Corporate Japan Is Still Watching the Sky

The Ministry of Finance's quarterly aggregation of private sector balance sheets and p&ls offers the best opportunity to see in detail just what corporate Japan is really doing, and really expecting. Those actions and expectations will ultimately determine when or whether the economy witnesses the 'true dawn' foreseen by Bank of Japan and PM Abe. What the 4Q survey shows is that corporate Japan is still watching the sky, successfully expanding its margins and accumulating an almost unprecedented cash-hoard, but not yet sufficiently convinced of Japan's future growth trajectory to risk investing it.

The core thing we can take from Japan's 4Q quarterly p&s and balance sheet is that though sales rose only 3% yoy during 2014, operating profits rose 12.6%, and the cashflow proxy (change in net debt plus investment spending) jumped 25.1%.

Although sales rose only 2.4% yoy in 4Q and only 3% yoy during 2014, cash and deposits on the balance sheet rose 10.8% yoy, and at year-end accounted for 11.2% of the total balance sheet, the highest proportion since 1992. In addition, these cash holdings are equivalent to 1.5 months sales, which is up a percentage point on the year, and is the highest since 1990. It is also equivalent to 21% of the book value of fixed assets, with the proportion rising 1.4pps on the year.

This has two negative results First, it means that leverage continues to fall: net debt fell Yn11tr during the year, cutting the net debt/equity ratio by 6.7 percentage points to a new low of 52.7%. In financial leverage terms (total assets/shareholders equity) the ratio fell to 2.7x by end-2014, down from 2.77x at end-2013. Those falling leverage ratios depress returns on equity.

It also weighs on asset turns, since the rise in cash and deposits alone accounted for 20.5% of the expansion of the total asset base during 2014. For 2014 as a whole, asset turns fell to 0.931x, from 0.943x in 2013.

And, of course, what was delivering this cashflow was the the sustained rise in operating margins,which rose to 4.28% in 4Q, and to 4.11% for the whole year. In fact, in margin terms,with the exception of 1Q14, 4Q14 was the fattest quarter since 2Q90, and the year as a whole was the best since 1991. (The data also suggests that the repeated depreciations of the yen have had an uneven effect on margins: for large companies, OPM has risen 1.5pps over the last two years, but for small companies OPM rose only 0.5pps, and for medium-sized companies only 0.2pps).

What was driving that margins improvement in 4Q? Margins widened 70bps qoq, with 40bps of that attributable to a fall in the cost of goods sold, and 30bps attributable to a fall in SG&A. Now, of that fall in SG&A, a fall in welfare costs accounted to 10bps, but that was fully offset by a 10bp rise in labour costs ex-welfare, so the remaining 30bps fall looks to be attributable to the hard-yards of cutting management and administration expenses. Meanwhile, the sales/expenses per employee ratio rose to 8.01x in 4Q, the highest since 4Q10, and rose to 7.97x for the year as a whole, the best since 2009.

Within the context of these numbers, it is no surprise that despite the spectacular margins and cashflow performance, even though ROA inched back to pre-crisis levels, there was no movement whatsoever in ROE. To be blunt, hoarding that cash is killing ROE.

We are still waiting for that cash finally to be reinvested. As it is, the 2.8% yoy rise in capex recorded in 4Q once again simply tracks depreciation, as it has since 2010. During 2014 as a whole, capital expenditure was only 101% of the depreciation allowances taken – ie, within the margin of error. Evidently, corporate Japan has yet to be convinced that sustained topline growth of more than the 0.5% pa averaged since 2005 can be achieved by Bank of Japan. What will it take?