SuMi TRUST Monthly Commentary

1. The Japanese Economic Outlook (pp. 1-2)

Consumption tax was raised to 8% on April 1st and we expect consumption to decrease in

Q2. However, with some sectors increasing their capital expenditure we expect to see a

spillover which will be beneficial to the economy as a whole as we expect the recovery in

Japan to continue.

April 2014

Cover

2. Our Company Focus: Fuji Electric (6504) (pp. 2-4)

Fuji Electric is an innovator in energy technology and is a leader in the manufacture of

inverters and power semiconductors. Their products are widely used in air conditioners,

hybrid cars, IT servers and power transformation systems. Their technology is key to

building a sustainable society not only in Japan but particularly in emerging markets where

power demand is rapidly increasing. Our analyst believes that Fuji Electric will grow further

together with the drive for further energy efficiency both in Japan and Asia.

3. The Equity Market in March (p.4)

Nikkei 225 remained unchanged from February and TOPIX rose by 0.2%. Risk assets were

sold at the beginning of March due to geopolitical risks in Crimea, however stability returned

later in the month and the Nikkei 225 recovered to the 15,200 level. After a policy meeting

on the 11th, BOJ Governor Kuroda revealed his views on the price outlook which he felt was

consistent with the BOJ’s scenario, and that there was no immediate need to implement

further stimulus. By month-end, which coincided with the Japanese fiscal year end, the

index recovered to 14,827.

Key Points

1. The Japanese Economic Outlook

We analyze the Japanese economic outlook from four dimensions as follows: 1) Consumption, 2)

Business activity, 3) Employment & Wages, and 4) the BOJ’s response. Consumption is certain to drop

in Q2, however, capital expenditure has been on the increase in the auto and services sectors, and we

expect to see a spillover effect to other sectors. Companies are also dealing with a labor shortages and

rising wages and thus we see continued recovery in Japan.

1) Consumption

a) A Dip in Q2

Prior to the consumption tax hike we saw a last minute increase in demand in March and expect a dip

post-hike, especially in autos and housing. The last time the consumption tax was raised in 1997,

private consumption dropped by 13.2% (QoQ, annualized, see Figure 1) in Q2. We expect a similar dip

this time but not worse, and anticipate a recovery in Q3. The next consumption tax hike is scheduled for

October 2015 (from 8% to 10%) which should also generate pre-hike demand.

b) Bipolarization

Consumers will be divided into two camps post-hike: a price-sensitive group and a value-conscious

group. European luxury brands have raised their prices several times in 2013 largely due to a weaker

yen, but were able to retain their customers. On the other hand, non-luxury brands lost business when it

raised prices by 10% last autumn. Consumers who are keen for value will not consume less, but those

who are price conscious will cut back spending.

2) Business activity

a) Capex is increasing

Machinery orders (private sector demand), the leading

indicator of Capex, increased by +20% YoY. According

to corporate statistics (Table 1), Capex increased by

+17.3% (autos) and +12.8% (services) in Q4 2013.

Japanese companies have held a mountain of cash

(Table 2) due to high real interest rates under a

deflationary environment. However, real rates are now

negative forcing companies to reconsider. The

government’s tax incentive (Table 3) is another tail

wind for Capex.

b) Large companies can be now expense business

entertainment

SME’s have enjoyed this benefit since 2013 and this

framework has now been extended to large companies.

We believe that entertainment expenses can stimulate

the economy. Business entertainment has shrunk to

less than JPY 3 trillion/annum in recent years, whilst it

exceeded JPY 6 trillion in 1990’s. 1

-15

-10

-5

0

5

10

Sep-96 Dec-96 Mar-97 Jun-97 Sep-97

1997

2014

2012

Oct-Dec Jan-Mar Apr-Jun Jul-Sep Oct-Dec

9,077 11,393 8,311 8,942 9,439

-8.7 -3.9 0.0 1.5 4.0

3,056 3,852 2,852 3,108 3,077

-9.6 -8.3 -9.1 -6.7 0.7

446 688 456 536 523

1.4 8.6 15.2 2.8 17.3

6,021 7,541 5,459 5,835 6,362

-8.20 -1.50 5.60 6.60 5.70

856 1,095 810 923 965

-27.4 -10.5 -3.5 3.3 12.8

（JPY bill ion、％（YoY））

2013

All Industries

MFG

Transportation

Non-MFG

Services

Table 1: Corporate Statistics, Capex

Source: MOF

Tax hike

Table 3: Tax incentive for Capex Tax Reduction

Investments for productivity 5%

Investments by SMEs 7%

Sources: Bloomberg & MOF

Source: Cabinet Office

Table 2: Cash rich Japanese companies

Figure 1: Private consumption (%, QoQ, annualized)

(JPY billion)

Company Cash

Toyota Motor 1,718

Mitsui & Co 1,425

Softbank 1,366

Mitsuibishi Corp 1,346

Honda Motor 1,206

Nippon Telegraph & Telephone 961

Sumitomo Corp 863

Marubeni Corp 849

Sony 826

Canon 789

Fanuc 728

Seven & I Holdings 711

Nissan Motor 691

Denso 665

-40

-30

-20

-10

0

10

20

30

40

50

2007 2008 2009 2010 2011 2012 2013 2014

All MFG Non-MFG Construction

Scarcity

Excess

2

3) Wages and Employment

a) Wages.

Many companies have increased wages from April.

According to the Ministry of Internal Affairs and

Communications, there have been more jobs than

seekers since last November, which potentially

generates an upward momentum in wages. A gradual

wage increase is a boom for inflation and the BOJ.

b) The Non-manufacturing sector has been hurt by

labor shortages.

The construction sector faces scarcity of carpenters

and other specialists especially in the Tohoku area.

They have had to lure carpenters and specialists from

other regions with higher pay in addition to

accommodation. Freight movement, an indicator of

economic activity, has become brisk, and some

logistics companies have been forced to decline

orders due to the shortage of truck drivers. It is also

notable that even manufacturing companies no longer

find excesses in employment.

Figure 2: BOJ Tankan (DI), Labor Shortage

Source: BOJ

4) The BOJ’s response

The BOJ seems satisfied with current price

movements. We expect the central bank to keep the

current expansionary pace. Yet, should the price

outlook turn lower, there is no doubt that the BOJ will

immediately provide another round of stimulus.

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2013/3/31 2013/6/30 2013/9/30 2013/12/31 2014/3/31

CPI All

CPI (less food)

Figure 3: CPI

Source: Ministry of Internal Affairs and Communications

2. Our Company Focus: Fuji Electric (6504)

Fuji Electric (6504) is well known for its advanced technology in inverters1 and power semiconductors2.

It shares the role of leading innovator with Mitsubishi Electric in power semiconductors and Infineon, a

German company, is another rival firm. Inverters and power semiconductors are indispensable devices

for energy efficiency. Fuji Electric is also viewed as a renewable energy provider owing to its

geothermal power generation technology.

Growth Drivers

1) Inverter: A typical example of energy conservation is the use of an inverter in air conditioners. Air

conditioners consume half the power used in most office buildings. Conventional office air conditioners

stop operating when the desired temperature is reached, and restart when the room temperature

drops/rises. This process consumes excessive energy and is wasteful, however, new air conditioners

with inverters automatically adjust their motor speed and never cease to stop. This continuous

operation is much more energy efficient than the previous stop-and-start method. Fuji Electric’s

domestic market share in inverters is 22%, second to Mitsubishi Electric. Furthermore, it operates

business in Asia, including China, where strong demand for air conditioners exists.

1) Inverter: An inverter is a power conversion equipment which can switch electricity frequency or change voltage. It is used in air conditioners, elevators, fans, trains and hybrid cars.

2) Power semiconductor: A power semiconductor controls power and enables to change voltage from 5V to 3V, or transmit AC to DC. It is used in electricity transmission systems, trains, air conditioners, IT servers, PC’s, hybrid cars and solar power generators.

-20

-10

0

10

20

30

40

50

2006 2008 2010 2012 2014

Operating profit (consolidated, JPY billion)

Source:Fuji Electric, SuMi TRUST

3

Photo 1: An air conditioner set up outside Photo 2: Power semiconductor in a hybrid car

(2) Power Semiconductors: A key device for inverters is the power semiconductor which controls power.

To develop this product for automobiles, cooling technology was essential due to engine heat. Fuji

Electric is also famous for its refrigerators and enjoy a 15% global market share, third behind Mitsubishi

Electric (29%) and Infineon (21%). The main material component of semiconductors has been silicon,

however, Fuji Electric is eager to use silicon carbide to create more energy efficiency.

(3) Coffee machines: Fuji Electric and Seven Eleven3 have co-developed a coffee machine which can

brew coffee in 40 seconds at a cost of just 100 yen to the customer. As result, there have been queues

for coffee outside the store at lunch time. Aggregated, more than 450 million cups were sold in a year

and according to our retail analyst, Seven Eleven is eager to introduce a second machine at each shop.

3) Seven Eleven: The largest convenience store chain with 16,319 shops.

Photo 3: A coffee machine Figure 4: Operating profit (JPY billion)

ESG Efforts

The mission statement of this company is to contribute to a sustainable society through innovation in

energy technology. They launched the “Fuji Electric Energy Park” in the Yamanashi region in April 2013

and launched a solar power generation business. The power conditioner, which is at the core of solar

power generation, is a new type of power semiconductor made of silicon carbide which has played a key

role in achieving the most efficient power generator in the world. It’s also worth mentioning that Fuji Electric

holds top global market share (40%) in geothermal power generation and provides turbines to New

Zealand, the US, Iceland and Indonesia. Our analysts have focused on this company from an ESG

perspective. Fuji Electric can play a key role in rebalancing power generation resources.

All photos by Fuji Electric

Photo 4: Fuji Electric Energy Park Photo 5: Power Conditioner

Company outlook

After the global financial crisis, Fuji Electric decreased costs through relocation. For example, vending

machines are now assembled in Mie prefecture and the hard disc business has been transferred to

Malaysia. Asides from cost control measures, the weaker yen contributed to profits in 2013. In 2014,

increasing demand for inverters and power semiconductors will be the main pillar for profits especially

when Japanese companies are about to increase their Capex. Also, future generations of power

semiconductors, which play a key role in hybrid cars, will be the next bread winner. Our analyst believes

that Fuji Electric which provide energy efficient devices and renewable energy will play a key role not only

in Japan but also in Asia.

3. The Japanese equity market in March

The Nikkei 225 closed virtually unchanged at 14,827

at end-March (vs. 14,841 at end-Feb) whilst TOPIX

rose by 0.2%. Risk assets were sold at the beginning

of March due to geopolitical risk in Crimea, however,

the outlook of Crimea's return to Russia brought

back stability, and the Nikkei 225 recovered the

15,200 level. After a policy meeting on the 11th, BOJ

Governor Kuroda revealed his view on the price

outlook which he felt was consistent with the BOJ’s

scenario, and that there was no immediate need to

implement further stimulus. This dampened investor

expectations and the Nikkei dropped to 14,224 by

the 20th. By month-end, which coincided with the

Japanese fiscal year end, the index recovered to

14,827.

Only one sector, consumer staples, achieved

positive returns in March. Fast Retailing’s (9983)

share price recovered after fears of a dip post-tax

hike were dismissed. Utilities saw profit-taking after

a rise in February and Tokyo Electric Power (9501)

fell by 12%.

The impact of the snow storm in the US has melted

away and we believe an economic recovery in the

US will soon be apparent. This will be a key driver to

move the market forward not only in the US, but here

in Japan in April.

Table 4: Major equity market performance (as of 31st March)

Source: Bloomberg, SuMi TRUST

Country Index Currency YTD Mar

USD -4.9% -0.7%

JPY -6.7% 0.2%

USD -6.4% -2.0%

JPY -8.2% -1.2%

U.S. S&P500 USD 1.3% 0.7%

USD 1.3% -1.3%

EUR 1.3% -1.1%

AsiaMSCI AC Asia

(ex. Japan)USD -1.1% 0.9%

Japan

TOPIX

MSCI Japan

Europe FTSE Eurofirst 300

Top 5 Sector Bottom 5 Sector

Consumer Staples 0.7% Utilities -4.7%

Consumer

Discretionary -0.2% Health Care -2.3%

Telecommunication

Services -0.9%

Information

Technology -2.0%

Financials -1.0% Materials -1.7%

Energy -1.3% Industrials -1.5%

Table 5: Sector performance of MSCI Japan (as of 31st March)

Source: Bloomberg, SuMi TRUST

4

Disclaimer This marketing communication is issued by Sumitomo Mitsui Trust International Limited (“SMTI”). SMTI is authorised and regulated by

the United Kingdom’s Financial Conduct Authority (the “FCA”), whose address is 25 The North Colonnade, Canary Wharf, London,

EC3N 2AA, United Kingdom. This marketing communication has been made available to you only because SMTI has classified you as

a professional client in accordance with the FCA’s rules. If you have received this marketing communication from a source other than

SMTI, you should contact SMTI before using it or relying on it. You must not send this marketing communication to any other person

without first having received written approval from SMTI. The information contained in this marketing communication (the “Material”) is

being made available for information purposes only and is designed to provide information on the investment services which SMTI may

offer to clients. Nothing in the Material amounts to or should be construed as an actual offer by SMTI to provide any investment

services to any person. If SMTI agrees to provide any investment services to any person, those services will be the subject of a

separate written agreement between SMTI and that person. Furthermore, the Material has not been prepared with any consideration of

the individual circumstances of any person to whom it is communicated. Accordingly, it is not intended to, and does not, constitute a

personnel recommendation in relation to the purchase or sale of, or exercise of any rights in relation to, any financial instruments or

advice in relation to any investment policy or strategy to be followed. The Material also does not contain the results of any investment

research carried out by SMTI and is not intended to amount to a financial promotion of any particular financial instrument which may be

referred to in it. While SMTI uses all reasonable endeavours to ensure the Material is accurate, it has not been prepared with a view to

any person relying on it. Accordingly, SMTI accepts no responsibility for any loss caused to any recipient of this document as a result of

any error, inaccuracy or incompleteness in the Material, nor for any error in the transmission or receipt of this communication.

Any enquiries regarding the products

should be made to:

Yusuke Karube

Director, International Sales

Sumitomo Mitsui Trust International Limited

3rd Floor, 155 Bishopsgate,

London EC2M 3XU, UK

Direct: +44 20 7562 8460

imd@smtil.com