Japan

In this briefing:

1. Japan Pharma – Top Picks
2. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.
3. Softbank Corp IPO – Trading Strategies
4. Takeda: Move Over Newton! Now It’s Spooky Action At a Distance
5. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

1. Japan Pharma – Top Picks

• While Gni Group Ltd (2160 JP) is our high risk-high return pick, Mitsubishi Tanabe Pharma (4508 JP)  is a contrarian call in anticipation of value accretive utilization of cash and Eq. (~40% of market cap.)
• Takeda Pharmaceutical (4502 JP) continues to remain our favourite pick from a medium to long term investment perspective
• Rest are event / catalyst driven trading ideas… (see attachment)

2. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.

We recently met NTT Docomo (9437 JP)  NTT (Nippon Telegraph & Telephone) (9432 JP), KDDI (9433 JP), and Rakuten (4755 JP) in Tokyo. Softbank Group (9984 JP) was unavailable as they were IPO’ing Softbank Corp (KK)(9434 JP) which lists tomorrow (Wed). While revenue headwinds seem to be strengthening, Chris Hoare thinks that neither DoCoMo’s price cuts, nor Rakuten’s entry, are sufficient to trigger a meaningful reduction in profitability in the next few years. The industry plans substantial cost cuts which will offset much of the damage, while falling handset subsidies create a further tailwind. Dividend payout ratios are set to rise gradually, boosting their attraction to yield starved investors. Chris believes that the attractive shareholder return environment over the past 4-5 years remains intact. Stocks have been recovering from the news of DoCoMo’s planned price cuts with the Softbank KK IPO a catalyst for the perception of the other telcos. For KDDI in particular, the impact of DoCoMo’s price cuts will be offset by the roaming agreement with Rakuten and a possible increase in shareholder remuneration (dividends and buyback).

3. Softbank Corp IPO – Trading Strategies

Bloomberg reported Softbank Corp (9434 JP)‘s international bookbuild was 2 – 3x covered while retail offering was at almost 2x. There were other reports of bookrunners struggling to sell shares to retail investors.

In this insight, we will look at how peers and market have performed since bookbuild and provide a sensitivity table with implied valuations for different price points and thoughts on the price range for near-term trading. 

We have already covered most aspects of Softbank Corp (9434 JP) ‘s IPO in our previous insights:

• Valuation from a retail investor POV –  Softbank IPO Review – Attractive from a Retail Perspective, Could Provide Short-Term Upside
• Valuation from an institutional investor POV – Softbank Corp IPO Review – Yield Ensured Demand May Not Guarantee Performance
• Updates from prospectus – Softbank Corp IPO Review – Segment Breakdown, Capex, and Risks
• Operating metric comparison – Softbank Telecom Pre-IPO – Higher Yield to Compensate for Poorer Metrics
• Impact of Rakuten entry and FCF and dividend sustainability analysis – Softbank Telecom Pre-IPO – All About the Yield
• Company background and overview – Softbank Telecom Pre-IPO Review – Vision Is Needed to Arrive at US$90bn Valuation

4. Takeda: Move Over Newton! Now It’s Spooky Action At a Distance

Over the weekend I published Softbank Corp, Takeda, and Newton’s Three Laws of Motion. Newton’s Three Laws helpfully guide one to understanding the nature of interaction of forces and bodies and the motion which results. Later, Euler’s laws of motion applied a framework for rigid and continuum bodies, and since then “action at a distance” has been replaced be Einstein’s Theory of General Relativity.

After I wrote the bit about one part of the index impact, FTSE unhelpfully changed their mind on timing based on an unhelpful change by the LSE. On Monday, the TSE exercised its discretion – clearly stated in the TOPIX Index Guidebook on p4 (2nd sentence of the opening paragraph) as something it may do – to go its own course in how it will adapt index changes to the first couple of increases in share count due to mergers with foreign corporations.

If an event not specified in this document occurs, or if TSE determines that it is difficult to use the methods described in this document, TSE may use an alternative method of index calculation as it deems appropriate.

So with the changes at FTSE and now TOPIX and JPX Nikkei 400, we no longer have quite the same clarity of forces on the bodies, and therefore less clarity on the resulting motion. The LSE’s announced market change appears to have led the MSCI to change its deletion date for Shire as well, now also (along with FTSE) deleting Shire at the close of the 21st (announcement early this AM Asia time).

Investors have prepared based on the idea that there was a reasonably tight relationship – helped because it was a lot of force applied in a short period (selling and buying all done in a short period in January) between the particles. Now that relationship is being stretched. A lot. 

The problem resembles that which Einstein famously pooh-poohed as “Spooky Action At a Distance”. Schrödinger called this entanglement – and it turns out to be one of the weirder branches of quantum mechanics – a field broken wide open by Bell’s Theorem a decade after Einstein shuffled off this mortal coil* – and about which John Wheeler famously said, “If you are not completely confused by quantum mechanics, you do not understand it.”

I cheerfully say quantum mechanics completely baffles me. 

I less cheerfully say this whole episode with Takeda and index providers has baffled me too.

But it is important to note that the timing and implications are vastly different than expected just two trading days ago. And the difference is worth thinking about. When the FTSE/MSCI net sell of risk was just 3 days apart, there was a clear connection across that three day distance. Now, the 6-10 week spread of time between the FTSE/MSCI events, the weird two weeks of SETSqx illiquid purgatory just as everyone is full up of risk, then the walk through the Valley of the Shadow of Flowback before we get the first really good net index inclusion to cover the Shire risk people have been dumping for months means that the certainty of understanding the movement of the particle on the other side is substantially lower.

If it all works out well, it might just be Spooky Action At a Distance.

5. Hitachi (6501 JP): A Bold but Risky Acquisition of ABB’s Power Grids

Hitachi Ltd (6501 JP) announced the acquisition of an 80.1% stake in ABB Ltd (ABBN VX)’s power grids business for $6.4 billion. ABB will retain the remaining stake in the divested unit, which is valued at an EV of $11 billion. ABB’s power grids is a global #1 player and makes transformers, long distance electricity-transmission systems and energy storage units.

In this briefing:

1. Idemitsu Kosan Tactical Support with Macro Cycle Drag
2. Renesas: Visit Suggests Utilisation Rate Rebound Could Take Longer Than Sell-Side Expects
3. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

1. Idemitsu Kosan Tactical Support with Macro Cycle Drag

Idemitsu Kosan (5019 JP) decline is nearing exhaustion support and sets up a tactical trade higher.

MACD breach of floor support now turns this key pivot level into a cap resistance on a recovery cycle. It also calls for a new and lower trading range.

Macro support breaks must be mended to turn the cycle from bearish back to neutral and will require a series of positive rally cycles for basing to unfold.

Tactical buy supports are outlined along with our tactical rally target, macro pivot resistance and the stop level.

2. Renesas: Visit Suggests Utilisation Rate Rebound Could Take Longer Than Sell-Side Expects

We visited Renesas Electronics (6723 JP) this week to discuss progress on inventory reduction and its likely ramp of utilisation rates/wafer throughput, as well as to gather further details on the IDT acquisition and its long -term strategy. On the whole, we continue to like the long-term picture, consider the stock to be undervalued and believe investors with long time horizons should be looking at the stock on the long side. However, our discussions suggested to us that while production cuts to reduce inventory should be completed this month or at worst in 1Q2019, a ramp in utilisation rates could take longer than is implied by consensus.

3. Tobacco: A Framework for Analyzing the Sin Sector from an ESG Perspective, with a Focus on ITC

Contrary to the perception that the rising adoption of socially responsible investment practices has caused Big Tobacco to be shunned by portfolio managers, our shareholding analysis shows that institutional holding in most of these ‘sin’ stocks has increased in the last 4 and 8 quarters.

Nevertheless, Big Tobacco suffered a pounding in 2018. Investors had bought into tobacco premising reduced risk products (Eg: e-cigarettes, Heat Not Burn products) would reduce regulatory risk and reverse decades of sales decline. As it turned out, regulators frowned at the popularity of vaping amongst teens in the US, calling out companies for baiting youngsters into long-term smoking habits. Regulators also told off companies for marketing e-cigarettes and HNBs as healthier options, as tobacco still kills.

Ethical portfolios with negative screens (for example, ones that will not invest in tobacco stocks) have underperformed in the long-term past. There is a growing tribe of funds committed to responsible investing with positive ESG screens. For such funds, we present in this insight a framework for analyzing the sector from an ESG perspective. A deep dive into ITC Ltd (ITC IN), the only cigarette major to turn in a positive performance this year, vindicates, in our view, its efforts to materially de-risk its asset and revenue profile, coupled with very high levels of commitment towards community development.

In this briefing:

1. FamilyMart: A Shrewd Head-Fake?
2. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019
3. Japan: Ticking the Bear Market Boxes
4. FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat
5. 2018 Was Not the Year for Value or Beta Names in Japan….

1. FamilyMart: A Shrewd Head-Fake?

We think the failed tender but continued asset sale between Familymart Uny (8028 JP) and Don Quijote (7532 JP)  is astutely beneficial for Familymart Uny Holdings (8028 JP) and parent Itochu Corp (8001 JP) . More details below 

2. Overview of My Winners and Losers in 2018…and 5 High Conviction Ideas Going into 2019

In a follow up to my note from last year Overview of My Winners and Losers in 2017…and 5 High Conviction Ideas Going into 2018 I again look at my stock ideas that have worked out in 2018, those that have not and those where the verdict is still pending.

Last year I provided 5 high conviction ideas and here is their performance in a brutal year for Asian Stock Markets:

4 out of 5 had a positive performance.

Below I will make a new attempt to provide five high conviction ideas going into 2019.

3. Japan: Ticking the Bear Market Boxes

After the market action on Thursday, this Insight provides a brief rundown of the technical position of our Japan Market Composite. I would categorise the current state of play as ‘The End of the Beginning’ and, despite the potential of short-term rallies, would still advise caution for the first quarter as the impact of the slowdown in global trade feeds through into earnings. 

4. FamilyMart Tender Offer for Don Quijote Misses The Mark as Mr. Partridge Stands Pat

In October, the Nikkei leaked and Familymart Uny Holdings (8028 JP) immediately thereafter announced that Familymart would sell the rest of its GMS (and financing) subsidiary UNY to Don Quijote Holdings (7532 JP) (which bought 40% of the company in 2017) and would conduct a Tender Offer later in 2018 at a 20% premium to the then-current price to buy a stake in Don Quijote of just over 20%. The Tender Offer was announced November 6th. Familymart had arranged to borrow shares it did not manage to buy in the tender so that at the next record date it will have 20% of the voting rights by hook or by crook. 

Don Quijote shares jumped to the Tender Offer price the same day and then spent a day there before investors decided that the news and structure of the deal was better news for Don Quijote than Familymart had priced in. 

Results of the Tender Offer have just been announced. Familymart had been trying to buy 32,108,700 shares for JPY 212 billion. They just missed. They got 0.08% of the total desired, or 24,721 shares for just over JPY 163 million.

THEY GOT NOTHING.

I expect Familymart had zero idea this would happen. I expect their bankers are surprised as well. They should not have been. They analysed this badly. There was a decent chance they would find it difficult to dislodge shares from owners. 

In FamilyMart Tender for Don Quijote – Elmer vs Mr. Partridge? I recalled how “Old Turkey” (from Edwin Lefevre’s Reminiscences of a Stock Operator) did not want to lose his position while Elmer was eager to take profits.

“I couldn’t think of selling that stock.” “You couldn’t?” asked Elmer, beginning to look doubtful himself. It is a habit with most tip givers to be tip takers. “Why not?” And Elmer drew nearer. “Why, this is a bull market!” The old fellow said it as though he had given a long and detailed explanation. 

Growth stock managers don’t like selling growth stocks until the growth stops growing. Don Quijote is still growing. And with UNY, Don Quijote may grow faster than previously expected. 

The announcement at the end of the Tender Offer Results announcement is also VERY telling. There was a plan to make Don Quijote an equity-method affiliate by buying in the Tender Offer, buying in the market, or borrowing lots of shares. There was a plan for Familymart to appoint directors to DQ.

There was a clearly-available trading strategy based on that. 

The new announcement puts that strategy into question. And Mr. Partridge might not be so inclined to call it a bull market. Since the launch of the deal, the markets have started the trip to Gehenna in a trug. From the one-month average prior to the Familymart bid news, Don Quijote is up 25%. Familymart is up 40%, the Nikkei 225 is down 10.7%, the TOPIX retail sector is down 5.5% but Familymart and Don Quijote have influenced that performance (without those two names, average performance is worse).

5. 2018 Was Not the Year for Value or Beta Names in Japan….

We looked back and identified which factors drove the Japanese market in 2018. We found that Value, which is historically strong in Japan, did poorly and really the only investment styles/factors that did well were large-cap and names with a high percent of retail investors.  

In this briefing:

1. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships
2. Global Markets Deteriorating…Except EM
3. BAUTO (BAUTO MK): New Models to Keep Strong Sales Momentum
4. Korean Government and Hyundai Motor Group’s Grand Ambitions to Expand Hydrogen Fuel Cell Vehicles
5. Japan: The 2018-Q3 Cash Flow Stakes – Runners, Riders & Red Flags

1. Universal, SegaSammy & Dynam Sit Best Positioned Among Japan Companies in Race for IR Partnerships

• We’ve reviewed 10 companies in the sector. Of those, three are the consensus favorites of our Tokyo based panel of industry, financial and economics observers of the IR initiative over many years.
• Based on pachinko alone, the stocks of these companies are fully valued. Based on potential tailwind from a license award within 6 months, they could be vastly undervalued.
• Each of the three noted here brings strength to a bid less based on financials than corporate focus, outlook and experience in the field.

2. Global Markets Deteriorating…Except EM

With U.S. markets stumbling, the MSCI ACWI index is breaking down to new lows: defensive Sectors remain attractive. Relative to MSCI ACWI however, emerging markets are the place to be. China, Brazil, Hungary, Qatar, India, Poland, and Indonesia all display positive price and/or RS trends. In this report we recap technical important levels on all major indexes and highlight attractive stocks within Real Estate, Health Care/Pharma, Precious Metals Mining, and Utilities.

3. BAUTO (BAUTO MK): New Models to Keep Strong Sales Momentum

• Improving asset turnover, relatively strong analyst recommendations, and slow asset growth relative to its sector
• New launches in FY2019-20 e.g. CX-3 facelift and 7-seat SUV CX-8 should stimulate sales going forward. Sales were up by 24% in 1QFY19 YoY
• Equity income from JV with Mazda Motor (7261 JP) should increase as production volume ramps up to meet strong ASEAN demand. Production up by 40% YoY in FY2018
• Attractive at a 19CE* 0.4 PEG ratio versus ASEAN Consumer Discretionary at a PEG of 0.9 and BAUTO is net cash
• Risks: Regulations and sluggish consumer demand, FX risk JPY and PHP

* Consensus Estimates

4. Korean Government and Hyundai Motor Group’s Grand Ambitions to Expand Hydrogen Fuel Cell Vehicles

• On December 18th, the Korean government announced numerous measures to reduce fine dust levels, including a significant increase in the number of hydrogen powered vehicles, including expanding hydrogen vehicles to 65,000 units by 2022 (cumulative). 
• The Korean government wants to encourage the growth of hydrogen powered economy and position the country as one of the global leaders in this segment. The Korean government plans to spend about 3.5 trillion won to support the Korean auto industry. The Korean government’s new plan is to expand the hydrogen vehicles to 65,000 units by 2022, which is a big increase from the previous plan of expanding the hydrogen vehicles to 15,000 units by 2022.
• The Hyundai Motor Group also recently announced a grand plan to expand its fuel cell vehicles with the announcement of its ‘FCEV Vision 2030.’ The Hyundai Motor Group plans to increase its annual production capacity for fuel cell systems to 0.7 million units by 2030, with plans to invest about $7 billion in the next 10 years to develop hydrogen fuel cell systems. 

5. Japan: The 2018-Q3 Cash Flow Stakes – Runners, Riders & Red Flags

JAPAN CORPORATE CASH FLOW UPDATE – This insight updates our previous Insight Yen Weakens > Normal Service Resumed with data from all of the most quarterly reports filed last month. Our aggregate cash flow model reformulated cash flows into eight categories which sum to Change in Cash – Free Cash Flow (Operating Cash Flow less Investing Cash Flow), Financing Cash Flow, Shareholder Cash Flow (Equity Cash Flow and Dividend Cash Flow) and Minorities. In the last three months, Japan’s non-financial companies generated ¥12.1t in Operating Cash Flow while investing ¥9.2t – the largest quarterly amount of capex since 2016-Q4.  Of the total ¥2.9t in Free Cash Flow, 65% was returned to shareholders of which half was in the form of reductions in equity – an improving and welcome trend which we covered in an earlier Insight. After a ¥0.8t increase in debt and a ¥0.3t increase in Minorities Cash Flow, aggregate cash rose by ¥2.2t for the quarter. Since 2011-Q4, 58% of the ¥102.7t in cumulative FCF has been allocated to shareholders and 40% to cash, leaving considerable room for improvement in the relative size of these ratios.

SECTORS & STOCKS – In the DETAIL below, we also look at sector cash flow trends and provide brief comments on some of the most significant changes in individual cash flows over the last three months including Softbank Group (9984 JP), Kawasaki Kisen Kaisha (9107 JP), Hanwa (8078 JP), Open House (3288 JP), Macnica Fuji Electronics (3132 JP), and Digital Garage (4819 JP).

In this briefing:

1. Belluna: Growing by Selling Gentility to the Expanding Older Market in Japan
2. Japan Retail Review 1H2018: Top Retailers Outperform
3. NTT Buybacks Will Roll On
4. Time-Out Not Time up for Trade War
5. Softbank Corp: When Does It Become a Buy?

1. Belluna: Growing by Selling Gentility to the Expanding Older Market in Japan

While Nissen and Senshukai (8165 JP) have hit new lows in the past five years, Belluna (9997 JP) has gone from strength to strength by sticking with printed catalogues and tying these to e-commerce and retail store expansion.

The company’s strategy is also helped by the core customer demographic being women over the age of 50, one of the few population segments that is still growing.

As a result, group sales have risen by 28.8% in five years and operating profit has almost doubled from ¥7.8 billion to ¥13 billion.

The acquisition of Sagami, a kimono retailer that suffered from lack of attention under Uny’s management, could also result in a boost to profits in the next year.

2. Japan Retail Review 1H2018: Top Retailers Outperform

Leading Japanese retail chains across all the major formats had a strong 1H2018 with surprisingly few exceptions.

Although some saw operating profits fall, and most of those that did expect profits to be lower for the year as a whole, other results were particularly impressive given the difficult operating conditions this year due to weather and natural disasters.

The following is a quick snapshot of the state-of-play at major Japanese retailers.

3. NTT Buybacks Will Roll On

There is an extensive history of writing on the NTT (Nippon Telegraph & Telephone) (9432 JP) family (and indeed Japan telecom sector) buybacks – their modalities and methods, impacts, legal and accounting requirements, competition, push-me-pull-you effect, etc. 

One of the longstanding features of buybacks for NTT is that NTT is subject to the NTT Law which requires (for the moment) that the government hold at least one-third of the shares outstanding in NTT.

Today, the Nikkei carried an article noting that the Japanese government’sFY2019 budget currently being formed proposes a sale of JPY 160bn of shares to help fund any revenue impact from the upcoming consumption tax rate hike from 8% to 10% next October. The article helpfully notes that they plan on selling when NTT is buying back shares.

This news is not unexpected to Smartkarma readers of the ongoing series. And there are implications and read-throughs. 

4. Time-Out Not Time up for Trade War

• Xi and Trump walk away from Buenos Aires with something to sell at home
• But trade negotiations will be dominated by fraught disagreements
• After 90-day negotiations, further delays to tariff escalation are likely 

5. Softbank Corp: When Does It Become a Buy?

Although we were bearish on the IPO initially and turned increasingly so following the relatively poor reception among retailers that was discussed in Softbank IPO: Signs Point to Risk of Early IPO Price Break, we were still a touch surprised at the extent of the drop today, with the stock finishing down 14.53% to close at the lows with 271.5m shares changing hands. With a rising dividend yield and looming buying from passive funds on the on hand and a potentially large overhang from retailers who may have been looking to flip for a profit on the other, we discuss what would turn us more bullish below.

In this briefing:

1. SoftBank Group (9984 JP): SoftBank Corp IPO Has Failed to Meaningfully Narrow the Holdco Discount
2. Semiconductor WFE Outlook. Things Just Got Really Ugly
3. Taisho Frontrunner to Acquire BMS’s French OTC Business
4. Japan Pharma – Top Picks
5. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.

1. SoftBank Group (9984 JP): SoftBank Corp IPO Has Failed to Meaningfully Narrow the Holdco Discount

Softbank Group (9984 JP)’s market cap has consistently traded below its NAV. A popular expectation was that the Softbank Corp (9434 JP) IPO should be a catalyst to narrow the conglomerate discount (holdco discount). On its trading debut today, SoftBank Corp’s shares fell 14.5% from its IPO price of JPY1,500 to JPY1,282 per share – the worst first-day decline ever for a major IPO in Japan since the Japan Display (6740 JP) IPO in 2014. 

2. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

3. Taisho Frontrunner to Acquire BMS’s French OTC Business

Event – Bristol Myers Squibb Co (BMY US)‘s  French OTC business UPSA has been on the block since June 2018. According to a December 17, 2018 Bloomberg report (link), Taisho has emerged as the frontrunner to acquire UPSA for ~$1.6b

Our Take

• If Taisho Pharmaceutical Holdin (4581 JP)  indeed goes ahead, it would get access to UPSA’s established (matured) OTC business, which generated ~$480m in sales in FY17
• UPSC’s key OTC brands include Aspirine, Dafalgan and Efferalgan pain relievers; Donormyl sleep aid; and Fervex cold and flu remedies
• Taisho also gains a foothold in France, contributing ~60% of UPSA sales (the rest is from other EU countries and China), by leveraging UPSA’s production facilities and distribution channels to perhaps market some of its own OTC products

Valuation

Preliminary analysis suggests that the potential acquisition would have only a marginal impact on Taisho’s financials in the short to medium term due to:

• Acquisition of a matured OTC portfolio that is projected to decline by 3-5% per year
• Absence of cost synergies; Taisho’s SG&A expense to increase by ~¥12-15b from FY19e
• Post deal Cash and Eq. of ~ $1b (assuming UPSA is an all cash deal)

4. Japan Pharma – Top Picks

• While Gni Group Ltd (2160 JP) is our high risk-high return pick, Mitsubishi Tanabe Pharma (4508 JP)  is a contrarian call in anticipation of value accretive utilization of cash and Eq. (~40% of market cap.)
• Takeda Pharmaceutical (4502 JP) continues to remain our favourite pick from a medium to long term investment perspective
• Rest are event / catalyst driven trading ideas… (see attachment)

5. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.

We recently met NTT Docomo (9437 JP)  NTT (Nippon Telegraph & Telephone) (9432 JP), KDDI (9433 JP), and Rakuten (4755 JP) in Tokyo. Softbank Group (9984 JP) was unavailable as they were IPO’ing Softbank Corp (KK)(9434 JP) which lists tomorrow (Wed). While revenue headwinds seem to be strengthening, Chris Hoare thinks that neither DoCoMo’s price cuts, nor Rakuten’s entry, are sufficient to trigger a meaningful reduction in profitability in the next few years. The industry plans substantial cost cuts which will offset much of the damage, while falling handset subsidies create a further tailwind. Dividend payout ratios are set to rise gradually, boosting their attraction to yield starved investors. Chris believes that the attractive shareholder return environment over the past 4-5 years remains intact. Stocks have been recovering from the news of DoCoMo’s planned price cuts with the Softbank KK IPO a catalyst for the perception of the other telcos. For KDDI in particular, the impact of DoCoMo’s price cuts will be offset by the roaming agreement with Rakuten and a possible increase in shareholder remuneration (dividends and buyback).

In this briefing:

1. NTT Buybacks Will Roll On
2. Time-Out Not Time up for Trade War
3. Softbank Corp: When Does It Become a Buy?
4. SoftBank Group (9984 JP): SoftBank Corp IPO Has Failed to Meaningfully Narrow the Holdco Discount
5. Semiconductor WFE Outlook. Things Just Got Really Ugly

1. NTT Buybacks Will Roll On

There is an extensive history of writing on the NTT (Nippon Telegraph & Telephone) (9432 JP) family (and indeed Japan telecom sector) buybacks – their modalities and methods, impacts, legal and accounting requirements, competition, push-me-pull-you effect, etc. 

One of the longstanding features of buybacks for NTT is that NTT is subject to the NTT Law which requires (for the moment) that the government hold at least one-third of the shares outstanding in NTT.

Today, the Nikkei carried an article noting that the Japanese government’sFY2019 budget currently being formed proposes a sale of JPY 160bn of shares to help fund any revenue impact from the upcoming consumption tax rate hike from 8% to 10% next October. The article helpfully notes that they plan on selling when NTT is buying back shares.

This news is not unexpected to Smartkarma readers of the ongoing series. And there are implications and read-throughs. 

2. Time-Out Not Time up for Trade War

• Xi and Trump walk away from Buenos Aires with something to sell at home
• But trade negotiations will be dominated by fraught disagreements
• After 90-day negotiations, further delays to tariff escalation are likely 

3. Softbank Corp: When Does It Become a Buy?

Although we were bearish on the IPO initially and turned increasingly so following the relatively poor reception among retailers that was discussed in Softbank IPO: Signs Point to Risk of Early IPO Price Break, we were still a touch surprised at the extent of the drop today, with the stock finishing down 14.53% to close at the lows with 271.5m shares changing hands. With a rising dividend yield and looming buying from passive funds on the on hand and a potentially large overhang from retailers who may have been looking to flip for a profit on the other, we discuss what would turn us more bullish below.

4. SoftBank Group (9984 JP): SoftBank Corp IPO Has Failed to Meaningfully Narrow the Holdco Discount

Softbank Group (9984 JP)’s market cap has consistently traded below its NAV. A popular expectation was that the Softbank Corp (9434 JP) IPO should be a catalyst to narrow the conglomerate discount (holdco discount). On its trading debut today, SoftBank Corp’s shares fell 14.5% from its IPO price of JPY1,500 to JPY1,282 per share – the worst first-day decline ever for a major IPO in Japan since the Japan Display (6740 JP) IPO in 2014. 

5. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

In this briefing:

1. BAUTO (BAUTO MK): New Models to Keep Strong Sales Momentum
2. Korean Government and Hyundai Motor Group’s Grand Ambitions to Expand Hydrogen Fuel Cell Vehicles
3. Japan: The 2018-Q3 Cash Flow Stakes – Runners, Riders & Red Flags
4. Belluna: Growing by Selling Gentility to the Expanding Older Market in Japan
5. Japan Retail Review 1H2018: Top Retailers Outperform

1. BAUTO (BAUTO MK): New Models to Keep Strong Sales Momentum

• Improving asset turnover, relatively strong analyst recommendations, and slow asset growth relative to its sector
• New launches in FY2019-20 e.g. CX-3 facelift and 7-seat SUV CX-8 should stimulate sales going forward. Sales were up by 24% in 1QFY19 YoY
• Equity income from JV with Mazda Motor (7261 JP) should increase as production volume ramps up to meet strong ASEAN demand. Production up by 40% YoY in FY2018
• Attractive at a 19CE* 0.4 PEG ratio versus ASEAN Consumer Discretionary at a PEG of 0.9 and BAUTO is net cash
• Risks: Regulations and sluggish consumer demand, FX risk JPY and PHP

* Consensus Estimates

2. Korean Government and Hyundai Motor Group’s Grand Ambitions to Expand Hydrogen Fuel Cell Vehicles

• On December 18th, the Korean government announced numerous measures to reduce fine dust levels, including a significant increase in the number of hydrogen powered vehicles, including expanding hydrogen vehicles to 65,000 units by 2022 (cumulative). 
• The Korean government wants to encourage the growth of hydrogen powered economy and position the country as one of the global leaders in this segment. The Korean government plans to spend about 3.5 trillion won to support the Korean auto industry. The Korean government’s new plan is to expand the hydrogen vehicles to 65,000 units by 2022, which is a big increase from the previous plan of expanding the hydrogen vehicles to 15,000 units by 2022.
• The Hyundai Motor Group also recently announced a grand plan to expand its fuel cell vehicles with the announcement of its ‘FCEV Vision 2030.’ The Hyundai Motor Group plans to increase its annual production capacity for fuel cell systems to 0.7 million units by 2030, with plans to invest about $7 billion in the next 10 years to develop hydrogen fuel cell systems. 

3. Japan: The 2018-Q3 Cash Flow Stakes – Runners, Riders & Red Flags

JAPAN CORPORATE CASH FLOW UPDATE – This insight updates our previous Insight Yen Weakens > Normal Service Resumed with data from all of the most quarterly reports filed last month. Our aggregate cash flow model reformulated cash flows into eight categories which sum to Change in Cash – Free Cash Flow (Operating Cash Flow less Investing Cash Flow), Financing Cash Flow, Shareholder Cash Flow (Equity Cash Flow and Dividend Cash Flow) and Minorities. In the last three months, Japan’s non-financial companies generated ¥12.1t in Operating Cash Flow while investing ¥9.2t – the largest quarterly amount of capex since 2016-Q4.  Of the total ¥2.9t in Free Cash Flow, 65% was returned to shareholders of which half was in the form of reductions in equity – an improving and welcome trend which we covered in an earlier Insight. After a ¥0.8t increase in debt and a ¥0.3t increase in Minorities Cash Flow, aggregate cash rose by ¥2.2t for the quarter. Since 2011-Q4, 58% of the ¥102.7t in cumulative FCF has been allocated to shareholders and 40% to cash, leaving considerable room for improvement in the relative size of these ratios.

SECTORS & STOCKS – In the DETAIL below, we also look at sector cash flow trends and provide brief comments on some of the most significant changes in individual cash flows over the last three months including Softbank Group (9984 JP), Kawasaki Kisen Kaisha (9107 JP), Hanwa (8078 JP), Open House (3288 JP), Macnica Fuji Electronics (3132 JP), and Digital Garage (4819 JP).

4. Belluna: Growing by Selling Gentility to the Expanding Older Market in Japan

While Nissen and Senshukai (8165 JP) have hit new lows in the past five years, Belluna (9997 JP) has gone from strength to strength by sticking with printed catalogues and tying these to e-commerce and retail store expansion.

The company’s strategy is also helped by the core customer demographic being women over the age of 50, one of the few population segments that is still growing.

As a result, group sales have risen by 28.8% in five years and operating profit has almost doubled from ¥7.8 billion to ¥13 billion.

The acquisition of Sagami, a kimono retailer that suffered from lack of attention under Uny’s management, could also result in a boost to profits in the next year.

5. Japan Retail Review 1H2018: Top Retailers Outperform

Leading Japanese retail chains across all the major formats had a strong 1H2018 with surprisingly few exceptions.

Although some saw operating profits fall, and most of those that did expect profits to be lower for the year as a whole, other results were particularly impressive given the difficult operating conditions this year due to weather and natural disasters.

The following is a quick snapshot of the state-of-play at major Japanese retailers.

In this briefing:

1. Taisho Frontrunner to Acquire BMS’s French OTC Business
2. Japan Pharma – Top Picks
3. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.
4. Softbank Corp IPO – Trading Strategies
5. Takeda: Move Over Newton! Now It’s Spooky Action At a Distance

1. Taisho Frontrunner to Acquire BMS’s French OTC Business

Event – Bristol Myers Squibb Co (BMY US)‘s  French OTC business UPSA has been on the block since June 2018. According to a December 17, 2018 Bloomberg report (link), Taisho has emerged as the frontrunner to acquire UPSA for ~$1.6b

Our Take

• If Taisho Pharmaceutical Holdin (4581 JP)  indeed goes ahead, it would get access to UPSA’s established (matured) OTC business, which generated ~$480m in sales in FY17
• UPSC’s key OTC brands include Aspirine, Dafalgan and Efferalgan pain relievers; Donormyl sleep aid; and Fervex cold and flu remedies
• Taisho also gains a foothold in France, contributing ~60% of UPSA sales (the rest is from other EU countries and China), by leveraging UPSA’s production facilities and distribution channels to perhaps market some of its own OTC products

Valuation

Preliminary analysis suggests that the potential acquisition would have only a marginal impact on Taisho’s financials in the short to medium term due to:

• Acquisition of a matured OTC portfolio that is projected to decline by 3-5% per year
• Absence of cost synergies; Taisho’s SG&A expense to increase by ~¥12-15b from FY19e
• Post deal Cash and Eq. of ~ $1b (assuming UPSA is an all cash deal)

2. Japan Pharma – Top Picks

• While Gni Group Ltd (2160 JP) is our high risk-high return pick, Mitsubishi Tanabe Pharma (4508 JP)  is a contrarian call in anticipation of value accretive utilization of cash and Eq. (~40% of market cap.)
• Takeda Pharmaceutical (4502 JP) continues to remain our favourite pick from a medium to long term investment perspective
• Rest are event / catalyst driven trading ideas… (see attachment)

3. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.

We recently met NTT Docomo (9437 JP)  NTT (Nippon Telegraph & Telephone) (9432 JP), KDDI (9433 JP), and Rakuten (4755 JP) in Tokyo. Softbank Group (9984 JP) was unavailable as they were IPO’ing Softbank Corp (KK)(9434 JP) which lists tomorrow (Wed). While revenue headwinds seem to be strengthening, Chris Hoare thinks that neither DoCoMo’s price cuts, nor Rakuten’s entry, are sufficient to trigger a meaningful reduction in profitability in the next few years. The industry plans substantial cost cuts which will offset much of the damage, while falling handset subsidies create a further tailwind. Dividend payout ratios are set to rise gradually, boosting their attraction to yield starved investors. Chris believes that the attractive shareholder return environment over the past 4-5 years remains intact. Stocks have been recovering from the news of DoCoMo’s planned price cuts with the Softbank KK IPO a catalyst for the perception of the other telcos. For KDDI in particular, the impact of DoCoMo’s price cuts will be offset by the roaming agreement with Rakuten and a possible increase in shareholder remuneration (dividends and buyback).

4. Softbank Corp IPO – Trading Strategies

Bloomberg reported Softbank Corp (9434 JP)‘s international bookbuild was 2 – 3x covered while retail offering was at almost 2x. There were other reports of bookrunners struggling to sell shares to retail investors.

In this insight, we will look at how peers and market have performed since bookbuild and provide a sensitivity table with implied valuations for different price points and thoughts on the price range for near-term trading. 

We have already covered most aspects of Softbank Corp (9434 JP) ‘s IPO in our previous insights:

• Valuation from a retail investor POV –  Softbank IPO Review – Attractive from a Retail Perspective, Could Provide Short-Term Upside
• Valuation from an institutional investor POV – Softbank Corp IPO Review – Yield Ensured Demand May Not Guarantee Performance
• Updates from prospectus – Softbank Corp IPO Review – Segment Breakdown, Capex, and Risks
• Operating metric comparison – Softbank Telecom Pre-IPO – Higher Yield to Compensate for Poorer Metrics
• Impact of Rakuten entry and FCF and dividend sustainability analysis – Softbank Telecom Pre-IPO – All About the Yield
• Company background and overview – Softbank Telecom Pre-IPO Review – Vision Is Needed to Arrive at US$90bn Valuation

5. Takeda: Move Over Newton! Now It’s Spooky Action At a Distance

Over the weekend I published Softbank Corp, Takeda, and Newton’s Three Laws of Motion. Newton’s Three Laws helpfully guide one to understanding the nature of interaction of forces and bodies and the motion which results. Later, Euler’s laws of motion applied a framework for rigid and continuum bodies, and since then “action at a distance” has been replaced be Einstein’s Theory of General Relativity.

After I wrote the bit about one part of the index impact, FTSE unhelpfully changed their mind on timing based on an unhelpful change by the LSE. On Monday, the TSE exercised its discretion – clearly stated in the TOPIX Index Guidebook on p4 (2nd sentence of the opening paragraph) as something it may do – to go its own course in how it will adapt index changes to the first couple of increases in share count due to mergers with foreign corporations.

If an event not specified in this document occurs, or if TSE determines that it is difficult to use the methods described in this document, TSE may use an alternative method of index calculation as it deems appropriate.

So with the changes at FTSE and now TOPIX and JPX Nikkei 400, we no longer have quite the same clarity of forces on the bodies, and therefore less clarity on the resulting motion. The LSE’s announced market change appears to have led the MSCI to change its deletion date for Shire as well, now also (along with FTSE) deleting Shire at the close of the 21st (announcement early this AM Asia time).

Investors have prepared based on the idea that there was a reasonably tight relationship – helped because it was a lot of force applied in a short period (selling and buying all done in a short period in January) between the particles. Now that relationship is being stretched. A lot. 

The problem resembles that which Einstein famously pooh-poohed as “Spooky Action At a Distance”. Schrödinger called this entanglement – and it turns out to be one of the weirder branches of quantum mechanics – a field broken wide open by Bell’s Theorem a decade after Einstein shuffled off this mortal coil* – and about which John Wheeler famously said, “If you are not completely confused by quantum mechanics, you do not understand it.”

I cheerfully say quantum mechanics completely baffles me. 

I less cheerfully say this whole episode with Takeda and index providers has baffled me too.

But it is important to note that the timing and implications are vastly different than expected just two trading days ago. And the difference is worth thinking about. When the FTSE/MSCI net sell of risk was just 3 days apart, there was a clear connection across that three day distance. Now, the 6-10 week spread of time between the FTSE/MSCI events, the weird two weeks of SETSqx illiquid purgatory just as everyone is full up of risk, then the walk through the Valley of the Shadow of Flowback before we get the first really good net index inclusion to cover the Shire risk people have been dumping for months means that the certainty of understanding the movement of the particle on the other side is substantially lower.

If it all works out well, it might just be Spooky Action At a Distance.

In this briefing:

1. Semiconductor WFE Outlook. Things Just Got Really Ugly
2. Taisho Frontrunner to Acquire BMS’s French OTC Business
3. Japan Pharma – Top Picks
4. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.
5. Softbank Corp IPO – Trading Strategies

1. Semiconductor WFE Outlook. Things Just Got Really Ugly

SEMI, the global industry association serving the manufacturing supply chain for the electronics industry, published three different forecasts for wafer fab equipment (WFE) sales in the past week. While the forecasts differ in approach and detail, they all agree on one thing, WFE revenues are continuing to fall and the outlook for 2019 is sharply down on previous estimates.

Specifically, Q4 2018 WFE revenues are set to decline 20.8% or $3.3 billion QoQ and the forecast which had just six months ago predicted 7% growth in 2019 is now calling for an 8% decline next year. 

These latest forecasts cast a dark shadow over the predictions of the leading WFE manufacturers that H1 2019 would be stronger than H2 2018 and we anticipate a strong downward revision of forward guidance in the upcoming earnings season. 

There may be a glimmer of hope on the horizon however as SEMI forecasts a strong rebound in the second half of 2019 leading to a return to growth of ~20% in 2020. Let’s see.  

2. Taisho Frontrunner to Acquire BMS’s French OTC Business

Event – Bristol Myers Squibb Co (BMY US)‘s  French OTC business UPSA has been on the block since June 2018. According to a December 17, 2018 Bloomberg report (link), Taisho has emerged as the frontrunner to acquire UPSA for ~$1.6b

Our Take

• If Taisho Pharmaceutical Holdin (4581 JP)  indeed goes ahead, it would get access to UPSA’s established (matured) OTC business, which generated ~$480m in sales in FY17
• UPSC’s key OTC brands include Aspirine, Dafalgan and Efferalgan pain relievers; Donormyl sleep aid; and Fervex cold and flu remedies
• Taisho also gains a foothold in France, contributing ~60% of UPSA sales (the rest is from other EU countries and China), by leveraging UPSA’s production facilities and distribution channels to perhaps market some of its own OTC products

Valuation

Preliminary analysis suggests that the potential acquisition would have only a marginal impact on Taisho’s financials in the short to medium term due to:

• Acquisition of a matured OTC portfolio that is projected to decline by 3-5% per year
• Absence of cost synergies; Taisho’s SG&A expense to increase by ~¥12-15b from FY19e
• Post deal Cash and Eq. of ~ $1b (assuming UPSA is an all cash deal)

3. Japan Pharma – Top Picks

• While Gni Group Ltd (2160 JP) is our high risk-high return pick, Mitsubishi Tanabe Pharma (4508 JP)  is a contrarian call in anticipation of value accretive utilization of cash and Eq. (~40% of market cap.)
• Takeda Pharmaceutical (4502 JP) continues to remain our favourite pick from a medium to long term investment perspective
• Rest are event / catalyst driven trading ideas… (see attachment)

4. Japan Telcos: Generally Positive After Recent Meetings in Tokyo.

We recently met NTT Docomo (9437 JP)  NTT (Nippon Telegraph & Telephone) (9432 JP), KDDI (9433 JP), and Rakuten (4755 JP) in Tokyo. Softbank Group (9984 JP) was unavailable as they were IPO’ing Softbank Corp (KK)(9434 JP) which lists tomorrow (Wed). While revenue headwinds seem to be strengthening, Chris Hoare thinks that neither DoCoMo’s price cuts, nor Rakuten’s entry, are sufficient to trigger a meaningful reduction in profitability in the next few years. The industry plans substantial cost cuts which will offset much of the damage, while falling handset subsidies create a further tailwind. Dividend payout ratios are set to rise gradually, boosting their attraction to yield starved investors. Chris believes that the attractive shareholder return environment over the past 4-5 years remains intact. Stocks have been recovering from the news of DoCoMo’s planned price cuts with the Softbank KK IPO a catalyst for the perception of the other telcos. For KDDI in particular, the impact of DoCoMo’s price cuts will be offset by the roaming agreement with Rakuten and a possible increase in shareholder remuneration (dividends and buyback).

5. Softbank Corp IPO – Trading Strategies

Bloomberg reported Softbank Corp (9434 JP)‘s international bookbuild was 2 – 3x covered while retail offering was at almost 2x. There were other reports of bookrunners struggling to sell shares to retail investors.

In this insight, we will look at how peers and market have performed since bookbuild and provide a sensitivity table with implied valuations for different price points and thoughts on the price range for near-term trading. 

We have already covered most aspects of Softbank Corp (9434 JP) ‘s IPO in our previous insights:

• Valuation from a retail investor POV –  Softbank IPO Review – Attractive from a Retail Perspective, Could Provide Short-Term Upside
• Valuation from an institutional investor POV – Softbank Corp IPO Review – Yield Ensured Demand May Not Guarantee Performance
• Updates from prospectus – Softbank Corp IPO Review – Segment Breakdown, Capex, and Risks
• Operating metric comparison – Softbank Telecom Pre-IPO – Higher Yield to Compensate for Poorer Metrics
• Impact of Rakuten entry and FCF and dividend sustainability analysis – Softbank Telecom Pre-IPO – All About the Yield
• Company background and overview – Softbank Telecom Pre-IPO Review – Vision Is Needed to Arrive at US$90bn Valuation