Chartwell Asia ETF
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Chartwell Asia zeros in on an under the radar screen investment theme and then lays out several creative options to capitalize on it.
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Wednesday, January 11, 2006
Japan's Secret iPod
After a long winter, Japanese markets have reached a five-year high with foreign investors doing the bulk of buying. Eager investors are clinging to the clean up of Japan's financial sector, an export surge to China and signs of a slight rebound in real estate prices and consumer spending. But the painful period following the bursting of Japan's financial bubble obscured the core of Japan's economic vitality-manufacturing-and this has stayed strong and is gaining momentum. Just look at Japan's current account surpluses over the past three years: $113 billion in 2002, $136 billion in 2003 and $172 billion in 2004 plus about $155 billion this year as estimated by Japan's Ministry of Finance.
These numbers are remarkable against the backdrop of a yen that though weakening against the dollar 16% this year is just about where it was at the end of 2002.
A majority of Japan's exports are manufactured goods and components. 50% of its exports to China in 2004 were electrical equipment and machinery and its top exports to the world include autos, electronic components, optical instruments, imaging equipment and computer parts.
Much is made over China's huge trade imbalance with America that reached $126 billion in the first eight months of this year.
No doubt a sizable share of Chinese exports to America are chock full of Japanese components. In addition, since components of products are made all over the world and then assembled somewhere else such as China for final shipment, it is hard to tell what country a product comes from. Take the tremendous success of the iPod with 30 million sold in the last four years.
Apple was lionized for its creativity in getting the jump on Sony.But guess what? A Merrill Lynch report by Jesper Koll estimates that 82% of the iPod's components were made by Japanese manufacturers.
While some of these components were made in offshore facilities, many were made in Japan, which has been able to hold onto its industrial base better than America. How do they do it? First, the Japanese keep moving up the value-added curve and are careful to keep the R&D and manufacturing of sophisticated components close to home while outsourcing the low end to lower wage countries. Secondly, even though China's wages are about 5% of Japan's, factory automation has lessened the importance of labor costs. For advanced high-tech products it accounts for only 10% to 15% of total costs.
Having manufacturing closer to home also shortens new product lead times and increases cooperation between R&D and production teams, leading to a crucial edge in staying ahead of its nimble competitors. Perhaps most importantly, having research, development and production closer to headquarters helps protect proprietary technologies. Of course supporting these new products requires capital investment - a lot of it.
This is a major reason the Japanese are adept at keeping their manufacturing prowess. Canon is building a large digital camera facility in Japan and plans to spend 80% of its $7.2 billion capital budget in Japan over the next three years. This is a reversal from the past ten years when 80% of its capital budget was spent overseas.
Fujitsu is building a $1.6 billion semiconductor facility. Sharp, Matsushita and Nippon Steel are also building major plants in Japan. Then there is Toyota Motors, which is rapidly building capacity in its drive to become the world's largest automaker-a title that has been held by GM since 1931. This is six years before Toyota Motors was founded in 1937 as a spin-off from a textile manufacturer. In its most recent quarter Toyota boosted capital spending by 50%, and Takeshi Suzuki, senior managing director, recently stated that Toyota will spend $12.2 billion to increase capacity this fiscal year.
Canon, Sharp Hitachi, and Toyota are all good plays on Japan's manufacturing edge while Sony will continue to lag until it boosts its R&D and catches up in product development. The Japan iShare (EWJ) exchange trade-fund is also an attractive option since it has about 50% exposure to Japan's manufacturing sector with an annual fee of only 0.59%.
And even though you may not go anywhere without your iPod, don't get too attached to Apple's stock. It has had an amazing run on the back of stellar iPod sales and recently reached a breakthrough agreement with NBC Universal that will allow iPod users to download television programs. Even so, with the stock at a 52-week high and at a high multiple, it's time to take some profits off the table and buy some more tunes. Many of the attributes highlighted during the Japan boom in the 1980s, such as its highly educated workforce, patient capital, pride in craftsmanship, loyalty, teamwork and discipline are all still in place. Investors can now hopefully profit from these skills being applied without excessive financial engineering.
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