Overview
One look at packed passenger trains in Tokyo tells you Japan’s Covid era is over, but you wouldn’t know it from the share prices of the country’s railway companies.
Japanese railway shares plunged in the early waves of Covid and have struggled to recoup their losses even as passenger flows normalised. Tokyo’s benchmark indices are up about 60 per cent since the start of 2020 but the Topix Land Transportation Index (Tpland), which is dominated by railway companies, still trades about 15 per cent below its level from the end of 2019.
Major operators such as West Japan Railway and Central Japan Railway have seen passenger volumes and revenues recovering to more than 90 per cent of pre-Covid levels. Increases in foreign tourists and domestic leisure travellers have helped offset the impact of people working from home. For many train companies, a complete recovery this year is in sight. Possible fare hikes in a reflating economy could also boost their earning power. And in addition to improvement in their core business, some large railway firms have real estate projects that benefit from Japan’s rising land prices.
So why no share bounce? The lingering effects of the pandemic on investors’ view of rail businesses may be one answer. Severe disruptions from Covid outbreaks and the new work-from-home culture have cast doubt on what used to be considered a mostly stable business model. And investors are concerned about the leverage of some railway companies that issued a lot of debt during the pandemic. Although their share prices have declined since 2019, these companies have seen their enterprise values bloated by debt. Moreover, the traditional use of railway stocks as a defensive play may be limiting investors’ appetite for them in Japan’s currently favourable market conditions.
Whatever the reason, the scale of the disconnect is now large. Globally, the MSCI World Road & Rail Index, which is led by railway firms, has risen more than 16 per cent since the start of 2020. In North America, Union Pacific and Canadian National Railway have gained about 30 per cent and over 40 per cent, respectively, over the same period. Japan’s largest railway stocks are trading at 9 to 15 times their forward 12-month earnings, compared to around 20 times for their North American peers.
The divide between improving fundamentals and lagging valuations implies room for a catch-up rally in the sector. With fundamentals back on the rails, a rerating may soon follow.
