Japanese businesses left behind this year as global equities rallied to a record found a winning strategy in buying back shares the rest of the world preferred to avoid.
Companies in the Topix index are acquiring their own stock at the fastest pace ever, led by NTT Docomo Inc. and Toyota Motor Corp., with $25 billion of announced purchases so far this year, data compiled by Bloomberg show. The buybacks are limiting losses in the world’s worst-performing developed equity market: Companies using the strategy have gained even as the Topix slid.
The combination of record cash, cheap shares and a government-led drive to buoy return on equity is making buybacks irresistible to Japanese executives at a time when the MSCI All-Country World Index is trading at unprecedented highs. Mitsubishi Corp. rose 6.2 percent this year through last week, compared with the Topix’s 2.6 percent drop. Japan’s biggest trading company said on May 8 it would buy back as much as 60 billion yen ($589 million) of shares, the most in seven years.
“It’s a pretty big sea change,” said Kieran Calder, head of equities for Asia at Coutts & Co., which manages about 28.5 billion pounds ($48.6 billion). “Corporate mindsets are definitely changing,” he said. “It makes Japan more of a normal market.”
The Topix rose 2 percent last week and fell 0.1 percent today. The Japanese measure dropped as much as 13 percent this year amid growing doubt Prime Minister Shinzo Abe will make good on promises for reforms from loosening labor laws to reducing government support for farmers. The index is down this year after a world-beating 51 percent jump in 2013.
Foreign investors, which account for about 60 percent of market turnover, reduced holdings of Japanese shares in all but one month this year just as buybacks surged. Companies that announced purchases worth more than $100 million this year climbed an average 4.1 percent in 2014 through June 20.
“Share buybacks have the effect of supporting the market when it’s weak,” Daiwa Securities Group Inc. quantitative analyst Masahiro Suzuki wrote in a report on June 10. “Return to shareholders is a big theme.”
Companies’ purchases of their own equity can be seen as a vote of confidence by executives that their stock has room to rise. The buybacks can also suggest a company has run out of things to spend money on, curbing its growth potential.
While gross domestic product expanded 6.7 percent in the first quarter, it’s forecast to contract 4.4 percent in the second, reflecting buying before a tax increase. Japan’s exports fell in May for the first time in 15 months on weak demand from the U.S. and Asia.
Even if buybacks continue, companies need to increase investments at a faster pace, according to Coutts’ Calder, a harder choice compared to improving return on equity with share repurchases in the short term. The amount of cash they hold means companies should able to afford both buybacks and capital investments, he said.
While businesses have boosted capital spending for three straight quarters, their investments in the period ended March remained 31 percent below a 2007 peak, Finance Ministry data show.
“Buybacks only result in raising ROE and share prices, so their effect on Japan’s economy is indirect,” said Masaru Hamasaki, a Tokyo-based senior strategist at Sumitomo Mitsui Asset Management Co. “Capital investment directly boosts the economy, so I think for now, they should invest more money there.”
Since the start of January, 152 companies on the Topix announced buybacks worth 2.5 trillion yen, data compiled by Bloomberg show. The previous high for an entire year was 1.5 trillion yen in 2008. Companies unveiled an average 567 billion yen in annual buybacks over the decade through 2013, the data show.
The change of heart by Japanese executives is already helping to boost return on equity, which measures profit against shareholders’ capital and had been among the worst in the developed world.
Topix companies earned an 8.6 percent return in the year through last quarter, the most since the 12 months ended March 2008. The 10-year average ROE at Japanese firms through 2013 was 6.2 percent, the second-lowest of 24 developed markets tracked by Bloomberg and less than half the level for the S&P 500.
“The government recognizes that in order to resuscitate Japan’s economy, there needs to be a cycle where corporations profit, then return those profits to the public,” said Hisashi Kuroda, the head of Japanese equities and chief portfolio manager at Meiji Yasuda Asset Management Co. “Even if public finances are used to help companies make more money, it’ll be negative for the economy if the firms just stockpile the cash.”
Non-financial firms’ holdings of cash and deposits rose to a record 232 trillion yen at the end of March, BOJ data show.
Earnings by Topix companies swelled 69 percent last year as unprecedented central bank stimulus drove down the yen, boosting exporters’ profits. That added to balances built by executives to shield their companies amid more than a decade of deflation and economic malaise.
For those executives contemplating share repurchases, valuations are attractive. The Topix trades at 1.2 times the value of its net assets, the lowest multiple among the world’s 10 biggest share markets. About half the gauge’s 1,806 members are priced at less than their book value.
“Companies are increasing buybacks at an incredible pace,” said Tomohiro Okawa, a Japan equity strategist at UBS AG in Tokyo. “They have excess cash and they’re feeling the pressure from the government to spend it.”
Other types of returns to shareholders are also on the rise. Estimated annual dividends per share for the Topix climbed to 24.4 yen last week, close to the highest since 2008. The higher payouts haven’t curbed capital investment, which increased 7.4 percent in the first quarter from a year earlier, the biggest jump since 2012.
Toyota plans 500 billion yen in domestic capital expenditures this year, the most since 2008, the Nikkei newspaper reported June 2. Mitsui & Co., the No. 2, raised its dividend payout ratio to a six-year high of 30 percent on May 7.
“We wanted to send out a message that management is very much concerned with returns on equity,” Mitsubishi Chief Executive Officer Ken Kobayashi told reporters in Tokyo on May 8 after unveiling the 60 billion-yen buyback. The stock jumped 18 percent from the announcement through last week.
The government’s tactics for altering executives’ behavior include helping to create a stock index that rewards companies generating the highest return on equity with investments from the 128.6 trillion yen Government Pension Investment Fund. About 130 institutions have adopted a new code to increase engagement with companies in which they own shares, and Abe wants to improve corporate governance standards.
NTT Docomo, which announced Japan’s biggest buyback by value this year on April 25, said it will spend as much as 500 billion yen. The Tokyo-based phone company’s shares, which had fallen as much as 11 percent this year, erased their annual loss after the announcement.
Toyota, the Toyota City, Japan-based automaker, held 4.3 trillion yen in cash, equivalents and short-term investments last quarter. It said March 26 it plans to buy back 360 billion yen of stock, its first such purchase in five years. Japan’s biggest company rallied 7.3 percent from then through June 20.
Brokerages are touting stock-picking based on who’s next to buy back shares.
Societe Generale SA says investors should seek out cash-rich companies with low leverage and valuations. Top picks include regional lender Tottori Bank Ltd. (8383) and homebuilder Mitsui Home Co., analysts led by Vivek Misra wrote in a June 4 report.
“Many investors don’t realize that corporate Japan is changing,” said Meiji Yasuda Asset Management’s Kuroda. “This is enough to boost Japanese shares and the market has a lot further to rise.”
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