In September, we began discussing some of the highlights from our business trip to Japan. As promised, we wanted to share a bit more with you about our meetings and some of the potential we see there for uncovering core companies.
When we look for new businesses, we target three characteristics:
- A business with sustainable competitive advantage
- Management who think like owners
- Strong capital allocation.
Across industries in Japan we see some of the most dominant businesses in the world:
- A snack food giant with 64% share of snacks (75% of chips) domestically
- A semi-equipment company with 80-90% share in its specific application
- An industrial manufacturer with 95% share of subway doors and barriers
- An industrial automation company that earns over 50% operating margins.
With metrics like these, it is clear that many businesses with serious competitive moats exist.
In the Japanese business culture, companies are entities upon themselves and the collective drives the way forward (which in many instances ends up sideways.) It is difficult to find companies with an ownership mentality, as we at Cambridge define it. To give one amazing example, often long term goals are set with expectations of them NOT being achieved.
Further complicating matters, doing business in Japan can be a very formal process, including the famous card exchanges at the beginning of the meeting, assigned seating by level on the organizational chart and meeting focus on confirming the thoughts of others rather than disagreeing and pushing back. Additionally, if you want to oppose someone there is another interesting ritual which I will leave for another blog.
That being said, prior to our trip we identified some very ownership-minded businesses. We were able to meet with two businesses that have eschewed traditional Japanese corporate culture of hierarchy and structure for a focus on what is right for the company - no matter who the idea comes from. This has led to dominant market positions, strong organic growth, and high returns for shareholders. We also met with a hands-on CEO/owner who is focused on capturing 100% share of the specific retail category they target from about 12% today. In order to do this he identified a key driver for the business and created an IT system to track retail stores on a daily basis. He also maintained his head office in rural Japan to keep costs low. We also met with one company whose founder sets 30-year forecasts. The last one that ended in 2010 was actually pretty spot on!
As for capital allocation, it narrowed the list down further. In most cases, returns were an output of a dominant franchise rather than a purposeful target for the business – but this is slowly changing. What is additionally amazing to me is how, for a country where money is free, so few businesses use their balance sheet for growth. This conservatism isn't a negative, but more so a latent value creation potential:
Abe's third arrow focused on less conservative balance sheets and investment growth, with return on equity (ROE) the key metric they focus on. With this we have seen more focus on return of capital to shareholders by companies with excess capital:
In summary, Japan offers a great deal of business with strong competitive advantages and numerous business leaders who think like owners which is great for our firm. While the capital allocation piece isn't quite there yet, we see it as a free option to the upside in the future. After all, the issue isn't that they are bad capital allocators (who destroy value), but rather they are not allocating a lot of capital and it is ending up as cash on the balance sheet. Our focus and in-depth research give us an edge on understanding the key drivers of these businesses and hopefully we can identify any inflection points on capital allocation. If we stay patient and focused we may be able to catch an exciting inflection point in returns for public companies in Japan.
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