Bet on a Recovery in Japan

Includes: CCJ, EWJ, JOF, NLR, SHAW
by: Glenn Rogers

The tragedy that has been unfolding in Japan this month has left us once again in awe of the powers of nature that we cannot control. Despite being the most natural disaster conscious country on earth with extensive preparedness programs and numerous early warning systems, a large part of Japan's northeast was devastated by one of the largest recorded earthquakes in history followed by a devastating tsunami. These combined disasters have led to an on-going nuclear emergency at one of Japan's largest power plants which continues to worsen as I write this.

All this you know, unless you have been living under a rock. The only consolation is that history shows that over time the emotional scars will heal, although they will likely never be forgotten by the Japanese people. Like Hiroshima, the events the past few days and the toll they have taken will be commemorated for years to come.

Although some people may think it inappropriate, this is a newsletter about investing and our job is to make readers aware of opportunities as they occur. Invariably, every major crisis creates such opportunities although they may only be suitable for aggressive investors. This one is no different.

The question is: where to begin? Usually the best place to start is by looking at some of the securities that were hardest hit by the big sell-off that followed the disaster.

Naturally the broad Japanese market was hit hard, dropping by 16% over the two days of trading on Monday and Tuesday. You can see the dramatic impact of that by looking at the price movement of the iShares MSCI Japan ETF (NYSE: EWJ). It is a broad-based fund that holds most of the major Japanese companies we are familiar with, such as Toyota Motor Corp. (NYSE:TM), Canon Inc. (NYSE:CAJ), Honda Motor Corp.(NYSE:HMC), Sony Corp.(NYSE:SNE), etc. The units opened the month at $11.53 (prices in U.S. dollars) and were trading at $11.27 on March 9, just before the earthquake struck. Once the news broke, the shares plunged, dropping all the way to $9.25 in intraday trading on March 15 before rallying. That was a drop of 18% from the March 9 closing price, an accurate reflection of what was occurring on the overall Tokyo market. Volume was 15-20 times normal. Typically, somewhere between 20 and 30 million shares change hands on a given day. On March 15, more than 200 million units traded and the next day the figure was almost 400 million. What is significant is that there were enough buyers to pick up the sell orders, a sure sign that the bargain hunters were out.

Japanese stocks weren't the only ones hit. Almost every company associated with the nuclear industry saw its share price plunge. General Electric (NYSE: GE), which manufactures nuclear plants and which designed the troubled Fukushima facility, saw its share price drop by 10% between March 9 and March 15 before it rallied (see update). Uranium miners like Denison (TSX: DNN) and Cameco (NYSE:CCJ) were also clobbered.

Also slammed was the Shaw Group Inc. (NYSE: SHAW). Most Canadians aren't familiar with this Louisiana-based integrated engineering firm but it is a key player in the nuclear industry, which is why the share price tumbled 32% between March 8 and March 14 before rebounding somewhat.

Shaw Group designs, builds, and maintains a number of nuclear facilities around the world and the market is guessing that at least some of these projects may be stalled or canceled as a result of what has happened in Japan. The fact that some countries, such as Switzerland, have declared a moratorium on the construction of new nuclear facilities has reinforced that view.

Switzerland generates about 40% of its electricity from five nuclear plants and had recently approved the construction of three more. The Swiss decision seems illogical as the country is geologically stable and is about the last place on earth that would be affected by a tsunami!)

I think the impact on Shaw's business will be less dramatic than the market expects. If Japan is able to contain the radiation leaks so that there are no widespread human health consequences (which we all devoutly hope will be the case) I think it is likely that most of the proposed projects that Shaw is involved with will go ahead, albeit at a slower pace.

Also, I think the market is missing the fact that a significant part of Shaw's business is environmental remediation services. The company could benefit from increased safety requirements both for both planned nuclear sites but also for existing facilities that may have to be upgraded to satisfy increased paranoia on behalf of national governments around the world. This ongoing maintenance and modification work should add to the company's pipeline even if there are delays in the construction some of the new facilities.

On March 13, the company released a statement regarding the disaster in Japan from CEO J.M. Bernard Jr. which said in part: "At this time, we do not believe that there will be an impact on Shaw's nuclear projects currently under construction United States and China. Our customers have indicated they intend to move forward, and we believe the construction timeliness will continue as planned."

He added: "The new generation technology under construction today has been designed with greater safety systems in place that will even more effectively address the challenges we are seeing in Japan. The industry consistently incorporates operating experience and lessons learned and will continue to use those insights to make nuclear energy even safer."

The company is also broadly exposed to a diverse portfolio of other projects including renewable energy along with more traditional fossil fuel sources like coal and natural gas, so they are not solely dependent on nuclear-related work.

Of course, all bets are off should there be a worsening of the crisis in Japan to the point where there was a core meltdown in one or more the reactors leading to significant loss of human life. If this were to happen the nuclear industry could be crippled for extended period of time. However, short of that and given the large number of installed nuclear facilities worldwide combined with an increasing need for clean power sources (I am not counting nuclear waste here) there is going to be an ongoing need for the services of Shaw Group.

Shaw is a Fortune 500 company with fiscal year 2010 annual revenues of $7 billion. It has approximately 27,000 employees around the world.

Shaw Group (SHAW) is a Buy for aggressive investors with a target of $42. The shares closed on Friday at $32.52.

There is also going to be the need for uranium going forward which makes the sell-off in the mining stocks all the more puzzling. I particularly like the prospects for Cameco at these levels and would recommend it for aggressive investors. The stock was originally recommended by Gordon Pape and closed on Friday at C$28.96, US$29.40.

Contrarian investors might also consider gradually adding Market Vectors Uranium Plus Nuclear Energy ETF (NYSE: NLR) as the situation Japan becomes clearer. This exchange-traded fund, which was launched in 2007, is designed to track the performance of the DAX Global Nuclear Energy Index, which provides exposure to publicly-traded companies worldwide that are engaged in the nuclear energy industry. These include several Canadian companies (Cameco, Denison, Uranium One, Fronteer Development, Hathor Exploration, First Uranium, and Forsys Metals). Major U.S. companies are Constellation Energy, Exelon, and USEC, plus there are several stocks from Australia and Japan.

The units closed on Friday at $22.81, down 13.5% from the closing price of $26.36 on March 9.

NLR is a Buy for contrarian aggressive investors.

Finally, there are number of ETFs that address the broader Japanese market and I have been taking small positions in two of those. They are EWJ, which mainly focuses in large-cap Japanese companies, and iShares MSCI Japanese Small Cap ETF (NYSE: SCJ) which focuses on small cap issues. I also bought shares in Japan Smaller Capitalization Fund Incorporated (NYSE: JOF) which up until the recent meltdown had been showing good growth for the past few months.

Timing is critical in these situations and since I'm aggressive investor I have been taking small positions since the middle of last week. More cautious investors may wish to wait a few more days to see how the situation plays out, particularly with regards to the nuclear threat. However, the old Wall Street adage of "buy when everyone else is selling" has worked for me for many years and I expect it will again. My formal recommendation for IWB readers is EWJ.

EWJ is a Buy for aggressive investors. The units closed on Friday at $10.37.

In closing, I would like to express my sympathy to those who have lost friends and relatives in Japan and to encourage readers to generously donate to the various charities that are helping with relief and reconstruction there (I have made a personal donation to the Red Cross for this purpose). Japan is obviously in a much better position to recover from a disaster of this magnitude than was Haiti but the scale of this calamity is breathtaking and Japan could certainly use our help.

Disclosure: I am long EWJ, SHAW, NLR.