Japanese companies are gradually getting better at creating value for investors, Robeco’s engagement work has shown.
In the land of the rising sun, achieving a rising share price is often blocked by a cultural adherence to hoarding money rather than returning it to shareholders. Part of the problem is that the country has lacked the corporate governance standards that protect investors in the West.
In 2015, Robeco’s Active Ownership team began a research project that aimed to improve governance and thereby enhance returns on Japanese investments. These efforts are now bearing fruit, though engagement is continuing with 10 companies and some sticking points remain, says Michiel van Esch, Engagement Specialist and co-author of the project.
The main problems are insufficient returns on capital compared to the West. These are often caused by poor capital allocation practices, such as companies hanging on to unprofitable business segments that should be sold or closed, he says. More general governance problems include low levels of qualified independent directors, a lack of understanding of duality between management and supervision, and poor communication with investors.
“In order to achieve sustainable economic value creation, a company’s return on invested capital (ROIC) should exceed its weighted average cost of capital (WACC),” says Ronnie Lim, Senior Engagement Specialist in the region. “Our analysis concluded that the majority of companies had poor capital management, with 70% of 2,000 TOPIX companies having a five-year negative return on their ROIC when compared with their WACC.”
“Although companies’ dividend payout ratios have risen by 29% over the last five years, their debt-to-equity ratios have declined by 14.4%. Therefore, the growth in returns has barely kept pace with the growth in earnings per share and cashflow.”
“The current dividend payout ratio of 35% is only just above the post-Abenomics average. The lack of progress on this measure helps explain why there has been little reduction in cash on balance sheets, despite large increases in earnings per share and dividends per share.”
“More encouragingly, the total payout ratio (including net buybacks) as a proportion of net profits has increased for the TOPIX to 46% in the second quarter of 2019 from 34% in the fourth quarter of 2017. However, this still remains well below Europe (75% for MSCI Europe) and 105% for the largest 500 US companies in the first quarter of 2019.”
Engagement has been conducted with 10 companies that aimed to:
“Of the five companies where we were effective in our objective of shareholder rights, three of these companies (in industries ranging from automation equipment to sports apparel) have also made improvements in creating shareholder value over the period of engagement,” Lim says.
“Tangible actions that the companies have made include the disposal of low-return investments and consistent share buybacks. These have led to steady increases in their return on equity in three out of five cases, and a flat-to-improved valuation in the price-to-book ratio in four out of five cases.”
“The trend of share buybacks is also very positive – in 2018, Japanese companies announced share buybacks of USD 55.6 billion, which exceeded the previous record of 2016 by 4%. The first half alone of 2019 saw announced buybacks totaling USD 53 billion, more than double the level in the first half of 2018.”
“With all other factors being equal, such buybacks reduce the over-capitalized levels of Japanese balance sheets, thus improving their return on equity, ultimately encouraging investors to value those companies more highly.”
But there remains some work in progress, particularly on subjects that are deeply ingrained in Japanese culture, Lim says. “One of the more intractable issues remaining is the slow pace of companies prepared to dispose of unprofitable or low-return assets (including cross-holdings) for reasons attributed to retaining business relationships,” he says.
Business practices on the whole have improved since the introduction of the Japanese Corporate Governance Code in 2015, while investors have become more assertive in their roles as owners of the companies, particularly when voting at company meetings. Robeco, in common with other investors, now blocks resolutions that include the reappointment of directors, if progress is not being made.
“Momentum is also gathering amongst investors exercising their fiduciary duty, as we’ve seen an increase in the number of shareholder proposals,” Van Esch says. "These developments are positive, and we are hopeful that the under-valuation of Japanese companies will narrow compared to other developed markets.”
Meanwhile, the ‘three arrows of Abenomics’ introduced by Prime Minister Shinzo Abe in 2012 – monetary easing, fiscal stimulus and structural reforms to combat an aging population – are also kicking in.
“Abenomics’ ‘three arrows’ represent a bold move to invigorate corporate Japan, and to enhance returns for investors in Japanese companies,” Lim says. “A key requirement for the success of structural reforms includes institutional investors engaging in constructive dialogue with companies to create financial strategies that support sustainable value creation.”
“These strategies are aligned with recommendations by Japanese institutions and include measuring the true cost of debt/equity, setting appropriate hurdle rates for specific categories of businesses and assets, and making realistic assumptions about risks and returns.”
“We have seen progress in disclosures and communication with investors, yet there is still much more work that needs to be done by investors to encourage companies to adopt a discourse of financially ratio nal strategies.”
The content displayed on this website is exclusively directed at qualified investors, as defined in the swiss collective investment schemes act of 23 june 2006 ("cisa") and its implementing ordinance, or at “independent asset managers” which meet additional requirements as set out below. Qualified investors are in particular regulated financial intermediaries such as banks, securities dealers, fund management companies and asset managers of collective investment schemes and central banks, regulated insurance companies, public entities and retirement benefits institutions with professional treasury or companies with professional treasury.
The contents, however, are not intended for non-qualified investors. By clicking "I agree" below, you confirm and acknowledge that you act in your capacity as qualified investor pursuant to CISA or as an “independent asset manager” who meets the additional requirements set out hereafter. In the event that you are an "independent asset manager" who meets all the requirements set out in Art. 3 para. 2 let. c) CISA in conjunction with Art. 3 CISO, by clicking "I Agree" below you confirm that you will use the content of this website only for those of your clients which are qualified investors pursuant to CISA.
Representative in Switzerland of the foreign funds registered with the Swiss Financial Market Supervisory Authority ("FINMA") for distribution in or from Switzerland to non-qualified investors is ACOLIN Fund Services AG, Affolternstrasse 56, 8050 Zürich, and the paying agent is UBS Switzerland AG, Bahnhofstrasse 45, 8001 Zürich. Please consult www.finma.ch for a list of FINMA registered funds.
Neither information nor any opinion expressed on the website constitutes a solicitation, an offer or a recommendation to buy, sell or dispose of any investment, to engage in any other transaction or to provide any investment advice or service. An investment in a Robeco/RobecoSAM AG product should only be made after reading the related legal documents such as management regulations, articles of association, prospectuses, key investor information documents and annual and semi-annual reports, which can be all be obtained free of charge at this website, at the registered seat of the representative in Switzerland, as well as at the Robeco/RobecoSAM AG offices in each country where Robeco has a presence. In respect of the funds distributed in Switzerland, the place of performance and jurisdiction is the registered office of the representative in Switzerland.
This website is not directed to any person in any jurisdiction where, by reason of that person's nationality, residence or otherwise, the publication or availability of this website is prohibited. Persons in respect of whom such prohibitions apply must not access this website.