Diary of a Financier

New investment themes: Japanese groundswells & select US durable goods

In Capital Markets, Economics, Trading Desk on Wed 16 Oct 2013 at 23:12

Approaching year end now, I’ve spent some time looking for fresh, new investment themes–places and things where few others (or no others) are looking.  This is about the future, what’s the next big thing to be chased by a rush of capital.

First, as we whittle away on the last of our Sony ($SNE) position, I’ve been on the hunt for some more Japanese exposure to supplement our capacity $DXJ stake.  I’ve unearthed two very interesting Japanese themes that I’d like to discuss herein.  Both leverage Abenomics, but more importantly both skate to where the puck is going to be–not where it is–in Japan.

Second, things have been very fluid in the American capital markets as well, so I’m looking for the best remaining tailwinds here at home.

As I come up with more actionable ideas within these nodes–whether singlenames or ETFs–I’ll insert them herein, making this a working post…

~~~~

Japanese energy transition

In the wake of Fukushima, Japan is obviously transitioning away from nuclear energy.  On top of that massive capital spend, the Yen’s devaluation has redoubled increasing energy imports.  Their mounting trade deficit is a headwind for an island that imports almost all of its energy–hydrocarbons or otherwise now.

Japan is now completing 2 new coal-fired power plants by YE13 and 12 gas plants by YE14.  Now that the $7B total CapEx has been made, we’d like to latch onto this theme.  I’m looking at ideas in transporters/shippers, local utilities, builders, or other derivatives of this theme.

Actionable ideas
Suppliers
– Tokyo Gas ($9531_JP)
Shippers
– Golar LNG ($GLNG)
– GasLog ($GLOG)
– Navios Maritime Acquisition ($NNA)

Abenomics’ third arrow

Part of Abe’s 3rd arrow promise for structural reform (a long term focus) will expand Japan’s National Strategic Districts plan, relaxing taxes and regulations to attract foreign companies.  The emphasis therein will be on non-service sectors, so I have to narrow-down my universe to some specific names here.

Japan’s domestic pharmaceutical industry is a separate opportunity associated with this catalyst.  Part of the proposed structural reforms will lift the ban on nonprescription drug sales via the internet.  This is compounded by aging population demographics too.

Actionable ideas
Generic drugs
– Sawai Pharmaceutical ($4555_JP)
– Nichi-Iko Pharmaceutical ($4541_JP)
Innovation/compound creation
– Chugai Pharmaceutical ($4519_JP)

US capital goods

I’ve pounded-the-table (I, II, III & IV) on the US durable goods theme all year, but I grew wary of it by Q3-end, since valuations got richer.  Accordingly, we swapped-out of our Ford ($F) position with big gains in September, plus we’re avoiding US housing and consumers.  A 2014 durables spending boom has become the preeminent null hypothesis to my bearish 2014 outlook.  That all led me to dig deeper into the research.

The Street has propagated that very null hypothesis, to which the keys to strategists’ arguments are as follows:

  1. The US capital stock is old
  2. Pent-up demand deferred from the Great Recession
  3. US capital goods spending/GDP post-crisis run-rate is on par with that of a 3rd world country, like Greece

I’ve already dispelled the myth of “below-trend” housing starts and justified some of the cause for aging in certain goods.  Regardless of those two counterpoints, the Street has been pushing the wrong avenues.  When you zoom-out and look further back than the 1990s–back before the great moderation and the baby boom’s ascent to peak spending–you get a clearer picture of which capital goods are really, truthfully, unavoidably in need of replacement.US equity outlook (2013q4) | Tom Lee (JP Morgan)

To wit, the table at the right looks at the average age and range (by decile) of specific capital goods all the way back to 1925.  Contrary to Wall Street’s favorite 2013-14 memes, neither the US housing stock nor autos are outrageously old.  5+ unit multifamily homes and manufactured homes are in need of new supply, but residential housing in aggregate is at an average of 26.8 years old–only its 8th decile in terms of what’s historically been considered “old” age, ranking 25th compared to other goods.  Autos are even newer, in their 1st decile, which ranks them 85th relative to others.

What are some genuinely “old” goods?  Mind you the table was generated using 2011 data.  Therefore, I’m choosing to focus on only the top-ranked capital goods assets–as in the oldest relative to their own historical life cycles:

  1. Industrial equipment- fabricated metals ranked #3 overall (10th decile¹); electrical transmission #1 (10th decile)
  2. Infrastructure construction- electrical utilities #5 (10th decile); telecommunications #1 (10th decile)
  3. Furniture/fixtures- #4 (10th decile)
  4. Transportation- Trucks/buses/truck trailer manufacturers #8 (10th decile)
  5. Healthcare construction- (hospital/medical/special care builders between #1-8 (10th decile)

Actionable ideas
Industrial equipment
– Valmont Industries ($VMI)
Infrastructure construction
– Argan Inc ($AGX)
Furniture
– Compass Diversified Holdings ($CODI)²
Truck manufacturers
– Navistar ($NAV)
– Oshkosh ($OSK)

~~~~

All according to our plan, some buying has returned our portfolio’s allocation up to 68/28/4 (stocks/bonds/cash) vs 60/40 benchmark. Beta clocks-in at 0.93 vs 0.76 benchmark and sigma 1.08 vs 0.51.

We continue to deemphasize US exposures, allocating more capital internationally (I, II, III & IV), where valuations provide incontrovertible margins of safety.

–Romeo

¹10th decile = extremely old relative to its own historical life cycle

²Owners of: Advanced Circuits, American Furniture, Arnold, CamelBak, Ergobaby, Fox, Liberty Safe, and Tridien

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