Pan-Asia Catalysts/Events, Quiddity Advisors

Travis Lundy

Pan-Asia Catalysts/Events

Quiddity Advisors

On Friday 11 June, the TSE published its final revisions to the Corporate Governance Code which had been undergoing review by the Council of Experts Concerning the Follow-up of Japan’s Stewardship Code and Japan’s Corporate Governance Code and subsequently comment for the past many months. The new Code went into effect as of 11 June. The first revision to the Guidelines for Investor and Company Engagement were published as well. The new version of Japan's Corporate Governance Code is <a href="https://www.jpx.co.jp/english/news/1020/b5b4pj0000046kxj-att/b5b4pj0000046l07.pdf" target="_blank" rel="noopener">here</a> with the tracked change version <a href="https://www.jpx.co.jp/english/news/1020/b5b4pj0000046kxj-att/b5b4pj0000046l0c.pdf" target="_blank" rel="noopener">here</a>. This is the second revision of the Code (the first revision was in 2018).The revisions to the JFSA Guidelines for Investor and Company Engagement are <a href="https://www.jpx.co.jp/english/news/1020/b5b4pj0000046kxj-att/b5b4pj0000046l3e.pdf" target="_blank" rel="noopener">here</a>. Tracked changes are <a href="https://www.jpx.co.jp/english/news/1020/b5b4pj0000046kxj-att/b5b4pj0000046l50.pdf" target="_blank" rel="noopener">here</a>.The major changes to the Code recommend enhancements to Board independence, diversity, Sustainability and ESG, and also recommend improvements to investor accessibility and voting and a small change to listed parent-listed subsidiary relationships which unfortunately will not do much to counter abuse by companies of listed sub minority shareholders. Below is more discussion of the changes and what they mean.But I remind investors, these changes are almost all box-ticking exercises. They will not improve governance for shareholders except at the margins. Companies which "get" good governance are still rare. And those which don't get it seem to abuse shareholders on a regular basis. And for that, investors still need more cowbell.

On Friday 11 June, the TSE published its final revisions to the Corporate Governance Code which had been undergoing review by the Council of Experts Concerning the Follow-up of Japan’s Stewardship Code and Japan’s Corporate Governance Code and subsequently comment for the past many months. The new Code went into effect as of 11 June. The first revision to the Guidelines for Investor and Company Engagement were published as well. The new version of Japan's Corporate Governance Code is here with the tracked change version here. This is the second revision of the Code (the first revision was in 2018).The revisions to the JFSA Guidelines for Investor and Company Engagement are here. Tracked changes are here.The major changes to the Code recommend enhancements to Board independence, diversity, Sustainability and ESG, and also recommend improvements to investor accessibility and voting and a small change to listed parent-listed subsidiary relationships which unfortunately will not do much to counter abuse by companies of listed sub minority shareholders. Below is more discussion of the changes and what they mean.But I remind investors, these changes are almost all box-ticking exercises. They will not improve governance for shareholders except at the margins. Companies which "get" good governance are still rare. And those which don't get it seem to abuse shareholders on a regular basis. And for that, investors still need more cowbell.

TSE Prime: Japan's Corporate Governance Code Finalized So Boxes Will Be Furiously Ticked

Event-Driven

In summer of 2016, I warned on Smartkarma that the BOJ was going to have to shift its ETF buy basket away from Nikkei 225. It did so in late 2016. I warned again in early 2018 that it was going to get worse, and suggested a revision to the Nikkei 225 Average methodology in <a href="https://www.smartkarma.com/insights/the-boj-s-ongoing-etf-impact-is-a-nikkei-225-reshuffle-in-the-cards" target="_blank" data-smartkarma-citation="insights:17331" rel="noopener">The BOJ's Ongoing ETF Impact - Is a Nikkei 225 Reshuffle in the Cards?</a> (followed by <a href="https://www.smartkarma.com/insights/japan-passive-boj-heading-for-trouble-with-nikkei-225" target="_blank" data-smartkarma-citation="insights:21980" rel="noopener">JAPAN PASSIVE:  BOJ Heading For Trouble with Nikkei 225</a>) whereby there would be a deemed minimum shares outstanding quantity so that Deemed Minimum Shares Out / Shares out multiplied by Existing Deemed Par Value would become NEW Deemed Par Value.
This would mean that some names would see lower weights, but on the whole, the Nikkei 225 basket would be much more liquid. 
Nothing was done. The BOJ again lowered its use of Nikkei 225 ETFs, then recently finally stopped using the average altogether. 
The Nikkei 225 had been made largely irrelevant by the Nikkei's refusal to adapt to the times.
<h2>The NEW News</h2>
Today after the close, the Nikkei Index Team announced the first proposed revision to the methodology of the Nikkei 225 Average in twenty years, and a consultation over the next five weeks. Because the concept of Par Value is no longer used in Japan in the Companies Act, it would get rid of the "Presumed Par Value" or "Deemed Par Value" for members and potential members of the Average, and replace it with a Price Adjustment Factor ("PAF") which is an inverse multiplier of the Deemed Par Value. 
In short.... it would do nothing to the index and its constituents as they stand today.
And new additions would be assigned a PAF which would presumably be related to their previously understood Deemed Par Value. But in any case, new constituents would be capped at 1% weightings so would see their Price Adjustment Factor.... adjusted. 
There are other changes proposed which change the rebalancing possibilities, and there is a note that the Average would only include members of TSE Prime (such that existing TSE1 and Nikkei 225 members which chose not to become members of TSE Prime would find themselves booted from the Nikkei 225. 
This is highly disappointing. A 20-year review could have been so much more interesting and the Nikkei could have rescued itself from effective oblivion. Alas, this misses the mark, by a wide margin. 
But details are details so we look at them below.

In summer of 2016, I warned on Smartkarma that the BOJ was going to have to shift its ETF buy basket away from Nikkei 225. It did so in late 2016. I warned again in early 2018 that it was going to get worse, and suggested a revision to the Nikkei 225 Average methodology in The BOJ's Ongoing ETF Impact - Is a Nikkei 225 Reshuffle in the Cards? (followed by JAPAN PASSIVE:  BOJ Heading For Trouble with Nikkei 225) whereby there would be a deemed minimum shares outstanding quantity so that Deemed Minimum Shares Out / Shares out multiplied by Existing Deemed Par Value would become NEW Deemed Par Value.
This would mean that some names would see lower weights, but on the whole, the Nikkei 225 basket would be much more liquid. 
Nothing was done. The BOJ again lowered its use of Nikkei 225 ETFs, then recently finally stopped using the average altogether. 
The Nikkei 225 had been made largely irrelevant by the Nikkei's refusal to adapt to the times.
The NEW News
Today after the close, the Nikkei Index Team announced the first proposed revision to the methodology of the Nikkei 225 Average in twenty years, and a consultation over the next five weeks. Because the concept of Par Value is no longer used in Japan in the Companies Act, it would get rid of the "Presumed Par Value" or "Deemed Par Value" for members and potential members of the Average, and replace it with a Price Adjustment Factor ("PAF") which is an inverse multiplier of the Deemed Par Value. 
In short.... it would do nothing to the index and its constituents as they stand today.
And new additions would be assigned a PAF which would presumably be related to their previously understood Deemed Par Value. But in any case, new constituents would be capped at 1% weightings so would see their Price Adjustment Factor.... adjusted. 
There are other changes proposed which change the rebalancing possibilities, and there is a note that the Average would only include members of TSE Prime (such that existing TSE1 and Nikkei 225 members which chose not to become members of TSE Prime would find themselves booted from the Nikkei 225. 
This is highly disappointing. A 20-year review could have been so much more interesting and the Nikkei could have rescued itself from effective oblivion. Alas, this misses the mark, by a wide margin. 
But details are details so we look at them below. 

After 20yrs, Nikkei 225 Proposes Minor Impact Rule Changes (Nintendo Disappointment?)

Senior Technology Analyst, Japanese Equities, LightStream Research

Scott Foster

Senior Technology Analyst, Japanese Equities

Long-Short Analysis on Japan, Asia and the World

LightStream Research

LightStream conducts quantitatively rigorous and data-driven analysis with a focus on Japan and Asia.

We consistently cover the Tech, Consumer and Industrial sectors, and provide ECM and Events coverage more broadly.

We supplement traditional qualitative insights from company relationships with a robust quantitative foundation that examines as much historical data as is available.
We further refine the accuracy of our insights and calls through the use of alternative data to flesh out current trends, and through a valuation framework that emphasises non-superficial peer group selection and a proper attempt to understand the metrics and changes that have driven security valuations in the past.

Equity Bottom-Up

Advantest achieved record orders and sales in FY Mar-21 and operating profit rose 20.5% to the highest level in 15 years. On top of that management is guiding for another 20% increase in operating profit in FY Mar-22. Are we looking at the peak?That will not be clear for another two quarters at least. In the meantime, the 1.2 Book-to-Bill ratio recorded in 2H of FY Mar-21, strong demand for both SoC and memory test systems, and much improved mechatronics and service margins suggest that FY Mar-22 guidance may be conservative.That would be consistent with last fiscal year, when guidance was raised twice but still fell short of the company's actual performance. We expect demand for test equipment to continue to rise as IC shortages are overcome.We maintain our ¥12,000 share price target, which indicates upside potential of 16%.

Advantest achieved record orders and sales in FY Mar-21 and operating profit rose 20.5% to the highest level in 15 years. On top of that management is guiding for another 20% increase in operating profit in FY Mar-22. Are we looking at the peak?That will not be clear for another two quarters at least. In the meantime, the 1.2 Book-to-Bill ratio recorded in 2H of FY Mar-21, strong demand for both SoC and memory test systems, and much improved mechatronics and service margins suggest that FY Mar-22 guidance may be conservative.That would be consistent with last fiscal year, when guidance was raised twice but still fell short of the company's actual performance. We expect demand for test equipment to continue to rise as IC shortages are overcome.We maintain our ¥12,000 share price target, which indicates upside potential of 16%.

Advantest (6857 JP): Further Growth Ahead

On January 10, we wrote that demand for semiconductor equipment could exceed SEMI's growth forecast for 2021, that Tokyo Electron's guidance for FY Mar-21 was probably conservative, and that Investors in Tokyo Electron (TEL)... should benefit, even if the shares appear to be overbought. (see<a href="https://www.smartkarma.com/insights/tokyo-electron-8035-jp-semiconductor-shortage-points-to-stronger-year-ahead" target="_blank" data-smartkarma-citation="insights:46893" rel="noopener">Tokyo Electron (8035 JP): Semiconductor Shortage Points to Stronger Year Ahead </a> ).  Since then, TEL has raised guidance, Intel and TSMC have announced big new capital spending plans, SEMI has raised its forecast of semiconductor equipment demand, and TEL's share price has risen by 24%. How much more upside is there?The shares are now selling at 34x management's EPS guidance for FY Mar-21 and 31x our estimate for FY Mar-22. These multiples are not high compared with those of other first-rate Japanese  precision manufacturing companies, but they are double what they were two or three years ago. It is tempting to say that valuations are extended in what remains a cyclical industry, but the greater risk to earnings growth, in our estimation, is high and rising depreciation and R&amp;D expenses as the company expands capacity and develops technology for the 2 nanometer node and beyond (See <a href="https://www.smartkarma.com/insights/screen-holdings-7735-jp-aiming-at-2nm-process-technology" target="_blank" data-smartkarma-citation="insights:49767" rel="noopener">Screen Holdings (7735 JP): Aiming at 2nm Process Technology</a> ).

On January 10, we wrote that demand for semiconductor equipment could exceed SEMI's growth forecast for 2021, that Tokyo Electron's guidance for FY Mar-21 was probably conservative, and that Investors in Tokyo Electron (TEL)... should benefit, even if the shares appear to be overbought. (seeTokyo Electron (8035 JP): Semiconductor Shortage Points to Stronger Year Ahead  ).  Since then, TEL has raised guidance, Intel and TSMC have announced big new capital spending plans, SEMI has raised its forecast of semiconductor equipment demand, and TEL's share price has risen by 24%. How much more upside is there?The shares are now selling at 34x management's EPS guidance for FY Mar-21 and 31x our estimate for FY Mar-22. These multiples are not high compared with those of other first-rate Japanese  precision manufacturing companies, but they are double what they were two or three years ago. It is tempting to say that valuations are extended in what remains a cyclical industry, but the greater risk to earnings growth, in our estimation, is high and rising depreciation and R&amp;D expenses as the company expands capacity and develops technology for the 2 nanometer node and beyond (See Screen Holdings (7735 JP): Aiming at 2nm Process Technology ).

Tokyo Electron (8035 JP): Getting Ahead of Itself

On March 24, the Nikkei newspaper reported that Tokyo Electron (TEL) (8035 JP), Canon (7751 JP) and Screen Holdings will cooperate with Japan's National Institute of Advanced Industrial Science and Technology (AIST) to develop "next-generation production technology in the 2-nanometer process and beyond by the mid-2020s."In response to our inquiries, Tokyo Electron and Canon said "No Comment," but Screen told us that (1) The article is basically true, (2) Only these three companies seem to be involved, and (3) This is a new activity for Screen.This should help Japanese equipment makers support TSMC, which is now targeting commercial production with 3-nm process technology in 2022. It is also a reminder that Screen, like TEL, is a long-term investment.Screen's share price has risen by 16% since we last wrote on the company at the beginning of February. But there remains 24% potential upside to our ¥12,000 share price target.

On March 24, the Nikkei newspaper reported that Tokyo Electron (TEL) (8035 JP), Canon (7751 JP) and Screen Holdings will cooperate with Japan's National Institute of Advanced Industrial Science and Technology (AIST) to develop "next-generation production technology in the 2-nanometer process and beyond by the mid-2020s."In response to our inquiries, Tokyo Electron and Canon said "No Comment," but Screen told us that (1) The article is basically true, (2) Only these three companies seem to be involved, and (3) This is a new activity for Screen.This should help Japanese equipment makers support TSMC, which is now targeting commercial production with 3-nm process technology in 2022. It is also a reminder that Screen, like TEL, is a long-term investment.Screen's share price has risen by 16% since we last wrote on the company at the beginning of February. But there remains 24% potential upside to our ¥12,000 share price target.

Screen Holdings (7735 JP): Aiming at 2nm Process Technology

Japan

Tokyo Electron Limited manufactures and sells industrial electronics products, such as semiconductor manufacturing machines, computer system, and electronic components.  The Company products are sold in US, Taiwan, and others as well as in Japan.

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Tokyo Electron (8035 JP)

TSE Prime: Japan's Corporate Governance Code Finalized So Boxes Will Be Furiously Ticked

The TSE on Friday announced the revisions to the Governance Code. This codifies the "governance thresholds" required to join TSE Prime next year....

Travis Lundy

After 20yrs, Nikkei 225 Proposes Minor Impact Rule Changes (Nintendo Disappointment?)

TWENTY YEARS after its last major index methodology review, the Nikkei has proposed changes to the Nikkei 225. Existing constituents are not...

Travis Lundy

Advantest (6857 JP): Further Growth Ahead

A strong order flow, improved margins and capacity expansion to overcome the shortage of automotive and other ICs point to further growth in demand...

Scott Foster