Japan Stock-Index Reject Seeks Inclusion With 100% PayoutTom Redmond and Toshiro Hasegawa
In Japan, a new stock index designed to shame executives into boosting returns is showing early signs of working.
Amada Co., a company left out of the JPX-Nikkei Index 400 when the gauge started this year, pledged last month to pay out about half its profit in dividends and spend the other half on stock buybacks. Shares of the almost 70-year-old maker of metalworking machines surged and inquiries from foreign investors flooded in, according to Senior Managing Director Tsutomu Isobe.
Amada was one of 74 firms on the Nikkei 225 Stock Average 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.
“I wasn’t too surprised when I heard we hadn’t made it because I knew how low our ROE was, but our president was a little shocked,” Isobe, who oversees Amada’s finance department, said in a phone interview from Kanagawa prefecture on June 6. “We’ve had lots of requests from foreign investors for one-to-one meetings in Japan since our announcement. It’s pretty much doubled from last year.”
Amada climbed 2.7 percent to 1,030 yen in Tokyo, its highest close in more than six years. The Topix index and the JPX-Nikkei 400 both advanced 0.8 percent.
Prime Minister Shinzo Abe is overhauling Japan’s corporate governance standards and putting pressure on companies to deliver higher returns to shareholders as he seeks to make the nation’s economic recovery sustainable. The JPX-Nikkei 400 was the brainchild of the bourse and officials in Abe’s Liberal Democratic Party. It slipped 4.1 percent this year, compared with a 7.5 percent drop for the Nikkei 225.
Indexes matter because institutional investors as well as government bodies buy stocks they include in order to tie returns to the success of a broad swathe of the economy. The buying can increase the value of those companies, allowing them to raise more capital for expansion.
The 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. A review of the index’s members is due in August.
ROE for Amada, which measures the company’s profit as a share of the equity contributed by shareholders, was 3.1 percent at the end of March, compared with 9.4 percent for the 124 members of the Topix Machinery Index, according to data compiled by Bloomberg. The JPX-Nikkei 400 posted ROE of 9.1 percent through March.
Amada is among Japanese companies whose returns are weighed down by cash hoards. Handing money back to investors through dividends and buybacks improves the return on each yen of remaining equity. Amada held more than $1 billion in cash and equivalents at the end of March, with shareholders’ capital funding 75 percent of the company’s assets, Bloomberg-compiled data show. Its debt-to-equity ratio stood at 8.1 percent, compared with 108 percent for the Standard & Poor’s 500 Index.
The JPX-Nikkei 400 was created to help boost equity returns that have been among the lowest in the developed world. ROE at Topix companies in the 10 years through 2013 averaged 6 percent, beating only Greece’s ASE Index out of 24 developed markets tracked by Bloomberg. Companies in the S&P 500 delivered 13.6 percent, while the MSCI World Index’s average ROE was 12.6 percent, the data show.
Amada’s low ROE has been reflected in its share price. In the 10 years through March 31, the company rose 8.4 percent while the Topix machinery gauge surged 71 percent. That’s reversed since the new capital policy was announced May 15, with Amada’s shares surging 33 percent, compared with gains of 7.9 percent for the Topix Machinery Index and 4.7 percent for the Topix.
The buybacks aim to please institutional investors while the higher dividends are for attracting individuals to the stock, Isobe said. About 70 percent of Amada’s shareholders are institutions, including a small number of foreigners owning 46 percent of the company, with individuals holding just 12 percent, he said.
“Foreign investors request better capital efficiency, share buybacks and so forth,” Isobe said. “Individuals tend to vote with the company at annual general meetings and be stable shareholders.”
Getting picked for the new gauge is important for accessing Japan’s pension money, according to Isobe. GPIF adopted the JPX-Nikkei 400 as an equity benchmark in April, cutting passive investments in the broader Topix to make room. Investment trusts tracking the index have pulled in another 101 billion yen, Nomura Holdings Inc. wrote in a June 9 report.
JPX-Nikkei 400 members are chosen based on return on equity and cumulative operating profit, which each account for 40 percent of the selection criteria. Market value makes up the remaining 20 percent. Companies that don’t meet corporate-governance criteria may be replaced.
By spending all of its profit on dividends or buybacks for the next two years, Amada hopes to be picked for the index when it conducts its annual revamp of members in the summer of 2016.
The new capital policy should increase ROE to about 7 percent, Isobe said. The company wants to lift the number of outside directors to two, he said.
These steps and a rising market capitalization would put Amada at around 300th in Japan under the JPX-Nikkei 400 criteria as of March 2016, up from 621st at the end of the last fiscal year, according to Isobe. That assumes other companies stay at present levels, he said.
While some of Amada’s listed competitors have questioned whether the company has gone too far, the move isn’t is drastic as it first appears, Isobe said. Amada has no pressing need to construct new buildings or open new branches around the world, he said, and the pledge can be reconsidered after two years.
“The policy won’t reduce what we have now,” he said, referring to the company’s internal reserves. “It just means it won’t increase.”
Isobe welcomes the new equity gauge even as he also expresses concern about it, saying it may make companies become more short-sighted in their approach.
“It favors borrowings over equity, and westernizing everything can be detrimental,” he said. Many of “Japan’s corporations have over 100 years of history. In some senses that’s not a bad thing, like for passing along traditional ways of doing things.”
Whatever the worries about the gauge’s impact, Isobe says Amada must change with the times.
“Companies today have to think not only of growth strategies but also capital efficiency and corporate governance,” he said. “They have to strike a balance between the three.”