Annual Financial Report

RNS Number : 1370T

AVI Japan Opportunity Trust PLC

16 March 2023

 

AVI JAPAN OPPORTUNITY TRUST PLC

ANNUAL REPORT 2022

LEI: 894500IJ5QQD7FPT3J73

Annual Financial Report for the year ended 31 December 2022

The Directors present the audited Annual Report for the year ended 31 December 2022.

Copies of the Annual Report can be obtained from the Company's website ("AJOT" or the "Company") www.ajot.co.uk or by contacting the Company Secretary by telephone on 07702 965 986.

AVI Japan Opportunity Trust plc ("AJOT" or "the Company") invests in a focussed portfolio of quality small and mid-cap listed companies in Japan that have a large portion of their market capitalisation in cash or realisable assets.

Notice of Annual General Meeting

The Company's Annual General Meeting ("AGM") will be held at 11.30 am on Tuesday, 2 May 2023 at the offices of Stephenson Harwood LLP, 1 Finsbury Circus, London, EC2M 7SH. Shareholders will be able to submit questions to the Board and the Investment Manager, Asset Value Investors Limited ("AVI") ahead of the AGM and answers to these, as well as AVI's presentation, will be made available on the Company's website. Please refer to the Notice of AGM for further information and the resolutions which will be proposed at this meeting.

Dividends

The Directors are proposing a final dividend of 0.80 pence per Share for the year to 31 December 2022. Subject to the approval of Shareholders at the forthcoming AGM, the proposed final ordinary dividend will be payable on 26 May 2023 to Shareholders on the register at the close of business on 28 April 2023. The ex-dividend date will be 27 April 2023.

Performance Summary

	31 December 2022	31 December 2021
Net Asset Value* (£)	156,395,000	160,721,000
Net Asset Value per Share (total return) for the year	-4.3%	12.3%
Share price total return for the year	-4.5%	10.0%
Comparator Benchmark
MSCI Japan Small Cap Index (£ adjusted total return)	-1.0%	-1.4%
Portfolio Valuation
Net Cash as % of Market Cap	41.9%	39.9%
Net Financial Value as % of Market Cap	63.0%	75.9%
EV/EBIT	6.0x	5.1x
FCF Yield	6.0%	5.4%
	Year to 31 December 2022	Year to 31 December 2021
Earnings and Dividends
(Loss)/profit before tax	-£6.6m	£17.9m
Investment income	£3.7m	£3.2m
Revenue earnings per share	1.69p	1.55p
Capital earnings per share	-6.79p	11.89p
Total earnings per share	-5.10p	13.44p
Ordinary dividends per share	1.55p	1.40p
Ongoing Charge
Management, marketing and other expenses   (as a percentage of average Shareholders' funds)	1.5%	1.5%
2022 Year's Highs/Lows	High	Low
Net asset value per share	120.7p	102.8p
Net asset value per share at 31 December 2022	114.11p
Share price at 31 December 2022	112.25p
Discount as at 31 December 2022	1.63%
(difference between share price and net asset value)

* For all Alternative Performance Measures, please refer to the definitions in the Glossary in the Annual Report.

COMPANY OVERVIEW

Company Purpose

Discovering overlooked and under researched investment opportunities, and utilising shareholder engagement to unlock long-term value.

Company Objectives and Strategy

AJOT aims to provide Shareholders with total returns in excess of the MSCI Japan Small Cap Index in GBP ("MSCI Japan Small Cap"), through the active management of a focused portfolio of equity investments listed or quoted in Japan which have been identified by Asset Value Investors Limited as undervalued and having a significant proportion of their market capitalisation held in cash, listed securities and/or other realisable assets.

AVI seeks to unlock this value through proactive engagement with management and taking advantage of the increased focus on corporate governance, balance sheet efficiency, and returns to shareholders in Japan.

The companies in the portfolio are selected for their high quality, whether having strong prospects for profit growth or economically resilient earnings. By investing in companies whose corporate value should grow overtime, AVI can be patient in its engagement to unlock value.

Benchmark

The MSCI Japan Small Cap Index.

Capital Structure

As at 31 December 2022, the Company's issued share capital comprised 137,461,702 Ordinary Shares of 1p each, of which 400,000 were held in treasury and therefore total voting rights attached to Ordinary Shares in issue were 137,061,702. As at  10  March 2023 it comprised  140,361,702 Ordinary Shares, none of which were held in treasury, and therefore total voting rights attached to Ordinary Shares in issue were 140,361,702.

Investment Manager

The Company has appointed Asset Value Investors Limited ("AVI" or the "Investment Manager") as its Alternative Investment Fund Manager.

The Association of Investment Companies ("The AIC")

The Company is a member of The AIC.

Website

The Company's website, which can be found at www.ajot.co.uk , includes useful information on the Company, such as price performance, news, monthly and quarterly reports as well as previous annual and half year reports.

CHAIRMAN'S STATEMENT

"Four years since launch, your Company has performed well in the face of multiple headwinds."

Overview of the Year

On behalf of the Board of Directors ( " the Board") I am pleased to present the Annual Report for 2022. This past year your Company has pursued its investment objective with ever more conviction and has not been in any way unnerved by the historic sell-off in bond and equity markets. I am truly appreciative of our Shareholders continuing to validate the Board's confidence in our investment approach. This confidence was demonstrated most clearly in October 2022 when Shareholders overwhelmingly decided not to take up the exit opportunity to which they were entitled. I would like to thank our brokers, Singer Capital Markets, for their efforts in canvassing opinion from Shareholders representing a significant majority of the shares in issue, that they did not wish to exit at this time - in so doing they have saved the Company, and you, a substantial amount of money that would have been wasted on the administrative expenses of putting an exit opportunity together. In accordance with the terms of our Initial Public Offering ("IPO"), an exit opportunity will continue to be offered on a biannual basis.

The war in Ukraine and other macroeconomic factors in the last 12 months have created a challenging environment for all investors, and your Company was no exception. Risk aversion has risen, and valuations have fallen, particularly for growth assets.

In Japan specifically, the Bank of Japan's ( " BoJ") ultra-low interest rate policy has continued to weigh on the Japanese Yen, despite core inflation reaching a 41-year high of 4% at the end of the year. The persistence of this high inflation rate may have been the root cause for the BoJ's slight modification to the 10-year Japanese Government Bond yield cap in December 2022, which increased from 0.25% to 0.5%. This small shift in policy could indicate that the BoJ is moving away from its loose monetary stance, towards further rate increases in 2023, which would benefit the Yen and have implications for assets globally.

Despite the challenging environment, your Company ended the year -4.4% in GBP terms in respect of net asset value, a less negative return than most global equity markets.  However, it was still below the -1.0% return of the official comparator benchmark, the MSCI Japan Small Cap Index. Total net assets at the year end stood at £156.4mn (31 December 2021: £160.7mn). Performance across the portfolio was generally good but was dragged down by two large detractors, Wacom and Pasona (as discussed in more detail below). Since inception, however, AJOT has proven to be a source of resilience, with returns since October 2018 of 21.4% versus 8.7% for the benchmark.

Year to date 2023, AJOT has returned +7.7% versus the benchmark's return of +2.4%.

Your Company's bottom-up, deep research approach focuses on investing in companies with solid fundamentals and attractive valuations. The portfolio has 63% of its market cap covered by net cash and investment securities, while trading on a lowly 6.0x EV/EBIT multiple. This, coupled with continued engagement, shielded us from the extreme re-pricing experienced in more highly valued stocks, as rising interest rates exposed stretched valuations.

Your manager, AVI, has continued public campaigns at four portfolio companies and sent letters or presentations in private to a further nine. AVI has leveraged its expanded Japan team in the past 12 months to step up the level and intensity of engagement. The team continues to build deep relationships with management, having had numerous high-level meetings with Chairmen, CEOs and outside directors of our portfolio companies. The preferred approach of private engagement has led to notable successes, with a raft of shareholder-friendly measures being introduced across multiple companies without requiring public campaigns. This approach of constructive engagement has helped the Company to navigate the challenging market conditions and deliver strong results for our investors.

Dividend

As provided for in the Prospectus at the IPO, the Company intends to distribute substantially all the net revenue arising from the portfolio. The Company paid an interim dividend of 0.75p per share in November 2022, and the Board has elected to propose a final dividend of 0.80p per share, bringing the total dividend for the year ended 31 December 2022 to 1.55p per share (2021: 1.40p per share).

Investment Strategy

AJOT listed in October 2018 to take advantage of the highly attractive opportunity to invest in under-valued, over-capitalised Japanese small-cap equities with strong underlying business fundamentals. We believed - and still do - that active engagement and corporate action will allow for the unlocking of valuation anomalies unavailable in other global developed markets, with the potential for attractive absolute and relative returns.

Four years since launch, your Company has performed well in the face of multiple headwinds: lacklustre performance of small cap stocks (MSCI Small Cap Japan has underperformed its larger MSCI Japan counterpart by almost 8%); a notable sell-off in the Japanese Yen which has detracted 11% from GBP returns; as well as a turbulent global environment. The Board remains confident AVI is well placed to continue executing on the strategy and that there are still plenty of mispriced investment opportunities.

Share Premium and Issuances

As at 31 December 2022, your Company's shares were trading at a discount of -1.6% to NAV per share. The Board monitors the premium/discount carefully and manages it by periodically issuing or buying back shares. During 2022, we re-issued 250,000 shares from treasury and employed the Company's authorised block listing facility to increase our shares in issue by 4,241,000. 400,000 shares were bought back during the year. As at 31 December 2022, 137,061,702 shares were in circulation, a pleasing increase from the 80,000,000 shares at AJOT's launch.

Since the year end, the Company re-issued the 400,000 shares which had been bought back during the year, as well as a further 2,900,000 shares using the block listing facility. As a result, as at 10 March 2023, 140,361,702 shares were in circulation.

The Directors believe that the performance of the Company since IPO should be attractive to a larger pool of investors and are constantly exploring ways to grow AJOT.

Debt Structure and Gearing

As described in the Prospectus, the Board supports the use of gearing to enhance portfolio performance. The Company has in place a ¥4.33 billion debt facility which was renewed on 2 February 2022. As at 31 December 2022, ¥2.47 billion of the facility had been drawn and net gearing stood at 5.1%.

Governance

The Directors firmly believe that greater diversity in the boardroom leads to better decision-making and therefore higher returns for our Shareholders. Needless to say, your Board meets or surpasses the various recommendations issued by the Parker Review, the Hampton-Alexander Review and the New Listing Rule 9.8.6 (9-11) for gender and ethnic diversity. However, the Board has even greater and, I would argue, more directly relevant diversity within its ranks: the diversity of social background, of education, of skills, of work experience and of lived experience. Our diversity of gender and ethnicity is a happy coincidence of constructing a Board with these broader attributes. Ultimately, I believe that boards should be comprised of the best people for the job, full stop. I am proud to confirm that for your Board these are the very people that we do have in place.

Investment trusts are different from operating companies. We do not have CEOs or CFOs which the FCA mentions in their recommendation for positive diversity on boards. The Board has chosen not to appoint a Senior Independent Director ("SID"), one of the roles that the FCA believes should count towards diversity targets. If a Board is functioning correctly then there should be no need for a SID. The Directors of AJOT are strong, knowledgeable, professional individuals who do not hesitate to inform me when I have made a mistake. It is the Chairman's role to foster a culture where the independence of Directors helps them serve as effective stewards of Shareholder wealth. This is how all boards should operate. For investment trusts a much more important role than that of the SID is filled by the Chair of the Audit Committee and we strongly believe that the FCA should recognise the unusual position of investment trusts and include the Chair of Audit role when looking at diversity considerations. Your Board's Chair of the Audit Committee role is held by a capable female Director.

The role of proxy advisors has increased over the past few years. This, I believe, is to the detriment of the investment trust industry as a whole. Proxy advisors seem to have little understanding of how investment trusts and their boards operate, and unfortunately their decision-making process remains opaque and final.

The use of a proxy advisor is understandable for an index fund charging minimal fees, but those shareholders are in a minority, or non-existent, in most investment trusts which are actively managed by their shareholders and where investment manager decisions are subject to active board oversight. While there are good reasons why the Board and the Investment Manager may make certain decisions, there is no forum or opportunity for boards to explain the rationale and circumstances for decisions to proxy advisors, who may then advise a vote against particular resolutions.

Proxy advisors also have an obsession with succession planning. In order to address this concern, the Board has formulated a succession plan which will see new Directors join the Board and existing Directors resign as their duties are handed over. However, I strongly believe that Shareholders should make the ultimate decision on who represents them on the Board and over the coming period I will be seeking Shareholders' views on the evolving composition of the Board, rather than have it dictated by others with an imperfect understanding on how the industry functions, let alone how specifically your Board operates, all while using arbitrary metrics.

Outlook

Japan reopened its doors to tourists on 11 October 2022 and much of the APAC region followed suit. As travel and tourism are set to resume across the continent, the added economic boost that this brings is likely to continue to drive inflation expectations upwards - a step-change from the long-entrenched deflationary mindset of Japan. The possible impact of these and other factors on BoJ and Japanese Government policy going forward has firmly returned this long neglected country to the forefront of global investors' minds for the first time in a generation.

Furthermore, the fundamental argument for Japanese equities remains compelling , especially when compared to developed market alternatives. Not only are we seeing continued improvements in capital management and corporate governance, but at the end of December 2022, the TOPIX traded at 1x price to book, lower than its long-term average, since 1993, of 2x. Similarly, the TOPIX's trailing PE stood at 14x at the end of December, below its long-term average of 21x (to 1993)*.

Predicting the future macroeconomic landscape is a difficult task. Instead, your Investment Manager's focus remains on finding high-quality companies trading at attractive valuations. AJOT's portfolio has become higher in quality since its launch, and its level of engagement has intensified materially. The current portfolio is well positioned with a concentrated yet diverse collection of high-quality, lowly valued companies, with multiple levers for re-rating. As a Board, we are confident that AJOT can continue building on its successful track record of engagement with companies and delivering overall attractive returns for investors.

In the coming weeks I shall be meeting any institutional investors who would like to see me and I encourage as many Shareholders as possible to attend our fourth AGM in May. The Investment Manager, your Board and I are respectful of the workload of our investors. We remain available to all our Shareholders - institutional and retail - who may wish to discuss an issue or ask a question.  As always, please feel free to reach out to me through our broker, Singer Capital Markets, to arrange a meeting.

Norman Crighton

Chairman

15 March 2023

*Bloomberg as at 31 December 2022

OUR TOP 10 HOLDINGS

1. DTS Corp (8.0% of portfolio, 6.9x EV/EBIT)

DTS provides IT-related services to Japanese corporations. Its business is expanding into Digital-transformation related ("DX") fields such as cloud, robotics and IoT ("Internet of Things"). Japanese companies have underinvested in their IT infrastructure, with antiquated processes and complex legacy systems. With encouragement from the Government, we believe companies will dramatically increase their IT expenditure - much to the benefit of DTS.

2. Nihon Kohden Corp (7.5% of portfolio, 9.3x EV/EBIT)

Nihon Kohden is a medical equipment manufacturer, with a product lineup of patient monitors, defibrillators and ventilators. It has generated a 5.4% 20-year sales CAGR, with sales declining in only three of the past 37 years, and has grown its overseas business to just over a third of sales. We expect this growth to continue as the business benefits from increased global healthcare expenditure and a shift to higher value-add digital solutions.

3. Konishi Co Ltd (7.0% of portfolio, 4.0x EV/EBIT)

Konishi is famed for its household glue brand BOND. It has a dominant market share across the domestic adhesives market and successfully expanded its business into infrastructure repair works. We believe Konishi has potential to grow its adhesive offering into more industrial applications and to establish itself overseas, which is not reflected in the lowly 4.0x EV/EBIT valuation.

4. NC Holdings Co Ltd (6.7% of portfolio, 7.4x EV/EBIT)

NC Holdings owns an eclectic mix of businesses, including solar panel consulting, conveyor belts and - the most attractive - car parking systems. Each standalone each business has its merits, but they have no synergies combined. This is part of the reason why the business trades on 7.4x EV/EBIT vs our fair value of over 10x.

5. Wacom Co Ltd (6.6% of portfolio, 9.4x EV/EBIT)

Wacom is a global leader in digital pen solutions. It is uniquely positioned to benefit from the growing adoption of digital pens. Its dominant market position allows Wacom to be at the forefront of technological innovation, developing solutions that utilise big data, artificial intelligence and virtual reality. Investors underappreciate the growth potential of Wacom's technology, but under the leadership of the relatively new President and with improved investor communication, we think this will change.

6. T Hasegawa Co Ltd  (6.6% of portfolio, 9.8x EV/EBIT)

T Hasegawa is a top 10 global flavour and fragrance ("F&F") manufacturer. Its products are used in a variety of products from tea to instant noodles. The Company's motto is "a company founded on technology" and it has a rich library of recipes. The F&F industry is appealing because of its high barriers to entry and resilient pricing power, which explains why T Hasegawa's global peers trade on an average EV/EBIT of over 20x.

7. Shin-Etsu Polymer Co Ltd (6.5% of portfolio, 3.5x EV/EBIT)

Shin-Etsu Polymer manufactures an assortment of devices, but its main product is a container used to carry semiconductor silicon wafers. It is a listed subsidiary of Shin-Etsu Chemical, and our base case is that Shin-Etsu Polymer is taken over. The companies' business operations are intertwined, and the management of both companies have made indications that they are open to addressing the parent/child listing issue.

8. TSI Holdings Co Ltd (6.1% of portfolio, <0.0x EV/EBIT)

TSI Holdings owns a collection of diversified apparel brands. Its unique focus on athleisure and outdoor wear sets it apart from competitors, but it trades at a steep discount due to a bloated balance sheet. Net cash, investment securities and real estate account for 176% of TSI's market cap, obscuring the underlying business. Were TSI to trade in line with peers, there would be a +150% upside to the current share price.

9. Fujitec Co Ltd (5.8% of portfolio, 18.3x EV/EBIT)

Fujitec is a global leader in manufacturing and servicing elevators and escalators. It has a unique focus on Asian markets, which offer a compelling growth opportunity. We launched a public campaign in May 2021, calling on Fujitec to address decades of underperformance and its undervaluation. Fujitec is the largest independent player left in a highly consolidated market, making it an attractive acquisition target for competitors.

10. Digital Garage Inc (5.6% of portfolio, 7.2x EV/EBIT)

Digital Garage's three main business interests are card payment processing, online marketing and venture investments. The real crown jewel is the wholly-owned payment processing business, a beneficiary of shifting habits towards cashless payments. Digital Garage's complex holding structure leads to a large discount and we have been engaging with management on ways to rectify this, including separating the payments business.

INVESTMENT MANAGER'S REPORT

"The portfolio trades at 6.0x EV/EBIT and is positioned for several potential idiosyncratic events with upsides of 50-100%. Combined with a cheap Yen and an increasingly supportive macro environment, we are optimistic about prospective returns. "

2022 was a year filled with challenges and volatility, with a war on European soil and rising interest rates leading to a sell-off in both bonds and equities. However, Japanese equities fared relatively well, with the MSCI Japan Small Cap Index rising by +0.8% in JPY and declining by -1.0% in GBP. This contrasts with the significant declines seen in other markets, such as the Bloomberg UK Government All Bonds Total Return Index, which fell by -25.1%, the MSCI AC World Index, which decreased by -8.1%, and the growth-oriented NASDAQ Composite, which saw a drop of -24.1% (all in GBP). A strong USD flattered these returns and in local currency they fared more poorly. 

Despite the challenging market conditions, your Company proved to be a source of resilience, with a GBP NAV decline of -4.4%. This is a testament to the strength of the portfolio and its low starting valuations. Performance across the portfolio was generally good, with several stocks contributing positively to the overall performance. Our three largest contributors, DTS, Fujitec and Teikoku Electric, all benefited from shareholder engagement, leading to a re-rating in their valuations. However, we experienced two large detractors, Wacom and Pasona, which had an outsized impact on performance, reducing returns by -6.4%.

Wacom suffered from a deterioration in its business environment while Pasona's decline was driven by a broad sell-off in growth equities. We will discuss both in more detail later, but the share price weakness has made their investment cases more compelling and we still see upside.

Like much of the rest of the world, inflation continued to creep higher in Japan, with the country's core CPI ending the year at 4.0%, the highest since the late 1980s. Pressure from inflation and relatedly, a low approval rating for Prime Minister Kishida, might have been the catalyst for the BoJ modifying its 10-year Japan Government Bond yield target from 0% ±0.25% to 0% ±0.5% in December 2022. Although only slight, it signalled a change in policy that might pave the way for further rate increases in 2023. The effect was a strengthening of the Yen against Sterling, which at the year low had weakened by -8.8% but ended the year down only -1.9%.

Adjusting for portfolio weight changes, i.e. keeping the weights of the stocks still held at the end of the period constant, the EV/EBIT multiple of the portfolio increased modestly from 5.8x to 6.1x. This was entirely accounted for by Fujitec's multiple rising from 8.6x to 18.3x, with the position beginning the period as a 6.1% weight in the portfolio. Although Fujitec suffered from a temporary decline in earnings driven by lockdowns in China, its share price gained 22% on hopes of an increased chance of a much-anticipated privatisation.

During the year we welcomed Shimpei Ochi to the Japan team. He joins us on a nine-month internship, having advised the Ministry of Economy, Trade and Industry in Japan on their M&A guidelines and subsequently completing a Master of Law from Columbia Law School.

The backdrop for shareholder engagement is as supportive as ever. Fifty-fivecompanies received shareholder proposals during the 2022 AGM season (almost double last year's number), Uniden was taken private in what we believe is the first successful friendly tender offer completed by a foreign engagement fund, while EGMs were called at Fujisoft, Fujitec and Japan Securities Finance.

Increased public engagement activity is helpful for our endeavours, reminding management of our portfolio companies that they are accountable to shareholders, and highlighting the risks of not listening to our suggestions. Support from regulators is also helpful, and it was encouraging that the Japan Stock Exchange continued discussing ways to improve corporate value of companies listed on the TSE. Shortly after the end of 2022, they decided to mandate companies to disclose policies and initiatives to address capital efficiency and low valuations (specifically a price/book ratio below 1x).

Our engagement was mostly behind the scenes, sending 24 detailed letters or presentations and holding 121 meetings with our 25 portfolio companies. This led to notable successes at DTS when in May 2022 it announced a new mid-term plan with a raft of shareholder-friendly measures, and Teikoku Electric when management committed to paying out 100% of earnings to shareholders and announced a 4.3% share buyback, the second in the space of nine months.

Our public engagement was limited to four companies, which were continuations of prior campaigns. We submitted shareholder proposals to NS Solutions, SK Kaken and Tokyo Radiator for the second year in a row, ranging from seeking higher shareholder returns to greater board independence. While all companies have controlling shareholders, we received good support from minority shareholders. The fourth was Fujitec, where at the end of June 2022 we released a public statement questioning whether Fujitec's independent directors were acting in the best interests of shareholders. This followed Fujitec's decision to retain the then President as Chairman, despite his appointment not having been approved by shareholders at the AGM.

There are a number of exciting engagement campaigns developing amongst portfolio companies. We intend to keep these discussions private and will only pursue them in the public domain when our progress stalls and management fail to accept our suggestions. Our lack of public activity this year is evidence of the successes we are having privately and we hope that this continues next year.

Portfolio Trading

Buying activity

Almost half of all purchases over the year were concentrated in two new positions: TSI Holdings and Nihon Kohden. TSI Holdings owns a collection of diversified apparel brands, with an attractive investment opportunity from a more shareholder-friendly management team, upside from managing the brands more efficiently and a bloated balance sheet, where net cash, investment securities and real estate account for 176% of TSI's market cap. We believe there is +150% upside to our fair value.

Nihon Kohden is a medical equipment manufacturer, with a product line-up across patient monitors, defibrillators and ventilators. Net cash accounts for 28% of its market cap, trading on a 9.3x EV/EBIT multiple vs medical equipment peers on 15.3x. Aside from the undervaluation, we believe the company is underearning, with margins below peer average. We have identified several improvement measures aimed at doubling the share price, something the President agreed was achievable during a meeting.

We added to positions in Shin-Etsu Polymer (a potential takeover target by its parent company Shin-Etsu Chemical), NC Holdings (where across our funds at year-end, we held 21% of the votes), Konishi (open shareholder register and trading on only a 4.0x EV/EBIT multiple), Wacom (on share price weakness), and we continued building our position in LOCONDO.

Selling activity

In the four years since launching AVI Japan Opportunity Trust, we have built up experience engaging with the management of our portfolio companies. Having gone through three AGMs and holding numerous meetings, this was a year to reflect on whether continued engagement at some companies was the best use of our resources. Our frustration with a handful of companies tended to coincide with companies where there was a high ratio of allegiant shareholders. We sold positions in Kato Sangyo, Daiwa Industries, King Co, Kanaden and Sekisui Jushi. The average % ownership of allegiant shareholders at our companies which are not  subsidiaries of parent companies fell from 27% to 21% over the year.

The largest sale was Daibiru, which was subject to a takeover bid by its parent company in 2021, followed by C Uyemura, where we took profits surrounding concerns over a potential semiconductor slowdown and following an +84% return on our investment. Other selling was modest; trimming a few positions on valuation strength to fund purchases of new positions.

Contributors

DTS Corp

Contribution (GBP)	1.4%
% of net assets	8.0%
EV/EBIT	6.9x
NFV/Market Cap	44%

DTS, an IT system developer, was the largest contributor to returns with a +22% share price increase, adding 140bps to performance.

We first invested in DTS in January 2020 premised on the appealing backdrop for increased IT development demand and management's openness to engaging with us on how to rectify the undervaluation. Across all AVI funds, we built a 10% ownership stake, becoming the largest shareholder. Since then, we have sent 12 presentations and letters to management covering corporate governance, employee remuneration, balance sheet efficiency and its growth strategy.

In May 2022 DTS responded to our suggestions and announced a new mid-term plan that included a raft of shareholder-friendly policies. Beyond higher shareholder returns which could see up to 35% of the market cap returned to shareholders in the next three years, DTS announced a strategy to double EBITDA by 2030, increase ROE to 16% and focus on high-value-added IT services.

We have been working closely with management and the board behind the scenes on the mid-term plan, holding multiple meetings, including face-to-face discussions in Japan. DTS' response to our engagement has been exemplary - they allowed us frequent dialogue with senior board members and, aside from a few minor points, actioned all our suggestions. The positive share price performance, and significant outperformance vs the market is, we believe, a testament to our efforts and clearly demonstrates the real value of AVI's constructive activism - something that we hope will not have gone unnoticed by our other investee companies, as well as other investors in the Japanese markets.

DTS' share price sold off towards the end of the year, ending on an EV/EBIT multiple of 6.9x vs peers' 13.5x. There remains considerable upside and, as the largest shareholder, we will continue engaging with management to achieve a higher share price.

Fujitec Co Ltd

Contribution (GBP)	1.3%
% of net assets	5.8%
EV/EBIT	18.3x
NFV/Market Cap	33%

Fujitec, the elevator and escalator company, was the second largest contributor over the period, adding 126 bps to performance as its share price increased +22%. The share price rise was driven by an increase in Fujitec's EV/EBIT multiple from 8.6x to 18.3x.

It was a busy period for our engagement work, which followed on from our public campaign in May 2020. At the end of 2021, Fujitec announced a mid-term plan which we felt was strategically misguided, with confusing growth plans and an unjustifiable capital allocation plan towards M&A. We responded by sending a presentation to the company, showcasing the plan's flaws, putting forward solutions and, importantly, threatening to take our grievances public. To our delight, management responded to all eight of our recommendations and released a supplementary plan at the start of March 2022.

Then in May 2022 Oasis, a Hong Kong-based activist investor, launched a campaign calling for shareholders to vote against the reappointment of President Takakazu Uchiyama, son of Fujitec's founder. Oasis highlighted several related-party transactions dating back to 1989, and as recently as 2021, alleging that Mr Uchiyama has enriched himself at the expense of shareholders.

Fujitec's response was troubling. Instead of admitting wrongdoing and strengthening corporate governance, Fujitec embarked on a campaign of denial and obfuscation. Fujitec's response omitted important details, the law firm appointed to investigate the transactions was not independent and the board, amazingly and despite ostensibly being 50% independent, unequivocally concluded that not one of the related-party transactions posed a problem for corporate governance.

When the AGM came around in June 2022, the motion to reappoint Mr Uchiyama as President was withdrawn just one hour before, in what we believe was an effort to conceal his low level of support. Then shortly after the AGM, Mr Uchiyama was reappointed as Chairman without the approval of the shareholders. Fujitec's disregard for shareholder rights and circumnavigation of the AGM voting process was astounding. We released a public statement to that effect, questioning whether Fujitec's outside directors were representing shareholders' best interests.

After our public letter, Oasis continued their campaign and in November 2022 called an Extraordinary General Meeting ("EGM") seeking to replace all of Fujitec's outside directors. The objective is to bring new elevator industry experience, reform the governance structure and, ultimately, unlock trapped value. Given the disgruntled shareholder base, we expect that the vote will be close and put the board in an untenable position where nearly half of the shareholder base does not support their appointment. We hope that the EGM will draw a line in the sand and with an improved board allow the company to focus on growing its business.

Since we established a position in 2018, we have achieved an +89% return. While the valuation is not as compelling as it was when we initiated the position, there is a higher probability that Fujitec could be subject to a takeover bid from a long list of potential suitors.

Teikoku Electric MFG Co Ltd

Contribution (GBP)	1.2%
% of net assets	0.5%
EV/EBIT	7.0x
NFV/Market Cap	39%

Despite a short holding period of just over a year, our investment in the pump manufacturer Teikoku Electric has been a resounding success, achieving a +51% return, with management responding positively to our engagement efforts. We identified Teikoku Electric as a company with an overcapitalised balance sheet, a good globally recognised product and a presence of several engagement funds on the register.

Shortly after we acquired a position, we sent a 51-slide presentation to management with a particular focus on exiting a loss-making non-core business and addressing the inefficient balance sheet. Since commencing our dialogue, management's openness to considering a sale of their non-core business has improved and they have taken aggressive steps towards rightsizing the balance sheet. After committing to paying out 100% of earnings at the start of the year, Teikoku Electric announced a buyback of 4.3% of its shares and a 110% increase in the dividend. The buyback came shortly after another 4.2% buyback, meaning in just under a year and a half Teikoku Electric will have bought back 8.5% of its shares while paying a 4.9% dividend yield.

Naturally, the more accommodating attitude towards shareholders, coupled with a +52% upgrade to full-year profit guidance, buoyed the share price. Although the EV/EBIT of 7.2x is below that of peers, the sustainability of the earnings strength is a concern, and we decided to trim our position. Teikoku Electric is still on our watchlist and, should the share price weaken, we might look to rebuild the position.

NC Holdings

Contribution (GBP)	1.0%
% of net assets	6.7%
EV/EBIT	7.4x
NFV/Market Cap	42%

We started investing in NC Holdings ("NCHD") in June 2021 following an acrimonious public dispute between NCHD and its then-largest shareholder TCS. NCHD owns a collection of businesses, including solar panel consulting, conveyor belts and, the most attractive, car parking systems. Collectively, they trade on an EV/EBIT multiple of just 7.4x, with net cash and investment securities covering 42% of the market cap.

After TCS failed to replace NCHD's board, NCHD repurchased their shares (c.32% of outstanding) at ¥900, a hugely accretive acquisition with the shares closing the year at ¥2,073. With growing confidence in the quality of NCHD's business, the presence of a US-based investor on the shareholder register and a compelling valuation, we have been slowly increasing our position. Over the year we almost doubled our ownership and, at the end of the quarter, we owned 21% of the company across AVI's funds. We note the US investor has also been increasing their ownership and now holds 25% of NCHD's shares.

Our engagement agenda has covered a wide variety of topics, from reviewing NCHD's conglomerate structure to improving corporate governance and adopting a more generous 100% total return pay-out ratio.

NCHD does not disclose a policy on shareholder returns and, excluding the repurchase of shares from TCS, has only paid out about 20% of its net income over the past three years. A 100% dividend pay-out ratio on next year's earnings would amount to a respectable 4.5% dividend yield. So far in our engagement we have not heard a convincing response from management as to why the three assets it owns should be held under the same corporate structure.

We believe if management act on all our suggestions, then the share price would be able to reach our target price of ¥2,700-¥3,000, or 30%-45% higher.

Detractors

Wacom Co Ltd

Contribution (GBP)	-3.5%
% of net assets	6.6%
EV/EBIT	9.4x
NFV/Market Cap	24%

The largest detractor over the year was Wacom, who saw its share price decline -35%. Starting the year with a 8.3% weight and being the largest position, the decline had a meaningful impact, detracting 346bps from performance. Wacom is the global leader in digital pen solutions and our investment was premised on the increased adoption of digital drawing and writing. Wacom manufactures both its own branded tablets and sells its technology to other electronic device manufacturers. For example, the S22 Ultra smartphone which launched at the start of 2022 has an embedded Wacom pen.

While we continue to believe that digital writing solutions will see strong growth over the long term, inflationary cost pressures and diminished consumer spending power have weighed on short-term profits. Encouragingly, Wacom's B2B business has been resilient with a growing customer base and higher adoption of digital pens, but the consumer business has suffered from a demand-led slowdown. In October 2022, Wacom released a profit warning revising down its full-year sales and profit guidance by -11% and -56% respectively. We have been a little disappointed in Wacom's investor communications surrounding the profit decline, with comments shortly before the profit warning now appearing naively optimistic, and poor planning to control gross margins and Selling, General and Administrative ("SG&A") expenses. We sent a letter during November 2022 outlining seven actions we think management can take to aid the situation. We recognise that the consumer environment is out of management's control, but there are several self-help measures that we would like to see implemented.

Our conviction in Wacom's technology and long-term growth potential is unchanged, and the market's myopic focus presents an opportunity to take advantage of the share price dislocation. Using normalised earnings, Wacom trades on an EV/EBIT multiple of only 5.3x, a remarkably low valuation considering Wacom's technology and structural growth tailwinds from the increased adoption of digital writing solutions.

We increased our holding in Wacom by 24% over the year, adding to our position on share price weakness. As a top three shareholder, we are working closely with management to address the underperformance and ensure that efforts are being made to maximise shareholder value. With a return to normalised profits, our estimated potential upside to the current share price is in the order of +100%.

Pasona Group Inc

Contribution (GBP)	-2.9%
% of net assets	3.8%
EV/EBIT	<0.0x
NFV/Market Cap	203%

Pasona was a large detractor, reducing returns by 294 bps to performance. The shares returned -43% over the period, driven by a -60% decline in Benefit One's share. Pasona is one of Japan's largest recruitment and outsourcing companies, mainly operating through three business segments: HR, Life, and Public Solutions. Pasona owns a 50% stake in Benefit One, which accounts for 202% of Pasona's market cap. Benefit One is a market leader in providing outsourced HR services, from education and training to healthcare and employee benefit options.

Benefit One's -60% fall was less driven by fundamentals but more by general market concerns over higher valued companies. Benefit One's share price strongly correlated with the MSCI Japan Growth Index which fell -16% over the year vs a smaller fall of -4% for the MSCI Japan. While Pasona traded on a large discount, Benefit One's valuation was on the richer side at the end of last year. We reduced our position by -30% ahead of the fall, but did not manage to exit entirely.

Pasona is making a greater effort this year to help realise the value in its business portfolio. Over the year, it IPO'd Circlace, a 43% owned digital experience consulting firm and Bewith, a business process outsourcing company. It is encouraging to see Pasona's newfound proactivity, and we expect that as the transparency of Pasona's businesses improves and the company continues to grow earnings, we will see a narrowing of the discount to its valuation.

Benefit One has 11.3m captive members on its platform, about 19% of the 60m employed workers in Japan, providing stable cash flows and an opportunity to sell additional services. With Pasona's 69% discount coupled with a more appealing Benefit One valuation, we see upside to Pasona's knocked down share price.

Teikoku Sen-i

Contribution (GBP)	-1.2%
% of net assets	2.1%
EV/EBIT	1.2x
NFV/Market Cap	85%

Teikoku Sen-I's share price fell -33%, reducing returns by 117bps. Teikoku Sen-I is the leading manufacturer and distributor of disaster prevention equipment in Japan, from fire hoses to airport firefighting trucks. Geographically speaking, Japan is precariously placed and each year suffers from typhoons, earthquakes, and flooding. The Government of Japan is devoting significant resources to disaster prevention infrastructure as have private companies (particularly nuclear power operators).

Teikoku Sen-I is well placed to benefit from this trend and has a fantastic track record of diversifying into new business lines. However, the market has difficulty understanding Teikoku Sen-I's business model as its earnings are extremely seasonal, with over 100% of profits coming in the first and last quarter of the calendar year. It means that investors must wait until the last quarter to get a good handle on the financial situation and, during the year, less sophisticated investors tend to extrapolate the weak Q2 and Q3 earnings.

As usual, profits were low in Q2 and Q3, but grew by +24% in Q1 and we are encouraged by the overall positive trend for Teikoku Sen-I's fiscal year so far. All the weakness over the period therefore came from a fall in the valuation, from an already low EV/EBIT of 4.2x at the start of the year, to a remarkable 1.1x.

We have been gradually reducing our position in Teikoku Sen-I, and trimmed it by a further 10% in 2022. Teikoku Sen-I's business outlook is good and clearly undervalued, trading on a 1.1x EV/EBIT, but the shareholder register is littered with companies that are allegiant to management, frustrating our engagement efforts. As we expect continued earnings growth, we are in no rush to exit the position. Still, we are unlikely to allocate further to the investment and it could be used as a source of capital for higher conviction ideas.

LOCONDO

Contribution (GBP)	-0.8%
% of net assets	4.2%
EV/EBIT	10.0x
NFV/Market Cap	29%

LOCONDO is a relatively new position in the portfolio. It runs a fashion e-commerce platform in Japan, which was launched to provide shoe manufacturers a venue to sell online. Importantly, it does not own the inventory of each brand, it simply matches buyers and sellers, then manages the logistics - storage, delivery and returns. This asset light business model is hugely appealing, and its larger peer, ZOZO, trades on an EV/Sales of 5.4x vs LOCONDO's 0.9x.

We were also attracted to LOCONDO's growth potential, with Japan's fashion ecommerce penetration currently standing at only 19% but estimated to grow to 41% by 2030. LOCONDO is aiming to have a 3% market share by 2030 which implies a nine year compound annual growth rate of +19%. After a -73% decline in the share price from its peak in September 2020, we are able to own this fantastic business on an EV/EBIT of just 9.7x and with net cash covering 29% of its market cap. While the EV/EBIT multiple is higher than the average company in AJOT's portfolio, this is more than compensated by its stronger growth prospects, and this is not factored into the share price.

During the year, LOCONDO announced that it had gained the rights to manage the Reebok brand in Japan, owning 66% alongside ITOCHU's 33%. The brand has been poorly managed, owned by Adidas and deprioritised for fear of cannibalising Adidas' sales. Reebok should be hugely accretive for LOCONDO, who only paid for the inventory (at a highly reasonable price) and is a large contributing factor behind management's confidence in growing profits by +75% next year.

We have built a near 10% stake in LOCONDO, making us the largest shareholder. We do not believe that the current share price reflects LOCONDO's intrinsic value and will be working with management on ways to rectify the undervaluation.

Outlook

The performance of our portfolio in the wider context of weak global markets is encouraging and shows that fundamentals and valuations do matter. The MSCI Japan Small Cap's return of -1.0% (in GBP) for 2022 against steep declines in other indices proves Japan's diversification value.

We are optimistic about the macro environment in Japan. The weak Yen makes Japan highly cost-competitive, both for tourism and manufacturing. Inflation has returned after a 40-year absence and, with wage growth and increased spending, we could see a more rational allocation of capital and improved productivity, which would bode well for your portfolio companies.

It is challenging to predict how 2023 will unfold, but we remain convinced that valuations are important. Your Company's portfolio trades at a lowly 6.0x EV/EBIT and is positioned for several potential idiosyncratic events with upsides of 50-100%. The potential for a reversal of foreign outflows, a stronger undervalued Yen, and a robust economic environment in the coming years, gives us reason to be optimistic about the potential for attractive absolute returns for our Company's portfolio.

Joe Bauernfreund

Asset Value Investors Limited

15 March 2023

PORTFOLIO CONSTRUCTION

The objective of AVI's portfolio construction is to create a concentrated position in about 20-30 holdings, facilitating a clear monitoring process of the entire portfolio.

AVI picks stocks that meet our investment criteria and once we decide to invest, a minimum position size of approximately 2% of the portfolio is initiated. In determining position sizes, AVI is mindful of liquidity and the likely timing of any catalysts to unlock value. A key consideration is the make-up of the shareholder register, a proxy for how receptive management might be to our suggestions. The portfolio is diverse in the industries within it, but we are sector agnostic and select investments based on quality and value.

Portfolio value by sector

	2022	2021
Materials	29%	28%
Capital Goods	19%	24%
Software and Services	18%	18%
Health Care Equipment and Services	7%	0%
Technology Hardware and Equipment	6%	8%
Consumer Durables and Apparel	6%	0%
Retailing	5%	7%
Automobiles and Components	4%	4%
Commercial and Professional Services	4%	5%
Transportation	2%	2%
Food and Staples Retailing	0%	4%

Equity portfolio value by market capitalisation

	2022	2021
<£250mn	26%	14%
£250mn - £500mn	15%	14%
£500mn - £750mn	19%	27%
£750mn - £1bn	17%	20%
£1bn - £2.5bn	23%	23%
>£2.5bn	0%	2%

INVESTMENT PORTFOLIO
At 31 December 2022
Company	Stock Exchange Identifier	% of  AJOT  net assets	% of investee company	Cost  £'000*	Market  value  £'000	NFV/Market  Capitalisation1	EV/EBIT1
DTS	TSE: 9682	8.0%	1.4	10,939	12,568	44%	6.9
Nihon Kohden	TSE: 6849	7.5%	0.7	11,274	11,660	29%	9.3
Konishi	TSE: 4956	7.0%	2.5	11,055	10,986	73%	4.0
NC Holdings	TSE: 6236	6.7%	17.1	7,842	10,405	42%	7.4
Wacom	TSE: 6727	6.6%	1.7	13,911	10,352	24%	9.4
T Hasegawa	TSE: 4958	6.6%	1.3	8,275	10,295	29%	9.8
Shin Etsu Polymer	TSE: 7970	6.5%	1.7	10,055	10,166	56%	3.5
TSI Holdings	TSE: 3608	6.1%	3.6	8,733	9,545	133%	<0.0
Fujitec	TSE: 6406	5.8%	0.6	5,309	9,104	33%	18.3
Digital Garage	TSE: 4819	5.6%	0.6	7,427	8,833	81%	7.2
Top ten investments		66.4%		94,820	103,914
NS Solutions	TSE: 2327	5.1%	0.4	8,649	8,019	47%	5.1
SK Kaken	TSE: 4628	4.8%	0.9	9,444	7,413	96%	1.3
Locondo	TSE: 3558	4.2%	8.5	8,213	6,603	29%	9.7
Pasona	TSE: 2168	3.8%	1.2	5,112	5,888	198%	<0.0
A-One Seimitsu	TSE: 6156	3.2%	8.0	4,571	4,977	86%	4.3
Toagosei	TSE: 4045	3.0%	0.6	5,753	4,741	56%	3.8
C Uyemura	TSE: 4966	2.9%	0.6	2,971	4,571	51%	3.9
Alps Logistics	TSE: 9055	2.4%	1.4	2,989	3,680	46%	3.6
Teikoku Sen-i	TSE: 3302	2.1%	1.3	5,580	3,334	85%	1.1
Tokyo Radiator MFG	TSE: 7235	2.0%	4.9	4,250	3,075	92%	0.0
Top twenty investments		99.9%		152,352	156,215
Soft99	TSE: 4464	1.9%	1.9	2,811	2,954	100%	<0.0
Aichi	TSE: 6345	1.8%	0.8	2,789	2,803	77%	2.0
Papyless	TSE: 3641	1.0%	2.5	2,141	1,543	18%	<0.0
Teikoku Electric MFG	TSE: 6333	0.5%	0.3	468	743	39%	7.0
ITFOR	TSE: 4743	0.0%	0.1	62	65	49%	2.4
Total investments		105.1%		160,623	164,323
Other net assets and liabilities		(5.1%)			(7,928)
Net assets		100.0%			156,395
* Please refer to Glossary in the Annual Report.
1 Estimates provided by AVI. For all Alternative Performance Measures, please refer to the definitions in the Glossary in the Annual Report.

LEI: 894500IJ5QQD7FPT3J73

FURTHER INFORMATION

AVI Japan Opportunity Trust Plc's annual report and accounts for the year ended 31 December 2022 and the notice of meeting for the Company's AGM will be available today on www.ajot.co.uk .

It will also be submitted shortly in full unedited text to the Financial Conduct Authority's National Storage Mechanism and will be available for inspection at https://data.fca.org.uk/#/nsm/nationalstoragemechanism in accordance with DTR 6.3.5(1A) of the Financial Conduct Authority's Disclosure Guidance and Transparency Rules.

Neither the contents of the Company's website nor the contents of any website accessible from hyperlinks on the Company's website (or any other website) is incorporated into, or forms part of this announcement.

 

END

 

 

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