March 2024SPARX Japan Equity Small & Mid Cap Strategy Rising Potential of Secondhand Markets

In 2024, in addition to the US presidential election, other critical elections are scheduled in India and other major emerging countries, creating an environment where geopolitical risks are likely to increase worldwide. Political risk may also cause concerns in Japan with the upcoming LDP presidential election. However, I think that Japan's economy should continue to grow driven by the domestic demand experiencing a virtuous cycle of inflation due to rising wages. Notably, small-caps, which are primarily domestic demand and have performed poorly compared to large-caps, seem to stand out as undervalued, making the appeal of investing in stocks with earnings growth potential higher than ever. I will strive to generate performance by selecting stocks focusing on advantages from inflation, business opportunities against the backdrop of a structural human resource shortage, and renewed growth in long-avoided capital investment.

My Strategy holds some retail and service companies whose performance is driven by consumers' growing defensive awareness amid Japan's ongoing inflation. In that vein, I would like to discuss the secondhand retail industry in Japan this time.

Secondhand shops that buy and sell used goods have existed for a very long time, and their market continues to expand as the consumer market grows. In developed countries that have become mass-producing, mass-consuming societies, the consumer market continues to grow, and the amount of stored unused products is likely to increase. It is estimated that stored unwanted items in Japan is worth as much as JPY 7 trillion per annum. Given that the current secondhand market is JPY 2.7 trillion, the industry should have massive market potential. The secondhand industry is also experiencing growth factors that include the spread of flea market apps, which have popularized the buying and selling of used goods between individuals, and a growing awareness for a circular economy.

On the other hand, some secondhand stores also focus on luxury items such as watches and brand bags. This type of business has also significantly increased its performance against rising prices for brand-name goods. Nevertheless, the transition in consumer behavior from purchasing goods to purchasing services and experiences in the post-COVID normalization period, coupled with the reduced purchasing power of visitors to Japan due to the economic slowdown in China, has led to a decrease in the market for used branded goods. This shift has posed challenges for secondhand store operators in managing these items.

Under these circumstances, I focused on general secondhand stores, which mainly handle clothing, and recently added one secondhand shop operator to my portfolio. Against a backdrop of declining real incomes due to high prices, demand is rising for secondhand stores that buy and sell used goods, as they offer consumers the ability to quickly convert used goods into cash while also serving as retail outlets that provide goods at a discount. As mentioned above, the rapid uptake of used goods in daily life, due to the widespread use of flea market apps and other factors, has expanded the market of secondhand shops to bring in senior citizens who had never used them before, one possible reason for the increase in demand.

I believe that, among other things, this new portfolio company has the following three strengths: First, it is highly motivated to open new stores. The company believes the secondhand market is poised for growth and plans to accelerate store openings over the next three years to capture the growing market demand. Second, it is adept at M&A. The company has a track record of multiple mergers and acquisitions, mainly of specialty secondhand shops focused on top brand names or golf goods. Since its M&A transactions primarily target undervalued companies and are unlikely to harm profits in existing businesses, I expect its M&A will continue to play a role in non-recurring profit growth. Third, it is a capable systems developer. Thanks to its in-house systems department, the firm can develop POS, appraisal, and other core systems in-house, enabling strict inventory control. It has long emphasized the use of data as it aims to optimize inventory control by building systems that allow stores to check multiple KPIs in real time.

Despite these unique strengths and its position in an industry that promises steady growth into the future, the company has remained undervalued, making it an attractive investment.

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This content has been prepared by SPARX Asset Management Co., Ltd. (SAM) for information purpose only. Certain information contains economic trends and performance, however, SAM does not warrant the accuracy or completeness of such information, and accept no liability whatsoever for any direct or consequential loss arising from any use of this content. The views and opinions contained herein are based on then-current beliefs of the authors and are subject to change without notice. Furthermore, it should not be assumed that past performance is an indication of future results. References to specific companies are for illustrative purpose only and are not intended to be, and should not be interpreted as investment advice or, a recommendation, offer or solicitation for the purchase or sale of any financial investment.