We are not quite reliving the plot of The Producers, where the impresario has everything to gain from a failed Broadway show, but for a certain type of Japanese chief executive — sweating under pressure to raise base salaries — this was an awkward time for a stellar earnings season.
Investors, meanwhile, may now see a double reason for cheer and, if they are lucky, the so-far elusive market narrative of 2018 that could prise the Topix off its tight correlation with the S&P 500.
It should not be too surprising that corporate Japan turned in a set of strong results for the October-December period of 2017 — the third quarter of most listed companies’ financial year. Bullish brokers have, to the point of obsession, identified large swaths of industry as perfectly geared to global growth, and the (much larger) non-manufacturing sector’s profits primed to feed off a tourism boom and domestic consumer revival.
Yet delivery on this well-flagged promise was still striking: companies representing more than 83 per cent of the Topix announced results last week, which resulted in net profits across the index up 39 per cent year-on-year in that bumper quarter. When there were analysts covering the stocks (and much of the Japanese market is uncovered), actual results beat consensus analysts’ estimates by 46 per cent, according to a calculation by broker CLSA.
Beating the analysts is one thing. The deeper story is the 152 corporates — around 12 per cent of companies with financial years ending in March that have reported 3Q results — that have already exceeded their own guidance for the full year. Some 14 of those are more than 100 per cent ahead of full-year guidance after just nine months. It makes, one broker observed, “a bit of a farce of the whole guidance process”.
But it may do more than that. Earnings guidance in markets everywhere is often a victim of the management instinct to lowball first so as to triumph later with an overshoot. In Japan, though, the pattern is too consistent for comfort, often strays into the deliberately deceptive, and is carried out as part of a habit of systemic conservatism. CEOs are not financially incentivised to reach for the stars, so opt for comfortable survival meeting targets they know are achievable. True, comparisons between the Topix and S&P 500 show the former’s earnings profile to be more volatile, but that could, and should, be solved with more frequent guidance updates.
A greater issue, however, is how Japanese managements of listed companies have historically been able to weaponise their conservatism when it comes to the ¥117tn of cash sitting on their collective balance sheets. Investors may, after years of pressure, have been able to demand more in recent years — the sharp increase in share buybacks has been a prominent feature of the past half-decade. But full-time employee wages, for which Prime Minister Shinzo Abe has called for a 3 per cent hike, remain caught in the conservatism trap.
With the deflationary mindset still haunting boardrooms, companies are reluctant to make the long-term commitments involved in a decent hike to base salaries. But in the absence of any really sustained activism against the inaccuracy of company guidance, it has suited management facing wage hike demands to point at their own lowballed profit guidance. If that guidance later proves wrong, they can always maintain later that the surprise upside was a happy fluke around which long-term policy should not be based.
As they approach this year’s closely watched shunto wage negotiation season however, companies face several difficulties maintaining the traditional posture. The first is that, in addition to Mr Abe’s call for a specific wage hike and the obviousness of rude financial health across many sectors, broader momentum is building for the sort of wage increase that could create another significant leg-up in the domestic consumption story.
In his new year speech last month, for example, Akio Mimura, chairman of the Japan Chamber of Commerce and Industry, said CEOs should be “ashamed” if cash reserves are piling up at their companies. At the top levels of the Abe administration, some have even begun using the word “giri” (obligation) — to refer to companies’ duty to raise wages. If that does not do the trick, say the wage increase bulls, reforms to Japan’s tax system for the coming financial year will offer large companies that raise wages by at least 3 per cent tax exemptions on 15 per cent of the increase.
Whether any of this pushes base salaries much higher remains to be seen. But if companies want to enter wage negotiations looking like they are the pre-eminent judges of their economic futures, they have work to do.
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