See <a href="https://www.smartkarma.com/insights/screen-holdings-7735-jp-aiming-at-2nm-process-technology" target="_blank" data-smartkarma-citation="insights:49767" rel="noopener">Screen Holdings (7735 JP): Aiming at 2nm Process Technology</a> ).</p>

On January 10, we wrote that demand for semiconductor equipment could exceed SEMI's growth forecast for 2021, that Tokyo Electron's guidance for FY Mar-21 was probably conservative, and that Investors in Tokyo Electron (TEL)... should benefit, even if the shares appear to be overbought. (seeTokyo Electron (8035 JP): Semiconductor Shortage Points to Stronger Year Ahead  ).  Since then, TEL has raised guidance, Intel and TSMC have announced big new capital spending plans, SEMI has raised its forecast of semiconductor equipment demand, and TEL's share price has risen by 24%. How much more upside is there?The shares are now selling at 34x management's EPS guidance for FY Mar-21 and 31x our estimate for FY Mar-22. These multiples are not high compared with those of other first-rate Japanese  precision manufacturing companies, but they are double what they were two or three years ago. It is tempting to say that valuations are extended in what remains a cyclical industry, but the greater risk to earnings growth, in our estimation, is high and rising depreciation and R&amp;D expenses as the company expands capacity and develops technology for the 2 nanometer node and beyond (See Screen Holdings (7735 JP): Aiming at 2nm Process Technology ).

Tokyo Electron (8035 JP): Getting Ahead of Itself

Japan

NIDEC CORPORATION is the world's leading manufacturer of small precision motors mainly used in HDD and optical disk drives. The company has extended its focus to the home appliance and automotive markets. NIDEC is active in M&A and its subsidiaries include the world's leading manufacturers of LCD panel handling robots and camera shutters.

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Nidec Corp (6594 JP)

Smartkarma Webinar | Japan IT Picks

Join us for a session with Insight Provider Scott Foster, who will present his hand-picked ideas in Japan's IT sector.

Smartkarma Research

2021 Nikkei 225 Rebalance: Nintendo, Murata, Keyence IN; Nisshinbo, Toyo Seikan, 'Skupper' OUT

The Nikkei 225 Rebalance is here. A small surprise in the ADDs. No surprises on the DELETEs. A couple of housekeeping changes, and 600 baskets to...

Travis Lundy

Nidec (6594 JP): Good 1Q, but EV Motors Face Tough Competition and Severe Pricing

1Q results were good, but a new electric vehicle JV with Hon Hai will be offset by rising competition from Hitachi and severe pricing in China. Not...

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Nidec (6594 JP): Guidance Probably Conservative, but Still Overvalued

Sales and profits continue to grow, but not fast enough to justify current valuations. The build-out of the EV motor business is a drag on margins...

Scott Foster

Tokyo Electron (8035 JP): Getting Ahead of Itself

The shared are up 33% so far this year, discounting record semiconductor capital spending and an upward revision to guidance. Peak earnings...

Scott Foster

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