Overview
Encouraging developments are taking place across corporate Japan but these are often going unnoticed among smaller and medium-sized companies. Sell-side coverage continues to shrink after MiFID II. Nearly half of the companies in Japan’s mid- and small-cap space are not actively covered by analysts.
Much has changed since I began covering Japanese companies in the early 1990s. Since then, valuations have come down while returns on equity have risen. As a result, from a price/earnings perspective, Japan is now among the world’s most attractively valued developed equity markets.
Notably, we continue to see encouraging signs of a shift in corporate mindsets, with Japanese companies increasingly focusing on greater capital efficiency. Historically, Japanese companies have been good at managing their businesses and profit and loss accounts, but less effective at managing their balance sheets. While the rate of change varies on a company-by-company basis, this commitment to broad-based reforms is clearly good news for investors.
Committed to corporate reform
There is now clear evidence of a concerted commitment to corporate reform and an integrated set of policies that are designed to encourage greater capital efficiency and return on equity. Japanese companies are actively taking steps to improve, and are delivering record levels of cash to shareholders. With a common focus on ROE, the Stewardship Code, Corporate Governance Code and ROE-focused benchmarks have left management with no place to hide.
Ten years ago, only a dozen Japanese firms released integrated reports explaining their plans to increase long-term corporate value. That figure jumped to 341 last year, according to data from KPMG Japan. Only 45.2 per cent of companies listed on the first section of the Tokyo Stock Exchange appointed outside directors in 2008, and that has since grown to 99.7 per cent.
At the same time, companies are refocusing on their core competencies, and cash-rich corporates are starting to deploy more of their surplus funds for investments. As returns from Japanese corporates go up, we should also expect equities to rise, particularly as valuations remain attractive.
Gateway to the rest of Asia
This improving picture at the company level is supported by a generally positive macro backdrop. In particular, employment conditions are strong, and the recent pickup in wage growth is supportive of Japan's move towards reflation. We are also seeing signs of the government gradually relaxing restrictions on foreign workers in Japan, which can create opportunities among recruitment or staffing companies, as well as providers of services for foreign residents. Barring an external shock, Japan’s economy is reasonably underpinned going forward, and Japan’s central bank is likely to lag its global peers in normalising policy.
Japan is also a gateway to the rest of Asia. Companies can develop strong nationwide brands here, then leverage them to expand across the region. The rise in regional tourism means that people from the rest of Asia visit Japan and become aware of the products here, so when homegrown Japanese companies expand to the rest of Asia they can enjoy enormous brand-recognition and support from consumers.
Inbound tourism has been growing about 15-20 per cent over the last few years, mainly due to tourists from mainland China taking advantage of more relaxed visa regulations, and this helps to sustain consumer spending. The tourist influx looks set to continue, with Japan hosting the Rugby World Cup in 2019 and the 2020 Olympics.
Change is certainly underway in Japan, and this is translating into better profits and returns for companies. Combined with attractive valuations, these are the perfect ingredients for sustainable returns for investors.
