Why I Don’t Invest In Japanese Construction

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:

  1. The industry is mostly uninteresting to me.
  2. Japanese value in the construction industry does not necessarily transfer well outside of Japan.
  3. 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)

Author: Clayton Young

Hi! I’m Clayton. My value investing journey began in 2012 during my college days. It was not until recently (2016!) that I decided to leverage my Japanese language skills to research Japanese equities. I hope to provide valuable insight on Japanese companies to the English-speaking world through this blog!

6 thoughts on “Why I Don’t Invest In Japanese Construction”

  1. Good work. I just found your blog. I’m from the states, but currently visiting in-laws in Tokyo (Hamura). Since I have been here started getting very interested in Japanese companies. I am having difficulty finding screens and even financial data for Japanese companies. Where do you look for your information? I don’t read much Japanese. Thanks really like your post on the washlet, I have one, and sent out to friends and family as christmas present. I agree that it must catch on at some point.

    1. Hi Phil, thanks so much for the kind comment! I hope you are enjoying your stay in Tokyo.

      I read the Nikkei every day so that’s normally where I start; if a company sounds interesting to me, I start digging. As for screens, I occasionally use them. I write for Guru Focus so I get to use their Asia subscription. They have historical financials, screens, various metrics, etc. I think they buy their data from Morningstar (not 100% sure). Sometimes the financials are wrong so you probably want to spot check data if you want to use the site. If you’re looking for a free source, I previously used Financial Times’ Equity Screen. Here’s the link.

      That is an interesting Christmas gift lol. I think the washlet would catch on in SE Asia before it starts gaining popularity in the US. Many toilets in the Philippines (where I currently live) come with a little hose with a spray nozzle on it. Eventually, I’m sure the wealthier folks here would be in the market for a washlet.

      Thanks again for the kind comment. If there are any Japan-related topics you’re interested in reading about, let me know! I’m always on a hunt for feedback 🙂

      Cheers,
      Clay

  2. Clay,

    Attempting to “invert” this a bit, let’s say you had a company like Fujii Sangyo trading cheaply and you had a big pile of money… maybe Fujii Sangyo’s entire market cap, sitting in cash. And let’s say somehow you could buy all the shares at its current market cap and turn your pile of cash into 100% of Fujii Sangyo (which is, itself, partly a pile of cash).

    Why wouldn’t you want to do this in this case?

    I’d really be interested in your thoughts of why it would be bad to own 100% of this company, at its current valuation, and be able to control the disposal of its assets.

    1. Hi Lion,

      Thanks for the comment and question!

      I don’t necessarily think it would be bad to own 100% of Fujii Sangyo. If I can take control of the company and direct utilization, acquisition, or disposal of assets, that’s something I’d carefully consider. The investment case changes entirely depending on whether I’m a minority or majority investor. My reality is that, regardless of what stock I invest in, I am a minority investor, so I try to think accordingly.

      Just to clarify, I’m also not saying there are no opportunities in Japanese construction.

      Cheers!
      Clay

  3. Also, this might have thrown you off, it throws me off:

    “Fujii Sangyo Co Ltd. (9906:Tokyo) is a good firm at a wonderful price with limited downside and ample upside given my conservative assumptions.”

    Mmm, it doesn’t seem like a bad firm, but what is clearly being echoed here is Buffett and Munger and this isn’t really a Buffett and Munger stock in my mind. The problem is you have a company piling up cash with no idea what to do with it. A Buffett and Munger stock is a company that can keep putting the capital to good use. So it’s a bit disorienting to think that the author is trying to fit this, implicitly, into the Buffett and Munger box. That creates some cognitive dissonance for me. I would’ve rather heard him say something Ben Grahamy about reversion to the mean and how every dog has its day.

    1. Hi Lion,

      Thanks for the interesting observation. I don’t necessarily categorize investment opportunities as “Buffett and Munger” or “Ben Graham”, so I didn’t get the cognitive dissonance you experienced. Occasionally, I plug popular investors into my articles (i.e., for Guru Focus, because the focus is on Gurus…) but otherwise, I don’t place too much weight on other authors’ wording.

      Cheers,
      Clay

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