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September 30, 2003

Hedgies for the Pros

By Kathryn M.Welling

The really high-quality restructuring stories like Nissan, we've had in the portfolio since we started Avera. And in those stocks, a lot of U.S.-based investors have kept us company. Where we are going now, though, is definitely a road less traveled in Japan. The thing that has encouraged me the most - there's a monthly data series, going back to 1971, that we pull called "average monthly total cash earnings, all industries," whose name doesn't do it justice. What it represents is Japan's household earnings from all sources, including wages and bonuses. The last data point we have is June, but the line on one chart has not only turned up, it has risen to its highest level since 1997, which puts year-over-year growth back into positive territory for the first time since 2000. In fact, it has reached pre-Asia crisis levels. If incomes are a precursor to spending, this is a good sign. For now, we only have a small position in the retailers. But when we get back from Japan in a month, it may turn out to be a very big position.

Which Japanese retailers tempt you most?

At the company level, we would like to see earnings beating expectations. On that score, a few stocks look to be in the very early stages of a recovery. You can already see analysts' consensus expectations starting to rise a little bit. So we are looking for information that says business is good, we are on track to meet our numbers, and here is why. In one case, the upturn is going to be all about digital electronics, flat panel TVs, as well as competitors going out of business in what has been a very tough environment.

Which company is that?

Yamada Denki. It's sort of the Best Buy of Japan. Yamada Denki is benefiting from market share increases. In August many of their competitors had negative same-stores sales growth, year-over-year. But Yamada Denki miraculously pulled out a positive same stores sales growth number. All the more impressive because the weather was lousy.

How does Yamada Denki's valuation stack up?

Here's a stock that trades at 15 times earning when the whole group is at around 21. It is trading at a big 0.4 enterprise value to sales ratio, which could double from here and just get back to its five-year average. This company has great margins. It's a real company with double-digit sales and EPS growth. It sells real things, all over Japan. Its five-year average return on capital, at 16 percent, is higher than the North American average. And when you consider the cost of capital is 1.5 percent in Japan, that makes for very strong economic value-added.

How about another example?