Corporate Japan looks healthier now than it has ever been (Englisch)

Japan’s deflationary era was more than a lengthy period of declining prices. It also brought about profound yet rational changes in corporate behaviour. That ingrained desire from companies to hold onto cash and rein in spending may take time to fully dissipate, but there is already a notable shift underway.

Cash-rich companies putting their cash to better use

One of the longstanding criticisms of Japanese companies was their insistence on hoarding cash, and therefore their lack of shareholder consideration. That precautionary, deflation-oriented corporate mindset was understandable in the past, albeit not a particularly helpful element for growth. But again, that dynamic has changed, and reflationary times mean that built-up cash must come out of hibernation to be used for more productive ends by larger companies, either to preserve competitiveness amid a rise in input costs via investment in technology or return cash to shareholders to increase return on equity. A surprising number of these cash-rich companies are also found in the small and mid-cap space, many of them reside in the labour-intensive services sector, and we are seeing them as well putting their capital to productive use.

Regulation encouraging more shareholder friendly behaviour

Recognising shareholders want to know how that excess cash will be put to work, the Tokyo Stock Exchange’s market reforms urge companies with positive cash flow (profits surpassing the cost of capital) to explain how they will use their cash. But the change is also borne out of the realisation from within firms that good investments and better allocation of balance sheets can make them more productive. Corporate cash is now being turned towards a whole host of things, including productivity-enhancing investments and software. As the following chart shows, capital expenditure and software spending from Japanese companies surged towards the end of 2023. Software spending in Q4 2023 saw the strongest year-on-year expansion since the early 2000s tech boom era.

Chart 1: Japan capital investment

Source: MOF, Nikko AM Global Strategy and Macrobond. Data as at 3 June 2024.

Good news for Japanese workers

Companies are spending more for human capital too because they can ill afford not to. Before 2021, Japan’s labour force had been declining for over a decade, while labour participation rates had been rising, particularly among women and those of traditional retirement age (above 60 years old). Until the COVID-19 pandemic, the rising participation trend helped keep wages contained. However, increases in labour participation are finite and have little further potential to continue keeping wage rises subdued.

Chart 2: Japan unemployment rate (%), Tankan Employment DI

Source: SBJ, BOJ, Nikko AM Global Strategy and Macrobond. Data as at 1 July 2024.

Moreover, the historic wage increases garnered by Japan’s labour unions in their “shunto” spring negotiations are expected to bring another round of increases in unionised wages, with non-union employers following with a lag. It is important to remember that while the shunto does not represent all of Japan's labour force, it is usually a strong leading indicator. Moreover, it is worth noting that Japan’s labour unions represent the least flexible part of Japan’s labour force—more flexible cohorts may soon discover they can vote with their feet (in favour of higher-paying jobs), given labour supply shortages.

A "stealth" cure for zombie businesses

Labour supply shortages have also been leading to the welcome demise of Japan’s so-called “zombie” firms— companies that are essentially unable to generate enough profit to cover their loan interest payments but manage to stay afloat thanks to continued financial support from banks and government measures intended to protect service sector jobs.

For several years, overseas investors have rightly questioned how long Japan would continue to keep these zombie companies alive, concerned that they stifle innovation and competitiveness, drain bank resources and helped contribute to Japan’s stagnant growth. But in the current environment of tight labour supply, more labour-intensive industries must now transform or be left behind. The chart below shows the ratio of services sector to manufacturing firms experiencing bankruptcy is at multi-year highs. The rising proportion of services sector bankruptcies indicates the attrition of zombie firms unable to pay higher wages. This, in turn, boosts services sector competitiveness.

Chart 3: Japan corporate bankruptcies

Source: TSR, Nikko AM Global Strategy and Macrobond. Data as at 10 May 2024.

Summary

Japan’s improved corporate climate has made Japanese companies more attractive both domestically and to overseas investors. But most encouragingly, the structural reforms taking place are of a long-term nature. Japanese companies are recognising that putting cash to use can ultimately help to generate greater profits in future, while improving their relationship with shareholders. This shift in mindset is not just a rational response to an inflationary environment it is also a game changer for corporate Japan.

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