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April 4, 2016

Seiko Looks Cheap Amid Sovereign Wealth Liquidations

by Sridharan Raman.

With oil prices hovering around the $30 per barrel mark, oil-producing countries are seeing huge deficits and are struggling to balance their oil revenue-reliant budgets. That has led to many of the largest sovereign wealth funds liquidating assets — and their first targets are likely the most liquid markets around the world. One that fits the bill is the Japanese markets. At one point in early February, they were down almost 30% in a little over a half year. Since then, along with oil prices, the Japanese markets have also recovered, however, the Nikkei is still down almost 20% from the highs reached in August 2015. We looked for companies in Japan that are undervalued that may have, perhaps unfairly, succumbed to the selling pressures of the sovereign funds.

Japan chart 1

Source: Eikon/StarMine

Search criteria

To find potential candidates, we searched for the most actively traded companies in Japan, i.e. those that average over a million shares traded per day. We also looked only at those that have more than $1 billion market cap. Finally we screened using the StarMine Relative Valuation model for companies in the top quintile of all companies in the region.

We then eliminated those companies that may have strained balance sheets by screening for companies scoring higher than 30 on the Combined Credit model. We then made sure we had companies with earnings that are likely to be sustainable. To find those, we eliminated companies with poor earnings quality since we wanted companies that generate earnings from sustainable sources. We only considered companies with Earnings Quality scores of more than 70.

We saw many auto companies come through this screen. However, when we screened for companies with analyst revisions score over 30, we took out the companies that analysts have been bearish on. For example, analysts expect that the strong auto market may have peaked in 2016 and hence have been lowering estimates for this industry.

Japan chart 2

Source: Eikon/StarMine

 Corporate views

Above is a list of companies that come through the screen and we looked at those that have large exports. Seiko Epson Corp. (6724.T) fits this bill with only a quarter of its revenues coming from inside Japan. Margins have stabilized at Seiko over the past year and the company generates strong cash flow from operations. The strong Smart Holdings model score indicates that the company fundamentals are aligned with those that institutional investors currently value. Finally, the company has been doing well despite the strengthening yen. However, as the chart below shows, after a year of strengthening, the median consensus is for the yen to weaken over the next year to 120 to a dollar from its current level of 113.40.

Japan chart 3

Source: Eikon/StarMine

Looking ahead

If the yen does indeed weaken against the dollar, then Japanese companies with large exports to the U.S. are likely to be the main beneficiaries as their products become more competitively priced. That is one reason why Seiko may perform even better in the coming year, if analyst predictions for the yen are correct. If the sovereign funds indeed did target liquid assets amid the oil plunge, Japan would be an obvious target, and that could mean these securities may be underpriced and ready for strong earnings in the coming year.

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