The Land of the Rising Return: Forager in Japan

In the latest Stocks Neat episode, Steve Johnson, Gareth Brown and Isabella Foley dive into Japan’s corporate transformation — from shareholder returns and buybacks to digitisation and the demographic shifts reshaping opportunities.

“It’s been like a snowball that’s been pushing across a flat surface for a long period of time. It’s finally started to gather some momentum.” – Steve Johnson

With Japan now a significant part of the international portfolio, the team shares where they’re finding value and why some of the most interesting ideas are hiding in plain sight. 

Transcript

EPISODE 38

[INTRODUCTION]

[0:00:03]ANNOUNCER: Just a quick reminder, this podcast may contain general advice, but it doesn't take into account your personal circumstances, needs or objectives. The scenarios and stocks mentioned in this podcast are for illustrative purposes only and do not constitute a recommendation to buy, hold, or sell any financial products. Read the relevant PDFs, assess whether that information is appropriate for you, and consider speaking to a financial advisor before making investment decisions. Past performance is no indicator of future performance.

[EPISODE]

[0:00:39]SJ: Hello, and welcome to episode 38 of Stocks Neat. I'm Steve Johnson, Chief Investment Officer here at Forager Funds. I'm joined by my regular co-host, Gareth Brown, Portfolio Manager on our international fund. Hi, Gareth. How are you?

[0:00:52]GB: Hi, Steve. I'm well, thanks. Hello, everyone.

[0:00:54]SJ: Nice to be back in Sydney. We've just been around the country over the past couple of weeks. You joined me in Brisbane and Melbourne. Fantastic to meet some clients out there, and it's even easier when the returns have been good.

[0:01:06]GB: Yeah, and a few potential new clients came along as well, which was nice to see.

[0:01:10]SJ: Was very good. If you missed us, make sure you get it in the calendar for next year. It's really good to get out there and meet people face-to-face. Today, we're going to be continuing on a bit of the conversation we had at the roadshow. It's a podcast about our Japanese investment in the international fund. Most of what you'll hear today will actually be Gareth and Bella discussing the opportunity up there in Japan. Bella's just come back from a very, very hot Tokyo, but some really interesting meetings with companies up there. I will let them do most of the talking.

But just to set the scene, Gareth, we kicked this fund off way back in 2013. We owned some Japanese stocks in the early days of the fund, and there had been a lot of talk about governance reform in Japan even back then, more than 12 years ago.

[0:01:55]GB: Yeah. We're already 25 years into the bear market in Tokyo after their big bubble in the late 80s. Our investments early in the fund's days were focused on really cheap net nets of businesses that are trading at least less the networking capital and often less than the cash on the balance sheet, the net cash on the balance sheet. We did quite well out of them, but we started following more closely, the going on in Japan. There's been talk about corporate reform there for a long, long time. More recently, we got to learn that the process has genuinely been working. It just takes a long time to get going.

[0:02:29]SJ: Yeah, maybe even just, I guess, a step back in terms of why it's important. When we were first investing up there, we were buying what are called net nets. These are companies trading at significant discounts to the very short-term assets, usually cash that are on their balance sheet, and that was really widespread in Japan. There were hundreds of companies that you could invest in that were in that situation. If you cast the net wider, it wasn't just those. There were lots of businesses that were maybe trading at sensible multiples of their earnings at 12 or 14 times, but they had half of the market capitalization in cash, in particularly the US, but even more so than in Japan and Australia, or the UK, those types of businesses, you could make money. There'd be something happen to them if that cash was just sitting there and doing nothing.

The scene was not just those net nets that we’re investing, but across the whole market, pretty low returns on capital, mostly because of lazy balance sheets and then lots of cross-shareholdings as well.

[0:03:23]GB: Yeah, related issues, right? There was very little in the way of activist investors, or takeovers, or anything to upset the apple cart. Some of that was related to the cross-outings that provide really strong defense against that, but some of it is cultural in nature. It was very much frowned upon to be activist, to be a belligerent shareholder voicing your opinions, especially domestically within the country.

[0:03:48]SJ: Yeah, so the market wasn't new to us. Then Harvey joined us in 2019. He had been and still is a big fan of Sony's business, some particular attributes about that business that he really liked. It was 3% or 4% of our portfolio for a fairly extended period of time, just in the one stock. Then March of 2023, I think it was, there was a key catalyst here in terms of us getting significantly more interested in the more idiosyncratic opportunities that were available up there. That's when the Tokyo Stock Exchange came out with some pretty clear criteria there, expected companies to follow.

[0:04:27]GB: Yeah. A real focus on lazy balance sheets and significant cross-shareholdings. The market moved pretty quick. By the time we were looking at Japan, it had moved up quite sharply. A lot of the stocks that we were interested in had moved up quite sharply in the months prior. We were fortunate that it ran into that little yen hiccup there in August 2023. We had built up some knowledge in the space. We built up a lot more subsequent to that. It's become a real area of focus over the last two years or so.

[0:04:59]SJ: Yeah, and it's gathering momentum as well. Yamaji-san, who's the CEO of the Stock Exchange, has really been pushing this agenda for more than a decade. He was in Sydney for a roadshow a few weeks ago. He said in that meeting that it's been like a snowball that he's been pushing across a flat surface for a long period of time. It's finally started to gather some momentum. You're really seeing that momentum turn up in both share prices and in actually cash return to shareholders as well.

[0:05:26]GB: Yeah. The data that we pulled out says that buybacks have doubled 2024 versus 2023 to about 20 trillion yen, which is to put in context about 130 billion US dollars of buybacks enacted in 2024-2025. I think the data is that they've already done more than that this year so far than they did in 2024. It is now that the buyback and dividend yield is something like 4% to 5%. Firmly above bonds in Japan, and an interesting place for people to look and quite a mark change from five years ago.

[0:06:04]SJ: I think you and Bella will touch on this later, but the other interesting aspect is just the retail investors in Japan. It's been a very, very cash-heavy retail savings pool for a long period of time. There were a lot of reasons why it was hard to get people to go from, okay, I'm only earning zero on cash, but the yield on my stocks is only one. I'm not going to take the risk for that. Whereas, that yield going up substantially has brought some of those retail investors off the sideline as well, and we're seeing that grow quite rapidly.

We're also seeing maybe more reluctant than some of the capital return stuff, but we are seeing more corporate activity. We're seeing more activist funds get involved in the Japanese market. I do think it's important to go about the activism differently in Japan. I'm seeing success with a more gently, gently approach, rather than belligerent activism work, but we are seeing it make a difference in that market.

[0:07:01]GB: I think the culture of accepting that inbound discussion is interesting. It was just viewed as criticism not that long ago and like, “We manage this company. You don't tell us what to do.” I think a lot of the changes coming from the stock exchange have helped management teams see that you do the right thing, you will get rewarded in your stock eventually. Maybe that's making them a bit more open to listening to what outsiders have to say.

[0:07:25]SJ: Yeah, it's a barely recognizable landscape from where we started 13 years ago. Our portfolio waiting up there has gone from 3% to 4%, like I said, to 18% to 20% as we sit here today. We're going to get Bella in for a chat to discuss some of the specifics about those opportunities and why we're particularly enthusiastic about them.

[0:07:45]GB: Steve's kindly offered to bow out in favor of our topic expert here, Bella Foley. Thank you for joining us, Bella. It's been a couple of years now that you've looked closely at Japanese stocks, made several trips to the country. Lots of meetings both in Japan and Australia and over Zoom with management teams, often quite arduous with translators and whatnot. It's been a developing area of expertise for the fund. Firstly, thanks to you and Harvey for doing the lion's share of the work here. It's been very, very useful and it's become a really important part of the portfolio.

Steve and I already talked about the governance changes that have gone on over the last, probably over the last decade, but have really come to the fore over the last few years and become obvious to, especially, the Western markets. I thought maybe we could start with some of the trends just below that. Digitization being a really obvious starting point.

[0:08:40]IF: Thanks, Gareth, for having me on the podcast. It's nice to join. For us, it's been very clear over the last few years how problematic this aging population issue is in Japan, and that's been the spark of what's got us interested in this digitalization space. They essentially don't have the demographics to replace that working age population fast enough.

[0:08:59]GB: What was the fun fact of being telling people on a roadshow?

[0:09:02]IF: The fact that they've stopped producing one company over their OG holdings has stopped producing infant diapers. They're only producing adult diapers now.

[0:09:10]GB: Adult diapers outsell the infant diapers, I believe.

[0:09:13]IF: Yeah, in 24 they overtook them and that's hence, why they've stopped selling the infant ones. That was the spark of the interest is the labor shortage issues and the fact that IT personal especially, there's a shortage of IT personnel there, so on the development side, the coding side, which is why we started looking at that digitalization space. The fact that you've got a very long history here of all the back-office processes being done on paper, being done on Excel, and now you just don't have the labor to actually do those administrative tasks.

[0:09:42]GB: It's weird like that, isn't it? You go to Japan and you see the flashing lights and the robots, and then you find out that they've got mostly paper back office still, as recently as a few years ago that they're often doing 2D drawings for architectural plans, for example, hand-drawn. It's just, they're behind the Western world in a lot of areas still.

[0:10:02]IF: Yeah. Very so. Just especially on the legacy systems, they're still spending majority of their IT budgets on maintaining those legacy infrastructure. 90% of those budgets are still going to just maintaining these systems.

[0:10:14]GB: The time everyone keeps using in discussions with us is the 2025 digital cliff. Maybe you can outline that for us.

[0:10:20]IF: Yeah. That is the fact that in this year, 2025, they came up with this a few years ago, but this year over 60% of core platforms are over 20-years-old. There is a real problem there and it's very clear that these systems need to be updated. They need to be digitalized and that's where we're starting to look, especially at that smaller medium business size. I think there's a lot of opportunity there, faster moving than some of these really large corporates that have been slower to move historically, onto the automation and digitalization side of things.

[0:10:51]GB: Maybe you can outline one of the beneficiaries of this tailwind for us.

[0:10:55]IF: Yes, as we mentioned, we lack the software space for this very reason, the fact that they are at the forefront of this digitalization theme. There's a few different end markets that they're serving, but all software businesses. Our exposure in the fund spread across seven different software firms. One of those, we've talked about a little bit before. The business model is quite similar to a zero. It's called Obic Business Consultants. It's doing the accounting payroll systems through their buggio suites of products.

[0:11:26]GB: When we look at businesses like this in the US, or in Australia and elsewhere, we tend to see fairly high multiples, even though maybe growth is slowed now that we're getting further through that maturity phase. What did you see in Obic when we invested in it?

[0:11:42]IF: It was the fact that we were able to buy it for a more reasonable multiple at the time. We also had to adjust for the fact that it was holding a third of its market cap in cash. When you actually look at that, you were able to buy it at mid-20s, pay multiples, versus in the US, Australia, a lot of these businesses trade closer to 40 times forward earnings. We are able to find these at more reasonable valuations. That is in part, because not many investors are looking at these stocks, and just the fact that valuations in Japan are more attractive.

[0:12:12]GB: At our roadshow, one of the questions we were asked at one of our roadshows, which I thought was a really good one, was you've got this table up here of software stocks. They're trading at multiples that might be cheaper than what you can get in the US, or elsewhere, but they don't strike me as particularly low multiples. You talked about, in this case, Obic 25 to 30 PE. Just with the case of Obic, what's the growth story like? Because that's obviously a really important part of it here.

[0:12:40]IF: Yeah. Firstly, we need to adjust for the cash balance with that one. The fact that it does have a third of its market cap in cash. Then we're expecting mid-teens to 20% growth here on the earnings piece, which is higher than you're getting in the US on the software index, which is only expected to grow 10% to 15%, and that trades at 35 times forward earnings. Relative to the US, you are getting more attractive valuations. That's a pretty sticky, stable business. We have some others that are growing faster than that, trading at different, or higher multiples even.

[0:13:11]GB: Maybe let's touch on one of those. Now, the story with Obic was it’s one of the bigger investments that we own over there, and it services mainly the smaller, medium enterprise side of the market. Let's inverse that, because we also have another business that's one of the smallest ones we own that serves the bigger end of town. Maybe you can touch on the tailwinds in that part of the world as well.

[0:13:33]IF: Yeah. I mentioned earlier that the large corporates are actually the slowest to change, and they have been the slowest. The smaller medium-sized businesses are actually, you're seeing them now at Doc Cloud. But the big, mega companies have just been too set in their ways. This company DreamArts that we're talking about, this is a microcap company. We bought this when it was less than 100 million US dollar market cap. Again, that's something that we are able to look at all the way down that market cap into the spectrum.

[0:13:59]GB: It took a little while, I’m going to say.

[0:14:00]IF: Yes. But this is a no-code platform, so your regular staff can essentially build these platforms that help these really large corporates to tackle inefficiencies. You're talking banks, you're talking manufacturers to actually help build that back end, and you don't need the IT engineering expertise to be able to do it. It can be your front-end staff. We really like this one. This one, we were be able to buy it. We were able to buy this one at a mid-teens P multiple, and that's growing 40-plus still, the owning sign.

[BREAK]

[0:14:33]ANNOUNCER: Stay tuned. We'll be back in just a sec. Are you a long-term investor with a passion for unloved bargains? So are we. Forager Funds is a contemporary value fund manager with a proven track record for finding opportunities in unlikely places. Through our Australian and international shares funds, investors have access to small and midsize investments not accessible to many fund managers, in businesses that many investors likely haven't heard of. We have serious skin in the game, too. Meaning, we invest right alongside our investors. For more information about our investments, visit foragerfunds.com. If you like what you're hearing and what we're drinking, please like, subscribe, and pass it on. Thanks for tuning in. Now, back to the chat.

[EPISODE CONTINUED]

[0:15:16]GB: It's a little strange to have this little 100 million market cap business serving the big corporates. They may be dinosaurs, but they are still big, deep pocketed enterprises with really complex problems. How does a small company like this go about serving those customers?

[0:15:34]IF: It's mainly on the staff side. They've got the engineers in their own development side to be able to put this no-code platform together to then help these large corporates, but it's more on the relationship side. We met with the CEO back in the beginning of September, and he was saying, now they're sometimes having to commit to 20 years’ worth of work with these mega companies, because there is just so much infrastructure that needs to be redone at the back end. This no-code platform is really helping there.

[0:16:03]GB: It's amazing. I thought we might move on now. We touched on the aging population. As an analyst, you would normally look at that and say, demand down problems. You would call that a headwind for most businesses in a normal economy. But we've got a few in this portfolio that are direct beneficiaries of that aging population. We've touched on one already, but let's move on to a couple of other ones. Maybe start with the labor sociality element of the aging population and how that's changing the market over there, which is happening pretty abruptly, I believe.

[0:16:34]IF: Yeah. Firstly, you're seeing a really significant cultural shift over in Japan. For many, many years you had this phenomenon of lifetime employment, where you'd start out of university and you'd worked till your 75 at the same company.

[0:16:47]GB: It was the great bulk of the economy, right? The work that way.

[0:16:50]IF: It was. It was. Now, what you're seeing is that graduates coming out of university are actually saying, “You know what? We're willing to move jobs, because it's such a tight labor market. They're in demand, essentially, for these skilled workers. Playing that theme where people are actually willing to change mid-career, mid-career hiring has really seen a take-off, especially you've gone through this period of very low inflation. If you move jobs historically, you'd typically be having to take a pay cut. But because of this very tight labor market, you've now got 5% wage inflation mostly being driven by this tight labor market, you're actually able to go after some more attractive job opportunities.

[0:17:28]GB: Let's talk about the output of that, which is Japanese companies used to have all their employment effort was done on the graduate side. Now, we have a more typical market for us, which is we have online classifieds and whatnot for advertising jobs. Maybe you can touch on their investment there.

[0:17:47]IF: Yeah. We own a company called Visional, and it operates a platform called BizReach, which is it's a dominant channel for that professional mid-career hiring. It's got leading market share in Japan. It has a user base of two and a half million employees on the employee side, and it's your headhunters and also direct recruitment, because that's now becoming more prominent. Direct employers would go on to the platform to access this database of two and a half million different employers, job seekers. You've seen some really nice growth there, and growth actually accelerated recently when you've seen this higher wage inflation that's attracted more people to move jobs.

[0:18:31]GB: What's the business model there? Who's paying the bills?

[0:18:33]IF: Yeah, so it's the actual direct employer and their headhunter recruiters that accessing the platform. Unlike your traditional recruitment, or headhunting industries where they take much larger clips, sometimes that's up to 30% of the placement cost, this is a much cheaper platform. It's lower. It's towards 15% is what they're ending up paying.

[0:18:55]GB: The growth here is coming from increase. You use a base number of potential employees that are on the site and the number of companies using it, or is it coming from a price per higher change, or is it a bit of both?

[0:19:07]IF: It's a bit of both. It's a bit of both. You've seen growth in the direct recruitment piece. This is your large company is actually going directly to the platform and wanting access to this database, rather than using a recruiter, or headhunter. It's a bit of both. Then they're able to also push the pricing element.

[0:19:23]GB: Okay. Anything else in this aging population demographic worth discussing, Bella?

[0:19:28]IF: Definitely. Just for context, I'd say, the health care space in Japan is one of the furthest behind in terms of digitalization. Because of this aging population problem, they have in hospitals, especially the government's been trying to figure out ways to deal with that. One of the ways is actually to bring people out of hospitals and into home care, towards that end of life, or even just general nursing. What they've seen is a growth in the number of at-home nursing stations.

[0:19:55]GB: It's massively cheaper, right, to service people at home than –

[0:19:57]IF: 30% or so cheaper. Yeah. Yeah. What you've seen is growth in this at-home nursing market, where we've got a company, Ewell, here that's got a platform that's bringing together the electronic medical records. It's bringing together billing. It's bringing together scheduling all into one integrated platform. The main focus is just to cut that administrative work down. It claims that you can save 15 hours a month by using this platform. It means that these nurses can just go out. They don't have to spend time doing all these reports. They can go out and actually do the nursing, which is what is most important.

[0:20:30]GB: Okay. You have a business here that is making the nurse’s jobs more efficient in terms of the management of their own business, or the small team that they're part of. What's the charging model there?

[0:20:40]IF: Yeah. It's a subscription, a base subscription, and then there's a per visit fee as well. The more at-home visits they're able to do, that's bringing their own revenue. Then Ewell's also getting a cut. It drives efficiency from both sides.

[0:20:54]GB: Okay. Maybe quickly touch on valuation.

[0:20:58]IF: I'd say, the beauty of this business is that it's very sticky. Once you start using it as a nurse, it's pretty unusual for you to go and want to change it. The other part of it is that they've only got 17% penetration in the market, because majority of these processes are still being done on paper, or Excel.

[0:21:14]GB: The 17% market share is not because there's a massive competitor, right? It's because these processes are not being done properly, or efficiently at the moment. We have growth in the number of nurses, perhaps growth in penetration. Then hopefully, at some point, maybe growth in price as well.

[0:21:30]IF: Yeah. I mean, they're doing some interesting things with integrating AI into this scheduling piece and just with basically, being able to generate reports using AI. That all helps to be able to price up and when they integrate that into the product as well.

[0:21:44]GB: Thanks for that run through Bella. We've discussed a little bit about four of those investments in Japan. We've got another three that we might have to touch on another time. This has not been a top-down decision to invest in Japan. We have been finding really interesting idiosyncratic smaller ideas and things that have been from a playbook that we've seen elsewhere in the world that are cheaper than they're available in the US, or Australia, or elsewhere. They're often growing a lot quicker, too.

We are widening that search. We are looking in other trends and ideas, other than digitization, for example, outside of technology. It will continue to be with a smaller cap focus. Though, we are seeing a lot more attention coming to Japan at the conferences we go to. They are mostly interested in the Sonys of the world and the Sumitomos, because Warren Buffett owns it. I think we have developed a skillset here in that smaller end to find really interesting smaller ideas. Thank you for your work on that, and thank you for your time today. I'll let you go now and I'll bring Steve back and we can wrap up.

[0:22:49]SJ: That was a really interesting conversation there, Gareth. People have probably seen this increasingly from us over the decades, and some macroeconomic tailwinds there or some high-level tailwinds to some very company specific opportunities. It's been interesting for me in a market like Japan. We've replicated some playbooks that we've used elsewhere in the world. There's also some playbooks, I think, that you're seeing there that you are going to be able to replicate back the other way.

This aging population demographic, I read an article that the falling birth rates, the rate of fall has accelerated quite dramatically over recent years. The best estimates now are that the world's population is going to start shrinking in 2050. We may see some of these investment trends and opportunities that we're seeing from an aging population come back into Western markets over time as well.

[0:23:39]GB: Look, it's very nice to have some tailwinds. It's part of our calculation of company valuation. But we are very much focused on the individual stock stories here. A few years ago, we were very long in the UK, because it was a uniquely depressed market and we were finding really interesting things to do that were really cheap. Japan has become a similar market for us today. We own a lot more than the index. Because we're finding things from that playbook that we've seen before that we can get very confident in the valuation. It's a different playbook to what we're seeing in the UK, but we are moving to where the opportunity is.

[0:24:14]SJ: Some of that macroeconomic tailwind there is fundamentally important in terms of realizing investment returns over time. Go back to the governance conversation we had right at the start of this podcast. Getting comfortable around the shareholder focus and shareholder return aspects of what's happening up there is as important as the growth in the earnings and the cash that these businesses are going to generate. We need to make sure it is going to turn up in shareholder returns over time. That piece of the puzzle there, I think, is incredibly important in terms of us being willing to allocate such a significant part of the portfolio to it.

With that, we will wrap up today's podcast. Thank you very much for tuning in. You should have quarterly reports in your email boxes, if you're investors or followers of us very, very soon. If you've got any podcast topics you'd like us to discuss, or any comments on today's podcast, please get in touch, admin@foragerfunds.com as per usual. Thank you.

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