Japan is home to many profitable companies that have significant levels of cash on their balance sheets but which have been relatively poor historically at distributing profits to shareholders. With this in mind, Ben Lofthouse, portfolio manager in the Global Equity Income Team, investigates the potential for dividend growth from the world’s third largest economy.
Dividends from Japanese companies grew rapidly in 2015 in local currency terms and the recent strengthening of the Japanese yen – which additionally boosts returns for overseas holders of Japanese assets – has provided a further fillip. Dividend growth in the first quarter of 2016 compared with the same period a year earlier was 21.1% in headline terms1 (10.5% underlying), according to the latest data available from the quarterly Henderson Global Dividend Index (HGDI). The HGDI is a long-term study into global dividend trends from the world’s largest 1,200 firms by market capitalisation, based in US dollars.
1Headline dividends reflect the total sum of payouts received within the HGDI in US dollar terms. Underlying dividends are adjusted for special dividends, changes in currencies, timing effects and index changes.
Source: Henderson Global Investors as at 31 March 2016. Index level measures the progress firms are making in paying dividends, using 2009 as a base year with a value of 100, calculated in US dollars. Figures relate to headline dividends.
While the recent pick-up in dividend growth in Japan is encouraging, comparisons with other developed markets can be revealing. Return on equity (RoE), for example, which measures how efficient businesses are at generating earnings from shareholders’ capital has been frustratingly low. In 2015, for instance, RoE in Japan was 8.7%, according to Citi Research, well below the US (16.4%), UK (13.2%), Australia (12.3%) and Europe ex-UK (11.4%).
Japan also has a history of cross-shareholdings (interlocking share ownership) between Japanese companies dating back to just after World War II, with banks among the biggest shareholders. The Tokyo Stock Exchange defines cross-shareholdings as ‘listed companies holding the shares of other listed companies for reasons other than pure investment purposes, for example, to strengthen business relationships’. Cross-ownership has led to the creation of conglomerate-style corporations where core businesses are often diluted. It has also led to interdependence of share prices that might otherwise have been uncorrelated.
Shareholder value could clearly be created through corporate efficiencies. One means of doing this could be through improved company board independence. At present, Japanese firms typically have less than 10% of their boards made up of outside independent directors according to ISS/Macquarie research. In contrast, US, German, Swiss and Australian companies, for example, typically have 50% or more independent board members.
In addition, many Japanese companies have had fixed dividend payout ratios based on a fixed percentage of their earnings. This has led to volatility in dividend payments as earnings have fluctuated.
Despite these issues, overseas share ownership of Japanese companies has increased in recent years from 4% in 1987 to around 31% in 2015 according to Bank of Japan / Macquarie Research.
In June 2015 ‘Japan’s Corporate Governance Code’ was introduced as part of Prime Minister Shinzo Abe’s ‘third arrow’ in an attempt to boost the economy and drive shareholder-friendly corporate governance reform.
One of the code’s main objectives is to promote transparent, fair, timely and effective decision-making by Japanese businesses. Companies are encouraged to appoint at least two independent directors, disclose cross-shareholdings and examine the rationale for major cross-ownership on an annual basis.
We are seeing some more opportunities for Japan, with companies announcing better dividend payments. Having said that, the market only yields around 2% at present, and with only 10.7% of the Japanese market expected to yield more than 3% looking ahead 12 months, it is proving challenging to find companies with an attractive dividend yield2. At present, Henderson International Income Trust only has limited exposure to Japan but as the reforms take hold and the dividend culture becomes more embedded we would expect to see more opportunities to invest in Japanese companies that meet our investment criteria.
2Source: Thomson Reuters Datastream, MSCI Japan Index, at 30 June 2016.