In this analysis for Wealth DFM, Richard Aston (pictured), portfolio manager of the CC Japan Income & Growth Trust plc, explains why he is encouraged by new plans to tackle undervalued companies in Japan
Several directives have been introduced to improve the corporate value of listed Japanese companies in recent history.
There were the Stewardship and Corporate Governance Codes that came into effect as part of Abenomics last decade. More recently, meanwhile, the Tokyo Stock Exchange was reorganised into three segments with strict listing criteria earlier this year.
Fundamentally, the trend is successfully creating an increasingly attractive investment environment.
More and more companies are moving away from the culture of cash hoarding that emerged during Japan’s economic crisis in the late 1990s. In its place, they are moving towards one focused on returning value to shareholders through everything from dividend hikes to the dissolution of cross-shareholdings.
The fact remains, however, that there is further to go here.
As at the end of January 2023, around half of all listed Japanese companies have a Price-to-Book Ratio, or “PBR”, of less than one. That compares to just 3% of the S&P 500.
It’s not just smaller companies, either. Around one-third of TOPIX 100 blue-chips are trading at a market value below their book value–including Toyota Motor Corp. and Mitsubishi UFJ Financial Group.
With this in mind, we were pleased to see the Japan Exchange (“JPX”) Group recently announce plans to tackle this issue head on. Even more encouragingly, there seem to be early signs that Japanese companies are sitting up and listening.
Push to create value
A PBR below one can effectively indicate–rightly or wrongly–that a company’s return on equity is falling short of its cost of capital.
In other words, it can show that its approach to capital allocation is inefficient. To enhance investor value, it would be prudent to take measures such as deploying more cash, increasing probability, and doing away with underperforming assets.
At the end January 2023, the JPX Group stated that one of the root causes of their PBR issue is a lack of awareness around cost of capital and stock price among company management. As such, it proposes to rectify the situation by:
- Requiring companies on the Prime and Standards market segments of the TSE with a PBR consistently below one to identify their cost of capital, capital efficiency, stock price, and market capitalisation properly. They would have to disclose policies and specific initiatives for improvement as necessary and demonstrate ongoing progress;
- Revising the Code of Corporate Conduct to clarify the responsibilities of listed companies, such as awareness of the cost of capital and respect for shareholders’ rights/protection of minority shareholders’ rights, and to ensure their effectiveness; and
- Promoting understanding and recommending stock compensation plans by providing training opportunities and sharing best practices to improve literacy related to capital markets and corporate governance.
It’s all at an early stage. And as it stands, there’s no suggestion that failure to adhere to the proposed requirements would result in a delisting from the Tokyo Stock Exchange.
But it seems the message has been received loud and clear by some market participants, who’d rather fix the issue now than put their Prime listing into future jeopardy.
For example, component supplier Dai Nippon Printing promised its largest ever share buyback in February. Shares quickly jumped 13%, helping to address a PBR that had been hovering just below 0.8.
Likewise, last month also saw Citizen Watch, which had been trading below book value for nearly five years, surprise investors with the news it would repurchase more than a quarter of its outstanding shares. The announcement, the first of its kind for the timepiece company since autumn 2021, immediately prompted a 16% rise in its market valuation.
Elsewhere during early 2023, we’ve also seen companies such as car maker Honda and glass manufacturer AGC join a growing list of corporates putting their large cash balances to better use.
Income boost
It’s perhaps a little early to say where these early signs will develop into a full-blown trend centred on boosting the PBRs of “undervalued” Japanese companies.
Regardless, the direction of travel is encouraging as far as we’re concerned.
As income investors, when this renewed effort to ensure company management creates value with their operational decisions; and is coupled with the current momentum and drive to improve shareholder treatment, it really stands to widen the pool of potential investments at our disposal rapidly.
We’ll wait and see, of course. But for the time being, this latest development is encouraging and reaffirms Richard Aston is portfolio manager of the CC Japan Income & Growth Trust plcer.
Richard Aston is portfolio manager of the CC Japan Income & Growth Trust plc
