Ice cream without Kono
Frozen, disappointed, dejected. This is the state of mind of us, the market and the majority of voters in the LDP, Japan’s largest party, following the defeat of Tano Kono in the fight for the premiership in Japan. 
Once again, the conservatism and gerontocracy of Japanese politics has won out over the renewal Japan needs. Given the depressed valuations of the Japanese market and the global trend of investment in physical infrastructure where the country excels, investors needed only hope of political renewal and structural reform to set off a violent and lasting up-trend for this forgotten market. This was unfortunately not the case.
The LDP party has had a Bulgarian majority for decades, which prevents political renewal. This is based on: a) an electoral system heavily weighted towards the dry single-electoral system, which gives more power to the majority and dilutes the minorities; b) a distribution of representation for the election of members of parliament (here called the Diet) that is heavily skewed towards rural areas, which historically are allergic to change and support the LDP; c) a very strong presence of the LDP marketing machine in local constituencies, which allows it to overwhelmingly win the single-electoral elections. 
This has led to a country with a populist, hyper-conservative right wing incapable of innovation. Herein lies part of the reason for Japan’s social and economic stagnation, its public debt, a state of renunciation of change (only about 50% of the population vote and less than 10% of the MPs in the Diet are women). In any normal state, a party that after almost 70 years of undisputed majority rule had achieved these results would be dead and buried. Not in Japan.
However, we cannot fail to see positive elements in this apparently only negative news:
1) Kono represented, within the LDP, the instance of renewal of ordinary people, in particular young people, and his defeat can only further alienate voters from the old politics, now represented by the LDP. A good reference that is certainly clear to older Italians to describe the LDP is the Christian Democrats. In November, general elections could jeopardise the LDP’s broad hegemony, which has lasted almost uninterruptedly since 1955. It remains a remote option, but not impossible.
2) It follows from the previous point that Kishida, the new PM, and the LDP as a whole, will trip over themselves to try to give the perception of renewal demanded by the people. From here something positive may come.
3) This negative demarche cannot fail to slow down somewhat the necessary and inevitable recovery of Japanese equities. This will give time to those who do not already have them in their own or their clients’ portfolios to possibly investigate the investment case and make the necessary changes in their asset allocations by adding or increasing this asset class.
Frogs and GIIRs
Once the frogs have laid their eggs, they tend to disregard the future of their offspring and happily croak with their peers. Some frogs, however, such as the bush frog, defend their eggs until they hatch, fighting to the death to protect them. 
Once the eggs have hatched, however, all tadpoles can only rely on their own strength. A small part will become frogs while the rest will be preyed upon by the other inhabitants of the pond.
In the corporate world, family ties are more respected and the fate of subsidiaries or investees is certainly given careful attention. This gives companies with illustrious births an extra layer of protection and therefore, ultimately, less risk. Despite this, investors sometimes seem to disregard this feature and do not include the lower risk associated with these companies in their valuation.
GIIR is a holding company of two medium-sized advertising agencies (turnover of around USD 400 million). It is therefore a small Publicis, Omnicom or WPP, for those who understand the industry. 
The company is 35% owned by LG Corp, the South Korean chaebol active in various sectors from consumer electronics to perfumes, telephone services and batteries for EVs. As well as managing other illustrious clients, GIIR is responsible for some of the LG group’s advertising. This gives it a certain continuity of turnover. From this we could infer that GIIR can count on valuations that are higher or at least similar to those, not demanding, of the big agencies mentioned above. Thus an EV/EBITDA of about 8 times. Nothing could be more wrong! GIIR has a negative EV because the net cash in the portfolio is higher than the company’s market capitalisation! The price/earnings ratio was about 10x in 2020, a particularly bad year, as we know, for advertising agencies, and would be 5x on the earnings of the year before. Evidently for the GIIR market, like the tadpole, it inexplicably remains a creature of high survival risk…
Commodities, joys and sorrows
Investing in equities exposed to commodities requires macro vision, technical knowledge, nose, luck and … stomach. The diabolical operating leverage of these companies, combined with the cyclical nature of the underlying price, leaves them exposed to enormous volatility which, in turn, attracts traders and speculators who add even more.
How does a value investor invest in commodities? Or at least how do we invest in the sector? We tend to find a commodity interesting when the average extraction and/or production price approaches the price at which it is traded on the market. This gradually leads to the bankruptcy/reduction of production/closure of players with the highest extraction/production costs who can no longer make a profit by selling the raw material. The resulting reduction in supply of the raw material causes the price to rebound and the survivors make good money. It therefore seems wise to stay with the most solid and the most diversified.
However, a caveat is in order. It is important to have an idea of the medium/long-term prospects of the raw material. You don’t have to be a genius to understand that the prospects for copper or coal are different. Therefore when one buys on weakness of the raw material a Stock exposed to it, it is important to have a presumable range of development of demand-supply in the successive years and to construct a tactic of management of the investment around it. Clearly, if the demand trend for the raw material is downward, the weakness may persist for a long time, sometimes too long.
At the same time there may be cases where we invest despite the fact that the market price of the raw material is well above the cost of production. This happens if we firmly believe that there will be bottlenecks between supply and demand, which will push up the price of the raw material. It is crucial, however, to have vehicles, i.e. mining companies, that do not already discount this scenario. If this was the case for lithium producers a year ago, we believe it is still the case for several nickel producers.
Very simply, nickel is divided into ferronickel and nickel sulphate. The former is mainly found in Asia, Canada and South America. The latter is found in Australia and Russia. The former is mainly used to produce stainless steel. The latter is mainly used to coat other metals (coating) and, in the future, will mainly be used to produce the cathodes of batteries for electric vehicles. However, ferronickel can be transformed into nickel sulphate through complex chemical processes (HPAL).
To meet the demand for auto electricity will require a lot of nickel sulphate in the future and it seems to us that, although the price of nickel is slowly rising, the market remains lukewarm about the possibility of a real bottleneck (much more demand than supply) in nickel. This stems from several factors:
1) The recent success of LFP batteries in China has many worried. These batteries, unlike the more powerful NCM/NCA, do not contain nickel. However, NCMs have more room for technical improvement. It is very likely that the two technologies will co-exist.
2) The market has memory. China emerged a few years ago with a technology to cost-effectively process nickel at very low concentration (NIP). This caused the price of nickel to plummet.
3) A phase of significant economic weakness (which we do not see, but which the market is beginning to fear) would lead to a significant drop in demand for stainless steel, weakening the price of nickel for a while regardless of the powerful trend in electric vehicles.
In our view, what the market is still struggling to take fully into account is the speed of EV penetration. The next 12 to 18 months will spell the end of the internal combustion engine and see a likely bottleneck for batteries. This, coupled with the still modest price of nickel, gives us some peace of mind.
How to expose yourself to nickel? It is still possible to build a diversified portfolio of mining stocks that do not incorporate any reserve premium into the portfolio. We indicate here a company exposed to nickel that has certain characteristics that are important to us: a) diversified; b) solid; c) cheap.
The company is Sumitomo Metal&Mining:
(a) Diversified. The company has three divisions. One related to metal mining, where nickel, copper and gold are the main players. Another linked to metal refining. Here, among other things, the company is a leader in the aforementioned transformation of ferronickel into nickel sulphate using the HPAL (High Pressure Acid Leaching) technology that it invented. At current prices, the process is very profitable and allows flexibility in the use of the raw material (stainless steel if kept as ferronickel or batteries if transformed into nickel sulphate). The third, perhaps the most attractive and least volatile, produces the materials (precursors) for battery cathodes as well as a range of materials for semiconductors and electronics.
(b) Solid. The company has cash and liquid investments of around USD 2bn net of debt, i.e. 20% of capitalisation. In the last twenty years it has always been free cash flow positive (cash generated after considering investments and before dividends) except for three years when it was practically at breakeven.
(c) Cheap. The company trades at just over 7x earnings and on earnings in a terrible year like 2020 trades at less than 14x. The company has a market capitalisation of about 0.8x tangible equity. Thirty-five years ago the company had the same capitalisation, but with 85% lower equity and profits 1/5 of what they are today. This reflects a stock market – the Japanese one – that has dramatically gone from boasting a significant premium over the global market to offering a significant discount over the latter.
The recent reversal of the share price makes it possible to increase exposure to nickel and copper through a share with a very strong valuation support and a lower risk than many of its peers, thus removing at least part of the anxieties linked to a sector, as already mentioned, full of joy but also of terrible pain.
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