Warran Buffet and Japan’s 5 biggest trading houses

 16 Sept 2020

Dear Fellow Investor,

Last week, it emerged that Warren Buffet had invested USD 6.3 billion of Berkshire Hathway’s capital in Japan’s 5 biggest trading houses. These giant conglomerates are involved in everything from commodities, textiles, technology manufacturing, food, retailing, shipping and chemicals. Companies are Mitsui Ltd, Marubeni, Sumitomo Corp, Misubishi Corp and Itochu. They are trading at multi year lows and are paying high dividends. They are also trading at less than book value. My view is that Buffet is anticipating inflation and pricing power. He made a big move into gold recently as another inflation hedge.  His cost of capital to buy the Japanese shares was 0.42 % as he locked in ultra low Japanese rates. Dividends more than cover his cost of carry.   

Commenting on the transactions, Buffet said, "The five major trading companies have many joint ventures throughout the world and are likely to have more of these partnerships... I hope that in the future there may be opportunities of mutual benefit."  All these companies are profitable, have strong moats and a high barrier to entry. They also are long established. Sumitomo was founded in 1670 while Mitsubishi was founded in the mid 1800s. 

Value in Japan

The Japanese market has been a fertile hunting ground for value investors for many years, especially in the market's small and micro-cap sections.

Berkshire's size means it can't really participate in small-cap stocks, which may be why we have not seen this sort of move before. The fact that Buffett has made his move now suggests that he sees value with these businesses. Shares of all five trading houses were trading at multi-year lows before the deal was announced.

What's also interesting is the fact that this deal has been announced less than 12 months after Berkshire borrowed $4 billion in Japan. At the time, the deal was the biggest yen-denominated issue ever by a foreign multinational. The most significant chunk, 146.5 billion Yen ($1.38 billion) in 10-year debt, carried a 0.44% coupon. Berkshire was able to borrow this money for almost nothing. In comparison, Mitsubishi Corp stock currently supports a dividend yield of 5%.

Considering Berkshire's capital cost, its Japanese investments don't need to achieve an outstanding return to yield a positive return for the conglomerate. Based on this straightforward analysis, it would appear that Buffett has completed an astute deal here. He has borrowed money at almost nothing in the market and invested it in a diversified portfolio of highly respected global institutions.

This could also be a sign that the Oracle of Omaha is becoming more confident investing outside of the United States. In recent years, he has lamented the high prices of U.S. equities. As a result, he has stayed out of the market and allowed Berkshire's cash pile to expand.

Berkshire has also been a net seller of U.S. equities this year. We will have to wait until the third quarter 13F filing is published for further information, but if Berkshire has stayed away from U.S. equities while increasing its international holdings, this could be a signal that Buffett himself is starting to sour on the prospects for the U.S. economy.

It is notable that he has been selling U.S. stocks this year while spending billions in increasing Berkshire's Japanese interests.

Overall, it seems as if Buffett's decision to borrow at near-zero interest rates in Japan and reinvest this cash into diversified conglomerates is a sensible one, which aligns with his value mentality and could help the conglomerate earn higher returns on its capital than it would otherwise be able to do in the U.S. market.

 

Extracted from Guru Focus and Bloomberg work station.

While researching for this letter I reviewed the latest 2020-2021 Japan outlook  from Daiwa Securities. The biggest risk to Japan is a 2^nd wave of Covid but they feel it a low odds probability.  Japan, Taiwan, HK Singapore and Malaysia infection and death rates are dropping and in Taiwan there are no cases. Economies are slowly returning to normal. This is another support for Buffet’s purchases and a proxy for growth in our Asian investments.    

Take care

Bill

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