Friday, March 21, 2008 0 comments ++[ CLICK TO COMMENT ]++

Adding Seiko to Watch List; Removing Others

I was searching the Japanese stock market (which still keeps dropping) for well-known brands and came across Seiko (TSE: 8050). I'm sure many of you have heard of Seiko, the Japanese watch company. The Japanese market continues to sell off and valuations keep getting cheaper and cheaper. The Japanese Yen has been strengthening and this is going to hurt exporters. Over the last few years Japan has relied on exports so their economy will take a hit. However, my feeling is that the lower valuations will compensate for any weakening of the economy.

Seiko is one of the dominant players in the watch industry. I don't know anything about watches (I'm not into them at all) so it's not clear if Seiko has a competitive advantage in the marketplace. Apart from the super-luxury brands, it doesn't seem like there is a huge brand loyalty at the low-end to mid-end area. Furthermore, with all the fake watches floating around, the watchmakers will face a continuing threat. Nevertheless, I took a quick look at the financials and looked at the business and it seems worth looking at. (If anyone has any Japanese stock suggestions, leave a comment below. I'm most interested in anything with a P/B <> 10%; established world brand is a plus.)

(all numbers are approximate)

Seiko Holdings
ticker: 8580 (Tokyo Stock Exchange)
market cap: Y56 billion (approx. $500 million)
industry: watches and high-precision devices

P/E (FY07) : 5.4
P/E (forward): 8.6; 8 (management FY08 estimate; analyst)
P/S: 0.24
P/B: 0.89

ROE (forward): 10.8 (mgt FY08)
Debt/Equity (not sure): 1.7 (a big negative)

Seiko is discontinuing some operations so be careful with any numbers. There are some extraordinary items in some of the numbers. The official English company website for investor relations seems quite basic.

Like most Japanese companies, the stock is trading near a 5 year low. The stock is quite attractive based on valuation measures like P/E and P/B. Any non-cyclical company trading with a P/E below 10 and ROE above 10% is good in my books (this is a newbie opinion! :) ). But I wonder if these numbers are at a cyclical high. I'm not sure if the watch industry will head down, now that the US consumer, along with possibly the Japanese consumer, cuts spending.

Seiko's debt is quite high and that poses one of the big risks in my eyes. It has been successful in trying to reduce its debt over the last few years but I wonder what will happen if sales decline due to a weakening economy. The problem I find with Japanese companies is that if you want reasonable ROE then you either have to pay up with valuation (i.e. high P/E) or have to take greater risk with higher debtload. My strategy is to prefer the latter because, although debt is a big threat in most circumstances, Japanese companies' debt is at low interest rates. My hope is that they will be able to service the debt even when the profitability deteriorates. If, on the other hand, I took on higher valuation, I am scared of P/E contraction. You can say a company is good, or is cheap, or whatever else you want, but if investors flee high P/Es for low P/Es elsewhere, you are in trouble. (As a side note, the reason Japanese stocks have high P/E ratios is not because of speculation per se, but because of depressed earnings and poor management of businesses.)

If the stock price hits around 50% of book then it will be very attractive. I'm not sure if it's going to get anywhere near there but we'll see. It'll also be worth waiting and seeing how much the stronger Yen will impact operations. I figure we'll know by fall/autumn of this year when FY2009 first and second quarter numbers will come out.

Re-jigging the Watch List

I'm removing the following from the watch list for the reasons mentioned:

  1. Countrywide (CFC), Pulte Homes Senior Notes due 2046 (PHA), Thornburg Mortgage 7.5% Conv Pref (TMA-PRE): I never realized how much levered Ambac is to the whole housing cycle and given my heavy exposure with Ambac, I'm not going to make any further investments in housing-related businesses (except possibly building materials suppliers or retailers). Additionally, I'm dropping Pulte because the unfolding crisis has made convertible bonds and equity far more attractive than straight bonds.
  2. Global Diversified Trust (TSX: DG.UN): Thank God I didn't invest in this (I was nowhere near investing in this though). If you ever wondered who owned the lower tranches of the subprime mortgage debt, well, it's mostly hedge funds and trusts like this. Canada also had this ABCP (asset-backed commercial paper) crisis and trusts like this were caught up in it. You can probably still make money in these things as a distress investor but it is extremely difficult to analyze these things. Everything is opaque and a mystery. Unless you work in the industry and maybe have access to tools (like Bloomberg data or some other source) where you can look into an MBS and figure out the underlying details, it's hard to say anything one way or another.
  3. Sanyo (TSE: 6764): This company may turn around at some point but I'm not willing to entertain these situations anymore. I guess it's a learning experience or just honing my skills, but I have decided to avoid highly-leveraged or high capex businesses with low margins. I would throw Sanyo into the same pile as some sectors I avoid like 'semiconductors', although Sanyo isn't really in that industry. (Maybe a semiconductor company like Intel may do well but how many AMD shareholders are happy? I would consider best-of-breed semis as a cyclical investment when their P/Es are high but would completely avoid the weaker ones or turnaround situations like Sanyo).
  4. Shoe Pavilion (SHOE): Given that nearly every single retailer is being beaten up, I am concentrating my effort on bigger, better capitalized businesses with stronger brands and stability.

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