If 2021 was about talking about the environment – most notably at COP26 – then 2022 and thereafter must be about doing. Some say that the transition of the environmental agenda from theory to reality will be a boon for Japan, as many of its companies are leaders in aspects of green technology. Others worry that the legacy of a powerful industrial sector built on carbon means that the country, and the market, has more to lose than gain. Below we attempt to weigh up how the cards might fall.
The foundation of the technological leadership argument is the world-beating number of green tech patents owned by Japanese companies.1 This weight of patent protection, and implied innovation, must be viewed critically not least because Japanese companies have a voracious appetite for the collection of any and all patents; R&D managers should be reminded that they are a means rather than the end in themselves.
Japanese companies also have a chequered history in commercialising technological expertise. A case in point is Panasonic, Japan’s number two owner of clean energy patents, which pioneered the development of lithium-ion batteries but now lags behind Korean and Chinese makers in their manufacture.23
This is not to dismiss Japanese technological prowess in the field of carbon-cutting. A lower risk approach could be to seek companies with the ability to apply their existing tech to new environmental solutions. For example, air conditioning company Daikin, recently announced that it would apply its high-efficiency cooling to refrigerated transport.4 Sony, too, could do well by applying its technology to an ever-wider suite of applications. In January, just prior to publication of this note, the company confirmed the establishment of a “mobility unit” and showed off its latest concept car.5
It is more likely that Sony’s automotive future is in components than whole vehicles, but the automotive sector is a key battleground. Not just because of its importance to Japan, but also as the sector most obviously and recently disrupted by a tech-enabled newcomer in Tesla. Here, Japan is sure to win…and lose. Also in December, Toyota announced the launch of thirty new battery electric models which it expects to account for 3.5m units by 2030.6 For reference, the company sells around 10m units annually.7 It is hard to believe that this decision was made in a vacuum; it is a response to competitive threat. Companies facilitating the retooling of old-world production to its greener alternative could be the best bet of all, companies like Fanuc – a leader in EV production equipment.8
Toyota, Sony, Fanuc…all great businesses and venerable members of Japan’s corporate aristocracy. But what about the pure-play environmental solutions companies which seem to pop up in Europe or America? In Japan they are rare and chasing environmental themes within otherwise challenged businesses is dangerous. Take Mitsubishi Heavy Industries for example; it is a global leader in carbon capture and storage as well as pure-hydrogen power generation and steelmaking yet 40% of its sales come from turbines and boilers for thermal power plants.9 Can both peacefully coexist or will the prosperity of one come at the price of failure in the other? For such companies it is going to be tough.
Given their scarcity, pure plays can become hot property, but investors should beware false idols. A good case in point is Renova, a well-liked ‘renewables play’ and broker favourite. Last month the stock cratered on the news that it had been overlooked to operate an offshore wind project it had been working on.10
Just because we believe that the very cream of Japan’s manufacturing sector – Toyota et al – can prosper in a greener world does not mean that all companies will.
Steelmaking is likely to be especially problematic. The world will continue to need steel but if it is to be made without massive emission of carbon dioxide then pure hydrogen will have to be used. All of this is possible, but it is costly, and enormously so, according to industry leader Nippon Steel. 11
The environmental challenge facing Japanese companies is a multi-decade one, hardly something that will be done and dusted in 2022, but recent announcements from big players suggests that the coming year could be a crunch period in setting the course for the mid to longer term. Opportunities abound, with new applications for the existing technologies in which Japanese companies are already rich.
Disruption to the competitive landscape, brought about by new challenges and differing abilities to meet them, will result in winners but big losers too. Some will not survive. Distinguishing between these two camps will occupy much of our time. Some industries will survive but will experience years if not decades of pain before they have sufficiently metamorphosed for the new environmental era. We intend to avoid these and suggest other investors do likewise. Japan’s increasingly rich IPO market is sure to birth some worthwhile environmental solutions companies, but until then they remain thin on the ground. Our view is that investors should resist the temptation to choose the best of a bad bunch.
10Bloomberg, Jan 2022
Outlook 2023: Japan’s uneasy equilibrium
Seeking income in a high inflation world
Quality can thrive through volatility
Enyasu or endaka? Japan’s currency conundrum
Demographics: Japan’s ‘mother theme’
The value of active minds: independent thinking