Greetings from Bento-box land! “What the heck’s a Bento box?” you ask? Think Japan’s version of the boxed lunch, usually packed with a diverse mix of bite-sized portions of fish or meat, rice, and veggie dishes. I’m a sucker for a well-made Bento and have enjoyed several during this first half of a two-week Asia research trip. These meals provided fuel for a busy lineup of meetings with Japanese companies, subway rides jam-packed with smartphone-entranced zombie commuters, and catch-ups with friends here with whom I used to work (I started my investing career in Japan almost 20 years ago). Yesterday, I was even able to mix in a day of play with a trip to Tokyo Disney with my family. They made the trek over with me, as our kids will attend three weeks of Japanese elementary school near my wife’s hometown.
So here I am in the Japan Airlines lounge at Tokyo’s Haneda airport, laptop charging and an hour to spare before boarding to Singapore for a final week of company visits. Since my turn is up for a newsletter article, I’d like to share a few thoughts on Japan as a place to invest – and on some of the companies with which I’ve been meeting.
Samuel Johnson wrote long ago that the use of travelling is to regulate imagination by reality, and instead of thinking how things may be, to see them as they are. I find this still rings true today, and that “kicking tires” in the localities of our current and prospective investments is worth the hassle of long flights and living out of a suitcase. My tire-kicking for the Japan leg of this trip consisted of an initial weekend with the in-laws in Hikone, Japan (a relatively small town in Western Japan), a day in Nagoya where I met with a Toyota affiliate, and five days in Tokyo where I met with nine additional companies.
Many global investors will tell you that Japan has been and will continue to be a “go-nowhere” market. The primary structural negative, they say, is a daunting demographic hurdle (shrinking population) that will perpetually stifle its growth prospects. What gets missed in this analysis, however, are several meaningful developments that, for now at least, make Japan a region worth exploring for investment candidates.
The key positive trends worth noting, in my mind, are as follows: First, among major developed economic regions, Japan’s political and social situations are arguably the most stable. Japan has one dominant political party, more jobs than applicants, and some of the lowest levels of wealth inequality in the world. Second, corporate Japan is becoming more shareholder friendly. Dividends and share buybacks are at all-time highs, boards are becoming more independent, and institutional investors are pushing for continued reforms. Third, valuations across the Japanese stock market are attractive. This is the case both in absolute terms and relative to the rest of the developed world, where Japan now trades at an unusually high discount.
In addition to these positives, it is worth remembering that our FIM Group team invests in individual companies rather than entire markets. So even if Japan, Inc., overall faces longer-term headwinds (including the above-mentioned demographic challenge), we need not passively own the market. Instead, we can look beneath the surface for stocks with superior attributes to the overall market, including those with their own unique growth tailwinds.
On this trip, my focus in Japan centered on several themes. The first of these themes is the rapidly growing Japanese senior sector. Unlike the nation’s overall shrinking population, the over-75 population is set to expand considerably in the years ahead (see graphic above left). In other words, Senior Citizen Japan, Inc., is a high-growth economy.
Among the companies I visited in this realm were real estate firms focused on senior living facilities and also Paramount Bed, Japan’s #1 medical bed brand. Paramount has been a family-run company for 60-plus years and dominates the market in both hospitals and senior care facilities. Management expects annual mid-to-high-single-digit growth in population growth of senior care facilities for the next decade, and this should drive longer-term revenue and profit gains. In addition to expanding with the senior care market, the company expects to grow its business abroad in emerging markets like Indonesia, China, and Mexico, where overall hospital per capital penetration remains very low and the long-term prospects are solid. As a smaller, family-controlled company, this one stays off the radar of many institutional investors and currently trades for around 10 times cash flow, which seems reasonable given its prospects and cash-rich balance sheet.
A second theme I focused on is e-commerce. Unlike the U.S., where e-commerce comprises approximately 8% of overall retail sales, Japan remains a laggard at around 5%. The overall market is growing robustly off a low base, however, making e-commerce-related companies worth a closer look. Two of the direct e-commerce players I visited were Softbank (36% owner of major Japan Internet player Yahoo Japan) and Rakuten (the leading Japan online shopping site – see a screenshot of its marketplace above right). Both are quite bullish on the prospects for their respective domestic e-commerce businesses as consumers grow increasingly comfortable with online purchasing.
I also visited several companies that are less obvious e-commerce-related ideas but nonetheless stand to benefit from this growth area in Japan. For example, Toyota Shokki is the global leader in forklifts and is making an intensified push into advanced materials-handling solutions. Such solutions provide the “guts” (hardware, software, and system design) of the distribution systems that enable e-commerce (think automated picking and palletizing systems, sorters, conveyers, and the like). Another company I met with, CRE Inc., is a real estate leasing, development, and asset management company solely focused on small and medium-size warehouse and logistics facilities. CRE’s business model is anchored by a stable, recurring cash-generating leasing and property management business. Looking ahead, it plans to leverage its know-how into new, fee-generating businesses centered on the development, sale, and asset management of modern warehouse facilities in the Greater Tokyo region.
A third focus theme of my trip was alternative energy. As a natural-resource constrained country, Japan has long depended on petroleum-related imports. After the tragic earthquake and tsunami hit Fukushima in 2011, the Japanese government has accelerated efforts to boost the nation’s energy efficiency and renewable energy production. By 2030, it aims to heighten renewables from 10% to nearly 25% of its overall energy mix (see graphic on page 2). On this front, I met with Spark Group, a leading independent investment fund company that began investing in solar farms even before Fukushima and now earns significant fees from this business. I also spent an afternoon with Ichigo Inc., an innovative commercial real estate firm that focuses on redeveloping existing office and hotel buildings with, among other things, energy efficiency retrofits. Ichigo also develops solar farms and sponsors one of Japan’s three listed green infrastructure funds.
I hope that this brief tour gives you a taste of the Bento box of investment themes I’ve been working on this week. All in all, I leave Japan feeling good about the stocks we currently own here and excited about new ideas that may someday make their way into our portfolios. I look forward to the week ahead in Singapore. And if I’m lucky, the Japan Airlines flight I’m about to board will include a Bento for lunch (pictured above).
Many of us are, have been, or will be confronted with a parent entering a nursing home. The weight of this reality can be emotionally overwhelming. One way to reduce the stress is to better understand the income tax aspects of the situation. Relevant questions to consider include the following: (1) are amounts paid for long-term medical care, including amounts paid to the nursing home, deductible?; (2) are insurance premiums covering the cost of long-term care, including nursing home expenses (for the part of the year before your parent enters the nursing home), deductible?; (3) will the gain on the sale of your parent’s home qualify for the $250,000 exclusion?; (4) can you claim your parent as a dependent?; and (5) can life insurance policies or reverse mortgages be tools to help fund long-term care costs? You should go over these matters and other tax aspects with your parent before he or she enters a nursing home.
Deductibility of long-term medical care services: The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent that they, along with other medical expenses, exceed 7.5% (over age 65) of adjusted gross income. Qualified long-term care services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, as well as maintenance or personal-care services required by a chronically ill individual and provided under a plan of care presented by a licensed health-care practitioner. To qualify as chronically ill, an individual must be certified by a physician or other licensed health-care practitioner (e.g., nurse, social worker) as unable to perform, without substantial assistance, at least two activities of daily living (eating, toileting, transferring, bathing, dressing, and continence) for at least 90 days due to a loss of functional capacity, or as requiring substantial supervision for protection due to severe cognitive impairment (memory loss, disorientation, and the like). A person with Alzheimer’s disease qualifies.
Deductibility of premiums paid for qualified long-term care insurance: Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subject to an annual premium deduction limitation based on age, as explained below) to the extent that they, along with other medical expenses, exceed 7.5% of adjusted gross income for those over age 65. A qualified long-term care insurance contract is insurance that covers only qualified long-term care services, doesn’t pay costs that are covered by Medicare, is guaranteed renewable, and has no cash surrender value. A policy isn’t disqualified merely because it pays benefits on a per diem or other periodic basis without regard to the expenses incurred.
Deductibility of amounts paid to the nursing home: Amounts paid to a nursing home are fully deductible as a medical expense if the person is staying at the nursing home principally for medical, rather than custodial, care. If the person isn’t in the nursing home principally to receive medical care, then only the portion of the fee that is allocable to actual medical care qualifies as a deductible medical expense. But if the individual is chronically ill (as defined above), all of the individual’s qualified long-term care services, including maintenance or personal care services, are deductible.
Including medical expenses you pay for your parent as part of your deductible medical expenses: If your parent qualifies as your dependent under the rules discussed below, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction. If your parent doesn’t qualify as your dependent only because of the gross income or joint return test (items (b) and (c) below), you can still include these medical costs with your own. However, if you are under age 65, the amount of unreimbursed medical expenses is deductible only over 10% of your adjusted gross income.
Claiming a parent confined to a nursing home as a dependent: You may be able to claim your parent as a dependent, thus qualifying for an exemption, even though he or she is confined to a nursing home. To qualify, (a) you must provide more than 50% of your parent’s support costs, (b) your parent must not have gross income in excess of the exemption amount ($4,050 in 2017), (c) your parent must not file a joint return for the year, and (d) your parent must be a U.S. citizen or a resident of the U.S., Canada, or Mexico. Your parent can qualify as your dependent even though he or she doesn’t live with you, provided that the support and other tests mentioned above are met. Amounts that you pay for qualified long-term care services required by your parent and eligible long-term care insurance premiums, discussed above, as well as amounts you pay to the nursing home for your parent’s medical care, are included in the total support you provide. If the support test (item (a) above) can only be met by a group (you and your brothers and sisters, for example, combining to support your parent), a multiple support form can be filed to grant one of you the exemption, subject to certain conditions.
Qualification for head-of-household filing status: If you aren’t married and you are entitled to claim a dependency exemption for your parent, you may qualify for the head-of-household filing status, which is more favorable than the single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you. To qualify for head-of-household status, generally you must have paid more than half the cost of maintaining a home for yourself and a qualifying relative for more than half the year. In the case of a parent, however, you may be eligible to file as head of household if you pay more than half the cost of maintaining a home that was the principal home for your parent for the entire year. Thus, if your parent is confined to a nursing home, you are considered to be maintaining a principal home for him or her if you pay more than half the cost of keeping your parent in the nursing home.
Exclusion of gain on sale of your parent’s home: If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In most cases, the seller, in order to qualify for this $250,000 exclusion, must have (a) owned the home for at least two years out of the five years before the sale and (b) used the home as his or her principal residence for at least two years out of the five years before the sale. However, there is an exception to the two-out-of-five-year use test under (b) if the seller becomes physically or mentally unable
to care for himself or herself at any time during the five-year period. Your parent can qualify for this exception to the use test if, during the five-year period before the sale, (1) your parent becomes physically or mentally unable to care for himself or herself and (2) your parent owned and lived in the home as his or her principal residence for a total of at least one year. Under this exception, your parent is treated as using the home as his or her principal residence during any time during the five-year period in which he or she owns the home and resides in any facility (including a nursing home) licensed by a state or political subdivision to care for an individual in your parent’s condition.
Exclusion for payments under life insurance contracts: If your parent is terminally or chronically ill and is insured under a life insurance contract, he or she may be able to receive tax-free payments (accelerated death benefits or so-called “viatical” payments) while living. Any lifetime payments received under a life insurance contract on the life of a person who is either terminally or chronically ill are excluded from gross income. A similar exclusion applies to the sale or assignment of a life insurance contract to a person who regularly buys or takes assignments of such contracts and meets other qualifying standards. These lifetime payments could be used to help pay the costs of your parent’s nursing home.
Reverse mortgage as alternative to nursing home: It is often desirable for an elderly person to remain in his or her own home with proper in-home care rather than entering a nursing home. A reverse mortgage loan may make this a feasible alternative. Many states permit a reverse mortgage loan, which is designed to permit elderly persons with limited income to remain in their homes by borrowing against the value of their homes.
Typically, a bank commits itself to a principal amount based on the appraised value of the property, which is loaned to the borrower in installments over a period of months or years. The monthly installments can be used to help pay for the upkeep of the home and for in-home care. Repayment of the loan is due when the principal amount has been fully paid to the borrower, or when the residence that secures the loan is sold, or when the borrower dies or ceases to use the home as his principal residence.
Understanding these issues will not remove all the emotional stress from the situation of your parent’s entering a nursing home. Yet having a better understanding of the law will help you make better decisions that are financially wise.
Source: 2017 Thomson Reuters/Tax & Accounting.
Pihlajalinna (pronounced: pea-la-ya-lean-ah)
Share Price / Market Cap:
17.92 euros / 369.39mm euros
“Pihlajalinna is one of the largest social and healthcare service providers in Finland. The company’s customers include private individuals, businesses, insurance companies, and public sector entities, such as municipalities and joint municipal authorities.”
Finland is currently undertaking an ambitious overhaul of their healthcare system. In the typical Finnish way, action, and practicality, these changes are broad and all encompassing. Municipalities are seeing their individual healthcare systems combined into larger (more efficient) regions while at the individual level even greater change arrives in the form of ‘choice’.
The opportunity is two fold, though going forward it has shifted from what originally attracted us to Pihlajalinna. Over the past few years, municipalities have been outsourcing their healthcare operations as they have come to realize that the private sector was better able to efficiently and effectively deliver services. Now that Finland is undergoing their so called “SOTE” reform, the opportunity set has shifted from large scale deal potential (i.e. taking over entire municipalities operations and their requisite population base). The consumer will now have the ability to choose their provider (for a year at a time).
While the possibility of winning municipality-level deals still remains, Pihlajalinna just signed a deal a couple weeks ago, the bulk of the opportunity set will be retaining and gaining a population that now has choice in their healthcare needs. In this respect we believe that Pihlajalinna is in a unique position to take outsized market share.
Pihlajalinna is one of four major healthcare outsourcing entities in Finland. Mehilainen is the largest private healthcare provider but is owned and controlled by KKR and Triton. Terveystalo, roughly the same size at Pihlajalinna, is also controlled by a foreign entity; the private equity group EQT out of Sweden. While Attendo is a listed entity in Finland they are primarily focused on nursing homes … which leaves Pihlajalinna (95% Finnish owned) as the only true local player.
Why is this important? The matter of making a profit on healthcare services, paid through taxes, is a very hot topic in the Nordics. While Sweden seems to be at one extreme with things at best heading down the path of regulated utilities and at worst an expectation of 0% profit margins – Finland is being a little more practical about things.
All indications thus far have been fairly market friendly and rooted in a belief that competition will be positive for the population over the long term. However, profits will be a topic and as Pihlajalinna has proven; being the ‘local’ guy can pay off. This is evidenced in the large municipal deals they have signed to date, thinking creatively and forming joint ventures to keep interests aligned, etc. Put another way, if the system will allow for some reasonable profit level, wouldn’t you rather it go to your fellow Finns?
At any rate the opportunity is large, with a healthcare system nearing 20bn Euros per year and roughly 1/3 of that opening up to private choice in the next couple years there should be ample room for three competitors. As things crystallize we would expect the market to open up further and continue expanding (recall the population base in the Nordics, especially Finland is skewed towards the elderly).
Pihlajalinna has a more concentrated geographic strategy which aligns well with the underlying population migration from the countryside into the major southern cities (the capital Helsinki, Tampere, etc.). This should allow Pihlajalinna to more efficiently allocate capital, quickly hone their service experience, and better differentiate their brand. If we look at their balance sheet compared to competitors (an area likely to see regulation) we will see that they employ far less leverage and it can be argued should lever up a little more, leaving them ample room for accretive growth.
Pihlajalinna has the brand, authenticity, and capital to leverage the opportunity set before them. Founded and controlled by medical professionals with a strong management team below them we expect Pihlajalinna to steadily grow in the double digit range, at some point in the not too distant future we would anticipate earnings in the 7% range and a requisite dividend to be paid out. Our scenario analysis (bull-bear-base) ends in a range spanning 30 euros to 50 euros in 2021 (vs a current share price of roughly 18 euros today), a recent contract win moves the shorterend up a little bolstering our confidence in management and the story.
As with our other investments, we will remain in close contact with management and the board; in this case also keeping an eye on the political environment and social sentiment towards privatization.
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