International investor confidence in Abenomics, the suite of reforms orchestrated by Japanese Prime Minister Shinzo Abe to boost the Japanese economy, is waning. But as hot international money flows out of Japan in pursuit of opportunities elsewhere, old Japan hands retain a keen interest in a kind of company that has become something of a Japanese specialty: the micromultinational.
Micromultinationals are small- or midcap component manufacturers with high worldwide market shares in specialized, esoteric products. Japan portfolio managers say that the difficulty of learning to produce these components from scratch and win consumer trust puts up high barriers to entry and enables fat operating margins.
According to Richard Kaye, London-based portfolio manager with Paris-based €16 billion ($21 billion) investment management firm Comgest, certain facets of Japanese culture lend the country to being a hotbed for microsector development: These include the Japanese language’s complex writing systems, which from an early age help to develop precise dexterity, and an ethos that promotes local identity, leaving small, specialized companies relatively uninterested in mergers and acquisitions.
One such niche area is the manufacturing of components for electric-hybrid vehicles. Genzo Kimura, an economist at Japan’s $474 billion Sumitomo Mitsui Trust Holdings, Japan’s largest asset management firm, cites Fuji Electric Co., a 322 billion yen ($2.84 billion) market-cap maker of power semiconductors used in hybrid electric vehicles. The success of Fuji Electric in maintaining a 15 percent global share of this large and growing market illustrates a key point about top micromultinationals: The innate challenges of making the component create a high barrier to entry. “When you talk about semiconductors in general, they’re commodities,” says Kimura. “But only Japan is very good at power semiconductors. Korea and Taiwan have not been able to catch up.” Because of its burgeoning market and strong position, shares in Fuji Electric have almost tripled over the past two years, to 470 yen.
Ben Williams, London-based investment director in charge of Japan funds at GAM, an arm of Zurich-based asset management firm GAM Holding, cites a company in a completely different growth area: label printing. Fuji Seal International — unrelated to Fuji Electric — is one of two businesses that dominate the global market in machines that make shrinkable labels for grocery products such as soda and laundry detergent. “I like this company because it has good global market share in an area of secular growth,” says Williams. “Competition on supermarket shelves is becoming so fierce that packaging, which draws attention to products, is becoming more important.” The manufacturer has an 80 percent share of the Japanese market and about a third of the European and U.S. markets.
Comgest’s Kaye has invested in a company that tops even Fuji Seal when it comes to market positioning. Hamamatsu Photonics has, he says, a 100 percent share of the market for the imaging systems used in MRI scanners. He notes that one large European high-tech manufacturer recently told him that it had given up trying to produce these components because it was too difficult. “No one else but Hamamatsu can achieve the standards required,” Kaye concludes.
In many cases, these strong market positions are reflected in high margins. Hamamatsu enjoys an operating margin in the mid-20s in percentage terms — high above the average for manufacturers, says Kaye.
Given the inherent profitability of successful companies in these niche areas, the first question of a smart potential investor is clear: How long before other companies break into these markets in search of these rich pickings, destroying the incumbents’ share price value?
“The barriers to market entry are relatively high, but the techniques could be copied,” says Kimura of Sumitomo Mitsui Trust. “Chinese or other Asian companies will, sooner or later, imitate these and produce cheaper equivalents.” He cites as an example Chinese success in copying Japanese companies’ technology in bullet trains.
Certain micromultinationals are better placed to resist imitation than others, however. Investors agree that some sectors are becoming governed by price competition as increasing numbers of manufacturers learn to produce at the requisite level of quality. Several analysts say, however, that many niche markets are resisting this tendency. “Specialty chemicals and more-advanced technology, such as the information technology of autos, are becoming less and less commoditized,” says Taku Arai, Tokyo-based product manager, Japanese equities, at London-based asset management firm Schroders. Arai, who also seeks out micromultinationals, points to vehicle control systems, including power semiconductors, as an example of a promising niche.
Another strong safeguard for these companies is the tiny size of their markets. If a giant Japanese manufacturer like Panasonic Corp. spent large amounts of money breaking into Hamamatsu’s market and made a success of it, the contribution to Panasonic’s overall profits would be equivalent to “a rounding error,” according to Kaye.
But even if micromultinationals are highly profitable and likely to remain so, are they attractively priced? Many remain somewhat unknown among fund managers because of their small size and geographic obscurity. Kaye cites OSG Corp., a manufacturing firm in Osaka that has a 25 percent global market share in the machines that make a component of screws known as the receiving line. Despite its strong market position and high profitability, it has a fairly modest forward price-earnings ratio of 17. Kaye notes that OSG is both small and — located near Toyota, a major customer — relatively far from analysts in Tokyo. Investors have not really noticed it. That is, until now, perhaps.
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