At a time when Japan's improving financial markets and economic position has attracted a lot of wealth management interest, Geneva-based asset manager Quaero Capital outlines its top Japanese stock picks this month.

Rupert Kimber (pictured), portfolio manager of a Japanese equity fund Taiko Japan at Quaero Capital, highlighted this month how Japan has come alive, and outlined his top stock picks.

“A new record high in the Nikkei, anticipated normalisation of the Bank of Japan’s (BOJ) monetary policy, and a level of renewed optimism permeating through the economy, has drawn many investors to increase allocations to Japanese equities,” Kimber told this news service.

“The strong rally since the beginning of the year was driven by better supply/demand conditions with individual investors easing selling pressure on the launch of the new NISA products, It also benefited from the shift in allocations from Asian funds towards Japanese ones being underpinned by mounting geopolitical concerns boosting a flight to safety." 

Is it now time to take stock of market performance and anticipate corrections on the mid-March BOJ rate decision and the near-term strength in the Japanese yen? He does not think so and he believes that any corrections will be short lived.

Kimber highlighted the shift in Japanese corporate behaviour over the last 5 years: “Companies have undertaken governance reforms which have accelerated the trend of divesting of strategic shareholdings with a renewed focus on core business operating performance." 

Given that strategic shareholdings still account for close to 30 per cent of listed shares, he expects this trend to continue.

“For Taiko Japan, this environment allows for a continued focus on companies geared to a positive macro environment, the changing corporate landscape with a key focus on capital efficiency resulting from industry consolidation,” Kimber said.

The objective of his fund, which has performed well, is to achieve long-term capital growth by investing in listed undervalued Japanese companies. This consolidation focus is the key differentiator and characteristic of this concentrated portfolio. Below, Kimber outlines six companies supporting this thesis.

NEC Corp (6701 JP) Market Cap JPY 95 Trillion Portfolio Weight 5.41 per cent
As a top 10 holding, Kimber believes that the restructuring potential behind this Japanese multinational information technology (IT) and electronics firm is likely to result in strong underlying free cash flow (FCF) which is now happening. There is also an ongoing transition to higher-margin services products, including consultancy. He highlighted how the early development of the artificial intelligence (AI) business with scale is not valued by the market and shareholder returns will improve sharply into the FCF recovery. The firm also has a disciplined approach to overseas mergers and acquisitions, he added.

Daiei Kankyo (9336 JP) Market Cap JPY 263.8 Billion Portfolio Weight 4.00 per cent
This Japanese waste management and recycling company has high profit margins, Kimber said. He believes that the fragmented industry will result in significant industry consolidation and the tougher regulatory environment will favour larger operators. The firm also has a strong historical acquisition track record, with a minimum risk of foreign entrants, he said.

Niterra (5334 JP) Market Cap: JPY 939.4 Billion Portfolio Weight 3.88 per cent
The firm specialises in auto spark plugs and auto emission sensors, with room to expand its market share as competitors withdraw. It is also cashflow generative, with a high ratio of recurring income from replacement demand, he said. Kimber believes that the current takeover of Denso business will add further scale, and he expects a further margin from higher selling prices as part of survivor premium.

Digital Hearts (3676 JP) Market Cap JPY 22.5 Billion Portfolio Weight 3.80 per cent
The Tokyo-based firm focuses on game software debugging services, and has strong underlying profit margins and cashflow from debugging services, he said. More recently, it has developed an IT services subsidiary, with high growth potential, which will be separately listed in early 2025. The IT services business is currently not priced into valuations, he added.

Broadleaf (3673 JP) Market Cap JPY 52.4 Billion Portfolio Weight 3.43 per cent
The Japanese firm is a platform in auto repair shop software, with a dominant market share resulting from acquisitions, and cashflow generative, he said. Kimber believes that it is mispriced due to the current transition from multi-year licenses to a monthly subscription model, and has a significant future average revenue per user (ARPU) potential from parts ordering.

Yoshimura Food (2884 JP) Market Cap JPY 29.6 Billion Portfolio Weight 3.26 per cent
The Japanese firm is a beneficiary of consolidation in the food industry, with a 10-year track record resulting in multiple acquisitions at low prices. Kimber believes that the opportunity for further acquisitions is significant, and its recent strategy has been to take a key position in the Japanese scallop industry. The scallop operations will be valued at multiples of the current market cap, he added. See more commentary here about investment opportunities in Japan.