January 2010

LONG ONLY JAPANESE EQUITIES

We take encouragement from the number of companies in our portfolio making progress with their businesses despite the awful economic environment. Nintendo sales in the last quarter of 2009 illustrated the potential that enticing new software can do for demand. The new release of a Mario title for Wii, itself a 31 year old franchise, sold over 10m units since its release in November - the fastest rate of sales for any video game in history. Its success was in part due to an installed base of captive customers bigger than any of the competitors. But it was also due to the allure of the software itself, which contributed to a further revival in sales of hardware. Altogether, a highly profitable combination.

Kao reported better than expected results and in doing so revealed swingeing cuts to expenses: salaries and bonuses down 5%, freight and warehouse costs down 7% and advertising down 5%. The company has issues with its premium cosmetics and its healthy food products but these are being addressed. Cash flow was strongly positive with a material reduction in debt from 30% of shareholder’s funds to 16% over the first nine months of the fiscal year. On the assumption that revenues stabalise we expect dividends to grow again or share buybacks to be re-instituted.

The Osaka Securities Exchange’s results reveal a business that is performing as well as last year despite lower markets and declining volumes. The surge in options trading, as regulators force unlisted options to list on exchanges, the profit contribution from the JASDAQ exchange and a strict control of costs have all played a part. As a result, 2009 dividends will not be cut after all.

Canon reported annual results which exceeded the market’s expectations. Together with the forecasts for 2010 the overall message is a steady recovery from the worst in late 2008 but one which will take some time to match the margins achieved at the peak in 2007. Part of the problem is the drag on the business from the semiconductor manufacturing equipment division. Losses here exceeded those in 2008. This business has generated cumulative losses over many years. We have agitated for a restructuring of the division to no avail but, now that its influence on profitability is proportionately more, we expect action sooner than later. The major issue holding back recovery for the core printing and copying divisions is restrained corporate spending in developed markets that is likely to remain under pressure for the foreseeable future and will hold back high margin consumables usage on which the company’s fortunes so depend. Over the long term such restraint will be countered by the slow but steady rise in colour printer penetration that brings with it greater consumable churn and higher consumable sales prices. There remains much potential. Still less than 20% of the installed base of units of laser beam printers are colour. This ratio has been kept down recently as there has been a renewed surge in demand for monochrome units from emerging markets, especially China that have emerged as an important source for future growth. Also, the company has been investing in distribution. Hewlett-Packard ('HP') has distributed its laser beam printers under HP’s name outside Japan for the last 20 years. Now the company has established an additional channel for its copiers through HP. Also Canon’s intended purchase of Oce is as much to secure distribution in the large format printing market as to acquire the technology. After all that is Canon’s core competence. This seems a rational way to claim an important share of market where they have had no presence. Like Kao, cash flow generation this year was impressive with net cash rising Y100bn, despite poor profits, and a dividend payout ratio above 100%. There was an important reduction in working capital and reduction in capital expenditure. Provided that the recovery trend in profits continues it is more likely that the company will either raise dividends in the future or opportunistically buyback shares.

Mandom and Obic Business Consultants both produced third quarter results that confirmed a recovery from late last year and once again a resolute profit performance from both companies exhibited strict control of costs despite falling sales.

Michael Lindsell
January 2010

12 February 2010 LTL 000-087-2