Warren Buffett, chairman and chief executive officer of Berkshire Hathaway, photographed during a 2011 trip to Japan.
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Japanese stocks have been on a tear since late last year, up nearly 15% since November, as the weak yen and inbound tourism help to reactivate the economy. But Warren Buffett added a spark in April when he visited Japan to announce that Berkshire Hathaway boosted its investment in Japanese trading houses to 7.4%. Overseas investors followed suit, buying $7.83 billion in Japanese stocks during five days of trading through April 14.
Buffett said the five — Itochu Corp., Marubeni Corp., Mitsubishi Corp., Mitsui, and Sumitomo Corp. — are comparable to Berkshire itself. They have diversified portfolios with long-term investments and a focus on value and cash flow.
“I just thought these were big companies. They were companies that I generally understood what they did. Somewhat similar to Berkshire in that they owned lots of different interests,” Buffett told CNBC’s Squawk Box during his April visit to Japan. “And they were selling at what I thought was a ridiculous price, particularly the price compared to the interest rates prevailing at that time.”
But many observers and Berkshire investors may still have questions for Buffett about his bigger bet on Japan’s economy as they descend on Omaha, Nebraska, this weekend for the Berkshire Hathaway annual shareholders meeting. For an investor who, in addition to looking for stocks trading a discount to intrinsic value, has always sought companies with durable economic “moats” in their industries and markets, what makes these Japanese firms so appealing?
Here are a few answers.
Samurai roots for Buffett’s Japanese stocks
The five trading firms that Berkshire has invested in are the biggest of Japan’s so-called sogo-shosha, or general trading companies. Their traditional role has been to import energy, minerals and food into Japan, a mostly mountainous archipelago with few natural resources, and to export finished products.
The sogo-shosha occupy a special place in the country’s business world, partly as a result of Japan’s unusual history. During the samurai period, the Tokugawa shogun dynasty closed Japan off from the rest of the world for over 200 years. After it was opened to trade in the 19th century, its new leadership feared colonization by Western powers and embarked on a rapid program of modernization. As industrialization began reshaping what had been an essentially feudal economy, the zaibatsu financial cliques centered on mercantile houses, some with roots going back to the 17th century, took on key trading roles and accumulated enormous influence on national policy. The Empire of Japan quickly caught up to Western powers and engaged in protracted military conflicts.
Post-World War II reorg through 1990s recession
The zaibatsu were dissolved or reorganized under the Allied occupation of Japan following World War II and replaced by keiretsu, which are groups of companies with cross-shareholding relationships and centered on a bank. They helped the country rebuild after wartime devastation, again accumulating massive wealth and clout. The trading companies played a key role in the keiretsu system by leveraging their overseas connections to help Japanese manufacturers expand their business abroad. But keiretsu began losing influence after the long Japanese recession that began in the early 1990s, while trading houses saw their own role diminish.
“They used to be the quarterback of their groupings (particularly for the zaibatsus, mainly linked with the main bank of the group), mainly helping Japanese firms expand their business abroad,” says Seijiro Takeshita, professor of management and informatics at the University of Shizuoka. “However, such need has dropped significantly, as the manufacturers are now able to negotiate on their own. Hence, the sogo-shoshas have diversified into various areas, particularly into energy and natural resources,” Takeshita said.
Business revenue beyond trading
Among Berkshire’s biggest investments are utility operations, rails, financials and insurance, and energy companies, but Buffett has bought everything from truck stops (Pilot Flying J) to fast-food chains (Dairy Queen), industrials and manufacturing companies (e.g., Lubrizol and Precision Castparts), and one of China’s leading EV developers, BYD.
Today, Japan’s trading companies derive most of their revenue from non-trade activities. In shifting from import-export to business management, they have built up interests in everything from logistics and real estate to frozen foods and aerospace; newer investments include electric vehicles and renewable energy. Their affiliated brands are fairly ubiquitous in Japan, but what they don’t have in common with some other notable Berkshire stock holdings is powerful global consumer products like Apple or Coca-Cola.
Still, their economic clout makes them underrated players. The shosha and their affiliates represent a large industrial grouping of 5,900 companies and 460,000 workers in over 200 cities around the world, according to the Japan Foreign Trade Council (JFTC), a shosha industry group representing 40 companies and 20 associations. These complex global operations make their business relatively difficult to understand for investors, but they’re also an advantage.
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“By getting involved in mutually related businesses in a wide range of areas, from upstream to downstream, shosha gain a bird’s-eye view of the entire business process and provide convenience to customers by providing functions such as finance, information, and logistics where necessary,” said Ryosuke Kawai, general manager of the Research Group at JFTC. “They are able to create new businesses with higher added value.”
“The point is not only that the scope of business is extensive and diverse, but trading companies also play a significant role in the global economy,” says Chika Fukumoto, a trading companies analyst with J.P. Morgan Japan. But some recent tailwinds are fading. Amidst heightened worry around a global economic slowdown, the trading companies ability to maintain and improve capital efficiency won’t necessarily come from higher commodity prices and a weaker yen, and to enhance shareholder return, Fukumoto says, “enhancing the quality of their portfolios would be the key determinant for longer-term share price.”
Shosha: The Big Five
The largest of Japan’s trading companies is Mitsubishi Corp., set up in 1954. Group founder Yataro Iwasaki was born in 1835 into a poor farming family that had lost its samurai status but he quickly climbed the social ladder as Japan underwent rapid social change. Iwasaki found success in shipping, transporting troops and materiel for the new imperial government, and founded the precursor of Nippon Yusen (NYK Line), Japan’s first passenger liner. Today, the Mitsubishi Corp. is one of the three core companies of the Mitsubishi keiretsu along with Mitsubishi UFJ Financial Group, the largest financial group in Japan, and Mitsubishi Heavy Industries, the country’s biggest defense contractor.
Mitsubishi Corp. is fairly typical of the other shosha in that it has businesses ranging from finance to raw materials to food; newer segments are focused on digital transformation and next-generation energy including offshore wind, solar, hydrogen and ammonia. It recently signed a $1.9 billion deal to supply rails, signals and communications equipment for a commuter railway project in Manila, part of its operations in 90 countries and regions through its 11 business groups. Mitsubishi is probably most familiar to everyday Japanese for its convenience store chain Lawson, named after Ohio dairy farmer James Lawson, which has some 19,000 outlets across Japan and East Asia.
Another trading house dating from the opening of Japan is Itochu Corp. It began in 1858 when Chubei Itoh began selling fabrics door-to-door. Textiles remain one of the company’s business groups today, along with typical segments of machinery, metals and minerals, energy and chemicals, food, general merchandise and real estate, and finance. Itochu’s 8th Company is designed to leverage synergies between its other segments, especially in consumer markets. Itochu is the majority holder in the FamilyMart convenience store chain, which has about 24,500 stores in Japan and overseas. Its other recent investments include the 160 MW Prairie Switch Wind Project outside Houston, licensing and distribution rights for the L.L. Bean brand, and supplying sustainable aviation fuel, produced by Finland’s Neste OYJ, to Japan Airlines and other carriers.
A customer leaves a FamilyMart Co. convenience store in Tokyo, Japan, on Wednesday, July 8, 2020.
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Sumitomo Corp. traces its history back to Masatomo Sumitomo, a Buddhist monk who sold books and medicine in Kyoto in the 17th century. His family began a smelting business, formed close ties with the ruling shoguns, and moved into trading and mining, opening the Besshi Copper Mine, which operated for 283 years. Established in 1919 as The Osaka North Harbour Company Limited, the Sumitomo sogo shosha concentrated on natural resources in the postwar era, but after significant losses around 2014 it changed its focus to infrastructure and automotive. It is invested in rail projects in the Philippines, German electric vertical take-off and landing aircraft (eVTOL) startup Volocopter and, along with Marubeni, transport of hydrogen from Australia to Japan. It has some 900 group companies and 75,000 group employees.
Japan’s third-largest sogo-shosha, Mitsui, is part of the Mitsui Group and was originally established in 1876. With 279 subsidiaries, its investments include an iron ore business in Australia, liquefied natural gas projects around the world, and a truck leasing joint venture in the U.S. with Penske Corporation. Like Mitsubishi, it has a convenience store business, supplying Seven and i Holdings Co., operator of the 7-Eleven chain, with systems for merchandizing and logistics. Its recent investments include Wellesta Holdings, a Singaporean pharma startup focused on drug approvals and marketing in developing countries, and Pittsburgh-based Optimus Technologies, which makes a biodiesel fuel system.
Like Itochu, Marubeni Corp. also traces its foundation to textile dealer Chubei Itoh; its name first appeared in 1921 out of the merger of two companies related to Itochu. It has similar business as the other shosha, including a transportation and industrial machinery group, but without a convenience store component. In recent projects, it has teamed up with U.S.-based LIFT Aircraft to stage the first piloted demonstration flight in Japan of an eVTOL, partnered with French startup Ynsect to develop insect-based feed for fish farmed in Japan like seabream and yellowtail, and invested $50 million in U.S. recycling company Cirba Solutions to extract rare metal compounds from batteries that have been discarded.