Thinking Points
- Japanese construction companies flood value-focused quantitative screens.
- Japanese construction doesn’t necessarily transfer well in other regions.
- My avoidance of Japanese construction is simply a decision heuristic, not a suggestion that everybody should avoid Japanese construction.
The backstory
As a lifelong introvert with pseudo allergies to social media, I never thought I’d write an article inspired by a Twitter post.
I was wrong.
Here is my first Twitter-inspired article.
Last week, Floris Oliemans shared Michael Koop’s Seeking Alpha blog post about Fujii Sangyo (TYO: 9906) on Twitter:
I enjoyed reading Michael Koop’s write up very much. If you have 10 minutes to spare, I highly suggest reading it. If not, here is my grossly reductionist summary:
The write up starts by highlighting several of Fujii Sangyo’s value characteristics, which can be summarized as: Healthy operating business, cash loaded balance sheet, and price below book value. Then, Michael discusses Fujii’s operating business and operating environment, which concludes that Fuji is likely to deliver business performance in-line with its key competitors and the overall industry. The write up then goes into analyzing the balance sheet, corporate governance, shareholder return, and key risks. Net of all the pros and cons, Fujii Sangyo looks like an attractive investment.
If you’ve ever done a value-oriented quantitative screen, you’ve probably come across the long list of stories similar to Fujii Sangyo (minus the corporate governance). Screens with low P/B, low P/E, low EV/EBIT, NCAV, etc tend to return a lot of construction companies. I haven’t actually sat down and counted how many, but generally enough for me to notice that there are many construction companies on the list.
Why I don’t invest in Japanese construction
If I had to identify three reasons why I don’t invest in Japanese construction, it would be the following:
- The industry is mostly uninteresting to me.
- Japanese value in the construction industry does not necessarily transfer well outside of Japan.
- Many of the construction companies are fighting for a bigger piece of a smaller pie.
Clearly, #1 is subjective. My background is mostly in supply chain management. Somewhere between engineering and manufacturing is where I find topics (and companies) that pique my interest. That said, things like Komatsu’s (6301) drone surveying technology and space development definitely interest me.
Point #2 and the Japanese environment
#2 requires a little more context. To paint the picture, Japan is a resource-starved first world nation. Lots of people with very little land. On top of that, the country is prone to natural disasters. Japan sits on four different tectonic plates. Every few years, we see headlines of a scary earthquake or tsunami affecting Japan. This is the environment Japan operates in.
I think the Japanese environment aids in the development of uniquely Japanese progress. Here is how I explain this to my friends: Japan is good at micro-innovation. The king of innovation is probably the US. If you want to make improvements to American innovation- like building things smaller, more efficiently, consistently, etc – you take the invention over to Japan and let them figure it out.
The perfect case study is Toyota. What happens when you take a car, an American invention, to a country that virtually imports every drop of oil? You get the Toyota Prius, a car that would make every imported drop of oil count. You also get wide adoption of American concepts like Lean Six Sigma through Toyota’s production system. Just in time delivery, vertical integration, pull production are all concepts that save resources.
The import problem stretches beyond oil and into every natural resource in existence. Lots of people, very little land, even fewer resources makes for some interesting developments. Japan has a natural need to be really good at things just to keep food on the table.
For similar reasons, if you are looking to build the tallest earthquake resistant building on the planet, you might want to start by looking for a Japanese construction company. Chances are, Japanese contractors will have a large portfolio of time-tested, earthquake resistant construction.
Transferring value
I think this has been a fair description of why the Japanese are meticulously detail-oriented. If that wasn’t enough, take a look at the 2011 earthquake that hit Japan. Just 15 seconds before the 2011 earthquake hit, Japan Railway East’s emergency system sent out a stop signal to 33 trains, preventing derailment and heartaches.
That’s impressive.
But the real question is this: how valuable is an accurate-to-the-microsecond emergency system in regions less prone to natural disasters?
This is what I’m getting at with point #2: Japanese value in the construction industry does not necessarily transfer well outside of Japan. The improvements made by Toyota are basically efficiency improvements as a result of Japan’s severe lack of resources. This will save resources regardless of where you take the improvements. The same cannot be said for construction. Chances are, if you pick any Tokyo building at random and place it in the middle of Dallas, Texas, the building will be considered overbuilt. This is because, well… when was the last time you heard about a major earthquake hitting Dallas?
To be sure, earthquake resistant construction isn’t the only thing Japanese construction is good at, but you can probably see why I’m less interested in Japanese construction.
Point #3
There really isn’t much to point #3. It probably isn’t surprising to many that construction spending in Japan for both public and private sector has decreased by about 42% since its peak in 1992. Spending seems like it has more or less stabilized over the past several years. Still, we have a pool of companies competing for a bigger piece of a shrinking pie. I doubt 2020 Tokyo Olympic construction would change the size of the pie.
What to make of this
Between construction not piquing my interest and point #2 above, I choose not to invest in Japanese construction. Maybe I don’t understand it well enough. Actually, I’m almost certain I don’t understand the industry well enough, which is a perfect reason not to invest in it.
That isn’t to say that there is no opportunity in Japanese construction. In fact, I have no doubt there are plenty of opportunities. I think Michael’s post on Fujii Sangyo is a perfect example. Investors ought to read it and throw a few questions his way.
Personally, I’d probably look at construction equipment rental companies before I look at construction companies. Here are a few:
- Nippan Rental (4669)
- Maeda Seisakusho (6281)
- Nanyo (7417)
- Wakita (8125)
- Kanamoto (9678)
