Monetary Easing Could Lead Japanese Firms Lower

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Loosening monetary policy is being cited as the driver for improvements in many Japanese companies. Yes, it makes their exports cheaper. Unfortunately, monetary easing will also make their imports more expensive and could lead to inflation in a highly indebted economy.

American investors should be very picky when selecting Japanese stocks. They should restrict themselves to companies that are trading at bargain price multiples. Below, I will explain why Sony (NYSE: SNE) is the most compelling Japanese stock available to American retail investors at today’s prices.

Panasonic Surprise Profit

The weaker yen is helping Panasonic (NASDAQOTH: PCRFY)Sharp (NASDAQOTH: SHCAY), and Sony to compete against Samsung Electronics (SSNLF) amid decreasing demand as they restructure their respective operations. Ichiyoshi Asset Management Chief Fund Officer Mitsushige Akino said, “It’s looking increasingly likely that they’ll be able to survive.  It’s important that they carry out drastic reforms.”

Recent results have been very promising. Panasonic and Sharp, Japan’s second and third largest TV makers, could be on their way to recovery after cost-cutting measures, asset sales and a weakening yen helped improve fiscal third-quarter income.  Panasonic posted 61.3 billion yen ($665 million) in net income for the quarter ended Dec. 31, beating analysts expected 17 billion-yen loss ($181 million), while Sharp managed an operating profit of 2.6 billion yen ($27.8 million) for the same period, its first after five quarters.

Iwai Cosmo Holdings Analyst Mitsuo Shimizu said, “The situation for exporters is getting better with the yen’s recent weakness as a tailwind.” He also said that the Japanese automakers are competitive enough and would be able to take the benefit of currency movements. But, the countries electronic manufactures require producing more attractive products to fight against the competition from Samsung.

Nevertheless, the two companies still maintained their full-year net loss forecasts totaling $13.2 billion, even as Panasonic Chief Financial Officer Hideaki Kawai said the weaker yen can help beat the company’s projected 765 billion-yen ($8.18 billion) loss estimate.

By March, Panasonic’s newly promoted President Kazuhiro Tsuga will announce a new medium-term plan that may include quitting businesses where operating margins are less than 5%.  Commons Asset Management President Tetsuro Ii said, “Panasonic should go faster.  Significant structural reforms haven’t occurred yet. The company should accelerate sales of unprofitable assets and divisions.”

In spite of the net income, Panasonic’s third-quarter sales dropped 8% to 1.8 trillion yen ($19.26 billion), led by domestic sales which fell 12% and sales of audio-visual equipment which plunged 20% 389 billion yen ($4.16 billion). Sharp’s net loss of 36.7 billion yen ($392.6 million) was larger than analysts’ estimate of 34 billion-yen ($363 million) loss, but not as bad as compared with the 174 billion yen ($1.86 billion) posted a year earlier.

Last December, Sharp agreed to sell as much as 9.9 billion yen ($105.9 million) of new shares to chip-maker Qualcomm (QCOM), which has so far bought 4.9 billion yen ($52.4 million) as the first of two tranches. Sharp also had talks with Hon Hai about selling a stake, after the latter bought a stake in one of Sharp’s LCD plant last year.  Last year, the TV maker expressed material doubt about the sustainability of its operations after bleeding 103 billion yen ($1.1 billion) in cash for the semester ending September.

Sharp President Takashi Okuda said, “We want to proceed with the negotiations with Hon Hai based on the fact that our trend is starting to rise.  Until now, there had only been negatives for us.”  Okuda admits the company’s financial situation is “tough,” but promises to immediately push through with structural reforms targeting to manage an operating profit for the second half and hopefully “post net income next fiscal year.” Myojo Asset Management Japan CEO Makoto Kikuchi seems to disagree, “There were at least no negative surprises in the results for Sharp and Panasonic.  Still, it’s hard to see how they can post net incomes next fiscal year.” 

The Bearish Case for Japanese Stocks

So what’s the problem?

If the Yen devalues further, then the assets of Japanese companies will be cheaper to foreigners. That means that if your stock is worth the same amount in Japan to a Japanese investor, it would be worse to you as a foreigner who counts returns in a depreciating foreign currency.

This relationship throws a monkey wrench into most valuation arguments that favor Japanese firms.

Going further, we can reason that currency devaluation and inflation favor firms with real assets and Yen-denominated, fixed-rate bonds. True believers in an ever-weakening yen would seek out firms with high debt-to-equity ratios, fixed-rate bonds with distant maturities (long duration), and real assets whose values go up with inflation.

I can’t advocate this strategy. Instead, I advocate finding firms with low financial leverage instead of making a macro bet on Japanese monetary easing by finding highly-leveraged stocks to buy.

Valuation

Though many Japanese stocks trade at low price-to-book ratios, many are highly levered.

<table> <tbody> <tr> <td> <p><strong>Ticker</strong></p> </td> <td> <p><strong>Company</strong></p> </td> <td> <p><strong>P/E</strong></p> </td> <td> <p><strong>P/S</strong></p> </td> <td> <p><strong>P/B</strong></p> </td> <td> <p><strong>D/E</strong></p> </td> </tr> <tr> <td> <p><span>MTU</span></p> </td> <td> <p><span>Mitsubishi UFJ Financial</span></p> </td> <td> <p><span>193.67</span></p> </td> <td> <p><span>2.91</span></p> </td> <td> <p><span>0.61</span></p> </td> <td> <p><span>4.18</span></p> </td> </tr> <tr> <td> <p><span>NTT</span></p> </td> <td> <p><span>Nippon Telegraph & Telephone</span></p> </td> <td> <p><span>10.9</span></p> </td> <td> <p><span>0.51</span></p> </td> <td> <p><span>0.62</span></p> </td> <td> <p><span>0.54</span></p> </td> </tr> <tr> <td> <p><span>SNE</span></p> </td> <td> <p><span>Sony</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.21</span></p> </td> <td> <p><span>0.68</span></p> </td> <td> <p><span>0.69</span></p> </td> </tr> <tr> <td> <p><span>IX</span></p> </td> <td> <p><span>ORIX</span></p> </td> <td> <p><span>13.89</span></p> </td> <td> <p><span>1.16</span></p> </td> <td> <p><span>0.8</span></p> </td> <td> <p><span>3.18</span></p> </td> </tr> <tr> <td> <p><span>SMFG</span></p> </td> <td> <p><span>Sumitomo Mitsui Financial</span></p> </td> <td> <p><span>7.87</span></p> </td> <td> <p><span>3.19</span></p> </td> <td> <p><span>0.93</span></p> </td> <td> <p><span>2.38</span></p> </td> </tr> <tr> <td> <p><span>NMR</span></p> </td> <td> <p><span>Nomura Holdings</span></p> </td> <td> <p><span>45.92</span></p> </td> <td> <p><span>1.1</span></p> </td> <td> <p><span>0.95</span></p> </td> <td> <p><span>4.28</span></p> </td> </tr> <tr> <td> <p><span>KYO</span></p> </td> <td> <p><span>Kyocera</span></p> </td> <td> <p><span>28.63</span></p> </td> <td> <p><span>1.26</span></p> </td> <td> <p><span>0.97</span></p> </td> <td> <p><span>0.02</span></p> </td> </tr> <tr> <td> <p><span>MITSY</span></p> </td> <td> <p><span>Mitsui & Co.</span></p> </td> <td> <p><span>6.78</span></p> </td> <td> <p><span>0.5</span></p> </td> <td> <p><span>0.99</span></p> </td> <td> <p><span>1.5</span></p> </td> </tr> <tr> <td> <p><span>DCM</span></p> </td> <td> <p><span>NTT DOCOMO</span></p> </td> <td> <p><span>12.63</span></p> </td> <td> <p><span>1.38</span></p> </td> <td> <p><span>1.09</span></p> </td> <td> <p><span>0.05</span></p> </td> </tr> <tr> <td> <p><span>KNM</span></p> </td> <td> <p><span>Konami</span></p> </td> <td> <p><span>13.6</span></p> </td> <td> <p><span>1.04</span></p> </td> <td> <p><span>1.17</span></p> </td> <td> <p><span>0.16</span></p> </td> </tr> <tr> <td> <p><span>MFG</span></p> </td> <td> <p><span>Mizuho Financial</span></p> </td> <td> <p><span>8.05</span></p> </td> <td> <p><span>3.63</span></p> </td> <td> <p><span>1.18</span></p> </td> <td> <p><span>14.56</span></p> </td> </tr> <tr> <td> <p><span>PC</span></p> </td> <td> <p><span>Panasonic</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>0.23</span></p> </td> <td> <p><span>1.21</span></p> </td> <td> <p><span>0.69</span></p> </td> </tr> <tr> <td> <p><span>HMC</span></p> </td> <td> <p><span>Honda Motor</span></p> </td> <td> <p><span>17.44</span></p> </td> <td> <p><span>0.67</span></p> </td> <td> <p><span>1.36</span></p> </td> <td> <p><span>0.98</span></p> </td> </tr> <tr> <td> <p><span>TM</span></p> </td> <td> <p><span>Toyota Motor</span></p> </td> <td> <p><span>20.01</span></p> </td> <td> <p><span>0.76</span></p> </td> <td> <p><span>1.38</span></p> </td> <td> <p><span>1.15</span></p> </td> </tr> <tr> <td> <p><span>NSANY</span></p> </td> <td> <p><span>Nissan Motor</span></p> </td> <td> <p><span>NA</span></p> </td> <td> <p><span>-</span></p> </td> <td> <p><span>1.45</span></p> </td> <td> <p><span>1.5</span></p> </td> </tr> <tr> <td> <p><span>CAJ</span></p> </td> <td> <p><span>Canon</span></p> </td> <td> <p><span>17.08</span></p> </td> <td> <p><span>1.24</span></p> </td> <td> <p><span>1.54</span></p> </td> <td> <p><span>0.01</span></p> </td> </tr> <tr> <td> <p><span>NJ</span></p> </td> <td> <p><span>Nidec</span></p> </td> <td> <p><span>16.39</span></p> </td> <td> <p><span>1.09</span></p> </td> <td> <p><span>1.74</span></p> </td> <td> <p><span>0.78</span></p> </td> </tr> <tr> <td> <p><span>MKTAY</span></p> </td> <td> <p><span>Makita</span></p> </td> <td> <p><span>17.99</span></p> </td> <td> <p><span>1.97</span></p> </td> <td> <p><span>1.78</span></p> </td> <td> <p><span>0.01</span></p> </td> </tr> <tr> <td> <p><span>KUB</span></p> </td> <td> <p><span>Kubota</span></p> </td> <td> <p><span>21.28</span></p> </td> <td> <p><span>1.28</span></p> </td> <td> <p><span>1.96</span></p> </td> <td> <p><span>0.61</span></p> </td> </tr> </tbody> </table>

Of the stocks on this list, Sony is the most interesting. It trades at low price-to-sales and price-to-book ratios and is neither a financial services company nor highly leveraged.


BillEdson11 has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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