Berkshire Hathaway buys stakes in Japan
What do Japanese Trading Companies Do? | Their Business Model and Why They Exist Only in Japan?
- Sales and marketing outsourcing and procurement outsourcing for domestic and overseas markets
- Earn intermediate margins from the BtB trading channel across suppliers and customers between Japan and overseas markets. SMEs with only manufacturing capabilities have trading company function needs because of the need for procurement, sales support, and outsourcing. In other words, Shoshas are complimentary partners when Japanese companies lack well-organized management capabilities. Many Japanese companies are managed by a chief factory manager, not by a management team. They do not know the end market, and marketing capability is minimal. Such an under-organized company is a typical good business opportunity for a trading company. On the other hand, they have large customers like Uniqlo, but they use trading companies to reduce their fixed costs, and the terms of business are very competitive.
- The uniqueness of commodity-related businesses is related to Japan’s energy security problems. Domestic production of resources is close to zero, and the country is almost entirely dependent on imports. Shosha plays a vital role in the procurement of imported energy, but the imported energy market size has remained flat since the 1990s due to improvements in energy efficiency. A long-term trend of decreasing demand is expected in Japan this century as the total population decreases.
- As a result, trading houses are shifting to non-commodity sectors. They are involved in early-stage businesses to secure new future business opportunities. They are developing customers through incubation to capture a larger TAM of both return on investment and channel margin share. However, Japan was dominated by traditional distribution channels, multi-layered and complicated, and now the direct sales business model is growing. This has led to a structural decline in intermediary margins and a slowdown in domestic customer growth, forcing the company to get involved upstream in partnerships and incubation, which can be regarded as being just inevitable.
- Berkshire chose a challenging sector where many value investors have faced challenges in the Japanese market in the past. It is also worth noting that they invested in five companies, rather than a single company. There are no differences between individual companies, and they are homogeneous, making discerning superiority and inferiority hard even for Buffett. In effect, he invested in a Japanese trading company ETF. This kind of approach is rare.
- The current cyclical weakness of the materials and energy business is a primary key source of return in the future. But if you want to bet on it, there are many other investment options globally.
- The idiosyncratic upside of Japan’s trading companies?
- Sure, the stock price is low, but is that cheap? In the past, trading company stocks have risen and fallen around book value and have been cheap and stable; ROA has a long time range-bounded around 2-3 % in the low single-digit percentage. As a result, trading company stocks have moved around book value and have been stably low priced; The big move wasn’t because of an adjustment in stock valuations, but because the commodity market was headed for a peak. If this is the case, then there is nothing special about why they look undervalued, but instead, we should consider that there is a good reason they are cheap. The following list also comes to our mind.
- Conglomerate discounting due to uncertain capital allocation effects
- Uncertainty about commodity markets and individual energy and commodity extraction projects will continue in the future.
- A large, old organization with many organizational legacies that have been passed down from generation to generation, making organizational change difficult
- The hidden influential impact of government control of energy through national security concerns
The long-term investment opportunities are not in commodities but other new areas. However, there are some structural challenges. It is not clear whether they have a competitive advantage, and the track record of investment in new areas is not very good. In Japan, due to corporate culture and regulatory issues, the approach through management reforms to send a management team to replace execution, as is the case with private equity in the US, does not work. Also, leading private equity and venture capitalists are active in Japan and have broader and deeper expertise than trading companies. The trading company’s incubation capability is regarded as average and lagging against the leading companies, and the inhouse experts do not stay in the company. The benefits of developing commercial channels on their behalf coexist with concerns about channel occupation’s revenue and business development side effects.
- It was suggested that Berkshire would pursue opportunities to work together. This is idiosyncratic and unique value-added. While this is sure to raise their opportunities, the five trading companies are competing with each other and how Berkshire will handle the co-investment relationships with them is unclear. We are also concerned if this kind of deal-driven catalyst would make their stocks more event-driven than internal improvement driven. We are hoping that the management team laser-focused on the improvement of internal mechanics. Also, with respect to risk premium, if this is not sustainable or repeatable, how much risk premium can get eased through co-investment?
- Looking back, trading companies have earned high returns only twice in the past 50 years, during the Japanese real estate bubble of the late 1980s and the commodity bubble of the early 2000s. Only the latter delivered above-market returns, however. In other words, shosha stocks were primarily driven by cyclical, externally dependent temporary events driven by commodity prices. There has never been a single time when risk premiums have declined as structural and inherent factors. The degree of external influence is so great that it impacts structural change from within less relevant.
- We are interested more in the effort to reinforce intrinsic change. That includes changes in organizational structure and the separation and spin-off of commodity businesses. That would more precisely define the discipline of capital allocation and internal cash and capital flows and capital cost, which could lower the risk of intrinsic and structural inherent factors. However, this may not be easy, given that cash from commodities is the primary source of investment in new areas. In other words, these are interdependent and inseparable parts. If so, the cost of capital will ultimately be determined by the commodity business. This is because they determine the more fundamental and underlying cash flow of the company as a whole.