Postcard from Japan

I recently returned from a research trip in Japan and was encouraged to find a new breed of companies emerging. Despite the deflationary pressures and declining population, these entrepreneurial—and mostly service sector—companies are identifying niche growth areas in the domestic market. More importantly, they are capitalizing on these opportunities, achieving double-digit sales growth. Meanwhile, they are also delivering profit margins and capital returns comparable to growth companies elsewhere in Asia.

In recent years, the perception of Japan has been that "growth" and "Japan" don't seem to belong in the same sentence. The stereotype held by many overseas investors is that Japanese companies have slow, low growth, low margins, low capital efficiency and lots of cash but nothing to use it on. Unfortunately, there are indeed many Japanese companies that fit such a bill in instances in which managers have yet to grasp and appropriately act on the challenges they face.
However, we are taking note of a handful of companies that are embracing new challenges and proactively looking to take advantage of opportunities arising from the currently difficult economic

environment. A Tokyo child care provider I met with is one such example. Japan has one of the lowest birth rates in the world, so you may be wondering (as I did prior to my meeting), "How could child care be a growth business?" In fact, this company is aiming to nearly double its business over the next three years as government plans call for an elimination of long waitlists for child care facilities, and to privatize publicly operated daycare centers. For many years, child care facilities in Japan have been lacking, and corporate child care providers are nearly non-existent. However, due to the decline in Japan's workforce, more women are now encouraged to continue their careers even after starting families. The firm I met with aims to capitalize on this trend and become the country's dominant child care provider.

At the end of the day, investors must not forget that Japan is still the third-largest economy in the world. With a GDP of over US$5 trillion, there is more than enough room for small entrepreneurial companies with innovative ideas to achieve growth, even in Japan's domestic market. Although these companies are still the exception, they are growing in numbers, representing the emergence of a new Japan.

Kenichi Amaki, Portfolio Manager, Matthews International Capital Management, LLC