Steelmaker JFE Holdings beat forecasts and boosted its full-year outlook by 11 percent. At All Nippon Airways, half-year net profit soared by 78 percent, while Panasonic raised its full-year forecast by 25 percent*. Hitachi is on track to net approximately $2.1 billion in the current year—beating forecasts by nearly $170 million. Bolstered by a weaker yen, Nintendo also
bested estimates and is now on track to log its first annual profit in four years.
Where Is There Value Left in Developed Markets?
A sinking currency and plunging fuel prices are helping Japan’s export-focused economy by propping up foreign demand for Japanese products. Japanese companies are also benefiting from an accelerating recovery in the U.S. This news, paired with Prime Minister Shinzo Abe’s all-out effort to jump-start the economy, suggests there will be additional opportunities for investors.
Getting back to zero
These opportunities gain clarity when the relative valuations of Japanese equity are compared to other developed markets: Japanese stocks have yet to achieve pre-2008 financial crisis levels—let alone approach the Nikkei’s all-time intraday high of 38,957.44, hit in December 1989. In contrast, U.S. stocks appear to be fully valued and P/E ratios are higher than they were before the downturn.
Not only has the Nikkei underperformed compared to other indexes, having risen just 7 percent since the beginning of 2014, but Japanese stocks also currently trail historical averages in both P/E, cyclically adjusted P/E and price-to-book-ratio. The result: Despite strong corporate performance, Japan is one of the cheapest markets in the world.
Ride the Tailwind of the Japanese Stimulus
A primary reason Japanese stocks trade at such a discount is relatively poor returns on equity (ROE), which average 8 percent, versus 15 percent in the U.S. Though many Japanese companies with low ROE boast strong balance sheets and cash reserves, overregulation and poor corporate governance have weighed on the performance of stocks and contributed to their undervaluation.
Abe’s third arrow
Much has been made of Prime Minister Abe’s decision to postpone an increase in the consumption tax and call a snap election for mid-December, two moves designed to reinforce the popular mandate for aggressive monetary policy. However, it is the self-described “third arrow” of Abenomics—an emphasis on corporate reform—that could prove to be more impactful than the first two initiatives (fiscal stimulus and monetary easing).
Yen Depreciation? No Problem
This ambitious reform plan flies in the face of Japan’s traditional consensus-driven decision-making, elaborate cross-shareholdings among companies, domestic protectionism and a reluctance to fully embrace the concept of shareholder value, all of which have long dampened Japanese corporate earnings. Despite resistance from Japan’s powerful bureaucracies such as the Ministry of Finance, Abe is determined to push ahead with reforms aimed at pressuring companies to pay more attention to shareholders. Among his goals: lowering corporate tax rates (already reduced by 2.4 percent in this fiscal year), removing barriers to entry in once impenetrable fields (healthcare, electricity) and relaxing visa requirements. But perhaps the most promising plank of Abe’s reform plan involves encouraging Japanese companies to undertake measures to reward shareholders.
Government pressure has already helped drive an 18.5 percent year-on-year increase in dividend payments, to a total of $25.2 billion in Q2—the largest individual quarter on record. (Toyota alone paid out $1.2 billion more than it did in the previous fiscal year.) Share buybacks are also more common now than they have been since 2008, with 249 companies initiating approximately $15.7 billion worth of repurchasing programs from April to September.
In the short term, such measures have helped enhance shareholder return. Longer term, they could potentially raise the country’s growth potential, and make Japanese companies even more competitive, efficient and focused, which, in turn, would drive up ROE.
From Buybacks to QE: Why Japan Deserves a Second Look
In the near future, a shrinking GDP may continue to overshadow the healthy momentum in corporate profits, but as of late October, forward earnings estimates in Japan have increased 8 percent year-to-date, and the outlook remains positive: Consensus forecasts show Japan’s earnings rising over 13 percent in 2015, versus just under 12 percent in the U.S. Even with weak GDP, this suggests Japanese stocks hold strong value in an increasingly pricey world.
Many investors are betting that in the coming months the government’s aggressive stimulus efforts will drive the Nikkei higher. But for value-oriented investors with longer time horizons, the real upside potential is that for the first time since World War II corporate reform in Japan may be for real and eventually reflected in stronger earnings. The results of the country’s upcoming snap election should yield additional signs of the commitment to corporate reform.
Investors Hitch a Ride on Japan's QE
*Source of information in this story is Bloomberg, as of 11/2014, unless otherwise noted.
This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any security in particular, nor is it a recommendation to purchase or sell, or an offer to sell or a solicitation of an offer to buy any security. Investing involves risk, including possible loss of principal. Past performance is not a guarantee of future performance.
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