A number of Japanese companies - and their shares - stand to benefit from a faster pace of corporate governance reform prompted by the global pandemic, the author of this article argues.
For some time, Japanese businesses have been shaken up by a set of corporate governance reforms. Less publicised than some of the other changes in recent years - fiscal and monetary expansion under former Prime Minister Shinzo Abe (“Abenomics”) - the changes have been a reason why several wealth managers are smiling on Japan.
One firm with an obvious Japanese insight is SuMi TRUST. Senior economist Naoya Oshikubo talks about how the global COVID-19 pandemic has further accelerated this process, and considers how this affects valuations of Japanese companies.
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COVID-19 has been grim news for the global economy but under the surface it has also made some companies more open to reforming traditional practices. This is especially true in Japan, a country that puts more stock in tradition than other developed nations. Japanese company profits hit a low in June 2020 but since then have risen strongly, partly as a result of a new found willingness to adapt and try new techniques. The impetus for reform comes both from shifting consumer expectations and a greater willingness in boardrooms to drive through change, even in the face of internal opposition.
Consumer attitudes are key to this shift. For example, prior to COVID-19, drop-off delivery was thought to represent a decline in the standard of service in Japan. During the pandemic, Japanese consumers, eager to minimise personal contact, became increasingly accepting of the practice. This change in attitude has been a huge benefit to the logistics industry, (which faces a serious labour shortage) greatly contributing to productivity and reducing costs at companies like Yamato Holdings and SG Holdings. The increase in remote working in the wake of COVID-19 has also reduced the number of redeliveries. The result is that logistics companies are able to cope with the headwinds of labour shortages much better.
Another productivity gain brought about by the pandemic is to be found in on-site visits. Before COVID-19, engineers based in Japan were expected to visit customer factories in Taiwan and China to install equipment. Due to the pandemic, instead local engineers and remote workers started to perform these tasks under remote supervision and this has brought about cost reductions as well as improvements in the skillsets of local staff for many businesses, such as Tokyo Electron, one of the world’s largest semiconductor manufacturers. Tokyo Electron's business performance is expected to reach a record high in FY2021 due to the contribution of such cost control measures in addition to the recovery of its core business.
Cultural changes among management and in the boardroom are also afoot, pushed by executives and senior management themselves as well as by the government. Japanese employees used to work in the office until late in the day because it was seen as a virtue and they were also required to use paper and stamps in day-to-day office processes, which was a big hindrance to remote working. However, during the pandemic Japanese companies had to change to survive.
Just as clients are willing to participate in remote meetings. so too are increasing numbers of executives and employees. Prime Minister Yoshihide Suga has also made digitalisation one of his key policies, and strongly backs ending the routine use of paper and stamps in order to boost productivity. As a result, remote working is now widespread, although still mostly in large companies. This shift to remote working has brought about a greater dependence on IT services for more everyday activities, which in turn is making it easier to unlock funds for system upgrades, increasingly cementing productivity gains, and benefiting the IT sector overall.
Automotive parts manufacturer Denso is a good example of one of the companies making the most of these trends. The company has switched to providing remote support for launching and maintaining overseas factories, and has also improved time efficiency through online meetings both for customer negotiations and internal meetings. Kansai Paint, one of Japan’s oldest paint manufacturers, has also used COVID-19 to shore up its business by making structural changes. Parts of its management team have long been pushing for reform but the pandemic gave them their opportunity and digitisation is now gathering pace at the company. In fact, its profit margin in India has improved by 2 per cent due to digitalisation, made possible to some degree because the company was able to abolish paper leaflets (for advertising purposes) in its retail business.
In other companies, the drive for reform created by the pandemic has allowed executives to take radical steps which they would normally have shied away from. An example of this is Shimadzu Corporation, a major measuring equipment manufacturing company, which has taken drastic measures and pulled out of its unprofitable aircraft-related business. The company has been highly profitable as a whole for some time, so beating a retreat from this poorly performing service line was always put off for another day. However, recently, its president made a top-down decision in order to restructure to pursue cost efficiency which led to leaving the loss-making aircraft business. It is unlikely that this would have happened without the widespread willingness to try new approaches that having to react to COVID-19 has imbued in corporate Japan.
The current wave of corporate reform does have other, more long-term causes. Institutional investors are exercising voting rights more actively and stepping up their stewardship activities. They are also putting pressure on companies to decrease cross-shareholdings for better corporate governance. This rise in shareholder activism, which was apparent before the pandemic, underpins some of the changes in corporate behaviour and should continue to have effects beyond the pandemic.
Nonetheless, investors can only do so much and it is very likely that the measures described above would have met strong resistance in more ordinary times. However, now that they have been implemented during these extraordinary times, they are here to stay. While the pandemic rages. the pace of long-term structural reform, much of it overdue, has picked up which makes this a good time for investors to take stock and select the companies set for success over the next decade.