There was so much to like about the 4Q survey that it takes a moment to appreciate why there's no substantial pick-up in capital expenditure – capex rose just 4% yoy in 4Q, which was significantly weaker than expected. Ironically, to a large extent it is Japan Inc's strengths that bar the way to any early rejuvenation of Japanese industry.
For the details show us just how corporate Japan is doing what it does best: securing margins, and using the cashflow to pay down debts even at a time when topline growth is insufficient to allow a rise in asset turns. What this playbook emphatically does not include is any sudden rise in capital stock, or any one-off rise in workers' compensation. The message from corporate Japan, rather, is this: topline growth will have to be seen and sustained before the working practices learned in such a hard school since 1990 are revised.
First, consider the good news: sales grew 3.8% yoy (though fell 0.5% on a 12ma basis), but operating profits jumped 28.5% yoy and 16.1% on a 12ma. Return on assets rose to 4% annualized, which was the best quarter since 1Q08, and the 12ma of 3.55% was the best since 3Q08. Similarly, ROE rose to 11% annualized, the best since 2Q08, and the 12ma of 9.8% was the best since 3Q08.
What's driving those profits are operating margins, which rose to 4.09% in 4Q, the best since 1Q07, with the 12ma rising to 3.76%, the best since 3Q07. OP margins rose 0.5pps qoq, with the gain being generated almost equally by a 0.2pp fall in cost of goods sold/sales and a 0.3pp fall in SG&A. Better still, the fall in SG&A/sales comes from ex-labour expenses, ie, falling management and admin costs.
But the usual suspects continue to offset the gains made by expanding margins. Financial leverage (total assets/equity) rose to 2.77x in 4Q, leaving the 12m unchanged at the record low of 2.77x. Net debt/equity ratio fell to 59.3% in 4Q from 60.4% in 3Q – another new low. And although 4Q asset turns (sales/total assets) rose to 0.97, this was best since 1Q12 only, and the 12ma of 0.943 was unchanged, again at a record low.
And that's the problem right there – asset turns are not yet improving, and until they do, there is little ROE incentive to add capacity. In fact, cashflow for calendar 2013 was down 25% yoy, even though 4Q was a sharp and positive reversal from the cashflow drain of 4Q2012. For the year, cashflow was only 3.2% of sales, which is not impressive for Japan – the long relationship is 3.9% of sales. That, and the fact that asset turns are still at historic lows, helps explain why capex is so low – up just 4% yoy, which means, for calendar 2013, investment is only just enough to cover the depreciation claimed! What we have, is stasis still, not expansion.
There is a second problem too: the good margins work is not yet being passed on to the staff. In fact, the number employed fell 2.9% yoy in 4Q. In addition, and compensation per employee fell 0.5% yoy in 4Q whilst sales per employee rose 2.3% yoy. Sales as a multiple of employee expenses consequently rose, to 7.77x, the highest since 4Q10. The problem is that on a 12m basis, that ratio is the highest only since 1Q13! In other words, as far as Japanese management is concerned, what's going on is simply a recouping of the margins previously sacrificed to labour in the immediate aftermath of the disasters of 2011. And there's no reason to believe the process is complete, or to expect an outbreak of corporate largesse.
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