Meeting high expectations

  • 10 Dec 2004
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Are there clear signals about the direction Japanese equities will take, or are there too many mixed signals? EuroWeek asked leading Japanese equity fund managers for their views. The participants included:

Yuichi Murao
Senior portfolio manager, Japan equity at Nomura Asset Management, Tokyo

Tony Roberts
Fund manager, Japanese equities, Invesco, Henley, England

Andrew Rose
Head of Japanese equity, Schroder Investment Management (Japan) Ltd, Tokyo

Robert Rowland
Manager, Fidelity Funds Japan Fund, Tokyo

Shigeki Sakaki
Head of economic research, Japanese equity at Nomura Asset Management, Tokyo

Naohiko Sasaki
Executive officer in charge of equity fund management department, portfolio management department and alternative invest management department, Kokusai Asset Management, Tokyo

In 2004 what has been your strategy in the Japanese equity market and what is your outlook for the next six to 12 months?
Tony Roberts, Invesco: Our strategy has been very defensive. While restructuring at Japanese companies has helped earnings grow, the economic cycle remains the key determinant of profits.

The cycle is mature and remains vulnerable to any drop in external demand. Valuations in much of the market do not reflect this ? we remain defensively positioned.

Andrew Rose, Schroder: In broad terms we have been overweight in better quality large cap firms and small cap deep value situations.

While individual names may change we think there is further to go in this strategy and accordingly do not currently envisage significant change to this broad positioning.

Robert Rowland, Fidelity: Regardless of the market environment, we always employ a bottom-up stock picking strategy based on in-depth analysis of corporate fundamentals.

We focus on companies that are capable of creating value by increasing free cash-flow and raising returns on assets and invested capital.

It is possible that Japanese share prices could face further periods of volatility, due to uncertainty about the outlook for the global economy during the second half of 2004.

However, once investors refocus on Japan's improving corporate fundamentals (strong earnings growth across a broad range of sectors and historically low valuations), the downside for the major equity indices is likely to be limited.

Shigeki Sakaki, Nomura Asset Management: At the beginning of this year we expected a recovery in corporate profits. These have risen slightly higher than our initial view and, with growth of around 25%, have grown above the analysts' and brokers' expectation of 15%-20%. But the performance of the stock market on the whole has been disappointing for us, compared to the strength of corporate performance, although one of the reasons for this may be the high oil price.

In the next six to 12 months, we expect the stock market to go up a little or move sideways. But if oil prices fall and global economic prospects improve, the market could look brighter.

Naohiko Sasaki, Kokusai Asset Management: Our strategy is to buy on the dips, especially the companies which seem to offer a high potential for meeting our performance targets and where the stock prices seem to undervalue the company. Our outlook is for the market to edge higher mainly due to the advance of management innovation at corporate Japan and expectations that Japan will break out of the deflationary spiral.

What is your outlook for corporate profits and therefore how do valuations in Japan compare to the major overseas markets of the US and UK?
Invesco: We expect corporate profit forecasts to be revised down over the next few months. Given this and the low return on equity, Japan is a relatively unattractive market.

Schroder: The profits outlook remains encouraging with underlying growth in excess of 10% possible for this year and next.

This leaves Japan trading on a P/E multiple in the mid-teens, which compares favourably with long term history. International valuation comparisons are broadly favourable, more so versus the US than the UK.

Free cashflow yields for the three markets are broadly comparable but with Japan having the lowest dividend yield, suggesting there is greater scope to benefit in Japan if recent signs are sustained that more of this free cashflow generation will be used to reward shareholders.

Fidelity: Corporate fundamentals continue to improve, as demonstrated by firms' historically low break-even ratios, rising profit margins and their elimination of excess debt. Valuations of Japanese shares are looking increasingly attractive, with the current P/E ratio standing at around 17 times, the lowest level in 30 years.

Nomura (Sakaki): We expect corporate profits to continue to increase, but at a slightly slower speed ? around 10% on a year-on-year basis. Japan is slightly cheaper than the US or UK markets, which may be slightly overvalued.

Europe is about right, but there is not much difference between the performances of the major markets and I expect that to continue.

Kokusai: Profits will increase in 2004 and 2005, but the growth rate will be lower. Compared with the US and UK, Japanese companies have a higher likelihood of meeting their performance expectations and therefore the market seems to be relatively cheap.

What sectors are you overweight or underweight and why?
We choose to invest in companies with stable earnings and low valuations. This has led to overweight positions in pharmaceuticals, utilities and railways. Given our current view of the cycle, we are underweight cyclicals such as steels and chemicals. We also have no exposure to banks.

Schroder: Our approach is bottom-up but looking at the sector exposure we are overweight trading companies, land transport, pharmaceuticals, the car sector and electronics.

Fidelity: As of the end of July 2004, the largest three sector overweights in the Fidelity Funds Japan Fund were transport equipment, electrical appliances, and glass/ceramics.

The largest three sectors we were underweight were electric power and gas, pharmaceuticals, and IT and telcos.

Nomura (Murao): Given that the major driver of the Japanese economic recovery has been the export sector, we structure our portfolio to benefit from overseas growth, investing in names with global operations.

Kokusai: We are bullish on steel, trading companies, marine transport and automotive. We see rises in goods and services prices, economic growth in developing countries and increase in the global sales of Japanese car makers, which are relatively attractive in terms of valuation.

What are the key factors you are watching for that will affect your view of the market in the next six to 12 months?

Invesco: The current cycle is being driven by external demand so the key factors to watch will be demand from America and Asia, especially China.

Schroder: There are three that stand out. First whether the economy, which has probably peaked in terms of rate of growth, settles into a trend rate of expansion. Secondly, whether deflation finally ends with the consequent knock on effects on monetary policy. Thirdly, whether micro reform is sustained and in particular whether improved shareholder awareness among listed Japanese firms continues and broadens.

Fidelity: Our prime concern is the sustainability of corporate earnings into the financial year ending March 2006. Factors that might affect corporate earnings should vary company by company.

However, in general terms we are looking for confidence in China's soft landing scenario, sustained economic growth in the US, final resolution of banks' non-performing loans and further reductions in idle corporate assets so that companies can improve their asset turnover.

Nomura (Sakaki): Oil is a very big factor. Our major export markets are China and the US, so the strength of their economies is very important. Domestically, capital expenditure has recovered, but is still much lower than cashflow.

We do not expect a big jump, but with a two to three year horizon, there is a chance it will rise more sharply.

Will Japan register and maintain domestic economic growth, or will the near term future of the stock market continue to be determined by corporate restructuring and the volatile world economy?
Invesco: The world economy (especially the US) will be key. Interest rate rises in the US will hold back consumption growth from an already heavily indebted consumer.

There is also less room for fiscal measures, such as tax incentives, to boost the US economy. In addition, fixed asset investment in China, which has helped many Japanese companies, reached unsustainable high levels. Profit margins and growth rates are likely to deteriorate here.

Schroder: Some recent economic data has disappointed expectations but on balance we expect the economy to grow at close to its trend rate of 2%-3% in real terms and at a somewhat slower rate in nominal terms in the next 12-18 months.

The key remains the consumer, with recent data sending out conflicting signals of improving consumer confidence but little support from income growth. Against this background, developments at the corporate level will continue to be important in determining stock market returns.

Fidelity: Although a number of leading indicators have softened, Japan's economy appears set for a period of slower growth rather than a recession. Any loss of momentum in the external environment will of course curb Japanese exports. However, developments at the micro level warrant optimism. 

Nomura (Sakaki): If exports are strong then capital expenditure will be strong so there will be external demand still driving the domestic economy.

We still expect to see growth, but more slowly than before. Exports to China have risen sharply ? last year they grew around 30%. This year they have slowed to 15% growth, but that is still a very high rate.

Kokusai: Increasingly strong moves are afoot for the Japanese economy to be on a self-sustaining recovery track due to widespread promotion of structural adjustments of the Japanese economy. This trend will continue though it will be affected by global economic volatility in the short term.

What is your view of the bank sector restructuring and how it will affect bank profitability and the broader economy?
Banks have made more progress in dealing with their balance sheets' bad loans.

However, loan growth remains negative and we are not seeing improvement in banks' lending margins. It is hard to see significant benefits to the broader economy.

Schroder: The large banks have made significant progress in reducing bad loan exposure and have also benefited from rising equity prices. So far, restructuring has led to little progress in terms of pre-provision operating performance with loan volumes continuing to shrink and asset margins showing few, if any, signs of improvement. The improvement in bank balance sheets should eventually lead to greater traction in monetary policy, lack of which has been a major structural impediment to the economy, but for the time being corporate Japan is cash generative in aggregate and not a net borrower as a result.

Fidelity: We feel that the banking sector as a whole is moving in the right direction. As the final disposal of bank non-performing loans (NPLs) is one of the prerequisites of the Japanese economy to break out of deflation, we expect that further industry consolidation in the banking sector should accelerate the NPL workout process.

Nomura (Sakaki): The major banks have written off huge amounts of NPLs and their operating profitability is reasonably good. Once they have taken the losses, their profitability should approach normal conditions, unless any hidden bad loans come out. In the case of smaller financial institutions, they might have to write off more NPLs and regional banks certainly need to make a greater effort.

Kokusai:  Elimination of NPLs is in the final stage, and final disposals nearly complete. This will have a favourable impact on entire economy. Banks continue to advance restructuring and consolidation, which will help to enhance profitability.

Corporate Japan has in recent years restructured, reorganised and radically improved its balance sheet and cashflows. Are companies now doing enough to expand, or should they be returning more cash to shareholders?
Dividends are rising, but it is sad to see that the dividend payout ratio is actually falling. Many companies have been buying back shares in recent years and holding it as treasury stock. However, getting companies to cancel this stock is far more difficult. Unwinding of cross-shareholdings in Japan should lead to more shareholder-friendly management but progress remains slow.

Schroder: The two objectives need not be mutually exclusive. There are examples (including major companies) where the scale of liquidity that has built up on the balance sheet and of cashflow generation is such that it is possible to grow the business and return more to shareholders. Indeed this needs to happen if the degree of balance sheet inefficiency at these companies is not to worsen further. What is required is a long term strategy that defines and justifies how shareholder reward will be determined. This is becoming more common but there is still quite a lot further to go.

Fidelity: Currently improvements in corporate earnings and cashflow point towards healthy growth in capital expenditure. Also, a number of companies are executing share buybacks and increasing the dividend payout ratio. 

Nomura (Sakaki): So far, companies have been paying back debt. Now some companies are investing money, some are buying back shares, but dividend yields are still low in Japan generally. Share buybacks are more likely.

Kokusai: They should invest in businesses with growth potential.

On the other hand, mature companies should return money to stockholders through company stock buybacks or increasing dividends. 

  • 10 Dec 2004

All International Bonds

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Citi 71,795.24 248 8.65%
2 JPMorgan 59,685.75 255 7.19%
3 Bank of America Merrill Lynch 52,401.35 173 6.31%
4 Barclays 50,153.02 148 6.04%
5 Deutsche Bank 44,937.03 167 5.41%

Bookrunners of All Syndicated Loans EMEA

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Deutsche Bank 9,857.42 14 13.05%
2 SG Corporate & Investment Banking 7,833.35 12 10.37%
3 Goldman Sachs 5,773.27 11 7.65%
4 Citi 4,606.54 14 6.10%
5 BNP Paribas 4,132.76 19 5.47%

Bookrunners of all EMEA ECM Issuance

Rank Lead Manager Amount $m No of issues Share %
  • Last updated
  • Today
1 Goldman Sachs 2,546.04 12 11.21%
2 JPMorgan 1,732.54 10 7.63%
3 Credit Suisse 1,727.84 7 7.61%
4 Deutsche Bank 1,465.10 11 6.45%
5 Citi 1,285.41 7 5.66%