Conventional wisdom suggests that it’s generally good for companies to have strong balance sheets, with low levels of debt and some cash on hand for a rainy day. The same logic also states that it’s less desirable to have high levels of debt with interest charges that can’t be covered in a downturn. However, that’s an overly simplistic way to approach balance sheets. By nature, some industries have more stable cash flows than others, making higher debt levels less of an issue. Companies also need to consider the cost of their debt and the potential returns they can make on their borrowings. Obviously, the lower the cost of debt and the higher the potential returns, the more sense it makes to borrow.
Japanese companies are well aware that there are certain circumstances where it makes sense to embrace more leverage on their balance sheet. Given the cost of borrowing is so low in Japan (the Japanese 10-year government bond has a negative yield) the hurdle rate on making an efficient return on the loan is also very low. However, this is where cultural traits can pose a barrier – the conservative nature of Japanese management has led them to hoard more cash than foreign investors would like them to. For years “gaijin” fund managers have asked Japanese companies to “sweat their balance sheets” and “optimise their capital structures” but the pace of change was glacial.
In recent years though, the dividends have been noticeably improving and during the latest results season, we noted a material increase in the number of share buybacks Japanese companies are conducting. The market now has a 2.5% dividend yield, supplemented by almost 1% of the market being bought back, meaning the total return yield of the market is close to 3.5%. Almost 200 companies have announced buybacks and the yen value of those buybacks is more than twice what is was two years ago. Indeed from January to April buybacks ran at +125% year-on-year.
It was not a surprise to see names like Toyota and NTT buying back stock, but even companies that have resisted such moves announced material buy backs, suggesting we are seeing more of a structural shift. Mitsubishi Estate is a case in point. Not only did it announce a surprise buyback, but it was material at almost 5% of shares outstanding. Perhaps the most interesting buy-back was from Sony, which had already announced a modest buyback of 1.5% earlier in the year. It felt compelled, however, to increase that to almost 5% in May, possibly spurred into action by a fear of activist shareholders.
Japan has many external and internal headwinds – slowing global growth and well documented trade wars offshore, coupled with demographic challenges at home, mean growth is tough to come by. But at least if companies make their balance sheets more efficient through dividends and buybacks, they will be able to influence their rates of return. We’d not say the market is fully healthy, but it’s nice to see the patient taking their pills!
Opinions and views from the Equities team at Kames Capital are not an investment recommendation, research or advice and should not be considered as such. Content discussing investment strategies and stocks is derived from and solely relates to the investment management activities of Kames Capital.
About the author
Robin Black is an investment manager within the global equities team. He has specific focus on Kames Japanese portfolios. Robin joined us from Macquarie Group, where he worked as global head of Pan-Asian sales in Hong Kong. He later returned to London, where he was tasked with establishing a global equity sales team. Prior to Macquarie, he worked for Deutsche Bank, Citigroup, Merrill Lynch and Martin Currie. Robin studied History and Economic History at the University of Aberdeen before obtaining an MSc in Project Analysis, Finance and Investment from the University of York. Additionally, he has an MSc in Investment Analysis from the University of Stirling. He has 24 years’ industry experience*. *As at 30 April 2019.