Since Shinzo Abe came to power a second time in Japan in 2012, institutional investors have focused on whether Abenomics — the Prime Minister’s grand plan to restore economic growth to Japan through monetary, fiscal and structural reform — will continue to boost corporate earnings. Most have given less thought to a vitally important issue for investors: How much of corporate earnings will be returned to shareholders through dividends and share buybacks?
“The key message from Tokyo is that there will be increasing corporate interest in the issue of returns for shareholders,” says Seiji Kawazoe, a Tokyo-based governance specialist at Sumitomo Mitsui Trust Bank, the Japanese investment manager with assets under management of $474 billion. “Higher returns on equity will mean higher dividends and more share buybacks. That will be very good news for investors in Japan.”
The mounting interest among management in boosting returns on equity, largely through dividends, is driven in part by fear. In the early 2000s average dividend payout ratios, the ratio of dividend per share to earnings per share, fell below 20 percent, notes John Vail, chief global strategist at $158 billion Nikko Asset Management in Tokyo. That was before the arrival of activist investors, such as the U.S.-based Steel Partners, which campaigned aggressively for the return of more cash to shareholders. “Japanese companies responded in two ways,” says Vail. “Many put in poison pill defenses, but even more started boosting dividends dramatically.” He notes that after falling back, from 2008 to 2011, because of the credit crunch and the financial effects of the tsunami, dividends have again begun to rise sharply as many companies reduce their huge cash piles—estimated in total by Sumitomo Mitsui Trust Bank at ¥300 trillion ($2.96 trillion).
Dividends per share for companies in the Japanese TOPIX share index have risen by 15 percent over the past year, compared with just 9 percent for the S&P 500. Japanese dividend yields, based on estimates for the year to March 2015, are at 1.9 percent.
Nikko AM’s Vail predicts 15 percent annual growth in Japanese dividends over the next five years—taking the dividend payout ratio from 27 percent to 37 percent and almost doubling the dividend’s value. Within the next ten years, Vail expects the ratio to rise to 50 percent—a level typical in Europe. “The rise in dividends is likely to be the defining factor for the Japanese market over the next five or ten years,” he says. “When people look back and say, ‘What drove the market so much?’ they will credit the fast rise in dividends.”
The January creation of the high-profile JPX-Nikkei Index 400 is evidence that the growth of a shareholder culture is starting to generate its own momentum. The Tokyo Stock Exchange, which developed the Nikkei 400, has responded to investor priorities by screening out companies with a low return on equity, which has resulted in some high-profile cases of corporate humiliation. Kawazoe of Sumitomo Mitsui Trust cites the case of manufacturing company Mitsubishi Heavy Industries. Three years ago its return on equity was a paltry 2 percent. However, it responded to its exclusion from the index by overhauling its structure to boost return on equity — largely by integrating the business more deeply to allow it to respond more rapidly to opportunities. Its return on equity is now around 8 percent, says Kawazoe. The company’s share price has more than doubled over the past two years, to ¥649.
Ruth Nash, London-based co–fund manager of JO Hambro Capital Management’s Japan Dividend Growth Fund, with £13.7 billion in assets under management, agrees that the arrival of the Nikkei 400 is playing a major role in changing shareholder culture. The fund was launched in March to take advantage of the dividend and share buyback opportunities arising from the much greater emphasis on the shareholder. “In Japan everyone wants to belong to the club and to be seen as one of the top players in the field,” says Nash. Exclusion from the Nikkei 400 club is, therefore, a big issue for management. She also attributes the growth in shareholder culture to the progressive unwinding of Japan’s cross-shareholding system, in which companies with historical connections hold large stakes in one another. This has created, in some cases, a notoriously lax approach to shareholder return.
The Japan Dividend Growth Fund has invested in Asahi Group Holdings, the brewer. Although it only yields 1.4 percent, Asahi is on a mission to boost its share price to generate capital for overseas mergers and acquisitions. As part of this policy, the company increased its dividend last year and is planning to buy back 4 percent of outstanding shares. Shares in the stock are up 19.5 percent on the year, at ¥3,255.
Nash thinks Japanese-listed companies’ operating profit will grow by about 10 percent in the year to March 2015, boosted by the continuing success of Abenomics, and that dividend growth of 15 percent could well be achieved.
The growth of a shareholder culture would not be possible without confidence among businesses that the economy will continue to improve — because if they do not expect improvement, they will be reluctant to reduce cash reserves. Many investors believe that confidence will keep growing because of Japan’s increasing political stability, with Abe strengthening his position because of the success of Abenomics. Genzo Kimura, Tokyo-based economist at Sumitomo Mitsui Trust, says businesses are working on the assumption that next year he will secure a second three-year term as head of the ruling Liberal Democratic Party, allowing him to remain as premier until 2018. “Companies think the political situation is very stable, so they can make midterm plans and invest,” he concludes.
There is another reason for Japanese companies to reduce their cash piles: the return of inflation. During the deflationary era, falling prices boosted the real value of money sitting in the bank. Now that inflation has returned, the real value of cash is falling. The first arrow of Abenomics — the expansion of the money supply to end deflation — has hit its target, and shareholders are beginning to enjoy more indirect benefits.
