Picking up from where we left off Market Largely Untroubled by Kao’s Troubles, Kao Corp (4452 JP) announced its FY2018 results yesterday (4th February). Kao’s Revenue grew 1.2% YoY in FY2018 to reach JPY1,508bn, while its EBIT margin improved by 10bps to reach 13.8%. Despite that, both revenue and EBIT fell short of company guidance for FY2018.
On Friday, Aisin Seiki (7259 JP) reported 3QFY03/19 results posting a slight decline in revenue by -0.5% YoY, below our estimates by -5.6%, although above consensus estimates by +1.4%. On profitability, Aisin failed to meet market expectations, posting OP significantly down by almost -51% YoY falling below market expectations by a significant -33%. However, the results for the nine-months ended FY03/19 reported revenue up by +4.7% YoY supported by the increase in AT and Brake and Body parts sales. OP, however, was still disappointing, declining by nearly -13% YoY for the period, on the back of increasing depreciation costs for advanced investments alongside the rising R&D costs.
Following the quite significant decline in OP this quarter, Aisin has revised its guidance for FY03/19E revenue and OP downwards. Aisin now expects FY03/19E revenue to increase by only +1.3% YoY (cf. previous guidance of +2.3% YoY) and OP to decline by -17.3% YoY (cf. previous guidance of -7.8% YoY), expecting an OPM pf 5.3%. This downward revision is despite the fact that the company has achieved almost 76% of its revised revenue target and 77% of the revised OP target as of 3Q FY03/19. Aisin could be expecting its depreciation on investments and R&D costs to increase further over the last quarter and may also the quarters in the next financial year, for the company to be on track to compete with leading players like Denso in the competitive automotive field. However, we feel that Aisin is being quite conservative by revising its revenue guidance downwards this quarter and we still believe that the company’s steady revenue growth could continue over the last quarter, alongside its business restructuring efforts driving margins to about at least 6% for FY03/19E cf. 6.1% for FY03/18. Following the release, Aisin closed 3.0% down on Friday from Thursday’s close, however, rallied up almost 6% on Monday’s open.
Denso Corp (6902 JP) failed to deliver as strong growth in revenue during its 3QFY03/19, compared to the first two-quarters of FY03/19. Denso reported a growth of only +1% YoY during 3QFY19, -1% below both consensus and our own estimate. Profitability of the company seemed more disappointing witnessing a decline of -17% YoY, falling below market expectations by -24%. The nine months ended cumulative figures for the company also looked depressing on the OP front, with Denso experiencing a -22% YoY decline, delivering an OPM of 6.1% (down from 8.1% during the same period last year).
However, Denso’s nine-month revenue looked relatively steady at 7.6% YoY growth. Denso has managed to make steady growth in revenue during the period despite the market slowdown in its key business regions, especially Europe and China. Revenue across all regions increased over the nine-months, supported by the overall increase in global car production and sales expansion from its recently consolidated subsidiaries (DENSO TEN and TD mobile). However, Denso’s OP over the current financial year has been on a downtrend citing its investments for future growth as the key reason. As we have previously mentioned, we consider this to be consistent with the company’s recent moves, having witnessed the company’s investment in companies such as Renesas, Metawave, Tohoku Pioneer, JOLED, ThinCI (Denso Prepares for the Future; Investments in Tohoku Pioneer EG Following JOLED and ThinCI). The stock moved down 5% from pre-release to post-release low.
Qatar Petroleum and Exxon Mobil (XOM US) have taken a positive final investment decision (FID) on the Golden Pass LNG export facility on the US Gulf Coast, one of 25 projects up for FID this year globally. Golden Pass awarded the engineering, procurement and construction (EPC) contracts for the project to a joint venture of Chiyoda Corp (6366 JP), Mcdermott Intl (MDR US) and Zachry Group, with the project expected to cost US$10bn and come on line in 2024. We discuss the company impacts, the project detail and market impacts
Our analysis shows that there are an unbelievable 25+ LNG developers that have stated (within the last year) they will take a final investment decision (FID) on their LNG liquefaction plants in 2019. Unless demand surprises to the upside, the expected LNG supply deficit in the mid-2020s could easily turn into a glut. In total there is almost 250 million tonnes per annum (mtpa) of capacity that plans to take FID this year – the equivalent of 80% of current global supply. In total there are ~US$180bn of contracts up for grabs – it should be a bumper year for the oil service (E&C) companies. This should be positive for the LNG contractors such as Mcdermott Intl (MDR US), TechnipFMC PLC (FTI FP), Chiyoda Corp (6366 JP) and Jgc Corp (1963 JP) .
Exxon Q4’18 conference call, “While we see a lot of high growth opportunities in LNG, capacity will come on in big chunks. It won’t be necessarily coordinated, so we’ll see, I suspect, periods of oversupply.”
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On Friday, Aisin Seiki (7259 JP) reported 3QFY03/19 results posting a slight decline in revenue by -0.5% YoY, below our estimates by -5.6%, although above consensus estimates by +1.4%. On profitability, Aisin failed to meet market expectations, posting OP significantly down by almost -51% YoY falling below market expectations by a significant -33%. However, the results for the nine-months ended FY03/19 reported revenue up by +4.7% YoY supported by the increase in AT and Brake and Body parts sales. OP, however, was still disappointing, declining by nearly -13% YoY for the period, on the back of increasing depreciation costs for advanced investments alongside the rising R&D costs.
Following the quite significant decline in OP this quarter, Aisin has revised its guidance for FY03/19E revenue and OP downwards. Aisin now expects FY03/19E revenue to increase by only +1.3% YoY (cf. previous guidance of +2.3% YoY) and OP to decline by -17.3% YoY (cf. previous guidance of -7.8% YoY), expecting an OPM pf 5.3%. This downward revision is despite the fact that the company has achieved almost 76% of its revised revenue target and 77% of the revised OP target as of 3Q FY03/19. Aisin could be expecting its depreciation on investments and R&D costs to increase further over the last quarter and may also the quarters in the next financial year, for the company to be on track to compete with leading players like Denso in the competitive automotive field. However, we feel that Aisin is being quite conservative by revising its revenue guidance downwards this quarter and we still believe that the company’s steady revenue growth could continue over the last quarter, alongside its business restructuring efforts driving margins to about at least 6% for FY03/19E cf. 6.1% for FY03/18. Following the release, Aisin closed 3.0% down on Friday from Thursday’s close, however, rallied up almost 6% on Monday’s open.
Denso Corp (6902 JP) failed to deliver as strong growth in revenue during its 3QFY03/19, compared to the first two-quarters of FY03/19. Denso reported a growth of only +1% YoY during 3QFY19, -1% below both consensus and our own estimate. Profitability of the company seemed more disappointing witnessing a decline of -17% YoY, falling below market expectations by -24%. The nine months ended cumulative figures for the company also looked depressing on the OP front, with Denso experiencing a -22% YoY decline, delivering an OPM of 6.1% (down from 8.1% during the same period last year).
However, Denso’s nine-month revenue looked relatively steady at 7.6% YoY growth. Denso has managed to make steady growth in revenue during the period despite the market slowdown in its key business regions, especially Europe and China. Revenue across all regions increased over the nine-months, supported by the overall increase in global car production and sales expansion from its recently consolidated subsidiaries (DENSO TEN and TD mobile). However, Denso’s OP over the current financial year has been on a downtrend citing its investments for future growth as the key reason. As we have previously mentioned, we consider this to be consistent with the company’s recent moves, having witnessed the company’s investment in companies such as Renesas, Metawave, Tohoku Pioneer, JOLED, ThinCI (Denso Prepares for the Future; Investments in Tohoku Pioneer EG Following JOLED and ThinCI). The stock moved down 5% from pre-release to post-release low.
Qatar Petroleum and Exxon Mobil (XOM US) have taken a positive final investment decision (FID) on the Golden Pass LNG export facility on the US Gulf Coast, one of 25 projects up for FID this year globally. Golden Pass awarded the engineering, procurement and construction (EPC) contracts for the project to a joint venture of Chiyoda Corp (6366 JP), Mcdermott Intl (MDR US) and Zachry Group, with the project expected to cost US$10bn and come on line in 2024. We discuss the company impacts, the project detail and market impacts
Our analysis shows that there are an unbelievable 25+ LNG developers that have stated (within the last year) they will take a final investment decision (FID) on their LNG liquefaction plants in 2019. Unless demand surprises to the upside, the expected LNG supply deficit in the mid-2020s could easily turn into a glut. In total there is almost 250 million tonnes per annum (mtpa) of capacity that plans to take FID this year – the equivalent of 80% of current global supply. In total there are ~US$180bn of contracts up for grabs – it should be a bumper year for the oil service (E&C) companies. This should be positive for the LNG contractors such as Mcdermott Intl (MDR US), TechnipFMC PLC (FTI FP), Chiyoda Corp (6366 JP) and Jgc Corp (1963 JP) .
Exxon Q4’18 conference call, “While we see a lot of high growth opportunities in LNG, capacity will come on in big chunks. It won’t be necessarily coordinated, so we’ll see, I suspect, periods of oversupply.”
Consolidated sales were up 4.1% year-on-year in the three months to December, supported by demand from the medical, semiconductor and factory automation sectors, to which sales were up 8.7%, 11.0% and 8.2%, respectively. Gross profit was up 4.5%, but higher S,G&A expenses resulted in a 1.8% decline in operating profit (the operating margin was, however, up from the previous quarter). Net profit was up 4.9% after a decline in extraordinary losses. It was a relatively good performance in view of the cyclical downturns in the semiconductor and factory automation markets, and medical sales growth of only 3.2% in FY Sep-18.
Management’s three-year plan calls for 4.2% growth in sales and 0.9% growth in operating profit this fiscal year, followed by acceleration in FY Sep-20 and FY Sep-21. This is predicated on investment in new production capacity, which should be largely completed over the coming year, sufficient demand to absorb that capacity, and depreciation leveling off in FY Sep-21. Sales growth was on target in 1Q while operating profit fell short, but management has a record of cutting R&D and other expenses in order to achieve profit guidance.
At ¥3,985, the shares are selling at 29x management’s implied EPS estimate for this fiscal year (net profit guidance/ current shares outstanding), 26x next year’s estimate and 22x the estimate for FY Sep-21.
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Just a day after the publication of a deep dive Smartkarma Originals report (Zozo: A Shooting Star Shooting Itself in the Foot) on ZOZO Inc (3092 JP) by Michael Causton and ourselves, the company announced moderate 3Q results, a 34% downgrade to its current year OP forecast and a cut to its year-end dividend from ¥22 to ¥10, bringing its full year payout down from ¥36 to ¥24.
At the results meeting questions focused on the fallout of Zozo’s new Zozo Arigatou initiative which prompted some brands to discontinue sales on the Zozotown Mall, the reason for such a large downgrade just after the announcement of a very bullish medium-term plan, and even management compensation given such a disappointment.
We feel that the results underscore the issues raised in our previous report and that the stock could remain under pressure in-spite of how far it has already fallen.
In my original insight on December 11, 2018 TRADE IDEA – Toyota Industries (6201 JP) Stub: Riding the Automation Wave , I proposed setting up a stub trade to isolate the market leading materials handling and automotive components business of Toyota Industries (6201 JP) that was trading at an unwarranted 35% discount to NAV . During the 56 calendar days that followed, Toyota Industries (6201 JP) has gained an underwhelming 4% and the trade has made 1.96% on the gross notional. This hasn’t exactly been a trade to tell the grand-kids about, more or less a flat result but in this insight I will outline why I think the trade is over.
In this insight I will discuss:
Performance of ALL my recommended stub trades
a post-mortem trade analysis on the Toyota Industries stub
alternative data support for my actions
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Consolidated results for the nine months to end-December 2018, announced by SMFG (8306 JP) on 31 January 2019, represented 91% of management’s full-year target of ¥700 billion for consolidated net profits. Nevertheless, 3Q results (October-December 2018) were well down year-on-year, with rising funding costs and higher credit costs offsetting much of the positives from the earlier deconsolidation of its two retail banking subsidiaries. Full-year guidance remains unchanged. SMFG is now poised to exceed its ¥700 billion FY3/2019 consolidated net profit target, although probably not by much.
The megabanks are always a ‘crowded trade’ for foreign investors when it comes to exposure to the Japanese banking sector: the choice usually coming down to either MUFG or SMFG. Mizuho, which significantly outperformed both MUFG and SMFG throughout CY2018, is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
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Just a day after the publication of a deep dive Smartkarma Originals report (Zozo: A Shooting Star Shooting Itself in the Foot) on ZOZO Inc (3092 JP) by Michael Causton and ourselves, the company announced moderate 3Q results, a 34% downgrade to its current year OP forecast and a cut to its year-end dividend from ¥22 to ¥10, bringing its full year payout down from ¥36 to ¥24.
At the results meeting questions focused on the fallout of Zozo’s new Zozo Arigatou initiative which prompted some brands to discontinue sales on the Zozotown Mall, the reason for such a large downgrade just after the announcement of a very bullish medium-term plan, and even management compensation given such a disappointment.
We feel that the results underscore the issues raised in our previous report and that the stock could remain under pressure in-spite of how far it has already fallen.
In my original insight on December 11, 2018 TRADE IDEA – Toyota Industries (6201 JP) Stub: Riding the Automation Wave , I proposed setting up a stub trade to isolate the market leading materials handling and automotive components business of Toyota Industries (6201 JP) that was trading at an unwarranted 35% discount to NAV . During the 56 calendar days that followed, Toyota Industries (6201 JP) has gained an underwhelming 4% and the trade has made 1.96% on the gross notional. This hasn’t exactly been a trade to tell the grand-kids about, more or less a flat result but in this insight I will outline why I think the trade is over.
In this insight I will discuss:
Performance of ALL my recommended stub trades
a post-mortem trade analysis on the Toyota Industries stub
In this version of the GER weekly research wrap, we dig into the debt tender for Softbank Group (9984 JP) and assess the merger between TPG Telecom Ltd (TPM AU) and VHA. On the IPO front, we initiate on CStone Pharma (CSTONE HK) while we update on Ebang (EBANG HK) . Finally, we dig into the beat at Facebook Inc A (FB US) and assess whether there are further legs for the investment case. We also provide a list of upcoming catalysts for upcoming event-driven ideas.
More details can be found below.
Best of luck for the new week – Rickin, Venkat and Arun
We look at the main topics of interest that came out of the results so far and what this means for the oil and gas sector. The areas in focus were the strong cash flow generation and capex plans, reserve replacement, new LNG projects, IMO impact for the refining sector and digitalisation. The upstream areas that got the most focus were the US onshore (specifically the Permian), US Gulf of Mexico, Guyana, Brazil and Venezuela. This follows on from our note 2019 Energy Market Themes & Stocks with Exposure: Focus on Oil, Refining, LNG, M&A & Renewables.
Results for the nine months to end-December 2018, reported on 31 January 2019 by Mizuho Financial Group (8411 JP), or MHFG for short, reveal the continuing pressure on management to stabilize revenues and profitability. MHFG reported consolidated recurring profits for the nine months to end-December 2018 of ¥547.56 billion (down 15.0% YoY) and net profits of ¥409.92 billion (down 13.8% YoY) on higher revenues of ¥2.858 trillion (+6.9% YoY). Core earnings dropped into the red as net interest and fee income is now insufficient to cover overhead expenses, while the group is running out of surplus loan-loss reserves to write back to profit to keep the megabank in the black. On a quarterly basis, results were much worse: 3QFY3/2019 was the worst quarterly performance reported by the megabank group since 2Q FY3/2014, with recurring profits falling 62.2% YoY to ¥80.64 billion while net profits fell 68.2% to just ¥50.56 billion.
Mizuho, which significantly outperformed both of its rival megabanks Mitsubishi Ufj Financial Group (8306 JP) and Sumitomo Mitsui Financial Group (8316 JP) in share price performance terms throughout CY2018 (largely through having lower foreign ownership than the other two), is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
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The past year has all been about dollar strength. That is an accepted wisdom. But the truth of the matter is that the dollar averaged 93.6 on the DXY in 2018 (3 January 2018 to 31 December 2018) and, as we write, stands at 95.5. From 1 January 2015 to 1 July 2017 the DXY averaged 97.2. The dollar is not strong, even by recent history standards. Moreover, it is no longer as important as it once was in policy making terms – and neither is the Federal Reserve.
KDDI’s (9433 JP) 3Q results were a small miss (2% vs our forecasts), at both the revenue and profit lines, but not enough to change our positive stance. A key part of our view is derived from our negative view on Apple (AAPL US) from August 2018 where we see an “air-pocket” of demand loss coming through. This is particularly important to Japan where the iPhone accounts for around 75% of smartphones. Apple has downgraded guidance and we believe is in a secular downtrend as refresh cycles elongate and that has been accentuated by the pull forward of demadn for the iPhone X.
This is playing out in Japan, with KDDI reporting handset revenues down 13% YoY, and the key cause of the revenue miss. KDDI increased discounting to offset falling sales in 3Q adding a ¥9.9bn increase in handset costs in the quarter. Without that, EBIT would have beaten expectations. KPIs were generally strong, and service revenue trends improved to -0.1% YoY from -0.8%. Given the nature of the miss, and the fact the company is reiterating guidance we do not expect material changes to forecasts. Our price target is ¥4,100, and our recommendation remains Buy.
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Campbell Gunn tackled Toppan, whose market capitalisation has grown by only 2% per annum or just ¥34b since December 2013. From the recent peak in June 2017, Toppan shares have underperformed the market by 27% and, for the last year, have been at their most extreme value relative to TOPIX over the previous thirty years.
Toppan’s investment portfolio (341 companies with an aggregate market value as of the last quarter of ¥498bn) has grown at a 39.1% compound annual growth rate (CAGR) over the last five years, outperforming Toppan’s core operations (6.4% CAGR) and the overall stock market (7.5% CAGR). The economic reality for Toppan is that the company’s investment business has far surpassed the core business in terms of ‘margins’ and contribution to Net Assets.
The company has become more (relatively speaking) proactive in managing equity risk, and recently sold 10.5m shares in Recruit Holdings (6098 JP)(its largest investment holding) for approximately ¥31.5b, reducing Toppan’s holding in Japan’s leading listing employment services business from 6.57% to 6.05%. With this sale, Toppan’s liquid assets will now exceed US$3b or 58% of the current market capitalisation.
Toppan’s business and investment portfolio should be radically pruned or eliminated. Such a transformation probably requires a change of management, the presence of an activist investor, or both. The latter is the more likely outcome.
HHIC mainly comprises its own shipbuilding/marine plant business (75% of GAV) and 80.54% in Samho Heavy stake (15% of GAV), both unlisted. Samho Heavy owns a 42.40% stake in Hyundai Mipo Dockyard (010620 KS). HHIC announced it will split-off (no new shares issues) with the surviving company an intermediate holdco (same ticker, 009540) and new opco (unlisted) holding Samho Heavy and the in-house shipbuilding/marine plant business.
Next, DSME undertakes its own rights offer (39.9% of DSME’s shares), via a third party allocation to intermediate Holdco with a target value of ₩1.5tn, in an all cash deal. The intermediate holdco will ultimately hold a 68.3% stake in DSME. DSME will remain a listed company therefore no tender offer to the remaining shareholders is expected, according to Sanghyun Park. Details are not finalised and further information is expected on the 8 March.
Netmarble Games (251270 KS)officially announced it is interested in buying Nexon/NXC Corp. At this point, it appears that a higher probability scenario is for Tencent Holdings (700 HK) to form a consortium with either Netmarble Games or Kakao Corp (035720 KS) in bidding for Nexon/NXC Corp. Douglas’ justification for this are:
To avoid the cultural backlash from Korean gamers.
Tencent is a minority investor of both Netmarble Games and Kakao. Tencent’s 17.7% stake in Netmarble Games is worth ₩1.6tn. Tencent’s 6.7% stake in Kakao which is worth ₩0.6tn.
Netmarble Games is more focused on games and has a stronger balance sheet than Kakao Corp, which has also shown interest in acquiring NXC Corp/Nexon.
Relationship problems started in 2013 when Itochu Corp (8001 JP) was pushed out of the leadership spot in Descente without any warning or even any face-saving honorary role for its outgoing leader. This was hostile and the frictions were laid bare for anyone who cared to see them. They got worse when Itochu bought shares last summer without telling Descente. They got even worse when Descente signed a deal which would effectively end in a merger with Wacoal without telling Itochu. So it should have been less of a surprise than it appeared when Itochu announced this past Thursday it would launch a Partial Tender Offer for 9.56% of the shares outstanding of Descente.
Itochu’s Partial Tender is interesting, and there is a trade here if enough people are sceptical of Descente’s ability to play hardball. It is, however, not particularly cheap, and the shares were below ¥2,000/share last Wednesday for a reason.
Because Itochu is putting itself in a place to not be able to win (i.e. not control the board post-tender, also knowing that Descente could dilute them at will), this is an invitation by Itochu to minority shareholders to make their opinions known, for the media and commentators to do so too, and for someone else to come in over the top.
Travis Lundy thinks this goes to close to ¥2800 – and did close at ¥2,771 on Friday – because of expectations that Descente will find a white knight to pay more or that the family could launch an MBO. Anybody who wants Descente doesn’t want it for its Japan business. So paying a higher price than someone who wants to expand aggressively in China to allow entrenched management to not expand aggressively in China requires deeper pockets or a lot more patience.
Healthscope has announced it has entered into an Implementation Deed with Brookfield, under which Brookfield seeks to acquire 100% of Healthscope by way of a scheme at A$2.50/share, and a simultaneous Off-market takeover Offer at $2.40/share, both inclusive of an interim dividend of $.035/share. The considerations under these proposals compare to the earlier indicative considerations of $2.585/share and $2.455/share respectively under the unsolicited conditional proposals announced back in November.
HSO also announced that the BGH-led consortium, which holds a ~20% stake, said it could improve the terms of its previous offer of $2.36/share, provided it was given access to Healthscope’s data room.
The 3.3% and 2.2% step down in Consideration under the Scheme and Off-market Offer compared to the earlier proposals underscores the uneasy backdrop to this Offer on account of various operational issues faced by Healthscope. It also underlines the fact that even provided due diligence, there can be no guarantee the BGH-led consortium will bump its initial bid.
Shares are trading at a punchy $2.45/share, facing either the Scheme proposal or the possibility the BGH ups its offer, with or without due diligence. This is a mid-single-digits annualized return which assumes that either BGH will up, or will take the Scheme rather than see whether the Off-Market Takeover gets done. This is okay, but not great. I’d look to enter closer to the Off-market consideration level.
On 26 October Hitachi Ltd (6501 JP)and Faurecia (EO FP)announced that Faurecia would take over Hitachi car audio and infotainment equipment subsidiary in Clarion a tender offer to be launched 3+ months hence. Clarion has now announced a forecast revision for the fiscal year to 31 March 2019 which involves a shortfall in revenue of 9.1%, a 16.7% drop in forecast Operating Profit, and a drop in Net Profit from ¥1.7bn to a loss of ¥500mn (a ¥2.2bn swing); fortunately Faurecia also announced it will go through with the deal with no changes (other than to extend the Tender Offer to 21 business days).
This deal is quite straightforward. The deal is on schedule and coming through as planned.
Travis expects this deal will end up with Faurecia owning over 90% and there will be a Demand For Shares as allowed to Special Controlling Shareholders (under Article 179, Paragraph 1 of the Companies Act) allowing them to force out minorities, potentially by the 3rd week of March 2019.
At the current close of ¥2,496, it is offering <2% annualized return for slightly more than one-month of cash usage, and negligible risk this deal doesn’t go through. Tight, but to be expected.
Thirty minutes after Eclipx guided down its FY19 NPATA figure, Mcmillan Shakespeare (MMS AU)announced that the first court meeting to be held on the 1st February – which would consider the Scheme documents that are sent to ECX shareholders – will be rescheduled. No new date was announced.
Taken purely on the guidance downgrade and the MAC’s described in the SIA, on balance, this deal still looks good to go. I don’t see a MAC being triggered here.
But this new development could/should also be viewed in conjunction with the large step down in NPATA guidance for FY18 (announced on the 6 August 2018, and resulted in the large decline as seen in the chart below), where FY18 NPATA was guidance was reduced to A$77-$80mn (13-17% growth ) versus prior guidance of 27-30% growth. Perhaps MMS want ECX to come out and say their forecast for annual NPATA is down 10%.
Still, at a 15% gross spread to terms and trading ~5% above its undisturbed price, prior to Sg Fleet (SGF AU)‘s August proposal – while ECX’s peer group is down 17% on average since SGF’s tilt – the negative news surrounding the NPATA guidance and the MACs appears fully priced in.
The deal is done. Shareholders approved the deal. Given where book value and market prices were on the day before the revised plan was announced on 7 December, Travis expects a spirited appraisal rights process.
For those who are now looking at this as an arb situation, the return is quite decent if you buy on the bid and can get multiples of leverage and keep them after the shares have been delisted, while waiting for payment. If you can get multiples of leverage only while the shares are listed, it is still pretty OK. If you are an arb with no leverage, this is still OK for a Japanese deal.
SCSK announced a Tender Offer to buy out minorities in Veriserve, in which it holds 55.59% of voting rights. The Tender Offer is at ¥6,700/share which is a 43.6% premium to the last traded price. The price does not seem egregiously unfair, but for investors who own it who think it has another double in it this year they might get upset. And the lack of good process here deserves attention.
The lack of imagining a competing bid is not good governance. The lack of looking for one is not either. The lack of true fairness opinion is also not good governance.
Still, it is at a 14+year high. It is a small cap. Not that many people will care. It is not cheap on a PER basis and not really inexpensive on an EV/EBITDA basis.
There IS a chance, theoretically, that this does not go through. SCSK doesn’t have a super-majority, and if it does not get 11.1% of the shares outstanding, it will not be able to automatically squeeze out minorities. But Travis does not think it will be particularly difficult to get there.
Sumitomo Corp (8053 JP) consolidated subsidiary SCSK Corp (9719 JP) announced a Tender Offer to buy out minorities in JIEC at ¥2,750/share, in which it has 69.52% of voting rights. This deal is a worthwhile example of some of the weaknesses in the execution of the current Corporate Governance Code and the “fairness” of M&A in Japan.
The lack of a competing bid and true fairness opinion are not good governance. The fact that the bid is 1.4% above the bottom of the Target’s own Advisor’s fair value DCF valuation range while the top of the range is 61.3% higher is disappointing.
But what are you gonna do? SCSK has a super-majority. The stock is super-duper illiquid. The Offer is a 31% premium to the highest price ever paid for the stock. There is no minimum to the tender so it will be “successful” if no one tenders.
So you suck it up and buy and tender, or tender what you own. And then you write a public comment to the METI Fair M&A process.
Mastercard Inc Class A (MA US) has made a £233mn Offer (£0.33/share) to take over cross-border payments firm Earthport, trumpingVisa Inc Class A Shares (V US)‘s offer late December by 10%. The Offer is conditional on 75% of EPO’s shareholders accepting with 13.08% of shares outstanding in the bag. EPO’s shares increased to £0.282 following Visa’s offer, but currently trade at £0.37.50, ~14% above the latest offer, suggesting a higher bid is likely, or at least expected.
For EPO shareholders, who watched their shares erase 70% of their value over the last 2 years and trade around £0.05 earlier this month, this is a fantastic result. Mastercard’s bid also comes at a 65% premium to the placement at £0.20/share on 4 October 2017.
A (significantly) higher offer price is plausible. EPO can be seen as a disruptor to these card giants. Instantaneous bank-to-bank transfers and the increase in mobile payments are a threat to their traditional business models as they eliminate payment cards from the transaction loop. Both Visa and Mastercard have deep pockets and EPO would help both Visa and Mastercard expand their product offering.
There is no clear or discernible pricing methodology to exact where a bidding war will send the share price. But it could get (unsurprisingly) crazier from here. I think a £0.40/share offer is not unreasonable or out of the question, and is a level where shares often found support for a year and half back in 2014 and 2015.
CMA CGM SA (144898Z FP)has published its prospectus for what is evidently a heavily orchestrated Public Tender Offer for CEVA. Ceva’s Board has concluded that offer is fair & reasonable but does not recommend shareholders tender. CMA CGM added that “the recommendation to shareholders from the CEVA board not to tender shares in exchange for cash is done in perfect agreement with CMA CGM“.
CMA CGM currently holds 50.6% of CEVA, via a 33% direct stake with the remainder in derivatives. After a 10-trading day cooling off period, the offer will be open for acceptances between February 12 to March 12, unless extended. It is the intention of CMA CGM to maintain CEVA’s listing.
For the month of January, seventeen new deals were discussed on Smartkarma with an overall deal size of US$91bn. This number does not include rumours on Nexon Gt Co Ltd (041140 KS) and Capitaland Ltd (CAPL SP)‘s acquisition of Ascendas-Singbridge. The average transaction premium was 43%, or 26% if ignoring Earthport plc (EPO LN)‘s offer. This insight provides a summary of ongoing M&A situations and a recap of news associated with each event situation in January.
HOC initially targeted an IPO in 2018 with an expected market cap and an enterprise value of ~₩8tn and ₩10tn respectively, as discussed by Sanghyun in an earlier insight (Hyundai Oilbank IPO Update: Timeline & Valuation). The IPO was postponed after the regulator picked over the balance sheet; and probably just as well, as falling refining margins resulted in HOC’s operating profit declining 42% to ₩661bn last year. The sale to Aramco is expected to push the IPO back to later this year.
Prior to Aramco’s involvement, HHI was (and effectively is) a weakish stub with the 31% stake in HHIC accounting for just 32%/26% of NAV/GAV; the unlisted operations and the future earnings of those investments were more critical to understanding HHI’s valuation. This investment by Aramco quantifies the valuation for the majority (~95%) of HHI’s unlisted investments, reinforcing the already somewhat prevalent view that HHI’s discount to NAV was excessively wide.
But HHI/HHIC weren’t done yet. Just when the NAV was expected to narrow further – especially as additional newsflow filters in on the outcome of the board meetings, the expected timeline to completion, and the possibility of HOC’s IPO later this year – HHIC announced a split-off, a PIK and rights issue. Please refer to this development in the “Events” section above.
The U.S. Treasury (OFAC) has lifted sanctions imposed on En+ Group plc, UC Rusal plc, and JSC EuroSibEnergo. The key to lifting these sanctions was Oleg Deripaska reducing his direct and indirect shareholding stake in these companies and severing his control. All sanctions on Deripaska continue in force.
Rusal announced that En+ had entered into a securities exchange agreement with Glencore, pursuant to which Glencore shall transfer 8.75% of Rusal’s shares to En+ in consideration for En+ issuing new GDRs to Glencore representing approximately 10.55% of the enlarged share capital of En+.
The transfer will be done in two stages: 2% to be transferred following the removal of Rusal and EN+ from the SDN list; and 6.75% 12 months later. This two-stage process appears geared to circumvent a mandatory takeover by En+. Hong Kong employs a “creeper” speed limit, where shareholders (holding between 30-50%) can creep their shareholding upwards by 2% in a 12-month period (Rule 26.1 (c)).
As an aside, after sanctions were lifted, En+ announced seven new directors, including Christopher Bancroft Burnham, who served as Under Secretary-General for Management of the United Nations (alongside John Bolton, Trump’s current national security adviser). Burnham was also on Trump’s Presidential Transition Team
Rusal’s NAV discount has narrowed to 68.5% from 71% the previous Friday. This compares to the 45-50% discount range prior to the sanctions being imposed. This should narrow further.
I issued a month-end share class summary, a companion insight to Travis’ H/A Spread & Southbound Monitors and Ke Yan‘s HK Connect Discovery Weeklies. This share class monitor provides a snapshot of the premium/discounts for 215 share classifications (ADRs, Koran prefs, Dual-class, Thai foreign/local Thai) around the region.
The average premium/discount for each set over a one-year period is graphed below.
By Travis’ calcs, there was something on the order of ¥630-650bn of shares of several names to buy on the close this past Wednesday. There was also, therefore, something like ¥630-650bn of TOPIX and JPX Nikkei 400 (almost all TOPIX) to sell on the close of Wednesday.
Softbank Corp (9434 JP) was expected to see total buying of ¥340bn or so; and Takeda Pharmaceutical (4502 JP)buying of ¥260-280bn at the close. (Both names did trade a very large amount off-market.) A number of other names see TOPIX inclusions because of them listing on TSE1 in December or because of share count increasing because of merger (like LIFULL (2120 JP)) or because of offerings.
A VERY significant amount of both names were purchased in “guaranteed close” trades where indexers actually paid close-plus pricing until the very end of the day because of fears that the actual market might not close. This meant that on-market volume for Takeda and Softbank was a fraction of what might be expected. The risk was transferred but to get in the flow you had to trade off-market.
The Centuria Capital (CNI AU) resolution has passed. This resolution was not a vote to decide on tendering the shares held by CNI in Propertylink Group (PLG AU) into ESR’s offer; but to give CNI’s board the authorisation to tender (or not to tender) those PLG shares.
Minebea Co Ltd (6479 JP)announced that it had received all relevant anti-trust approvals but would not start the Tender Offer for U Shin Ltd (6985 JP) until the start of February (the original announcement had said the Tender would commence at the end of January).
The interesting path of the Mobius strip of connections that is the HCN continues: China Goldjoy (1282 HK)‘s chairman Yao Jianhui (& others) have pledged 12.14% of China Goldjoy to Huarong Investments (2277HK). Goldjoy is the Offeror for New Sports Group (299 HK).
CCASS
My ongoing series flags large moves (~10%) in CCASS holdings over the past week or so, moves which are often outside normal market transactions. These may be indicative of share pledges. Or potential takeovers. Or simply help understand volume swings.
Often these moves can easily be explained – the placement of new shares, rights issue, movements subsequent to a takeover, amongst others. For those mentioned below, I could not find an obvious reason for the CCASS move.
Asian LNG spot prices have dropped for a short time below the UK NBP gas price, reversing the established trend that sees Asian LNG offering a premium to the European LNG price benchmarks. This note takes a look at the latest trends in the LNG markets and the renewed plans unveiled by Qatar to challenge its competitors, in particular, those from the US.
Keyence reported higher sales and profits but lower rates of growth in the three month to December. Consolidated sales were up 11.8% year-on-year compared with 15.2% growth in 2Q and 19.7% growth in 1Q. Operating profit was up 9.1% compared with 12.7% growth in 2Q and 21.2% growth in 1Q. The operating margin declined to 53.8% compared with 55.2% in 2Q, 54.6% in 1Q and 56.6% in 4Q of FY Mar-18.
Once again, the results at Keyence were much better than those at other factory automation related companies – notably Fanuc (6954 JP) and Omron (6645 JP), where operating profits dropped at double-digit rates. But Keyence is geared to incremental improvements rather than large capital outlays, and to customers’ R&D spending, and it has a diversified base of user industries. On the other hand, it is not immune to weakening demand in China, Europe and elsewhere.
Since hitting a 52-week low of ¥50, 780 on October 26, Keyence has rebounded by 13%. At ¥57,270, the shares are now selling at 30x our EPS estimate for this fiscal year and 27x our estimate for FY Mar-20. Their 5-year historical P/E range is 18x – 42x. Other valuations are also well up in their historical ranges.
The sales and profit data suggest difficult year-on-year comparisons for the next few quarters.
Hoya Corporation (7741 JP) reported its 3QFY03/19 earnings yesterday (01st Feb). The revenues grew at 4.9% YoY while operating profit increased by a hefty 20.2% YoY during the quarter. On a constant currency basis, revenues grew 6.6% YoY while pre-tax profit increased 15.0% YoY during the period. In addition, Hoya’s margin too witnessed an expansion with operating profit margin reaching 27.8% from 24.3%, while it reported a pre-tax margin of 27.7% compared to 25.4% a year ago. Moreover, the company beat consensus estimates on revenue, operating profit and pre-tax profit.
JPY (bn)
3QFY03/18
3QFY03/19
YoY Change
Consensus Median
Actual Vs. Consensus
Revenue
136.8
143.4
4.9%
141.6
1.3%
Operating Profit
33.2
39.9
20.2%
37.3
7.0%
OPM
24.3%
27.8%
26.4%
Pre-tax Profit
34.7
39.7
14.4%
37.7
5.3%
Pre-tax Margin
25.4%
27.7%
26.6%
Source: Company Disclosures, Cap IQ
Revenues grew thanks to strong performances by the Life Care and Electronics businesses although the Imaging business saw a decline.
Earnings have been announced for Intel, Samsung, SK hynix, and Western Digital, and the memory business is clearly undermining all of these companies’ earnings. In this Insight I review each of the companies to show where they are, and will explain what the future holds for them as today’s oversupply unfolds.
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In this version of the GER weekly research wrap, we dig into the debt tender for Softbank Group (9984 JP) and assess the merger between TPG Telecom Ltd (TPM AU) and VHA. On the IPO front, we initiate on CStone Pharma (CSTONE HK) while we update on Ebang (EBANG HK) . Finally, we dig into the beat at Facebook Inc A (FB US) and assess whether there are further legs for the investment case. We also provide a list of upcoming catalysts for upcoming event-driven ideas.
More details can be found below.
Best of luck for the new week – Rickin, Venkat and Arun
We look at the main topics of interest that came out of the results so far and what this means for the oil and gas sector. The areas in focus were the strong cash flow generation and capex plans, reserve replacement, new LNG projects, IMO impact for the refining sector and digitalisation. The upstream areas that got the most focus were the US onshore (specifically the Permian), US Gulf of Mexico, Guyana, Brazil and Venezuela. This follows on from our note 2019 Energy Market Themes & Stocks with Exposure: Focus on Oil, Refining, LNG, M&A & Renewables.
Results for the nine months to end-December 2018, reported on 31 January 2019 by Mizuho Financial Group (8411 JP), or MHFG for short, reveal the continuing pressure on management to stabilize revenues and profitability. MHFG reported consolidated recurring profits for the nine months to end-December 2018 of ¥547.56 billion (down 15.0% YoY) and net profits of ¥409.92 billion (down 13.8% YoY) on higher revenues of ¥2.858 trillion (+6.9% YoY). Core earnings dropped into the red as net interest and fee income is now insufficient to cover overhead expenses, while the group is running out of surplus loan-loss reserves to write back to profit to keep the megabank in the black. On a quarterly basis, results were much worse: 3QFY3/2019 was the worst quarterly performance reported by the megabank group since 2Q FY3/2014, with recurring profits falling 62.2% YoY to ¥80.64 billion while net profits fell 68.2% to just ¥50.56 billion.
Mizuho, which significantly outperformed both of its rival megabanks Mitsubishi Ufj Financial Group (8306 JP) and Sumitomo Mitsui Financial Group (8316 JP) in share price performance terms throughout CY2018 (largely through having lower foreign ownership than the other two), is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
Consolidated results for the nine months to end-December 2018, announced by SMFG (8306 JP) on 31 January 2019, represented 91% of management’s full-year target of ¥700 billion for consolidated net profits. Nevertheless, 3Q results (October-December 2018) were well down year-on-year, with rising funding costs and higher credit costs offsetting much of the positives from the earlier deconsolidation of its two retail banking subsidiaries. Full-year guidance remains unchanged. SMFG is now poised to exceed its ¥700 billion FY3/2019 consolidated net profit target, although probably not by much.
The megabanks are always a ‘crowded trade’ for foreign investors when it comes to exposure to the Japanese banking sector: the choice usually coming down to either MUFG or SMFG. Mizuho, which significantly outperformed both MUFG and SMFG throughout CY2018, is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
Note: The Results & Revision Score is the average of our Results Score and Forecasts/Revision Score and is updated daily for each company and then cap-weighted-aggregated into Peer Groups, Sectors and the Market Composite. Both scores have a maximum of +30 and a minimum of -30 for each period. The Results Score is calculated quarterly, using the most recent eight quarters of company data for revenues, operating income and operating margin and measures the rate, degree and consistency of change for each metric. The Forecast/Revision Score is based on Annual and Interim period company forecasts and compares changes from previous forecasts as well as against the trailing twelve-month or previous first-half results, with annual forecasts being double-weighted.
DRIP, DRIP, DRIP – We ‘lead’ this fortnight’s update with our All-Market Composite Results & Revision Score. Calculated daily, the score is a ‘real-time’ measure of the state of, and the outlook for, listed Japanese corporations. As the scoring methodology includes earnings momentum ‘factors’, the data series can be a useful leading indicator of forward earnings. The correlation with the market over the last four years is 0.578, with the indicator leading more often than lagging. Since peaking on 16th November 2017, the Results & Revisions Score has fallen by 62% and has now returned to the level of May 2017. In the last ten years, the score has only been lower than at present one-third of the time – mostly during the fiscal year ended March 2017 when the total market value averaged ¥550t, close to the December 2018 low. If we are to repeat the relatively-mild cyclical downturn of 2016, the Results & Revision Score will turn negative in May of this year, and the 25th December 2018 low will be retested.
Source: Japan Analytics
PAST THE PEAK – Our earnings indicator peaked 14 months ago, two months ahead of the market’s high point on 26th January 2018. It now appears that aggregate reported earnings, as well as aggregate company forecasts for the current year, are now turning decisively lower after nine quarters of uninterrupted growth. Forecast Net Income for the current year is now 7% below the high point in trailing-twelve-month (TTM) Net Income from this cycle, which was reached two months ago. Operating Income is, as usual, ‘lagging’ and forecasts are still marginally ahead of TTM. The TTM all-market price-earnings ratio reached 11.5 times on Christmas Day, which will prove to be the cycle low point. We expect the return to median levels, to be achieved more through lower ‘E’ as opposed to a higher ‘P’. Mr Market is currently implying that Japanese corporate profits are due to fall by 23% on average from the cycle peak, or by 30% if we are to revisit the December low-point.
Source: Japan Analytics
THE FIRST CUT – 23% of listed companies reported their most recent quarterly earnings results in the last two weeks. For these companies, TTM revenues grew by 5.1% year-on-year, but only by 0.5% quarter-on-quarter, the lowest qoq growth rate in over a year. TTM Operating Income is now 0.8% lower than the TTM total of one year ago and declined by 4.4% qoq. Operating margins fell by 49bps year-on-year. Current forecasts for this group of companies imply 3.1% yoy top line growth, but only 0.3% compared to the quarter just declared. For Operating Income, the rates are -2.0% and 0.6%, reflecting the normal TTM-to-forecast ‘lag’. Corporate Japan’s profits are now rolling over and will be in a ‘recession’ by the fiscal year-end.
Source: Japan Analytics
INTERREGNUM – Our bear market rally has paused to look at and digest the earnings-announcement news flow and will likely be trendless for the next few weeks as ‘good’ reactions offset ‘bad’. In due course, we expect the preponderance of negative momentum to tip the scales.
Source: Japan Analytics
TORAKU @110 – The Toraku advance-decline indicator has continued to recover and is within ten points of the overbought zone, which has only been breached once since the market peak of January 2018. This signal is ‘amber’ and could be ‘red’ by the end of next week.
OUTLOOK & RECOMMENDATIONS
We continue to recommend an underweight position in Japan in global portfolios.
The equity market decline at the end of last year was well in advance of the underlying trends in the economy and corporate profits; the recent 10% rally has corrected that imbalance. Nevertheless, the global cycle has turned down sharply, and many economies will be in a recession by the end of this quarter. We expect Japanese corporate earnings to follow suit.
Although some of the coming decline in aggregate earnings has been well-discounted, our Results & Revision Score has yet to turn negative. Accordingly, we expect the market to retest the December 2018 low, probably in May when the FY2020 forecasts are announced and our score starts ‘seeing red’.
In the near term and despite the rally in the more cyclical sectors, we continue to favour undervalued domestically-orientated companies in the Information Technology, Internet, Media, and Telecommunications sectors. We would avoid or short Banks and Non-Bank Finance.
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The past year has all been about dollar strength. That is an accepted wisdom. But the truth of the matter is that the dollar averaged 93.6 on the DXY in 2018 (3 January 2018 to 31 December 2018) and, as we write, stands at 95.5. From 1 January 2015 to 1 July 2017 the DXY averaged 97.2. The dollar is not strong, even by recent history standards. Moreover, it is no longer as important as it once was in policy making terms – and neither is the Federal Reserve.
KDDI’s (9433 JP) 3Q results were a small miss (2% vs our forecasts), at both the revenue and profit lines, but not enough to change our positive stance. A key part of our view is derived from our negative view on Apple (AAPL US) from August 2018 where we see an “air-pocket” of demand loss coming through. This is particularly important to Japan where the iPhone accounts for around 75% of smartphones. Apple has downgraded guidance and we believe is in a secular downtrend as refresh cycles elongate and that has been accentuated by the pull forward of demadn for the iPhone X.
This is playing out in Japan, with KDDI reporting handset revenues down 13% YoY, and the key cause of the revenue miss. KDDI increased discounting to offset falling sales in 3Q adding a ¥9.9bn increase in handset costs in the quarter. Without that, EBIT would have beaten expectations. KPIs were generally strong, and service revenue trends improved to -0.1% YoY from -0.8%. Given the nature of the miss, and the fact the company is reiterating guidance we do not expect material changes to forecasts. Our price target is ¥4,100, and our recommendation remains Buy.
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In this version of the GER weekly research wrap, we dig into the debt tender for Softbank Group (9984 JP) and assess the merger between TPG Telecom Ltd (TPM AU) and VHA. On the IPO front, we initiate on CStone Pharma (CSTONE HK) while we update on Ebang (EBANG HK) . Finally, we dig into the beat at Facebook Inc A (FB US) and assess whether there are further legs for the investment case. We also provide a list of upcoming catalysts for upcoming event-driven ideas.
More details can be found below.
Best of luck for the new week – Rickin, Venkat and Arun
We look at the main topics of interest that came out of the results so far and what this means for the oil and gas sector. The areas in focus were the strong cash flow generation and capex plans, reserve replacement, new LNG projects, IMO impact for the refining sector and digitalisation. The upstream areas that got the most focus were the US onshore (specifically the Permian), US Gulf of Mexico, Guyana, Brazil and Venezuela. This follows on from our note 2019 Energy Market Themes & Stocks with Exposure: Focus on Oil, Refining, LNG, M&A & Renewables.
Results for the nine months to end-December 2018, reported on 31 January 2019 by Mizuho Financial Group (8411 JP), or MHFG for short, reveal the continuing pressure on management to stabilize revenues and profitability. MHFG reported consolidated recurring profits for the nine months to end-December 2018 of ¥547.56 billion (down 15.0% YoY) and net profits of ¥409.92 billion (down 13.8% YoY) on higher revenues of ¥2.858 trillion (+6.9% YoY). Core earnings dropped into the red as net interest and fee income is now insufficient to cover overhead expenses, while the group is running out of surplus loan-loss reserves to write back to profit to keep the megabank in the black. On a quarterly basis, results were much worse: 3QFY3/2019 was the worst quarterly performance reported by the megabank group since 2Q FY3/2014, with recurring profits falling 62.2% YoY to ¥80.64 billion while net profits fell 68.2% to just ¥50.56 billion.
Mizuho, which significantly outperformed both of its rival megabanks Mitsubishi Ufj Financial Group (8306 JP) and Sumitomo Mitsui Financial Group (8316 JP) in share price performance terms throughout CY2018 (largely through having lower foreign ownership than the other two), is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
Consolidated results for the nine months to end-December 2018, announced by SMFG (8306 JP) on 31 January 2019, represented 91% of management’s full-year target of ¥700 billion for consolidated net profits. Nevertheless, 3Q results (October-December 2018) were well down year-on-year, with rising funding costs and higher credit costs offsetting much of the positives from the earlier deconsolidation of its two retail banking subsidiaries. Full-year guidance remains unchanged. SMFG is now poised to exceed its ¥700 billion FY3/2019 consolidated net profit target, although probably not by much.
The megabanks are always a ‘crowded trade’ for foreign investors when it comes to exposure to the Japanese banking sector: the choice usually coming down to either MUFG or SMFG. Mizuho, which significantly outperformed both MUFG and SMFG throughout CY2018, is nominally the cheapest of the three megabanks on standard valuation methods; however, the difference between all three at present is marginal. We expect that all three megabank groups will continue to see further downward pressure on domestic margins, while their overseas operations (especially in Asia) remain vulnerable to any further increases in US$ interest rates. In the absence of any significant catalysts to prompt foreign investors to actively buy the shares, we expect all three megabanks to disappoint in terms of share price performance in CY2019.
Note: The Results & Revision Score is the average of our Results Score and Forecasts/Revision Score and is updated daily for each company and then cap-weighted-aggregated into Peer Groups, Sectors and the Market Composite. Both scores have a maximum of +30 and a minimum of -30 for each period. The Results Score is calculated quarterly, using the most recent eight quarters of company data for revenues, operating income and operating margin and measures the rate, degree and consistency of change for each metric. The Forecast/Revision Score is based on Annual and Interim period company forecasts and compares changes from previous forecasts as well as against the trailing twelve-month or previous first-half results, with annual forecasts being double-weighted.
DRIP, DRIP, DRIP – We ‘lead’ this fortnight’s update with our All-Market Composite Results & Revision Score. Calculated daily, the score is a ‘real-time’ measure of the state of, and the outlook for, listed Japanese corporations. As the scoring methodology includes earnings momentum ‘factors’, the data series can be a useful leading indicator of forward earnings. The correlation with the market over the last four years is 0.578, with the indicator leading more often than lagging. Since peaking on 16th November 2017, the Results & Revisions Score has fallen by 62% and has now returned to the level of May 2017. In the last ten years, the score has only been lower than at present one-third of the time – mostly during the fiscal year ended March 2017 when the total market value averaged ¥550t, close to the December 2018 low. If we are to repeat the relatively-mild cyclical downturn of 2016, the Results & Revision Score will turn negative in May of this year, and the 25th December 2018 low will be retested.
Source: Japan Analytics
PAST THE PEAK – Our earnings indicator peaked 14 months ago, two months ahead of the market’s high point on 26th January 2018. It now appears that aggregate reported earnings, as well as aggregate company forecasts for the current year, are now turning decisively lower after nine quarters of uninterrupted growth. Forecast Net Income for the current year is now 7% below the high point in trailing-twelve-month (TTM) Net Income from this cycle, which was reached two months ago. Operating Income is, as usual, ‘lagging’ and forecasts are still marginally ahead of TTM. The TTM all-market price-earnings ratio reached 11.5 times on Christmas Day, which will prove to be the cycle low point. We expect the return to median levels, to be achieved more through lower ‘E’ as opposed to a higher ‘P’. Mr Market is currently implying that Japanese corporate profits are due to fall by 23% on average from the cycle peak, or by 30% if we are to revisit the December low-point.
Source: Japan Analytics
THE FIRST CUT – 23% of listed companies reported their most recent quarterly earnings results in the last two weeks. For these companies, TTM revenues grew by 5.1% year-on-year, but only by 0.5% quarter-on-quarter, the lowest qoq growth rate in over a year. TTM Operating Income is now 0.8% lower than the TTM total of one year ago and declined by 4.4% qoq. Operating margins fell by 49bps year-on-year. Current forecasts for this group of companies imply 3.1% yoy top line growth, but only 0.3% compared to the quarter just declared. For Operating Income, the rates are -2.0% and 0.6%, reflecting the normal TTM-to-forecast ‘lag’. Corporate Japan’s profits are now rolling over and will be in a ‘recession’ by the fiscal year-end.
Source: Japan Analytics
INTERREGNUM – Our bear market rally has paused to look at and digest the earnings-announcement news flow and will likely be trendless for the next few weeks as ‘good’ reactions offset ‘bad’. In due course, we expect the preponderance of negative momentum to tip the scales.
Source: Japan Analytics
TORAKU @110 – The Toraku advance-decline indicator has continued to recover and is within ten points of the overbought zone, which has only been breached once since the market peak of January 2018. This signal is ‘amber’ and could be ‘red’ by the end of next week.
OUTLOOK & RECOMMENDATIONS
We continue to recommend an underweight position in Japan in global portfolios.
The equity market decline at the end of last year was well in advance of the underlying trends in the economy and corporate profits; the recent 10% rally has corrected that imbalance. Nevertheless, the global cycle has turned down sharply, and many economies will be in a recession by the end of this quarter. We expect Japanese corporate earnings to follow suit.
Although some of the coming decline in aggregate earnings has been well-discounted, our Results & Revision Score has yet to turn negative. Accordingly, we expect the market to retest the December 2018 low, probably in May when the FY2020 forecasts are announced and our score starts ‘seeing red’.
In the near term and despite the rally in the more cyclical sectors, we continue to favour undervalued domestically-orientated companies in the Information Technology, Internet, Media, and Telecommunications sectors. We would avoid or short Banks and Non-Bank Finance.
Smartkarma supports the world’s leading investors with high-quality, timely, and actionable Insights. Subscribe now for unlimited access, or request a demo below.
