FREE KIC - NO. 90 JUNE 14
In previous opinion pieces I have outlined why I think it will be difficult to revitalise the Japanese economy. Nothing in the new "Abenomics" reform package has inspired me to change my mind and therefore I still think that the most likely scenario is for a relatively slow growth Japan.
There is however something that is new that might be a catalyst for improved returns for some quoted Japanese companies. This new development is the JPX-Nikkei 400 Index that was introduced in January.
Here is how they construct the index.
The important thing to note about the index is that Return on Equity (ROE) has a 40% weight in determining the companies that go into the index.
Here is a section from a Bloomberg article that gives an example of the changed behaviour:
Amada was one of 74 firms on the Nikkei 225 Stock Average (NKY) that wasn't selected for the JPX-Nikkei 400, which picks members based on profitability and use of cash and is a benchmark for the 128.6 trillion yen ($1.3 trillion) Government Pension Investment Fund. The company is seeking to more than double its return on equity by March 2016, exactly the response hoped for by the government and the Tokyo bourse, the index's planners.
Amada and NTT Docomo aren't the only cash rich company in Japan. I hope most of these cash rich companies want to be part of the JPX Nikkei 400 and therefore I hope they will follow the Amada and NTT lead. I am going to take a serious look at some of these companies to see if I can find the next Amada!
There are however plenty of Japanese companies that are not cash rich. In fact a large number of Japanese companies are not as fortunate as Amada and NTT. They are neither market leaders nor cash rich. I do not believe that these companies will be prepared to do what is necessary to increase their ROE because in a large number of cases this would involve closing factories and making workers redundant. Loyalty to employees is so ingrained at a cultural level that I don't think many companies will be inclined to take the necessary steps. (I have written about this in my opinion pieces on Asahi Chemical and anyone interested in the slow pace of change at Asahi Chemical can read about their restructuring plans for their low ROE chemical business here)
I therefore remain cautious in my opinion as to how the Nikkei 400 will impact upon the broader market and I think some commentators might be getting too optimistic.
Readers might be asking themselves why it is so important to a company like Amada to be included in this new APX Nikkei 400 index. It appears that the government has managed to pull off a coup by managing to get this new index to be used as a benchmark by the biggest pension scheme in the world (the Government Pension Investment Fund - GPIF). This is attracting a significant amount of attention:
"GPIF is changing in several ways, or at least I sense their will to change," said Kazuyuki Terao, Tokyo-based chief investment officer at Allianz Global Investors Japan Co. "JPX-Nikkei 400 is designed to encourage investment in stocks with high return on equity, which aims to change corporate governance using the power of the market. Plus, they're trying to boost returns."
JPX-Nikkei 400 looks increasingly likely to change the behavior of many companies as they seek inclusion in the gauge, Naoki Kamiyama, an equity strategist at Bank of America Corp.'s Merrill Lynch unit, wrote in a June 2 note.
The government has sent out an important signal by making the APX Nikkei 400 a benchmark for the GPIF. I think that companies will want the prestige of being part of the index and will want to be part of the GPIF portfolio of holdings.
Another example of the cultural difficulties that will prevent Japan from changing rapidly was highlighted at Takeda Chemical. Takeda recently decided to appoint a French national as Chief Executive but here is what the Telegraph had to report on the proposal:
110 members of the Takeda family and former executives have signed a letter of protest to the present board of the 230-year-old company in protest at the approval. According to the Yomiuri newspaper, their opposition is based on the belief that Mr. Weber could sanction the sale of the company to a foreign company and its technologies would be transferred overseas and lost.
The Yomiuri quoted one of the Takeda family as saying that "Weber does not know anything about the Japanese health care industry." "He does not know about the tradition and [corporate] culture of Takeda Pharmaceutical, either," he said. "It is absurd to install such a person as president," the newspaper said.
These are some of the reasons why it is Tricky to know what will happen to the Nikkei!