Record Cash Collides With Yen

Record Cash Collides With Yen as Topix Valuation Approaches Low
The Topix declined 1 percent last week to 726.44, the third straight loss, as concern about Europe’s debt crisis worsened after Moody’s Investors Service cut its credit rating outlook for Germany, the Netherlands and Luxembourg. Photographer: Tomohiro Ohsumi/Bloomberg

Japan’s stagnating stock market, its aging populace and the slowing global recovery are masking record cash in company accounts and equity valuations that are close to a 20-year low.

The 1,671 companies in the Topix Index, the country’s broadest measure of equity performance, had 105.2 trillion yen ($1.34 trillion), or 41 percent of their market value, according to the latest filings compiled by Bloomberg. Almost half have more cash than debt, a record. At the same time, the index’s 75 percent drop since 1989 pushed prices to 0.86 times book value, 4 percent from a two-decade low, data show.

For bulls, the combination makes Japanese shares irresistible as earnings rebound from last year’s earthquake and chief executive officers spend more on buybacks and dividends that have doubled since 2006. Bears say the country has been disappointing investors for the last 20 years and that rising cash shows managers are reluctant to invest as the yen appreciates and the recovery weakens.

“The price that a Japanese company sells for is significantly lower than the rest of the world,” said David Herro, the Chicago-based manager of the $8.5 billion Oakmark International Fund and Morningstar Inc.’s international fund manager of the decade. “What would really ignite the Japanese stock market is an acceleration of better capital allocation and a weakening in the yen. I think those are the only two factors preventing the Japanese from exploding on the upside.”

The Topix declined 1 percent last week to 726.44, the third straight loss, as concern about Europe’s debt crisis worsened after Moody’s Investors Service cut its credit rating outlook for Germany, the Netherlands and Luxembourg.

Safety Margin

The gauge’s 17 percent drop since March 27 has left it trading at almost half the valuation of the MSCI World Index relative to book value, or assets minus liabilities, data compiled by Bloomberg show. The Topix advanced 0.7 percent to 731.74 in Tokyo today.

Profits are forecast to rise 55 percent this year, rebounding after last year’s earthquake and nuclear disaster, and 12 percent in 2013, data compiled by Bloomberg show. Companies from JFE Holdings Inc. to Kewpie Corp. reported income this month that beat estimates, driving valuations lower. Mitsubishi Motors Corp. and Panasonic Corp. are among more than 660 companies reporting results this week.

Almost half of Topix companies have more cash than debt, the highest percentage of any developed-country index, according to data compiled by Bloomberg. In the U.S., fewer than 25 percent of Standard & Poor’s 500 Index companies have leverage so low, while less than 20 percent of the FTSE 100 Index has that much cash compared with debt, the data show.

Economic Growth

The Topix will rise 24 percent to 900 by the end of 2012, compared with an estimate of less than 1 percent for the S&P 500, according to strategist projections compiled by Bloomberg. Japan’s economy may grow 2.4 percent this year, more than every other developed economy, as it rebounds from last year’s natural disaster, the International Monetary Fund forecast this month.

Rising cash and lower valuations have prompted 217 companies in the index to announce they will buy back shares in 2012, after 396 in 2011, data compiled by Bloomberg show.

Dividend yields for companies in the Topix have exceeded those for the S&P 500 Index since September 2010, Bloomberg data show. The dividend ratio for Nikkei 225 Stock Average companies rose to 54 percent in 2011 from 26 percent in 2006, according to data compiled by Bloomberg.

Giving Back

Topix companies yield 2.6 percent while those on the U.S. equity benchmark offer 2.1 percent, the data show. Japan’s 10-year government bond yields 0.73 percent, compared with the U.S.’s 1.55 percent. The Bank of Japan scrapped this month a 0.1 percent yield floor for government bond purchases, opening the door to the possibility of negative yields on shorter-dated securities.

Companies are increasing payouts to lure older investors who need income greater than that offered by bonds, according to John Vail, chief global strategist at Nikko Asset Management Co., which manages $158 billion.

“It’s a gigantic structural shift that is very rarely noted in the world,” Tokyo-based Vail said in a phone interview. “It’s a conscious effort by companies to make their shares more attractive, especially to people who need income as the population ages. Barring a global disaster, we don’t see dividends falling in Japan. In fact, we see them increasing.”

When valuations were this low during the financial crisis of 2008, the Topix rallied 43 percent from March 2009 through April 2010. The record magnitude-9 earthquake and the ensuing disaster at the Fukushima Dai-Ichi nuclear plant in March 2011 all but erased those gains.

Bubble Legacy

The Topix is up less than 3 percent since global equity markets bottomed in March 2009, compared with 105 percent for the S&P 500 and 81 percent for the MSCI World Index of developed markets.

Stocks haven’t recovered since the bursting of the property market bubble in the early 1990s. More than a decade of deflation sent the Topix to 726.44 last week from 2,884.80 at its December 1989 peak. The yen has doubled in value against the U.S. dollar since then, eroding the competitiveness of exports and decreasing the value of overseas sales.

Valuations approaching record lows show investors don’t expect earnings to be sustainable as Europe’s debt crisis spreads and the Japanese population dwindles. Japan has about 2.4 working-age people for every person over 65 years old now, compared with 9.1 in 1965, according to research presented March 15 by Takehiko Nakao, the vice minister for international affairs.

Lagging Behind

Government debt will balloon next year to 223 percent of GDP, up from a projected 214 percent this year, “pushing Japan’s public finances further into uncharted territory,” the Paris-based Organization for Economic Co-operation and Development said in May. Debt may exceed 1 quadrillion yen, about $13 trillion, next year, the biggest in the world, the OECD said.

“The frustrating thing about Japan is the policy inaction,” said Sean Darby, chief global equity strategist Jefferies Group Inc. said in a phone interview. “Judging economies on relative growth isn’t going to work now for any fund manager. This is really about who has got loose enough monetary conditions to deal with a very, very bad deflation environment. On that score, Japan is lagging behind.”

Rising Cash

Investors should buy assets in U.S. dollars and other currencies of strong developed nations because Japan may default within five years, Takeshi Fujimaki, a former adviser to billionaire investor George Soros, said in an interview last month. Should the Japanese government default, the yen may weaken to 400-500 per dollar, and the yields on benchmark 10-year bonds could surge above 80 percent, according to Fujimaki, whose agreement with Soros ended in 2000.

None of that has stopped companies from increasing earnings. JFE Holdings’s price-to-book ratio declined to 0.4 2013 estimates after the stock tumbled 24 percent this year. Japan’s second-largest steelmaker more than doubled first-quarter profit and forecast full-year earnings will beat estimates.

Seven & I Holdings Co., the owner of the 7-Eleven convenience-store brand, increased cash for the past two quarters to 738.9 billion yen, 35 percent of the company’s market value, the most among the Topix companies that have reported earnings for the three months ended June 30. The shares advanced 16 percent this year after 2012 earnings expanded 16 percent.

‘Less Risky’

Kewpie’s cash reached a record 32.2 billion yen in the three months ending May 31. The mayonnaise maker reported quarterly earnings that exceeded analyst projections on July 2 after raising its first half net income forecast in June. The stock is up 5.6 percent this year and still trades at its 2013 book value estimate.

“Japanese companies have good balance sheets,” said Andrew Smithers, chairman of London-based advisory firm Smithers & Co. “Japan looks less risky as a market and the buybacks are a big part of that.”

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