Can automation boost Japan’s economic outlook?

 September 2023
 

Japan’s economic growth has captured attention recently, but the Walter Scott Investment team says the country has long been the home to industry leaders. Here they highlight several leading companies poised for long-term growth.

Highlights

• A shrinking labor force and rising inflation are causing more companies to turn to automation – an area where Japan leads
• Electric vehicle (EV) battery demand is higher than current supply levels – and this market is expected to grow

‘Buy Japan’ has emerged as something of a market refrain in recent months. The re-emergence of inflation after a decades long-struggle with stagnant prices, alongside some impressive GDP numbers (up 6% in the second quarter of 2023¹) and government attempts to improve corporate governance have raised hopes that the Japanese economy and its stock market may be on the brink of a renaissance.

While we welcome this renewed enthusiasm, over the many decades we’ve been investing in Japan our perspective on investment opportunities has never been defined by the nature of the economic backdrop. Had it been, we might not have found much cause for optimism given the ‘lost decades’ that followed the bursting of the country’s epic asset bubble in the early 1990s. Rather, we’ve always considered opportunity at the company level, understanding that a lack of economic vigor is often no barrier to corporate excellence. Viewed through this lens, Japan has always been and continues to be a fertile hunting ground for investors in search of high-quality, market-leading companies.

No problem looms as large for Japan as demographics. More elderly people and a declining working-age population are not a recipe for economic dynamism. And while the country is not alone in facing this demographic challenge, nowhere is it more acutely felt. But a shrinking labor force is leading more and more companies across multiple industries to turn to automation, an area in which Japan is the acknowledged global leader. If people are in short supply, bring in the robots!

Shaping the global economy 

We believe nobody encapsulates Japan’s talent for automation more than Fanuc, the world’s leading manufacturer of computerized numerical controls and industrial robotics. A relentless innovator since its founding in the 1950s, Fanuc has faced challenges in recent years with trade wars, Covid-19 and supply chain disruption, but a visit to the company’s demonstration center in the shadow of Mount Fuji leaves one in little doubt about its technical prowess. This is a business entirely focused on helping other companies do more with less and to do it more efficiently. No surprise that tight labor markets and rising inflation globally will likely lead more and more companies to invest in automation.

Robot demand is also getting a significant boost from the transition to electric vehicles (EV). Whereas internal combustion engine manufacturing is largely a manual process, EV batteries make much greater use of robots of all sizes. Indeed, supply is unable to keep up with demand at present, given the scale of investment by EV manufacturers. Enjoying long-standing relationships with the established automakers, Fanuc is in a very strong competitive position.

EV batteries are also driving long-term growth at SMC Corporation, which makes factory automation-related pneumatic products. Inexpensive, compact and environmentally friendly, pneumatic instruments enable automation in industries as diverse as semiconductors, autos, pharmaceuticals and food. With a long-held reputation for quality and reliability, SMC is the acknowledged global leader, with a market share close to 40% ² and an unrivalled product range.

SMC expects the EV battery market to grow rapidly over the next three years, particularly in China and South Korea. As the shift to EVs gathers pace in other regions of the world, most notably the US and Europe, SMC also stands to benefit.

Helping to tackle another challenge is Daikin Industries, the world’s leading manufacturer of air-conditioning (AC) systems. With much of the northern hemisphere enduring another hot summer, populations are unsurprisingly turning to air conditioning to help combat the stifling heat. Daikin produces highly energy-efficient systems using R32, a refrigerant developed in-house that has become the industry standard due to its low global warming potential. An even more environmentally-friendly refrigerant is expected to be rolled out commercially in the coming years. 

While Daikin's lead in energy efficiency and environmental technology already stands the company in very good stead in the traditional AC space, the business is leveraging its impressive R&D capabilities to grow its share of the heat pump market. As Europe looks to mitigate its climate impact by banning combustion boilers in 2030, heat pumps are viewed by many as the logical alternative. With a strategy in place to gain first-mover advantage as a pan-European installation and servicing operation, Daikin is confident of capturing a significant share of this sizeable opportunity.

As demonstrated by Daikin, SMC and Fanuc, many of the best Japanese companies are in the vanguard of long-term structural trends that are shaping the global economy. Masters at driving efficiency and productivity improvements, and with a commitment to continuous innovation, they have carved out enviable positions in industries that should support impressive growth rates for many years to come.