Tokio Marine Asset Management analyses the structural reasons as to why corporate governance matters so much for Japanese corporates and looks beyond booming dividends and share buybacks for new investment ideas.
Investors with even a slight interest in Japan have probably heard of the recent efforts there to improve corporate governance and raise ROE levels. As a Japanese bottom-up growth manager, we would like to highlight why corporate governance matters and discuss the implications on stock selection.
For foreign investors, boosting shareholder return and strengthening corporate governance in Japan has long been on the agenda. So, why is it now that we are finally seeing an improvement? We believe the reasons become clearer when you consider Japan's past 20 years of deflation.
Japanese style restructuring
During deflation, Japanese corporates hoarded cash as this was one of the best strategies at the time. (There was little incentive for them to invest in capital that would lead to a year-on-year price reduction).
They also paid down debt and as a result, their shareholder equity rose significantly. Cash accumulation on this scale would not have taken place in a 'normal' inflationary environment.
Another striking aspect was corporates' approach to restructuring. When people hear 'restructuring,' the first thing that normally springs to mind is a reduction in a company's headcount.
But, a different approach was taken when Japanese corporates restructured in the deflationary era. Instead of reducing the headcount, they decided to freeze or even lower their levels of CAPEX, as the below graphs show.
In order to make up for this lack of capital expenditure, Japanese corporates used cheap labour; they stifled the wages of contracted workers and made use of temporary ones to the greatest extent possible. In this way, they were able to counteract the decrease in productivity from cutting back on CAPEX.
We believe the above-mentioned two features (cash accumulation and CAPEX reduction/maximum use of cheap labour) reflect the true nature of Japanese restructuring under deflation.
What's changed? Inflationary pressure
Japan's slow shift back to inflation is a potential game-changer in our view. In an inflationary environment, keeping its stockpile of cash is no longer an efficient strategy for corporates (it detracts from value rather than adding to it).
Having sensed this change, we are now seeing corporates deploy their accumulated cash in the form of record dividends and share buybacks, as shown below.
At the same time, rising wages and a shortage of labour, particularly in sectors such as construction and IT, mean that corporates are finding it more difficult to keep using previously abundant cheap labour. We believe that corporates will now have to increase their CAPEX by much higher levels to sustain current levels of productivity.
In our view, Japan is slowly moving back to a 'normal' environment and this is why corporate governance and rising ROE is so prominent now.
Looking beyond Corporate Governance
Even if corporates continue to keep dividends and share buybacks at these new levels, they will still have too much cash on their balance sheet. Their next targets for cash deployment will be related to domestic CAPEX as well as M&A activity (as shown below).
We feel that this isn't a temporary phenomenon owing to a cheaper yen and the upcoming Olympics either. Rather, it is because managements are feeling the pressure from changing operating conditions.
The importance of picking corporates that successfully use their cash will become greater. Japan is famous for being a long-term 'value' market but we are finally seeing signs of a return to a more normal market as described above. As a growth-biased manager, we look to take advantage of this situation for our clients.
Tokio Marine Asset Management is a Japan/Asia equity specialist with 30 years' market experience and approx. $48bn AUM (as at September 2015). The Focus strategy is a concentrated portfolio of 20-40 high conviction stocks using the best investment ideas of today. For more information about the strategy, please contact Business Development at Tokio Marine Asset Management (London) Ltd.
Email: [email protected]
Tel.: +44 (0)20 7280 8580
Website: www.tokiomarineam.co.uk
Disclaimer
Important Information: This document is intended to be for indicative purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. This information is for professional investors only and is not suitable for retail investors. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Tokio Marine Asset Management does not warrant its accuracy. No responsibility can be accepted for errors of fact or opinion. Issued by Tokio Marine Asset Management (London) Limited, 20 Fenchurch Street, London, EC3M 3BY, U.K. which is authorised and regulated by the Financial Conduct Authority. You may not copy, reproduce, recompile, decompile, disassemble, distribute, publish, display, modify, upload, transmit, or in any way exploit any part of the document.
