On the afternoon of March 11, Rob Taylor was sitting in a meeting in Tokyo when the floor beneath him began to shake. His hosts, experienced in earthquake preparedness, dove under the conference table and urged Taylor to do the same. It seemed as if they were there for an eternity, although it was just a few minutes.
As one of the managers of the Oakmark International fund, Taylor is a frequent visitor to Japan. He has even endured a few earthquakes, although they pale in comparison to the devastating 8.9-magnitude temblor. But one thing that wasn't shaken that day was Taylor's confidence in the Japanese stocks in the fund's portfolio.
SEEING AN OPPORTUNITY
Even before the quake, Japan was by far the fund's largest country allocation. Taylor and co-manager David Herro liked that after decades of stagnation, Japanese companies were starting to implement shareholder-friendly moves, and shedding their stodgy management cultures and cronyism. In fact, over the last decade, many Japanese firms got serious about expanding profit margins, boosting dividends and increasing profits, characteristics Taylor and Herro look for when evaluating stocks.
It didn't hurt that shares have been trading at reasonable valuations. "It was hard to find management teams that cared about shareholder value," Taylor says. "Many CEOs treated the company's cash as their personal cash."
Oakmark's Japanese holdings do not include property and casualty insurers or utilities. These two sectors were hit hardest by the earthquake, tsunami and nuclear crisis.
The trio of catastrophes has had only a short-term impact on Oakmark International's names, Taylor insists. Rolling blackouts will certainly lead to supply disruptions if companies are not able to keep their factories operating at full capacity. However, in the long term, it should not have much impact. "The earthquake hasn't changed the global demand for cars," he says.
Rather, the big price declines in Japanese stocks provided the fund with opportunities to add to the names he already liked. At the end of March, Oakmark International held 24.8% of its non-cash investments in Japan.
The fund has carved out an impressive reputation by focusing on the long term. Over the last three years, Oakmark International is up 7.6% a year annualized, landing in the foreign large value's top 1% as of April 15. For the last five years, it's up 5.5% a year annualized, in the category's top 3%, according to Morningstar.
DEEP IN JAPAN
While Japanese companies have a long way to go, they have also come a long way, Taylor says. In 2000, the return on capital of the average Japanese firm was 1% to 2%, while the average stock in the MSCI EAFE index had a return on equity of 10%. By 2007, Japanese firms' return on equity rose to 10%, while the MSCI EAFE's leapt to 15%. "The incremental change was higher than anywhere else," he says.
The Japanese names populating the Oakmark International fund are those that have come to symbolize this new business outlook in Japan. Among the fund's biggest holdings is Toyota, the world's largest automobile manufacturer, which has been moving toward a leaner corporate profile. For example, shortly before the earthquake and tsunami, Toyota announced plans to shrink its board to 11 members from 27.
Toyota has suffered a parts shortage in the wake of the earthquake and tsunami, and the firm has been forced to shutter plants in the U.S. and Europe while waiting for Japanese production to resume. But Taylor believes this is temporary.
There are several trends working in Toyota's favor: auto sales are rebounding in the U.S. and the company is expanding its presence in emerging markets, which now account for more than 40% of sales.
Toyota shares are down 0.7% since the beginning of the year. Not surprising, the stock cratered 8.7% in the month after the quake. But Taylor says Toyota is not alone in experiencing problems. "A lot of suppliers to Daimler and GM are based in Japan," he says. "This is going to hurt them, too."
Similarly, semiconductor maker Renesas has suffered a slowdown, but again Taylor believes this disruption will be short-lived. Renesas originally said it would not restore its capacity for manufacturing semiconductors for automobiles until July. But the firm recently said plants would reopen in June.
Another long-term holding is consumer electronics maker Canon. The company recently announced that it resumed manufacturing toner cartridges at its plant in northern Japan, the region that had the worst damage.
Prior to the quake, Canon had shifted its business away from its home country to other markets. Taylor likes that Canon has been actively repurchasing its shares as a way to deploy the $8 billion it holds in cash and securities. The stock trades at 13.2 forward price-to-earnings ratio. Shares were down 5% over the last 12 months.
PLAYING EMERGING MARKETS
Of course, there is plenty outside of Japan that Oakmark International likes, too. But the fund is wary of emerging markets. "We are just as excited about the growth in emerging markets as anyone," Taylor says, "but we don't want to have to pay for that growth."
Instead, the fund is on the lookout for ways to participate in fast-growing emerging markets like Brazil, China and India without buying the stocks of companies based there. Taylor notes that 20% of the revenues of the portfolio's holdings already come from emerging markets.
One way to get the growth from emerging markets without overpaying for it is through a stock like Holcim, one of the world's largest cement and concrete manufacturers. Although based in Switzerland, Holcim's fortunes are directly tied to infrastructure growth in emerging markets. What's more, its stock sells at a 1.1 price-to-book ratio.
Nonetheless, Holcim has struggled against the headwind of a strong Swiss franc, making its products less competitive to international buyers. The stock was up 0.75% this year through April 13, but Taylor thinks it will perform better in a more favorable currency environment.
Similarly, German-based Daimler also sells an increasing amount of its Mercedes-Benz cars in emerging markets. "China is now its third-largest market," he says. The stock was hammered in 2008 due to shrinking U.S. sales, but it's been on a tear since.
Moreover, Daimler has embarked on a program of cost cutting, which is also helping to drive profits. Daimler's stock is up 50.5% over the last 12 months.
Elsewhere in Europe, Taylor found value in Spanish bank Santander Bancorp. The stock swooned amid last year's European debt crisis. But Taylor thinks it was unfairly lumped together with troubled financial institutions in Portugal, Ireland, Greece and Spain.
In fact, Santander has less exposure to these troublesome markets than most. Close to a third of its revenues come from Latin America. "Buying this quality of management at just over book value is a real opportunity for us," he says.
Opportunity, indeed. Santander is up 98.4% over the last 12 months yet sells at book value.
Ilana Polyak is a regular contributor to Financial Planning.
BBA, University of Wisconsin-Madison
Portfolio manager, Oakmark International (2009-present); director of global research, Harris Associates (2004-present); international analyst, Harris Associates (1994-2004)
Inception of fund: September 1992
Style: Foreign Large Value
Assets under management:
Three-year performance as of April 15, 2011: 7.6%
Five-year performance as of April 15, 2011: 5.5%
Expense ratio: 1.08%
Front load: None
1.45 vs. MSCI EAFE
1.45 vs. MSCI EAFE Value
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