Managed by Masakazu Takeda and Yu Shimizu, the fund, which is part of California-based Hennessy Advisors, invests in a concentrated number of high-quality Japanese companies. The portfolio managers search for value opportunities among companies that have good management, a strong balance sheet with little to no debt, a durable competitive advantage, a high return on equity, strong cash flow generation and above-average earnings growth.
In a recent market commentary, Takeda and Tadahiro Fujimura, who manages the Hennessy Japan Small Cap Fund (Trades, Portfolio), discussed the bolstered investor sentiment for Japanese stocks following Berkshire Hathaway's (BRK.A, Financial)(BRK.B) 5% investment in several major "sogo shosha" conglomerates. They said the companies complement Warren Buffett (Trades, Portfolio)'s investment style, but noted that he saw opportunities since stocks trade at discounts to their fair value "due to mistaken perceptions by non-Japanese investors."
Keeping its investing criteria in mind, the fund established only one new position during the quarter, which was in Olympus Corp. (TSE:7733, Financial). It also divested of its Ryohin Keikaku Co. Ltd. (TSE:7453, Financial) holding and curbed a slew of other investments, including Kubota Corp. (TSE:6326, Financial), Mitsubishi Corp. (TSE:8058, Financial) and Shimano Inc. (TSE:7309, Financial).
The fund invested in 322,700 shares of Olympus, allocating 0.95% of the equity portfolio to the holding. The stock traded for an average price of 1,884.39 yen ($17.83) per share during the quarter.
The Japanese manufacturer of optics and reprography products has a market cap of 2.81 trillion yen; its shares closed at 2,182 yen on Wednesday with a price-earnings ratio of 69.69, a price-book ratio of 7.77 and a price-sales ratio of 3.72.
The Peter Lynch chart shows the stock is trading above its fair value, suggesting it is overpriced. The GuruFocus valuation rank of 2 out of 10 also supports this assessment since the share price and price-sales ratio are near 10-year highs.
Olympus' financial strength and profitability were both rated 6 out of 10 by GuruFocus. In addition to having adequate interest coverage, the high Altman Z-Score of 3.7 indicates the company is in good standing.
Although the operating margin is in decline, the company's returns are outperforming over half its competitors. Olympus is also supported by a moderate Piotroski F-Score of 6, which suggests business conditions are stable, and a predictability rank of one out of five stars. According to GuruFocus, companies with this rank return, on average, 1.1% annually over a 10-year period.
The Japan fund divested of its remaining 284,100 shares of Ryohin Keikaku, which had an impact of -0.58% on the equity portfolio. Shares traded for an average price of 1,477.69 yen each during the quarter.
GuruFocus estimates the fund gained 44.83% on the investment.
Also known as Muji, the company, which retails household and consumer goods, has a market cap of 457.65 billion yen; its shares closed at 1,740 yen on Wednesday with a price-earnings ratio of 36.56, a price-book ratio of 2.36 and a price-sales ratio of 1.13.
According to the Peter Lynch chart, the stock is overvalued.
GuruFocus rated Ryohin Keikaku's financial strength 7 out of 10, driven by a comfortable level of interest coverage as well as a robust Altman Z-Score of 4.46. The return on invested capital, however, is eclipsed by the weighted average cost of capital, indicating that the company is not turning a profit on its projects and is, therefore, destroying value.
The company's profitability fared a bit better, scoring a 9 out of 10 rating. Although the operating margin is in decline, it, along with the company's strong returns, outperform over half of industry peers. Ryohin Keikaku also has a low Piotroski F-Score of 3, which indicates business conditions are in poor shape. As a result of declining revenue per share over the past year, the 4.5-star predictability rank is on watch. GuruFocus says companies with this rank typically return an average of 10.6% annually.
No gurus currently have positions in the stock.
With an impact of -1.37% on the equity portfolio, Hennessy curbed its Kubota stake by 34.45%, selling 648,700 shares. The stock traded for an average per-share price of 1,527.69 yen during the quarter.
The fund now holds 1.23 million shares, which represent 2.88% of the equity portfolio. GuruFocus data shows it has lost an estimated 4.58% on the investment since the first quarter of 2014.
The company, which manufactures tractors and other heavy equipment, has a market cap of 2.27 trillion yen; its shares closed at 1,877.5 yen on Wednesday with a price-earnings ratio of 17.97, a price-book ratio of 1.58 and a price-sales ratio of 1.25.
Based on the Peter Lynch chart, the stock appears to be overvalued. The GuruFocus valuation rank of 2 out of 10 aligns with this assessment since the share price and price-sales ratio are approaching two-year highs.
Kubota's financial strength was rated 6 out of 10 by GuruFocus. Although the company has issued approximately 187.7 billion yen in new long-term debt over the past three years, it is still at a manageable level due to comfortable interest coverage. The Altman Z-Score of 2.52, however, indicates it is under some pressure since assets are building up at a faster rate than revenue is growing.
The company's profitability scored a 7 out of 10 rating. Despite the operating margin being in decline, it is supported by returns that outperform over half of its competitors and a moderate Piotroski F-Score of 5. As a result of revenue per share declining over the past year, the three-star predictability rank is on watch. GuruFocus data shows companies with this rank return 8.2% on average annually.
Impacting the equity portfolio by -0.93%, the fund reduced its Mitsubishi position by 22.64%, selling 257,300 shares. During the quarter, the stock traded for an average price of 2,338.51 yen per share.
It now holds 879,400 shares, which account for 2.91% of the equity portfolio. GuruFocus estimates Hennessy has lost 5.65% on the investment so far.
The industrial conglomerate, which is involved in a broad number of markets ranging from business services and infrastructure to energy and chemicals, has a market cap of 3.72 trillion yen; its shares closed at 2,512.5 yen on Wednesday with a price-earnings ratio of 9.3, a price-book ratio of 0.71 and a price-sales ratio of 0.27.
The Peter Lynch chart suggests the stock is undervalued.
GuruFocus rated Mitsubishi's financial strength 5 out of 10. As a result of issuing approximately 578.6 billion yen in new long-term debt over the past several years, the company has poor interest coverage. In addition, the Altman Z-Score of 1.51 warns the company could be in danger of going bankrupt since revenue per share has declined over the past year. The WACC also surpasses the ROIC, indicating it generates poor returns on its investments.
The company's profitability scored a 7 out of 10 rating, driven by operating margin expansion, strong returns that outperform over half of its industry peers and a moderate Piotroski F-Score of 6.
The fund holds 0.06% of Mitsubishi's outstanding shares.
Hennessy trimmed the Shimano holding by 12.4%, selling 27,500 shares. The transaction had an impact of -0.69% on the equity portfolio. During the quarter, shares traded for an average price of 20,263.8 yen each.
The fund now holds 194,200 shares, which occupy 6.92% of the equity portfolio. GuruFocus estimates Hennessy has gained 32.4% on the investment.
The company, which manufactures cycling components, fishing tackle and rowing equipment, has a market cap of 1.92 trillion yen; its shares closed at 20,720 yen on Wednesday with a price-earnings ratio of 32.96, a price-book ratio of 3.85 and a price-sales ratio of 5.63.
According to the Peter Lynch chart, the stock is overvalued. The share price and price-sales ratio are also close to 10-year highs.
Shimano's financial strength was rated a perfect 10 out of 10 by GuruFocus on the back of comfortable interest coverage and a robust Altman Z-Score of 28.1.
The company's profitability also fared well, scoring an 8 out of 10 rating. Although the operating margin is declining, it is still outperforming versus competitors. Shimano also has strong returns that beat a majority of other players in the industry as well as a moderate Piotroski F-Score of 6. Despite recording a decline in revenue per share over the past year, the company also has a one-star predictability rank.
The Japan Fund holds 0.21% of Shimano's outstanding shares.
Additional trades and portfolio performance
Among the many other positions that were reduced by the fund during the quarter were Unicharm Corp. (TSE:8113), Daikin Industries Ltd. (TSE:6367), Rohto Pharmaceutical Co. Ltd. (TSE:4527), Recruit Holdings Co. Ltd. (TSE:6098) and SoftBank Group Corp. (TSE:9984).
The Japan Fund's $609 million equity portfolio, which is composed of 23 stocks, is most heavily invested in the industrials sector with a weight of 29.04%. The consumer defensive and consumer cyclical spaces represent 18.31% and 18.08% of the portfolio.
According to Hennessy's website, the fund posted an 18.04% return in 2019, slightly underperforming the Russell/Nomura Total Market Index's return of 20.07% and the Tokyo Stock Price Index's return of 19.67%.
Disclosure: No positions.
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