Letter number 74 of April 2013


News : The financial analysis of Japanese companies

We thought that it would be interesting to look at the effects on Japanese companies of more than a decade of very slow growth (1% in volume on average since 2000), combined with deflation (-0.3% per year on average for the price index since 2000), and very low interest rates: less than 1% at less than 10 years currently and population stagnation.

Our study was based on listed groups which are not necessarily the most dynamic, but which are normally those with the best performances.

3,470 Japanese companies were listed in December 2012 on the Tokyo and Osaka stock exchanges.  We removed companies with market capitalisations of less than $100m, companies in the banking, insurance and real estate sectors, companies for which part of the accounts are not available over 5 years (like Japan Airlines due to its bankruptcy), and we were left with 1,569 companies for which audited accounts were available.  These were kindly provided by Infinancials, which also provides the 32 financial data for 16,000 listed groups in the world, available on the www.vernimmen.com site.  They represent 80% of the market capitalisation of Tokyo and Osaka, which is around €2,320bn.

We analysed these companies using the standard financial analysis methodology (1).


Wealth creation

The combined sales of Japanese companies in the sample was around €4,500bn in 2011. Notwithstanding its specific features, Japan does not escape the 20/80 rule.  20% of the largest listed Japanese companies account for 84% of sales and 80% of EBIT, with average figures of €9bn and €350m respectively.  And 1% of the largest groups account for 23% of sales and 13% of overall EBIT.

On the other hand, 20% of the smallest companies account for 1.7% of sales but 3.3% of EBIT with average sales of €180m and €15m respectively.

Industry still accounts for a large share of the Japanese economy:  65% of the sales in our sample, with in particular, the motor industry at 15%, accounting for 3 of the 5 largest Japanese groups in terms of sales –  Toyota, Nissan and Honda.

Growth of activity has been negative since 2007, at -2.9% per year.  This negative growth is mainly in volumes as over the same period, Japanese inflation was running at only -0.5%.  This means that these listed companies have shrunk in volume, three times as fast as the Japanese economy, which has “only” shrunk in volume at a rate of 0.7% per year since 2007.

Only 37% of the companies in our sample recorded 2011 sales that were higher than 2007 sales. For 23% of them, sales were lower by 20%.

On the whole, Japanese companies have stood up rather well to the fall off in their activity, -11% in four years, with a drop of only two points for EBIT and of one and-a-half margin points for EBITDA.



















Change in turnover





















Financial result







Net income







As we saw above, 20% of the smallest listed companies in terms of sales have operating margins that are twice as high, at 8.3% in 2011. By comparison, in 2011, listed European groups posted EBITDA margins of 17.8% and EBIT margins of 11.7%.



Investments are mainly in fixed assets, which make up three-quarters of the capital employed of Japanese groups.  Unsurprisingly, given the negative growth, investments in fixed assets over the period studied are 7% lower than depreciation and amortisation.  This means that fixed assets were down by 4%.  When average sales are declining by 11%, entrepreneurs are hardly likely to increase the size of their industrial and commercial facilities.

Over the same period, working capital requirement fell off slightly, by 3%, but since sales were falling off even faster, once expressed in days of sales, it went from 69 to 77 days in 2011:













Days' sales outstanding












Days' payables outstanding












Days' inventory outstanding












Working capital in days of sales






We can see that trade payable and customer receivable periods expressed in days are more or less the same. Is this just a coincidence or is it a sign of an economy that is less open than others to the outside world?  When we look at the working capital on the basis of the size of the company, we are struck by the fact that groups in the bottom quintile have the lowest working capital expressed in days of sales (13% less than average), immediately followed by groups in the top quintile (9% less than average).  Working capital of groups in the three intermediate quintiles are much higher than average, with the prize in this area going to groups in the 3rd quintile, with a working capital in days of sales higher by 67% to that of the average in our sample.


A comparison with a European sample drawn up in the same way, speaks volumes. 41% of European groups have negative working capital requirement, compared with only 14% in Japan.  Part of the explanation is the large share of industry in the Japanese economy, and, on the other hand, the small share of services where it is easier to record negative working capital.  Another part of the explanation is probably to be found in the poorer operating efficiency, whether this is intentional (not putting pressure on weaker customers or suppliers), or the result of circumstances, for example the low interest rates over the last decade do not encourage managers to manage this item optimally.  What a turnaround in 35 years for this country which invented just-in-time and zero inventories!



Unsurprisingly, for an economy that is not experiencing much growth, free cash flows after financial expense are positive, even if they are falling, but 2011 was not an ordinary year for Japan (Fukushima) and free cash flows were used over four years to give €355bn back to shareholders while reducing net bank and financial debt by 5% (€40bn):













Cash flow






- Change in working capital






= Operating cash flow







- Capital expenditure







= Free cash flow after financial costs






-Dividends paid







+ Share issues - share buy back







= Reduction (increase) in net debt







Since changes in working capital are negative, the Debt/EBITDA ratio is relevant.  At around 2, the overall situation is not yet worrying, even though it might surprise us that in an economy without growth, there is no net deleveraging.  But the low margins limit internal financing and explain this situation.  In Europe, the same ratio in 2011 was 1.5.













Net debt/EBITDA






But in this area, analysis should really be carried out company by company.  On this basis, we find that 14% of listed Japanese companies have a Debt/Ebitda ratio of over 4 and that these companies account for 56% of gross debt (which is €1,600bn).  Of these debts, the short-term share is 47%.  At the other extreme, 51% of listed groups have net negative debts and this figure is 64% for groups with a Debt/Ebitda ratio that is lower than or equal to 1. In other words, the correct average of 2.1 hides very large disparities and situations that are highly critical.   Only 19% of listed groups have a “normal” ratio of between 1 and 3 times.  In short, we could say that in Japan, most companies are either collapsing under a huge cash pile out of fear of the future and/or a lack of ideas, or they are in very bad shape.



With an average ROCE of between 2.6% and 6.5%, Japanese groups are far from earning their cost of capital, which is estimated at 7%:




























In 2011, only 40% of groups earned their cost of capital or more and one-third had a ROCE of less than 4.5%.  It is again at the extremes that the best performances are recorded: 15.5% of after tax ROCE for the quintile of companies with the lowest sales, and 5.6% for the top quintile, although this figure is not exactly a stellar performance.  


As an illustration, the largest Japanese company in terms of sales, Toyota, has not achieved a return on equity of more than 4% since 2008, and Sony has recorded losses since that time.  



Even though the Nikkei 225 has returned to its 1986 level, thanks to a rise of around 20% since the latest elections in December 2012, the average Price to Book ratio is 1.2. Given an average return on equity of 4.7%, much lower than the average cost of equity of around 10%, such a P/B ratio is only justified if the ROCE of listed Japanese groups improves rapidly. 

Japanese managers have their work cut out for them if they don’t want to disappoint their investors yet again.

In greater detail, the top quintile of listed Japanese companies which earns its cost of equity is valued with an average P/B ratio of 3.5. The central quintile which generates an average return on equity of around 6% is valued with a P/B ratio of 0.9. And as for the poor performers, their average P/B ratio is 0.5 for an average return on equity of 2.3%.  . . 


*                *             *

All of this points to a rather strange world, in which the drying up of creativity (where are the successors of the walkman, compact discs and the just-in-time process of the 1970s?), the ageing of the population followed by its decrease in size, and deflation over more than 10 years, have been passed down to listed companies, which were supposed to be the jewel of the economy, but whose sales are falling, which have low margins, and insufficient internal financing for any substantial deleveraging for those carrying the most debt.  Others are not at risk of going bankrupt, given the huge amounts of cash they are hoarding to protect themselves against a future that they seem to fear and because of a lack of investment opportunities.  All in all, very few groups meet the required returns of shareholders, which is never a guarantee for survival, but since corporate governance of Japanese companies is weak, the situation may continue for some years to come.  Let’s hope that our world won't turn out like that.

(1) For more information, see chapter 8 of the Vernimmen.

Statistics : Global senior leverage loan volumes

2012 has been a very different year for the 3 main economic zones :

US all-senior volumes have skyrocketing in 2012 with an increase of 34 % compared to 2011 and close to their all-time high of 2007. Europe was still impact by the crisis. European leverage loan volume was down 34% from 2011 and 85% (sic) from 2007. Asian leveraged loan volume was 12.6bn, down 34%. Early 2013 has been very active on both side of the Atlantic. The US maintain the 2012 trend on the back of strong liquidity and Europe enjoys a healthy start.

Research : Ownership structure and financial constraints

With Simon Gueguen – Lecturer-researcher at the University of Paris Dauphine

Shareholders who exercise control over a company, often have decision-making powers that are disproportionately high compared with the stakes they hold in the company’s capital. In order to achieve this, they use shares with double voting rights, or pyramid-shaped holding structures. This phenomenon was documented in a well-known article written in 1999 (1). The consequences for the company are generally negative. 

In addition to the traditional problem of agency between shareholders and managers, this system leads to a conflict of interest between the majority and minority shareholders.  With this sort of shareholding structure, the shareholder who has control may have an interest in ensuring that the choices and the resources of the company go towards increasing his/her exclusive profit, at the expense of the other shareholders. 

This month, we present an article(2) which shows that this situation could make it more difficult for companies to get access to external financing. The article focuses on financial constraint, i.e., the problems experienced by a company in accessing external financing.  A company that is financially constrained will be unable to pursue projects that create value, or at the very least, will have to postpone them.  All other things being equal, such a company will have a lower level of investment, lower levels of cash flow, lower levels of sales growth and smaller dividends. 


In collating these data and carrying out an empirical study on a sample of US companies between 1997 and 2002, Clin et al show that the existence of a divergence between controlling power and the size of the stake in the capital, increases this financial constraint, and that this leads to a drop in the level of investment. By classifying companies into three groups according to their financial constraint, the most constrained have a level of investment that is 17% lower than that of the least constrained.

The most interesting results of the study concern the factors that influence this relationship. 

A lack of transparency in terms of information makes monitoring more difficult for external investors, and facilitates expropriation by the majority shareholders; accordingly, financial constraint will rise.  In order to measure the lack of transparency of information, Clin et al consider the following sorts of companies to be the least transparent:


  • smaller companies (measured by the amount of assets);
  • companies that are followed by fewer analysts;
  • companies whose debt is not rated by rating agencies;
  • companies that are not included in a major stock market index (in this case, the S&P 500).

These criteria are all factors that will increase the link between capital-control divergence and financial constraint. 

It should be noted that the number of analysts covering the company appears to be the most important criterion, leading us to believe that this is an essential criterion for the transparency of financial information.  Conversely, the presence of institutional investors in the capital of the company reduces this link.  Institutional investors are able to monitor the majority shareholder, even when they only hold a small percentage of the capital.


For all of these reasons, the gap between the size of the stake held in the capital and the amount of control exercised by the majority shareholder, is an essential element in the capital structure of companies.  If this gap widens, the company will find it more difficult to get external financing, and this will have an impact on its value.



(1) R. LA PORTA, F. LOPEZ-DE-SILANES et A. SHLEIFER (1999), Corporate ownership around the world, Journal of finance, vol. 54, p. 471-517

(2) C.LIN, Y.MA et Y. XUAN (2011), Ownership structure and financial constraints : evidence from a structural estimation, Journal of Financial Economics, vol.102, p. 416-431

Q&A : How to measure liquidity?

A security is said to be liquid when it is possible to buy or sell a large number of shares on the market without it having too great an influence on the price. Liquidity is a typical measure of the relevance of a share price. It would not make much sense to analyse the price of a stock that is traded only once a week, for example.

A share price is relevant only if the stock is sufficiently liquid.

A share’s liquidity is measured mainly in terms of free float, trade volumes and analyst coverage (number of analysts following the stock, quality and frequency of brokers’ notes).

a) Free float

The free float is the proportion of shares available to purely financial investors, to buy when the price looks low and sell when it looks high. Free float does not include shares that are kept for other reasons, i.e. control, sentimental attachment. A skyrocketing share price could make sellers out of loyal shareholders, thus widening the free float.


Free float can be measured either in millions of euros or in percentage of total shares. It is becoming more common to use free-float-based indices, i.e. indices composed of the relative free float value of each company. The free float factor is normally given by the percentage of shares remaining after the block ownership and restricted shares adjustments are applied to the total number of shares:


Thus it may happen that a company with a high total market value has a lower percentage in the free float index because the percentage of shares “free to float” is low. At the same time, mid-caps could increase their relevance in the indices if core shareholders hold a low portion of the entire equity.

b) Volumes

Liquidity is also measured in terms of volumes traded daily. Here again, absolute value is the measure of liquidity, as a major institutional investor will first try to determine how long it will take to buy (or sell) the amount it has targeted. But volumes must also be expressed in terms of percentage of the total number of shares and even as a percentage of free float.