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Positive signals for Japan's prospects after Corona
We live in extraordinary times. Not only does the coronavirus pandemic pose immediate public health risks, it is likely to have far-reaching effects around the world. We have already witnessed how the crisis has caused severe upheaval in the economy that will almost certainly result in a recession in the world economy. While this may seem impossible, the potential effects of the pandemic will not be consistently negative. From an investor's point of view, Japan is a possible winner of the coronavirus crisis as it forces traditional companies to look for innovative work models and rely on new technologies. Of course, some manage to adapt and develop better than others. Active selection is therefore extremely important.
In times of crisis: "Cash Is King"
Japan's high beta stock market is far from immune to the consequences of the coronavirus outbreak and suffered heavy losses in Q1 as the general escape from risk assets. It was encouraging, however, that despite the extreme uncertainty, Japanese companies were able to further increase capital repayments to shareholders in the form of share buybacks and dividends overall.
“In times of crisis, cash is king,” they say. And Japanese companies have plenty of that. Japanese companies had the highest cash reserves ever at the start of the coronavirus crisis. Overall, according to the Japanese Ministry of Finance, they had cash reserves of more than 6.5 trillion in their balance sheets as of the end of December 2019. USD from. In addition, these cash reserves are available in almost every sector of the Japanese economy.
Figure 1 shows that as of December 31, 2019, all Japanese companies had a considerable cushion of liquidity, which is particularly advantageous in difficult market phases. Large cash reserves also open up opportunities for Japanese companies. For example, you can use excess liquidity to pay off debts, reinvest in the company, or return more capital to shareholders and improve return on equity (ROE). In recent years, Japanese companies have clearly focused on this third option. Enormous sums of money went into higher capital repayments to shareholders through record-high share buybacks and higher dividends.
Japanese companies have very high cash reserves
(Fig. 1) Cash and liquidity as a percentage of the company's total assets
As of December 31, 2019.
Source: Japanese Ministry of Finance, data analysis by T. Rowe Price. Contains only non-financial stocks.
Higher repayments to shareholders, scope for further potential increases
Since Japan gave the go-ahead for the economic strategy known as "Abenomics" in 2012, the total payout ratio of Japanese companies (i.e. dividends plus share buybacks) as a proportion of net profit has almost doubled - to around 60% at the end of 2019.2 Traditionally, however, Japanese companies tend to uselessly hoard cash reserves on their balance sheets. We therefore find this strong increase quite impressive.
Nevertheless, the capital repayments to investors still have more room for improvement. In the period from 2012 to 2019, the cash balances and short-term deposits of Japanese companies also almost doubled. We'd think it would be good if instead of falling back into bad habits, companies used more of that money to fund higher dividends to their shareholders and improve their ROE.
These higher shareholder repayments are a trend that has been helped in part by better corporate governance rules in Japan. We have discussed this topic in detail before. Prime Minister Shinzo Abe has made the alignment of Japanese governance standards with global norms a priority. A new governance framework has been introduced based on global best practices that encourages companies to return more capital to their shareholders.
Given the high level of financial resources, we believe that fewer companies in Japan will have to cut dividends in the short term than in other global markets where cash reserves are not as high. We also believe that Japanese stocks will only become more attractive if post-pandemic companies can show they want to leverage their high levels of cash and reward their shareholders early on.
This is how the pandemic accelerates change
The coronavirus pandemic is changing Japan - with significant long-term repercussions. For example, the restrictions introduced due to the coronavirus have uncovered many inefficiencies in Japanese companies and are forcing them to look for flexible working models and to rely on new technologies.
The pandemic is accelerating change
(Fig. 2) Lack of flexibility on the part of Japan's companies has been exposed
1 Source: Japan Ministry of the Interior, as of 2018. Survey of companies with at least 100
2 Source: Reuters, as of February 2020. Survey of Japanese companies, cross-sector, from January 2020 to February 2020.
Some companies use call center solutions with artificial intelligence (AI), others have set up media / conference platforms to stay in contact with their employees in the home office.
For a country known for its technological know-how and innovative strength, many companies are still using outdated technology. This is at least partly due to older employees who are more reluctant to use modern technology. But there are also legal hurdles, such as the requirement that many documents from companies have to be stamped with a company. Maintaining such traditional practices hinders progress in today's digitally efficient world.
The fax machine is a symbol of the conservative thinking that is still widespread in Japan. In other major economies, fax machines have long been a thing of the past and are considered "technology of yesterday". But in Japan, a recent government study showed that practically every business and every third household still uses fax machines for some of their communications.
Crisis accelerates change to innovative, flexible solutions for everything to do with work
Working from home was an inevitable innovation for Japan's businesses after the government urged them to reduce the number of people in offices by 80% to help curb the spread of the coronavirus. For many Japanese workers who hate the congested daily commute, long office hours, and the inefficiencies of their organizations, working from home has been a revelation - something they don't want to be without, even after the lockdown has been lifted completely.
Working long hours, being there for customers late into the night and working overtime have long been considered a prerequisite for professional success in Japan. This work culture has changed constantly; more and more older workers are retiring and a younger generation of progressive minded workers is emerging.
The coronavirus outbreak has exacerbated this trend. The pressure to find new, flexible working models has made some Japanese companies realize that teleworking is not only possible, but also a very good alternative to long office hours. Happier employees can be more productive. The Japanese government shares the view that many traditional ways of working will have to give way to more modern models such as teleworking, digital transactions and moving business processes to the Internet in order for Japan's economy not to lose touch.
Resilience and persistence have been something of a hallmark of the Japanese stock market for the past few decades. These characteristics, and the high cash reserves on corporate balance sheets, should enable Japan to cope well with a potential short-term global economic downturn - and perhaps even lead a subsequent recovery. In the longer term, the coronavirus pandemic has revealed some shortcomings in Japan. If the coronavirus pandemic has any good, it's that it is forcing Japanese companies to adapt and embrace new work models and technologies. The acceleration of change in Japan could be a boon to long-term growth in Japan in terms of productivity alone.
We will pay attention to this in the near future
In the last few weeks, a significant surge in growth has confirmed that we should continue to focus on companies that should be able to achieve steady growth in the medium to long term. The coronavirus has brought some of these growth factors to the fore, because consumers have to work and consume remotely and also rely more on new technologies in their everyday lives. Therefore, we take a very close look at our positions in areas such as payment processing and other technology-oriented solutions. Although they performed relatively well during the current crisis, we remain very confident in these stocks because we believe the growth prospects are now indeed clearer.
1 Source: Japanese Ministry of Finance. As of December 31, 2019.
2 Source: Annual reports, Japan Exchange Group, analyzes by Empirical Research Partners. The data excludes the financial and utilities sectors after deducting issued shares.
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