Japan's corporate cash-hoarders
Updated: May 5, 2021
“Keyence’s sunken treasure” was the headline of the FT’s critical ALPHAVILLE article in late 2018. This brought images of submerged gold nuggets lost and waiting to be extracted from the deep by treasure hunters. The article talked about low payouts to shareholders; saying the company’s generated cash was simply locked away in the “in the piggy bank”. The view expressed by the article is not unique and is shared by parts of the wider financial community.
However, the article fails to highlight that over their survey period (2000 to 2018), Keyence’s market capitalization grew by over 600%, massively outstripping the market's performance. Keyence is a growth firm, with sustainability at its center, managed on strong ESG principles and this has allowed it to create value to the benefit of all stakeholders. Much of the ongoing debate over Keyence’s cash seems to have a misplaced focus, focusing on a few gold nuggets while ignoring the importance of nurturing and protecting the golden goose.
The purpose of a company, I hope we can agree, is to sustainably create value over the medium to long term, and ensure its benefits accrue equitably to all stakeholders (eg. customers, suppliers, employees, and shareholders). The value creation process can be understood using a simple DCF model and is created from any one or more of a) increasing cash flows from current assets b) increase the expected growth rate of earnings c) increase the length of the high growth period d) reduce the cost of capital. AT NO POINT, DOES LIFTING PAYOUT RATIO COME INTO THE EQUATION. This gets a lot of attention but it is NOT a strategy for creating sustainable corporate value.
Equity investors in public markets do require a return. The evidence is that in the long term, (1) cash flow growth per share is the major share price driver, followed by (2) dividends then (3) multiples. The graph above presents a decomposition of the total return of the MSCI ACWI over the period Dec/1994 to Sept/2015, clear evidence of the key importance of raising cash flow per share to returns.
So back to Keyence and this ongoing brouhaha over their JPY950 billion cash with zero debt. As of FY3/2020, the company had JPY1.8 trillion in shareholder equity, for an equity ratio of 96%. Impressive by any measure. The company has been a cash-generating machine, with its amazing growth over decades, with double-digit operating margins. The earnings growth propelled the market cap to $91b as of May 2020, making it the 4th largest company in Japan. THIS COMPANY HAS CLEARLY CREATED REAL VALUE.
The major upside opportunity OR downside risk is NOT increasing cash payouts but the the market's estimate of the present value of the company’s future free cash flow.
While some market participants haggle over a few golden nuggets perceived to be “sunken,” Keyence continues to nurture and protect the goose that is laying the golden eggs, and lots of them. Protecting the golden goose also likely explains why Keyence only discloses what is only absolutely required as a listed company, and very little extra. You want to protect the secret sauce, not release it to be replicated. This is good for stakeholders and good for Keyence.
STAKEHOLDERS-HOW HAVE THEY FARED?
Customers have clearly benefited from using Keyence as they continue to use their service to improve efficiency, safety, and automate the shop floor in good times and bad. Employees are well paid (~20mn JPY/year on average), and well trained, and seem satisfied (See extensive comments on Glassdoor). Suppliers to the fabless model get paid in one month and have seen growing business as the company grows. And the big winners are Shareholders, who have seen the value of their holdings rise over 600% over the past decade.
The Japanese IA firm earnings report, highlighted, among other things, the criticality of CASH and ESG factors for resilience, sustainability, growth, and returns. Over the past two months, investors have rewarded cash-rich stocks as well as ESG stocks, and Omron, trading near its all-time highs, is no exception.
Omron has $1.7b in cash and no debt. The proverbial barbarians in at the gate have long complained about Japan's cash pile (2019 Retained earnings 130% Japan GDP; 52% TPX names net cash. FT ). However, the reality is that globalization has increased supply chain risks/disruptions, while financial liberalization and high debt levels have increased cross border financial fragility. Japanese companies, which tend to have a long-term horizon, have good reason to assume a more defensive posture over the years. CASH is allowing the company to weather the current crisis with the flexibility to take advantage of emerging opportunities post-COVID-19.
Omron is the gold standard in Japan when it comes to sustainability and ESG. The link between strong ESG focus and operational and stock market performance is a settled debate. Other Japanese corporates may lag in these areas, but the delta is most definitely positive, spurred on by significant measures in the context of "Abenomics." The latest revisions to Japan's Corporate Governance code explicitly incorporate sustainability and ESG factors. Omron leads the way in this respect. As for Omron, CEO Yamada already has a plan to make strategic investments to gain in a post-COVID-19 world; he has the CASH as well as the sustainability operational framework to execute.
Guido Giese, Linda-Eling Lee, Dimitris Melas, Zoltán Nagy, and Laura Nishikawa. "Foundations of ESG Investing: How ESG Affects Equity Valuation, Risk, and Performance." The Journal of Portfolio Management July 2019, 45 (5) 69-83 https://www.msci.com/documents/10199/03d6faef-2394-44e9-a119-4ca130909226
Financial Times, November 7, 2018. "Keyence's sunken treasure" https://ftalphaville.ft.com/2018/11/07/1541595472000/Keyence-s-sunken-treasure/
WSJ, August 20, 2019. "Investors' New Weapon in Japan: Votes to Embarrass the Boss" https://www.wsj.com/articles/investors-new-weapon-in-japan-votes-to-embarrass-the-boss-11566295201
Yahoo ESG Risk Rating https://finance.yahoo.com/quote/6861.T/sustainability//
Keyence FY3/20 Tanshin(Japanese only) https://www.keyence.co.jp/pdf/tansin_2019-4Q.pdf
Keyence: Creating Sustainable Corporate Value https://www.keyence.com/about-us/sustainability/corporate-value.jsp
Omron(6645) Presentation summary: https://www.omron.com/global/en/assets/file/ir/irlib/20200423_presentation_e.pdf
Omron(6645) Results briefing- lots of detail: https://www.omron.com/global/en/assets/file/ir/irlib/20200423_presentation_script_e.pdf
FT - Coronavirus shows the value of Japan Inc’s cash piles: https://www.ft.com/content/e15f9572-6803-11ea-a3c9-1fe6fedcca75
FSA -Japan Revised Corporate Governance Code: https://www.jpx.co.jp/english/news/1020/b5b4pj000000jvxr-att/20180602_en.pdf