In this briefing:
- Bank of Kyoto – Nintendo Sale A Portent of Changes To Come?
- BBTN: Indonesia Has Special Mention Problems Too
- Westpac Banking: Looking Fragile
- Tochigi Bank (8550JP): Red Flags but No White Flags (Yet)
- LG Uplus: Risks Now Largely Priced In. Raise to Neutral on CJ Hello Deal Synergies
1. Bank of Kyoto – Nintendo Sale A Portent of Changes To Come?
On Friday 22 February after the close, Nintendo Co Ltd (7974 JP) announced a buyback (E, J), a share cancellation (E, J), and a public equity offering of secondary shares (J-only). This kind of event is not abnormal in a year when profits are weaker and share prices are down. Cross-holders often sell shares into the end of the year in order to realise profits and let unrealised gains from the balance sheet filter into the income statement.
This time it is five sellers from four banks which all hail from the area: Bank Of Kyoto (8369 JP), Nomura Trust (which holds shares in a trust account for the MUFJ Bank pension fund as a beneficiary), Mitsubishi Ufj Financial (8306 JP)‘s MUFJ Bank, Resona Holdings (8308 JP), and Shiga Bank (8366 JP). The MUFJ Bank holdings likely originate from Sanwa Bank which was Osaka-based before merging with BOT-Mitsubishi almost 15 years ago, and Resona is also from Osaka – next door to Kyoto where Nintendo was founded – and Shiga Bank is the prefecture next door.
This would look like a normal sell-down… except for one thing.
There was a note in the announcement to the effect that “in the context of how companies deal with their policy cross-holdings becoming the subject of greater focus, we confirmed that several shareholders desired to sell shares, and as a company subject to such cross-holdings, we are conducting the above-mentioned Offering.”
The “greater focus” comes from the both the change in the Japan Corporate Governance Code which was introduced last spring and went live June 1st (discussed in Japan’s Corporate Governance Code Amendments – A Much Bigger Stick for Activists and Stewards) which raised the bar for disclosure of reasons, and results, of such policy crossholdings in a revised version of Principle 1.4, and an example of how a board should make decisions and execute an unwind of corporate crossholdings. This example was given by Japan Exchange Group (8697 JP) itself regarding the TSE’s stake of 4.95% in Singapore Exchange (SGX SP) and was discussed in Japan Crossholdings: Japan Exchange’s Sale of SGX Shares Sets A Precedent – Watch Closely.
In the TSE crossholding of SGX situation, the sale was not the most important part. The explanation of how the Board came to its decision and what they decided to do about it was important.
On the other hand, Japan’s Corporate Governance Code (the Code), which was introduced in 2015, requires listed companies to examine and explain the economic rationale and future outlook of holding shares of other listed companies for reasons other than pure investment purposes. Following a review of the requirements under the Code, JPX reached the conclusion that the existing cooperative relationship with SGX would continue even without holding the shares of SGX. [my bold]
The Japan Exchange Group had now provided the example for why even companies with cooperative business relationships should not own cross-holdings. And it is, if active stewards of capital choose to make it so, more subtle. Shareholders have even an even better pressure point. IF a company’s cooperative relationship with another company would not survive the unwinding of cross-holdings to improve capital efficiency for both sides, is that company truly independent? Is that company beholden to the company whose shares it holds? Is the cross-holding board doing its job?
And the Japan Exchange Group had said it would unwind its holdings of SGX over three years, so as not to overly impact the market for SGX shares. This provided an example of HOW to unwind, in addition to the WHY to unwind announced above.
The BIG QUESTION (And Nothing Else Matters)
The big question here is whether the reasoning for selling is really because of the new focus on policy cross-holdings, or it is just Bank of Kyoto and other banks trying to top up profit before the end of the fiscal year, using heretofore unrealised gains.
The Nintendo-specific situation is discussed in Nintendo Offering & Buyback: The Import & The Dynamics.
An analysis of the Bank of Kyoto-specific situation is discussed below.
2. BBTN: Indonesia Has Special Mention Problems Too
Bank Tabungan Negara Persero (BBTN IJ) appears to have a nasty combination of high Special Mention Loans (SMLs) and elevated “past due but unimpaired Loans”.
The implication is that provisioning levels are insufficient in an environment of eroding asset quality.
But the bank continues to grow credit by around 20% YoY.
The bank is hugely exposed to the retail real estate market (91% of Loans).
In fact, the Indonesian Banking Sector is rife with high SMLs and in some cases elevated “past due but unimpaired Loans”.
SMLs are traditionally associated with Chinese under-reporting of underlying bad loans, and hence the production of a somewhat flattering Asset Quality picture.
Maybe, the health and valuation of the Indonesian Banking Sector needs to be reassessed with implications for IDR.
3. Westpac Banking: Looking Fragile
Westpac Banking (WBC AU) is facing a class action suit regarding alleged irresponsible lending in home loans since 2011. This is the first class action against a major Australian bank since the publication of the royal commission’s final report.
The ramifications of the royal commission report remain a source of debate with elections coming up. But, in general, banks will not be allowed to conduct operations in a “business-as-usual way”. There will be consequences for credit provision.
Westpac’s Balance Sheet looks decidedly fragile as it stands. The bank is entering a slowdown from a position of weakness.
Exposures to Australia’s slowing economy (not unrelated of course to China), the dovish turn at the Central Bank, and in particular its bubbly housing market make us hyper cautious. The highly volatile Aussie dollar tumbled from levels above $0.7200 to below $0.7100 following reports that China banned coal imports from the country at a major port.
Despite the sinking share prices of Australia’s main banks, valuations may still be too high given the varied headwinds.
4. Tochigi Bank (8550JP): Red Flags but No White Flags (Yet)
If one were looking for evidence of the inherent dangers of risk concentration in the banking industry, one need only look to tiny secondary regional bank Tochigi Bank (8550 JP), which reported its earnings for the nine months to end-December 2018 on 31 January 2019. Having made consolidated net profits of ¥1.57 billion in 1H FY3/2019, the bank plunged into the red in 3Q by ¥1.80 billion as a result of losses on disposing of fixed-rate US$-denominated securities. Rather surprisingly, foreign investors own just over 21% of outstanding shares. Tochigi Bank may not be the only small Japanese bank to run into trouble with its foreign securities portfolio in CY2019. Caveat emptor! (May the buyer beware)!
5. LG Uplus: Risks Now Largely Priced In. Raise to Neutral on CJ Hello Deal Synergies
LG Uplus (032640 KS) shares have fallen around 20% from the highs of January when the market was excited by 5G. That always seemed overly optimistic given the lack of viable business cases and unknown investment requirements and we were comfortable with our Sell rating from mid October and KRW15,000 target price. Following weak results, an easing of 5G enthusiasm and the recently announced CJ Hello (037560 KS) deal the share price has fallen to around the KRW15,000. Alastair Jones now thinks a lot of bad news is in the price and the available synergies from CJ Hello offset a weaker earnings outlook.
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