Japanese Stocks and Airlines: Oh How the Market Loves Thee

by JT McGee

Here at Money Mamba I focus on the markets from a value perspective, never forgetting that in the short term the markets are a voting machine, but in the long term, a weighing machine.

Stocks are not just ticker symbols. Stocks are ownership in a business, and I only want to own stocks that I can be comfortable owning for years and years, not just days or weeks.

I’ve written articles on my two least favorite investments: Japanese stocks and airlines and shipping companies, and it might be time for a follow-up.

Japan, cool your excitement

As is typically the case, the market likes to turn against me. After writing an article on Japanese stocks and how I generally view them as uninvestable, the Japanese stock market went on a tear. I believe cultural differences will forever leave Japanese equities to lag public companies in the United States.

Japan has a very different view of capitalism than America. Even when companies trade for paltry multiples…say, 1-2x EV/EBITDA or 1-2x earnings less net cash, cultural differences rarely allow for value creation. See the article “Investing in Japanese Stocks: NOPE” which includes a story about a famed value investors’ attempt to unlock cash that was owed to shareholders. If you haven’t heard of the cultural differences in Japan before, you might be surprised at how their corporate boards act in ways that go against the shareholder and capitalist.

Cash on the balance sheet is the shareholders’ in every country except for Japan. That makes for a terrible investment, and despite the surge in Japanese stocks, I’m holding strong in my viewpoint that they will underperform over the next 10-20 years, just as they have through history. When cash never comes back to shareholders, how much is a company really worth? Zero? Yeah. I think so, too.

To be entirely fair, the Japanese economy is improving. A spokesperson from City Index recently commented “The Japanese economy grew at a faster rate than expected in the first three months of the year, according to new figures. Government data shows the country’s economy expanded at an annualised rate of 4.1 percent in the first quarter of 2013, significantly higher than the original estimate of 3.5 per cent. Japan’s current account surplus had doubled at the end of the three-month period compared with a year earlier, standing at 750 billion yen (£4.9 billion) in April, according to Ministry of Finance figures.”


So what about airlines?

I took a lot of heat on a series of articles about how airlines and shipping companies have the worst business economics of any industry, even though that thesis was largely proven with historic ROIC metrics in another post.

The airline industry has since consolidated, which some (falsely, in my view) believe will result in better and smarter pricing. But it all comes down to the classic case of the prisoner’s dilemma. It is in the best interest of airlines to cooperate and encourage higher pricing, even if it means not every seat on a flight is full.

Unfortunately for the industry, you can’t always get everyone on board. Rapidly growing Spirit Airlines is growing quickly by slashing prices to win over cost-conscious customers. Meanwhile, American Airlines is adding capacity not by adding planes, but by reclaiming one inch of leg room on many of its planes to add new seats. It never ceases to amaze me how investors fall for the same tricks time and time again. Capacity is going up, which means the incentives to sell tickets at lower and lower marginal prices will follow.

The economics of the airline business are the worst in the world. Due to the fact that airlines have exorbitant fixed costs and very low variable costs, there are huge incentives to lower prices for the few unsold seats on a plane. When one airline gets greedy, all airlines suffer. Right now airlines are content with their pricing and capacity, but it’s only a matter of time before poor microeconomics show themselves.

Bulk dry shipping

Even worse than airlines and Japanese stocks, bulk dry shippers have had a mixed record since I wrote about how awful this industry really is. Highly-competitive with no customer loyalty and carrying inherently high fixed costs due to capital investments in new ships, this industry destroys more dollars than any other on the planet.

Unlike railroads or even land-based, non-asset shipping companies, bulk dry shippers cannot have a competitive advantage in any way, shape, or form. Frequent boom and bust cycles mean that this industry is prone to the pork cycle, whereby capacity goes from too low to too high to too low over, and over, and over again. The result is a few good years followed by a few bad years – or many, as we’re seeing right now.

This industry gets rocked by the three Cs: competitiveness, cyclicality, and capital intensity. The only way to win in this space is to time the macroeconomic picture perfectly year after year. No one can do that – and if they could, they wouldn’t be shipping stuff across the world; they’d have a job as a trader making billions, not millions as a shipping exec.

Staying firm

Sometimes the hardest thing in the world is staying firm in what you know. When Japanese stocks rose something like 70% in less than one year, or airlines surged after the big four came to control more than four-fifths of all flights, it was not easy to shy away from a robust bull market. It’s very easy to think that “this time is different,” and invest accordingly, throwing out everything you’ve ever known for a shot at quick profits.

This time isn’t different, though. You won’t change the culture of Japan, nor will you change the greediness of the airline business, or the cyclicality of the shipping industry.

In the short term the the stock market behaves like a voting machine, but in the long term it acts like a weighing machine.

{ 2 comments… read them below or add one }

Value Indexer June 13, 2013 at 11:14

Given the bad history of airlines, which everyone knows, why do so many investors keep buying the stocks?

I noticed yesterday that Japanese stocks have had a huge run since last year. However, given that the Yen has lost a lot of value in that time (around 20%?) it may be partly a currency effect.


JT McGee June 13, 2013 at 11:44

I justify it by the fact that there are a lot of people who will buy a stock to make 10-40% in a year, but who would never buy the same stock if they had to hold it for 20 years. Even fund managers won’t own a quality, underpriced business unless it will perform at or above the market within the next quarter or two. It’s short-sided, but it is what it is. Add on momentum investors, indexes, short-term traders and you have a market for any security.

You can see the returns of Japanese stocks minus currency changes with the DXJ ETF, which hedges out the effects of currency fluctuations: https://www.google.com/finance?chdnp=0&chdd=1&chds=1&chdv=1&chvs=maximized&chdeh=0&chfdeh=0&chdet=1371153600000&chddm=44183&chls=IntervalBasedLine&q=NYSEARCA:DXJ&ntsp=0&ei=SfW5UbjYFIKI0QHMFg A significant part was currency flux at the height of the Nikkei this year. Now the Nikkei is up about 20% vs. 18% for DXJ year to date, which nets out the effect of currency. Performance is roughly equal for the last year, too. Wake me up when the culture changes in Japan 😉


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