Shannon McConaghy
Market Views – June South West Japan Trip Notes, May‐June 2015 0 Shannon McConaghy
Market Views – June The objective of this research trip was to observe economic conditions both within mega‐cities and regional areas, in addition to conducting meetings with corporates, industry experts and the Bank Of Japan. My key conclusion is that Japan has seen two very different demographic trends over the last five years with regional Japan suffering the brunt of the population decline (‐2.46% over the last five years) as young workers have been sucked into mega‐cities. This has allowed the mega‐cities to see slight growth in population (+0.25% over the last 5 years). Japan’s three mega‐city conurbationsi set around Tokyo, Osaka and Nagoya are now set to follow regional areas as they too experience accelerating population decline. Mega‐cities are already showing signs of extreme aging of the population but will only now experience population decline. Following forecasts are from the National Institute of Population Research. Japan Population by Age Group (million)
130
120
110
100
90
80
70
60
50
40
30
20
10
0
-1.14% -1.97%
% decline 5 yr increments
-2.77%
-3.35%
29.5 34.0 36.1
-3.85%
36.6 36.8
-4.32%
37.4
38.7
81.7
76.8
73.4 70.8
67.7
63.4
57.9
16.8 15.8 14.6 13.2 12.0 11.3 10.7
2010 2015 2020 2025 2030 2035 2040
age <15
15‐64
>64
Population living in Regional Areas
Regional population fell by ‐2.46% from 2010‐
2015, the rate of decline will keep accelerating In 2040 the total population is forecast to be ‐18.8% lower. The working age population 15‐
64 will be ‐33.1% lower. The regional issues seen in this report will get worse and worse.
-2.46% -2.94%
-3.68%
Population living in Mega‐cities
Mega‐city populations grew +0.25% from 2010‐
2015 but will now decline ‐0.98% from 2015‐2020
+0.25% -0.98% -1.86%
-4.16%
Mega‐cities will expereince decline rates currently seen by regional areas in 10‐15 yrs.
-2.54% -3.11% -3.57%
-4.62% -5.11%
16.3 18.3 19.5
19.7 19.5
19.3 19.5
40.8 37.8
35.5 33.7
32.0 29.9
27.3
13.2 15.6 16.7 16.9 17.3
18.1 19.2
40.9 39.0 37.9
37.1 35.7
33.5 30.6
8.8
8.1
8.1
7.4
6.7
6.0
5.6
5.3
2010 2015 2020 2025 2030 2035 2040
age <15
15‐64
>64
7.7
7.2
6.6
6.0
5.6
5.4
2010 2015 2020 2025 2030 2035 2040
age <15
15‐64
Unfortunately to look at demographic trends within regional Japan is to look at the future for all of Japan. The objective of this trip was to observe how demographic pressures manifest in the real economy. Consistent findings from the trip were that demand in regional areas is weak or falling, capacity needs to be reduce and deflationary pressures persist. Regional areas experience less benefit from the weakening Yen with many exporters headquartered in mega‐cities. And inbound tourism also appears to provide little benefit outside of the mega‐cities. The impact of inbound tourism seems over reported by the media given tourist spending accounts for only 0.45% of GDP (Cabinet Office). The following observations are in a chronological order as I travelled through South West Japan towards Tokyo. This is a relatively wealthy area, with areas of North East Japan facing more significant population declineii. I am told by those who arrange research trips that it is rare for institutional investors to spend much time outside of major cities. I hope these trip notes provide balance to the many reports of still relatively lively activity within mega‐cities. Anecdotes do not make a science, but are important to cross check against formal economic analysis (which is available on request). 1. Flying in: business class 1/3rd occupied on flight from Hong Kong to Fukuoka. (DragonAir 11am on a Wednesday). The flight back from Tokyo to Hong Kong was full. Regional Japan is not seeing inbound tourism that mega cities are. This was also noticeable in hotels and retail outlets, I hardly saw any Chinese tourists until arriving in Osaka.
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Market Views – June 2. Fukuoka: Half of the shops shuttered at Hawks Town Mall. 1990’s development near central Fukuoka, Trip Advisor suggests it is generally deserted. Half of the shops were shuttered for good, five in the main thorough‐fare in this photo. One local suggested that most people now shop at the redeveloped train station mall. It is clear that without population growth any redevelopment investment simply takes customers away from existing retail outlets. Fukuoka prefecture has actually had relatively mild population decline of ‐0.52% over the last five years, this rate will now triple to ‐1.54% over the next five years whilst the working age population will fall by ‐5%. Fukuoka shows signs of mild depopulation and excess retail capacity with much worse to come.
3. Fukuoka: Deserted beach hut restaurants and Marizon Pier (high end restaurants, shops and wedding/event hall). Empty on a lovely 28 degree evening at 7pm. Demand for wedding halls has halved over the last 10 years in Japan whilst funeral services have increased by a quarter (METI Tertiary Industry statistics). The situation does not look set to improve as around 40% of 20 to 40 year olds think marriage is pointless (Japan Today).
4. Tokuyama: “Mike” a regular patron at “Hands Bar”, has lived in Tokuyama for 20 years: Mike teaches English to mid‐level managers at Japanese companies who are sent to run overseas plants as Japanese companies close plants at home. Mike sees more plants closing in the area to move production overseas with falling domestic workforce and demand. He also owns a hair salon with his wife where business is a struggle. “nothing has improved here under Abenomics (for the local economy)”. “I see some people take free bank money, try and start a business but then have to shut it down after six months”. Yamaguchi prefecture population ‐3.63% 2010‐2015, ‐4.19% 2015‐2020. 5. Hiroshima: Sogo Department Stores closed rooftop amusement park. Japan’s population of children has almost halved since the 1970’s. This does not look set to improve with a record low number of births in 2014.
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Market Views – June 6. Hiroshima: Isetan Mitsukoshi Department Store Food Court. Some department stores have an average customer age of over 60. Stores compete for elderly client base with cheap ground floor dining. It is hard to believe that this is a sustainable long term client base. Isetan Mitsukoshi’s (3099) shares trade on 35x P/E & 1.52x P/B.
7. Onomichi: Seaside town with 500 Abandoned Houses and Shops. The unusual thing about this town is someone has been brave enough to publicise the issue (link: Onomichi Abandoned House Project). This town is the norm rather than the exception with 13% of houses currently unoccupied in Japan, forecast to rise to 24% by 2028 (Fujitsu Research Institute). The increasing supply of property (elderly passing away/moving into care) and falling demand (population decline) means land price deflation per square meter in Japan will increase. Regional banks provide mortgages and SME loans against the collateral value of these properties, many trade on 17x P/E and 0.9x P/B. 8. Osaka: University closure. It is not just regional areas that are seeing a deterioration in land demand/supply balance. Around 500 schools and universities close each year in Japan, a number which is forecast to increase. This recently closed university is a 10 minute train ride from central Osaka Station, the back of the university grounds are already being turned into a large new residential village. This new supply of property cannot be good for land prices in the area given population of Osaka has already begun to decline. I actually took the second photo outside of what looked to be an abandoned building behind me. Sumitomo Realty and Development has numerous new residential projects in Osaka and trades on 35x P/E and 24.7x EV/EBITDA with 340% net debt to equity.
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Market Views – June 9. Osaka: Labour Utilisation. Much is made of Japan’s impending labour shortages by the media. Across Japan you still find significant numbers of employed people essentially doing very little, the country has the lowest productivity amongst G‐7 nations. Hankyu Hanshi (a private railway company) employed 3 men to direct people to buses, despite very clear signage. And 2 men to direct traffic whilst the traffic lights were functioning well amidst light traffic. Hankyu Hanshin said the population along its Osaka Area railway lines has been growing but will start to fall in 2–3years. Hankyu Hanshi shares trade on 19x P/E and 1.45x P/B. Redundancies in Japan costs around 2 years of salary and “The Company must prove that its business circumstances are such that redundancies are unavoidable” i.e earnings have already crashed. There were two men of working age living in a shanty under the bridge nearby.
10. Osaka: Kamagasaki “Slums”: It is estimated that 25,000 people live within this 2km square area just South of central Osaka. Most of which are single elderly underemployed men, a rapidly growing demographic across Japan. This shanty area was around 1km from our hotel. More striking photos can be found on the internet (Tokyo Times). Details of the area’s history, including the 24 riots/human rights protests since 1961 are available on Wikipedia.
11. Nara: Dreamland. Over 100 theme parks have been closed in Japan as the population of children plummets. Dreamland has been closed since 2006 and sits on a huge amount of land less than 2km from the centre of Nara. More artistic photos can be seen on websites dedicated to the new trend of Haikyo (exploring abandoned areas).
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Market Views – June Dreamland makes me think of Oriental Land (4661) which generates all of its earnings from owning Tokyo Disney, which is still running but has seen declining customer numbers, 95% of which are Japanese. Oriental Land trades on 38x P/E and 4.9x P/B. Oriental Land’s market cap is 20% of Walt Disney’s (DIS). Walt Disney generates 20% of its earnings in theme parks. Essentially the equity in one Disney theme park in Japan is valued at the same level to all of Walt Disney’s theme park portfolio (two large U.S. parks & majority share in four other parks in nations with increasing children). Tokyo Disney is investing $4b in updating/expanding the park, whilst the population under 15 is forecast to fall 28% over the next 20 years (hard to see great investment return on a 20 year investment horizon). 12. Nara: Town Centre. As a previous capital city of Japan and a UNESCO World Heritage Site Nara has many significant cultural attractions. However, half of the tourist stalls outside the main temple and museum were closed on a Sunday afternoon. The town centre had abandoned stores, no signs of recent investment and limited demand.
13. Kameyama: Food deflation. This restaurant surprised me. It was extremely efficient sushi train, with three wait staff for 80 seated customers and 15 customers queuing with an automated system allocating your seat. You could also order specific dishes on the LCD screen, with an RFID chip in the plate holder notifying you when it arrived. The wait staff just cleared plates and took payment (also automatable?). I ate a super tasty five plate meal for GBP2.90 (USD4.46). The ¥100 a plate (ex VAT) price was recently cut by 5% and another 10% during weekdays. A very clear indication deflationary food pressures persist. Food and eating out accounts for ~20% of household consumption.
I met a fish farmer on the trip who felt that fish prices could never rise in Japan and would instead keep falling. He felt the supply of fish (capacity of fish farms) would remain high whilst the consumption base (population) was falling. Larger restaurant chains (like the one above) were collaring lower prices by playing off suppliers for large orders whilst mom n’ pops purchased less. The large nationwide sushi train chain restaurant above Hamazushi belongs to Zensho Holdings which trades on 58x P/E, 2.6x P/B with 173% net debt to equity. To be honest I am not certain of the prospects even for this particular restaurant with the major employer in Kameyama being the perpetually loss making Sharp Corp LCD plant. If that plant closed the other mom n’ pop restaurants in town would be hit harder … but then again every other restaurant I came across in this town was already looking empty and desperate. Regional banks have large mom n’ pop restaurant and fish farm loan books. 5 Shannon McConaghy
Market Views – June 14. Futagawa abandoned buildings. Futagawa is considered within the Greater Nagoya mega‐city conurbation, it is close to the Shinkansen train line and with numerous large export factories nearby. I came across at least 10 abandoned looking buildings walking 10 minutes from the train station to my meeting. The last house had been turned into a storage area by the neighbours. It appeared that some houses had been torn down with the land used for make shift car parks or garden plots. New legislation will see any building unoccupied for 6 months torn down. I can’t help but wonder if regional banks that use purchase price for collateral valuation can still do so if the house is no longer there. I met four regional banks during my trip, each confirmed that they have been using more relaxed Non Performing Loan recognition for failing mortgage and SME loans under the SME Finance Facilitation Act. They have also increased loans to delinquent borrowers who cannot make monthly payments as required under the act. My forecasts of asset impairment at regional banks from normalisation of loan loss provisions available on request.
15. Yokohama 20 minutes from central Tokyo by train. Across Japan I felt “the Yen is too cheap”, here I could eat a three course restaurant meal for ¥850 (USD6.80), Lobster for ¥2,900 (USD23.20) and stay at a nice hotel for ¥7,959 (USD63.00). Yokohama is within the Tokyo mega‐city, outside of the mega‐cities hotels were even cheaper. I did spend one evening at the famous Okura Hotel in central Tokyo for ¥26,136 (USD200.00) as a last good‐bye before they tear it down to build a 38 story tower including office, hotel and retail floorspace.
16. Tokyo: Redevelopment Extravaganza. The thing that most struck me about Tokyo was the sheer scale of office and commercial floor space expansion coming on. I had to take two photos of the Shinagawa rail yards as the area was too large to capture in one photo. This area around the new Magnetic Levitation Station and its adjoining developments will add roughly half the size of Central Park NYC to the available ground floor real estate supply in Tokyo. Most of it will be high rise on currently unused land. There were too many other large planned developments around Tokyo Station, Shibuya, Toranomon, Shinbashi to take photos off. I can send my maps aggregating known development projects on request. With the working age population of Tokyo’s central prefecture forecast fall by 6% over the next 15 years I am not sure who will fill all these buildings at current rent per square meter, which is still high by global standards. Mitsubishi Estate the largest owner of office space trades on 50x P/E and 2.5x P/B which is also high by global standards. Regional Japan which is already in population decline is seeing sustained downward 6 Shannon McConaghy
Market Views – June pressure on real estate valuations, whilst these mega‐city buildings will be newer and shinier I can’t see a different outcome as their populations begin declining. 17. Tokyo: The elderly and the inefficient. Within 5 minutes of arriving in central Tokyo I had seen a lot of elderly people, one of whom was asleep outside the Bank of Japan and five staff at a completely empty Japan Post branch. None of the regional banks I met offered a strategy on how they would compete with Japan Post Bank if it is allowed to provide loans via 24,000 post branches after its upcoming IPO. Given Japan Post and Japan Post Bank currently sport 0.16% and 0.18% return on assets on the largest deposit base in the world I can’t see why it wouldn’t. 18. Tokyo: Isetan Mitsukoshi’s Flagship Department Store. Had a very similar elderly customer base to that in Hiroshima. The chicken and chips meal for ¥648 (USD 5.18, GBP 3.40) was 40% cheaper than what you would pay for KFC equivalent in London and much nicer. I only saw one person use the traveller’s tax reclaim desk in the 30 minutes whilst I used their WIFI. The ladies at the desk suggested the April cherry blossom season was much busier.
19. Chinese tourists buying made in China. The Don Qujiote retail store was seeing Chinese tourist flow, the company informs me that rice cookers, automated toilet seats and knifes are amongst the largest selling items to Chinese tourists. In each of these items I found that much of the product offering was in fact made in China. 7 Shannon McConaghy
Market Views – June 20. Otaku Women. Japan is famous for its “Otaku” (proudly geeky) men who prefer to have simulated computer game girlfriends and form relationships with body pillows covered in a girl’s image. The shying away from real world relationships, and the high pressure social requirements that come with it, are often given as a reason for the low birth rate. The increasing trend in the anime industry is for female products. The following images are from an interesting evening with an anime gaming industry expert where we visited (1) a busy female oriented store, (2) selling “boyfriend” pillow covers and (3) a café celebrating “virtual boyfriend” video games. I cannot see the birth rate increasing anytime soon.
Every conversation held during the trip on the subject of demographics acknowledged some awareness of the issues but also indicated that acceptance of significant immigration anytime soon is highly unlikely. I feel the demographic decline will continue to be the most important long term economic factor for Japan as external factors (exports) account for less than 15% of GDP and trade balance hovers around zero (less consumption of imports as the population declines will match slow decline in increasingly automated export production). Whilst global cyclical factors may influence market sentiment and some sectors earnings, longer term there should be a continued decoupling of economic activity away from growth in nations with demographic expansion. Nominal demand decline against existing levels of over‐capacity will reduce earnings and provide excellent relative and absolute shorting opportunities in Japan given equity valuations against current earnings are similar to global averages. The greatest earnings pressures will continue to be felt by companies focused on regional areas but perhaps more significant shocks against market expectation will come increasingly within earnings derived from mega‐cities. The deflationary pressures that will persist in Japan should result in the Yen strengthening against other currencies. On a real effective basis the Yen is now the weakest it has been since the 1985 Plaza Accord, 15% weaker than the previous low in 2007. If inflation remains at zero in Japan whilst other countries see inflation then the nominal Yen exchange rate has to appreciate otherwise the real exchange rate will become even cheaper. It is easy to see when travelling around Japan just how cheap items like housing, food, beer, transport, clothing, services and hotels are in USD or GBP terms compared to other countries. The strengthening of the Yen to a normalised trend level would bring significant downside to exporter earnings, which would drag down equity markets given their high weighting. It is only a matter of time before the Yen correction occurs. Japan is the world’s largest net foreign creditor with over USD3 trillion net investment overseas. Much of this is private individual’s savings for retirement with 91% of Japan’s net assets belonging to those over 60. As these soon to be retirees stop working they are more likely now to return those funds to live off than to generate further savings to send overseas. This repatriation of savings will not lift consumption in Japan (it is just a replacement of current earnings) but it will bring significant Yen buying and Yen appreciation. Even without Yen appreciation there will be many attractive short opportunities focused on declining consumption in domestic Japan. The final critical takeaway from my trip is that the current rate of QQE may in fact be heading towards tapering over the next year due to JGB liquidity constraints, which would be a huge negative surprise to most equity market investors and the currency markets. This is a rather complicated issue that requires detailed analysis of asset holdings by investor type and uses of those assets such as collateral for overseas loan books. I am always happy to discuss in person, on the phone or over email. The following are the meetings whilst in Japan which can be discussed further upon request. Towa Pharmaceutical (4553) Fukuoka Financial Group (8354) Hankyu Hanshin Holdings (9042) Mazda Motor (7261) The Bank Of Japan Izumi (8273) Resona Holdings (8308) Hiroshima Bank (8379) 8 Ship Healthcare Holdings (3360) Toyota Motor (7203) Honda Denshi (unlisted) Iriso Electronics (6908) Nomura Securities Fixed Income Specialists Secom (9735) Shannon McConaghy
Market Views – June Zenkoku Hosho (7164) Sato Holdings (6287) Credit Suisse Securities Auto Analyst (ex Aisin Seiki) SCSK Corporation (9719) Hitachi Kokusai Electric (6756) Joyo Bank (8333)
i
For this report I have used Tokyo conurbation as (Tokyo, Saitama, Kanagawa, Chiba prefectures), Osaka conurbation (Osaka, Hyogo, Kyoto prefectures) and Nagoya conurbation (Aichi, Gifu prefectures). The total mega‐city population derived from this approach is similar to official Statistics Bureau estimates for mega‐cities. This approach may in fact be a little generous in my mind, many of Japan’s cities have joined boundaries over time to form a continuous conurbation however from my experience and looking at the data many of the central Tokyo, Osaka or Nagoya inner city trends are not shared by adjoined cities ... for example observation #14 Futagawa is within Nagoya mega‐city and Aichi prefecture. ii
I am told that heavy snow in Northern areas of Japan creates further problems as communities with mostly elderly are isolated for long periods and unable to clear several meters of snow drift on roof tops. Some communities have been asked to sign waivers stating that the government is no longer responsible for maintaining infrastructure like bridges due to lack of working age manpower. Disclaimer Issued by Horseman Capital Management Limited (“HCM”), which is authorised and regulated by the Financial Conduct Authority (“FCA”) in the United Kingdom. The investment services of HCM are only available to professional clients and eligible counterparties as defined by the rules of the
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