This week I am going to follow on from the last blog about
Tokyo and focus on what I think I learnt about things that are happening at
corporate Japan that strike me as interesting, and could have implications for
the equity market. My general view as
someone who is no expert on Japanese companies and how they behave is that
there is a growing willingness to acknowledge shareholders as more important
than has been the case in the past. I
distinctly remember encounters in the 1990s when it was clear that shareholders
were tolerated at best, but we were nothing more than a residual that did not
deserve more than one day of management’s time a year. Shareholders have been very much second or
arguably even third class citizens for a long time in Japan, and until fairly
recently were an afterthought on a good day rather than any kind of
priority.
That is not the impression I got in March 2015 talking to a
fairly broad cross section of companies over one week, ranging from a
relatively high tech internet company, to a mobile game company, to companies
in financial services, property, and traditional manufacturers. My sample was not scientific as it was skewed
to companies that we hoped might offer us value (you can find value in relatively
high flying internet stocks if you can make a solid Sum Of The Parts case), nor
was it sufficiently large to be anything on which one could base a sound
investment strategy; but I think several elements were sufficiently consistent for
me to extract a few key points. Indeed
companies willing to attend a conference are of course a biased sample in the
first place.
With all those caveats let me commence. First off shareholders are firmly on the
agenda. This manifests in two ways. Perhaps most important is the greater
attention paid to Return On Shareholder’s Equity and Return On Capital Employed. Even in these days of zero interest rates,
capital is not a free good, unless you happen to be a central banker. For corporates and for poor struggling
investors, we want a return. That message
has got across. Companies find a better
reception in capital markets when they deliver improving Return On Capital
Employed, and even more so when they return something to shareholders.
This is where the second part of the story comes into
play. Companies in Japan historically
have been poor dividend payers, and did not consider share buybacks even when
trading well below intrinsic value, or in many cases even below net cash and liquid
securities. Thus there is a large
number, indeed hundreds of companies in Japan listed on the stock market where
the business value net of detachable financial assets, is less than zero. In this department there was evidence of genuine
momentum and improvement. Several
companies I saw are doing one or both.
Raising dividends has become a regular event. Share buybacks are becoming less rare than
they were. Interestingly the market
reacted positively in almost every instance where this happened. Management teams are beginning to
notice.
Another encouraging trend is the increase in genuinely
non-aligned, non-executive directors.
This suggests corporate
governance in Japan is going in the right direction. That leads me to another topic that surfaced in
nearly every meeting. Recent guidelines
from the Regulator have focused on a long standing grievance from outside shareholders
and an issue that is still pervasive in corporate Japan. Almost every company has a portfolio of
investments. Many if not most are in
companies with which they do business in some form; so this portfolio is more
about quasi strategic relationship building than investment return. For many years that point was painfully
apparent as the value of the portfolios shrunk; but following the recent
revival of the Japanese stock market now you can find some fairly chunky
embedded profit at quite a few companies.
This was most clear in my meeting with one of Japan’s
leading insurance companies, MS&AD, but almost companies are now scurrying
around talking to their relationship investees about the fact that they are
under pressure to get rid of these holdings or justify them to the regulators. In many cases they will not be able to
justify them. So a lot of latent value
is likely to be unlocked. Almost every
management team with whom I talked has this as one of the issues they are
discussing at board level. Both improved
corporate governance and potentially higher share values could result. Here is a rare instance of a regulator doing
something positive for shareholders.
Another issue discussed at every meeting was the question of
wages. This is critical to Abe’s third
arrow. If he is to succeed companies
have got to raise wages so workers will spend more and there will be an uplift
in domestic consumption leading to a stronger domestic economy. So far, however, companies have generally
resisted his entreaties. There have been
token gestures. Nearly everyone I spoke
to was reluctant to raise the bar on wages though equally nearly all have paid
out higher bonuses and expect to do so again this year. That on its own will not do the trick. So here was perhaps the most discouraging of
the key themes I encountered during my visit.
Overall, however, I came away comfortable that the Japanese
equity market can continue to go up. If
the two primary reasons above do not do the trick, then there does remain the
other much talked about issue that the companies themselves did not discuss. It was in contrast a topic if not the main focus at every gathering of fund managers
and brokers outside of the formal corporate sessions; and that was just how
much money the Government Pension Investment Fund is going to put into the
equity market. Here comes the big gorilla,
a buyer that has historically not been doing much but has recently been in the
market raising its domestic weighting to around 20%. Now they have the leeway to go to 34%. You can make a good case that all categories
of domestic investor are underweight : people, pension providers, and insurance
companies, the lot in fact - except corporates who may own too much. There is a major reallocation underway, but I
think the net movement will be positive and so supportive of higher equity
prices.
In the past there has been little allocation to equity. Potentially
a large wall of money is headed towards equity.
Yet only a modest amount has arrived so far. It is a dangerous investment thesis to buy on
the basis that you will make a turn selling something onto the next person a
month or two down the road. Still that
seemed to be the primary investment rationale of several New York based funds I
encountered. For those of us with longer
term investment horizons, it is encouraging to know we are by no means the last
buyer.
I said much of this – rather more concisely - in my brief
interview on Channel 5 that apparently survived the editor’s cut. So my return to Tokyo coincided with an even
rarer appearance on national television.
Sadly I missed seeing it, but much to my surprise several people at the
Daiwa Conference came up and congratulated me.
If anyone can forward a clip please do so. It helps I suppose that I was saying
something positive about the future of the Japanese equity market. That was what this audience wanted to hear. My point was that it does not really matter
where the index is. Indices almost
always go up over time. Look at every main
market chart, except perhaps of course Japan (over the last 20 years). They have been making periodic new highs even
with inevitable, occasional setbacks.
What matters are the valuation multiples, and whether a company is
improving returns and Return On Capital, and whether corporate governance is
getting better or worse. Generally in
Japan these trends are favourable so there is no reason for the index not to
make new highs.
Lastly I would note that since I got back to Singapore,
there have been a couple of very interesting developments relating to these key
themes. Firstly Fanuc, a leading robotics
manufacturer, and a notably secret company described by CLSA as a bastion of
shareholder unfriendliness, announced that they were creating a new investor
relations department and looking at ways to enhance shareholder value. A leading activist recently arrived on its share
register. That may have had something to
do with it; but in any event the market responded very favourably with the
stock up over 10% on the day. The other
big news was an announcement that Toyota will raise wages by over 3%. Abe must have been popping the champagne, or heating
up some sake the night that news hit. Others
may feel obliged to keep pace. Indeed it
did not take long for Nissan and Honda to follow suit. Big electronics firms like Panasonic and
Hitachi were not far behind. This means
wage growth in Japan is now accelerating at the fastest rate in over 40
years. The reluctance I encountered at
the conference to raise base wages may be changing as I write. If this becomes “the new normal” for
employees in Japan then rising costs may affect profits at some companies yet also
help generate demand at others, and overall should be another plus for the
Japanese equity market.