Corporate Japan Unfazed, Unmoved in 3Q

Japan's quarterly survey of private sector p&ls and balance sheets is usually more revealing than the GDP estimates.  After all, these allow us to pick apart just how corporate Japan is making money, and what it's then doing with the money it's making. The short answer is that despite the pressure on topline revenues during the last six months, operating margins continued to rise, thanks to gains in employee sales easily employee costs. Those sustained margins mean cashflow remains strong, up 56% yoy in 3Q and up 64.1% on a 12m basis. But there's still no significant appetite to re-invest that cash: investment in plant and equipment rose only 5.5% yoy, equivalent to only 77% of cashflow during the last 12 months. Moreover, that investment once again only just covered the depreciation expenses claimed.

Good News First: Margins Survive Sales rose 2.9% yoy against a fairly easy base of comparison, with the quarterly result just as disappointing in 3Q as in 2Q: in other words, the topline continued to suffer from the after effects of the sales tax rise.  Still, operating profits rose 3.8% yoy, which pushed up the 12m OPM to 4.07%, the highest since the immediate aftermath of the Bubble in 1991.  

How has that rise in 12m margins been achieved, and is it sustainable? For the quarter, the cost of goods ratio rose 0.8pps to 78% in 3Q, and rose 0.3pps to 77.7% in the 12m to Sept. For the quarter, this was only partly offset by a 0.4pp fall in SG&A/Sales to 18.3%, but on a 12m basis, SG&A fell 0.8pps to 18.3%. The main driver behind that improvement was personnel expenses, which rose only 1.7% yoy in 3Q (compared to the sales rise of 2.9%). For the quarter, personnel expenses/sales fell 0.4ps to 12.6% of sales, and on a 12m basis, they fell 0.6pps to 12.5%. More directly, sales per employee rose 7.1% yoy and 9.6% on a 12ma, whilst expenses per employee rose only 2.2% yoy and 4.3% on a 12ma. The sales/expenses multiple per employee rose to 7.98x in 3Q14, which was the highest since 4Q10, and on a 12m basis it rose to 7.91x, the highest since 2Q11.

There is no reason to think that corporate Japan will be content to allow this multiple to slip – certainly not before it reaches the levels around 8.3x that was achieved immediately prior to the financial crisis.

And Now The Less-Good News  But despite the ability to maintain margins, corporate Japan has not entirely managed to escape the tax-generated headwinds which slowed the economy. After all, it is easier to patrol margins in these circumstances than to restructure the balance sheet in the face of a probably transient shock to the top line. Corporate Japan's asset turns (sales/total assets) were hit hard in 2Q, slipping to an annualized 0.91 from 1 in 1Q, and although they edged up to 0.93 in 3Q, this has not been enough to rescue the 12m multiple, which fell marginally to 0.939. This is as low as this multiple has been (and the same as in 4Q09), but it is not impossible it will fall further in 4Q.

In addition, corporate Japan's ultra-conservative attitude towards the balance sheet needed no adjustment to the disappointment in 3Q topline growth: net debt fell by Y2.92tr qoq, and cash on hand rose by Y4.375tr, cutting the net debt/equity ratio by 1.2pps to 53.5%, another record post-Bubble low.

The result is that for both ROA and ROE, the margin gains being squeezed out of the workforce were lost this quarter by the fall in asset turns and leverage.

Nevertheless, whilst the recovery in ROA and ROE has stalled, cashflows remain very strong: investment in plant and equipment came to Y9.45tr in 3Q, up 5.5% yoy, whilst net debt fell Y2.92tr during the quarter. In all, then, that amounts to Y12.36tr of cashflow achieved in 3Q, up 55.5% yoy and up 64.1% on a 12m basis.

The problem is that nothing in these balance sheets suggest any increased willingness to deploy that cash back into the economy. Although investment spending over the last 12m is up 5.2%, this amounts to only 77% of cashflow: meanwhile, amount of cash on the balance sheet amounted to 11% of total assets, the highest since the immediate aftermath of the Bubble. And it's still climbing. Meanwhile, the Y9.45tr in 3Q capex is actually slightly less than the Y10.715tr claimed in depreciation expenses: unless Japan's depreciation schedules are unrealistically aggressive (but they are!), this implies an actual shrinkage of the the capital stock of corporate Japan. And 3Q was not exceptional in this regard: over the last 12 months, capex spending was only 2% more than the depreciation expenses booked!