Senior Bank Analyst - Japanese Banks, Windamee Research

J. Brian Waterhouse

Senior Bank Analyst - Japanese Banks

Windamee Research

Japanese Banks

Equity Bottom-Up

Fukuoka Financial Group / Equity Bottom-Up

When approaching icebergs, a rear-view mirror is not much use in avoiding the danger.<a href="https://www.smartkarma.com/entities/fukuoka-financial-group-inc" target="_blank" data-smartkarma-citation="entities:3712:1" rel="noopener">Fukuoka Financial Group (8354 JP)</a> has announced a significant accounting policy affecting the way the group’s four subsidiary banks provision for potential credit costs, moving to ‘forward-looking’ provisioning.  As a result of this accounting policy change, loan-loss reserves have been increased by ¥41.8 billion in FY3/2020, roughly equivalent to 40bps in additional annual credit costs.  Combined with an additional ¥8.7 billion in COVID-19 precautionary provisioning, as well as unbudgeted extra costs of some ¥1.2 billion relating to business integration expenses, the impact on FY3/2020 earnings has been to reduce the group’s forecast for consolidated recurring profits from a profit of ¥52.5 billion to a recurring loss of ¥5.0 billion, while net profits have now been reduced from a forecast ¥148.5 billion to ¥111.0 billion.  This suggests that 4Q FY3/2020 results may have turned into a consolidated net loss of around ¥38.5 billion.  Nevertheless, the ¥85/share annual dividend will not be affected by this announcement.Whether other regional banks will be encouraged to follow FFG’s lead and move to ‘forward-looking’ credit provisioning remains to be seen.  We remain skeptical, given the current state of many regional banks’ balance-sheets.  FFG has adopted a pragmatic approach to credit provisioning among the coronavirus pandemic, and has been able to absorb these additional costs thanks to a ¥117.43 billion ‘windfall profit’ in FY3/2020.  Other banks do not have this luxury. Moreover, while the policy change is to be welcomed, it raises questions as to what the true state of Eighteenth Bank’s asset quality might be that could have prompted such a drastic accounting policy move.Caveat Emptor!  (May the Buyer Beware!)

When approaching icebergs, a rear-view mirror is not much use in avoiding the danger.Fukuoka Financial Group (8354 JP) has announced a significant accounting policy affecting the way the group’s four subsidiary banks provision for potential credit costs, moving to ‘forward-looking’ provisioning.  As a result of this accounting policy change, loan-loss reserves have been increased by ¥41.8 billion in FY3/2020, roughly equivalent to 40bps in additional annual credit costs.  Combined with an additional ¥8.7 billion in COVID-19 precautionary provisioning, as well as unbudgeted extra costs of some ¥1.2 billion relating to business integration expenses, the impact on FY3/2020 earnings has been to reduce the group’s forecast for consolidated recurring profits from a profit of ¥52.5 billion to a recurring loss of ¥5.0 billion, while net profits have now been reduced from a forecast ¥148.5 billion to ¥111.0 billion.  This suggests that 4Q FY3/2020 results may have turned into a consolidated net loss of around ¥38.5 billion.  Nevertheless, the ¥85/share annual dividend will not be affected by this announcement.Whether other regional banks will be encouraged to follow FFG’s lead and move to ‘forward-looking’ credit provisioning remains to be seen.  We remain skeptical, given the current state of many regional banks’ balance-sheets.  FFG has adopted a pragmatic approach to credit provisioning among the coronavirus pandemic, and has been able to absorb these additional costs thanks to a ¥117.43 billion ‘windfall profit’ in FY3/2020.  Other banks do not have this luxury. Moreover, while the policy change is to be welcomed, it raises questions as to what the true state of Eighteenth Bank’s asset quality might be that could have prompted such a drastic accounting policy move.Caveat Emptor!  (May the Buyer Beware!)

Fukuoka Financial Group  (8354 JP):  When Approaching Icebergs ...

Thematic (Sector/Industry)

Last week was an extraordinarily volatile period for Japanese bank stocks, with the sector rising around 14% after a protracted period of negative performance.  Some regional bank stocks rose as much as 35% for the week, while even the mighty megabank <a href="https://www.smartkarma.com/entities/mitsubishi-ufj-financial-gro" target="_blank" rel="noopener" data-smartkarma-citation="entities:218:1">Mitsubishi UFJ Financial (MUFG) (8306 JP)</a> rose an eyebrow-raising 17%.  Regrettably, this is not evidence of a paradigm shift in the Japanese banking sector’s fundamental outlook, but more like a knee-jerk reaction to the Bank of Japan’s efforts to restore order to the somewhat chaotic financial markets through buying ETFs, perhaps aided – if financial media are to be believed  –  by government-owned pension funds such as the GPIF.The Yen has not weakened against the US Dollar, as one might have expected if international investors had been adopting a ‘risk on’ approach, but has failed several times to break though the Y112 level (as noted recently by Smartkarma contributor <a href="https://www.smartkarma.com/profiles/campbell-gunn" target="_blank" rel="noopener" data-smartkarma-citation="accounts:2531">Campbell Gunn</a>) and is now in sharp retreat: a ‘risk off’ reaction.  This is not good news for Japanese financial stocks.The fundamental outlook for Japan’s banks has not improved: if anything, the outlook for FY3/2021 and beyond is now even more challenging than FY3/2020 has been.  As we have frequently pointed out in past Insights, margins remain under downward pressure generally, many regional banks remain underwater on their core domestic businesses, credit costs are rising across the board for all banks and many may face substantial losses on their investment portfolios as they close their accounts for FY3/2020.  Under the circumstances, the recent strength in Japanese bank stock prices is logically unsustainable without further massive intervention by the Japanese financial authorities and the further disruption of price discovery.Japanese banks have underperformed Topix virtually unchecked since 2015.  We expect this trend to continue.  “Caveat Emptor!”  (May the Buyer Beware) remains our advice to would-be investors in Japanese bank stocks for FY3/2021 and beyond.

Last week was an extraordinarily volatile period for Japanese bank stocks, with the sector rising around 14% after a protracted period of negative performance.  Some regional bank stocks rose as much as 35% for the week, while even the mighty megabank Mitsubishi UFJ Financial (MUFG) (8306 JP) rose an eyebrow-raising 17%.  Regrettably, this is not evidence of a paradigm shift in the Japanese banking sector’s fundamental outlook, but more like a knee-jerk reaction to the Bank of Japan’s efforts to restore order to the somewhat chaotic financial markets through buying ETFs, perhaps aided – if financial media are to be believed  –  by government-owned pension funds such as the GPIF.The Yen has not weakened against the US Dollar, as one might have expected if international investors had been adopting a ‘risk on’ approach, but has failed several times to break though the Y112 level (as noted recently by Smartkarma contributor Campbell Gunn) and is now in sharp retreat: a ‘risk off’ reaction.  This is not good news for Japanese financial stocks.The fundamental outlook for Japan’s banks has not improved: if anything, the outlook for FY3/2021 and beyond is now even more challenging than FY3/2020 has been.  As we have frequently pointed out in past Insights, margins remain under downward pressure generally, many regional banks remain underwater on their core domestic businesses, credit costs are rising across the board for all banks and many may face substantial losses on their investment portfolios as they close their accounts for FY3/2020.  Under the circumstances, the recent strength in Japanese bank stock prices is logically unsustainable without further massive intervention by the Japanese financial authorities and the further disruption of price discovery.Japanese banks have underperformed Topix virtually unchecked since 2015.  We expect this trend to continue.  “Caveat Emptor!”  (May the Buyer Beware) remains our advice to would-be investors in Japanese bank stocks for FY3/2021 and beyond.

'Quantamental' Japan Specialist, LightStream Research

Campbell Gunn

'Quantamental' Japan Specialist

ja research

ja research is an independent research platform focused exclusively on Japanese equities. Leveraging data and graphic analysis provided by Japan Analytics, we provide insights on small and medium-sized companies that have been ignored by the sell-side as well as challenging conventional wisdom on larger companies. We also offer analyst and corporate access, the latter with translation if required. 

<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/403/original/2020-02-18_08-44-22.png?1581983074" class="editor-image img-responsive" data-smartkarma-image-id="118403"></figure><figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/404/original/2020-02-18_08-42-56.png?1581983098" class="editor-image img-responsive" data-smartkarma-image-id="118404"></figure><div class="content-caption">Source • Japan Analytics</div>THREE-YEAR LOW - With <a href="https://www.smartkarma.com/entities/bridgestone-corp" target="_blank" data-smartkarma-citation="entities:8914:1" rel="noopener">Bridgestone (5108 JP)</a>'s results and revision now added, our final tally for this season is a 196 basis point decline in our Results Sore - the lowest since March 2017.  In contrast, the Forecast/Revision Score reached a three-month high as the 470 companies with December year-ends put an optimistic gloss on their medium-term outlook. As we have noted in our recent daily roundups, a normal precondition for a cycle low is for the Forecast/Revision Score to rise above the Results Score. Forecast/Revision Score peaks and troughs usually occur one to two quarters ahead of those for the Results Score.  Covid-19's impact will likely see the 2016 'playbook' repeated next quarter with a lower Results Score and a 'sideways' Forecast/Results Score. The Results Score cycle low point will be reached with the mostly-interim results to be released in six months. <figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/405/original/2020-02-18_09-29-28.png?1581985792" class="editor-image img-responsive" data-smartkarma-image-id="118405"></figure><div class="content-caption">Source • Japan Analytics</div>LEADING INDICATOR - By including several momentum factors into our Scoring (see below), we can provide a better indication of future business conditions. Indeed there is a 0.83 correlation between the Cabinet Office's Business Condition Leading Indicator and the Forecast/Revision Score. Reported earnings, as well as company forecasts, are lagging indicators and, as shown in Part 1 of this Insight. Both data series peaked one year after our Scores and the market peaked in early 2018. SCORING METHODOLOGY - For those new to these Insights, we briefly recap our scoring methodology below:-<ul>
<li>Results Scores are calculated using the most recent eight quarters of company data for Revenues, Operating Income and Operating Margin and, for each, measure the rate, degree and consistency of change. The Results Score has a maximum of +30 and a minimum of -30 for each period. Our data series commences from the time a particular company issues quarterly results. The sample size becomes significant from March 2005.</li>
<li>The Forecast/Revision Score is based on both Annual and Interim period company forecasts and compares changes from previous forecasts as well as against the trailing twelve-month (TTM) or previous first-half results, with annual forecasts being double-weighted. This Score also has a maximum of +30 and a minimum of -30 for each period.  For this series, our data samples start from August 2008.</li>
<li>The combined Results &amp; Revision Score (RRS) is the average of the Results Score and the Forecasts/Revision Score.</li>
<li>
All company Scores are then cap-weight-aggregated into Sector, Peer Group and Market Composite Scores for which the seventeen-year monthly and two-year daily track records are shown above. Only currently listed-companies are covered in the aggregate Scores, and the Total Market Capitalisation excludes delisted entities. REITs are not included.
<hr>
• SECTOR SCORES •
<figure class="editor-figure mceNonEditable"><img src="https://static-prod.smartkarma.com/images/media/000/118/410/original/2020-02-18_09-55-29.png?1581987489" class="editor-image img-responsive" data-smartkarma-image-id="118410"></figure><div class="content-caption">Source • Japan Analytics</div>
In the DETAIL Section below, we provide a detailed breakdown of our RRS Scoring for Sectors, Peer Groups and individual companies, highlighting this quarter's 'winners' and 'losers'. The chart above shows a  seventeen-year 'timeline' of the cap-weight-aggregated Sector RRS Scores and the ebbs and flows around the business cycles. The Metals Sector is the most volatile on the downside and has yet to 'bottom' this cycle. Technology Hardware appears to have already rebounded; however, Covid-19 suggests this Sector may relapse. On the upside, the Information Technology Sector has replaced the Internet and Telecoms Sectors as the contra-cyclical 'champion'. 
</li>
</ul>

Source • Japan AnalyticsTHREE-YEAR LOW - With Bridgestone (5108 JP)'s results and revision now added, our final tally for this season is a 196 basis point decline in our Results Sore - the lowest since March 2017.  In contrast, the Forecast/Revision Score reached a three-month high as the 470 companies with December year-ends put an optimistic gloss on their medium-term outlook. As we have noted in our recent daily roundups, a normal precondition for a cycle low is for the Forecast/Revision Score to rise above the Results Score. Forecast/Revision Score peaks and troughs usually occur one to two quarters ahead of those for the Results Score.  Covid-19's impact will likely see the 2016 'playbook' repeated next quarter with a lower Results Score and a 'sideways' Forecast/Results Score. The Results Score cycle low point will be reached with the mostly-interim results to be released in six months. Source • Japan AnalyticsLEADING INDICATOR - By including several momentum factors into our Scoring (see below), we can provide a better indication of future business conditions. Indeed there is a 0.83 correlation between the Cabinet Office's Business Condition Leading Indicator and the Forecast/Revision Score. Reported earnings, as well as company forecasts, are lagging indicators and, as shown in Part 1 of this Insight. Both data series peaked one year after our Scores and the market peaked in early 2018. SCORING METHODOLOGY - For those new to these Insights, we briefly recap our scoring methodology below:-
Results Scores are calculated using the most recent eight quarters of company data for Revenues, Operating Income and Operating Margin and, for each, measure the rate, degree and consistency of change. The Results Score has a maximum of +30 and a minimum of -30 for each period. Our data series commences from the time a particular company issues quarterly results. The sample size becomes significant from March 2005.
The Forecast/Revision Score is based on both Annual and Interim period company forecasts and compares changes from previous forecasts as well as against the trailing twelve-month (TTM) or previous first-half results, with annual forecasts being double-weighted. This Score also has a maximum of +30 and a minimum of -30 for each period.  For this series, our data samples start from August 2008.
The combined Results &amp; Revision Score (RRS) is the average of the Results Score and the Forecasts/Revision Score.

All company Scores are then cap-weight-aggregated into Sector, Peer Group and Market Composite Scores for which the seventeen-year monthly and two-year daily track records are shown above. Only currently listed-companies are covered in the aggregate Scores, and the Total Market Capitalisation excludes delisted entities. REITs are not included.

• SECTOR SCORES •
Source • Japan Analytics
In the DETAIL Section below, we provide a detailed breakdown of our RRS Scoring for Sectors, Peer Groups and individual companies, highlighting this quarter's 'winners' and 'losers'. The chart above shows a  seventeen-year 'timeline' of the cap-weight-aggregated Sector RRS Scores and the ebbs and flows around the business cycles. The Metals Sector is the most volatile on the downside and has yet to 'bottom' this cycle. Technology Hardware appears to have already rebounded; however, Covid-19 suggests this Sector may relapse. On the upside, the Information Technology Sector has replaced the Internet and Telecoms Sectors as the contra-cyclical 'champion'. 



🇯🇵 JAPAN • IT’S A WRAP! Part 2: 2020-Q1 Results & Revision Scores

We expect the stock price of <a href="https://www.smartkarma.com/entities/suruga-bank-ltd" target="_blank" rel="noopener" data-smartkarma-citation="entities:6267:1">Suruga Bank Ltd (8358 JP)</a> to significantly outperform the rest of the Japanese banking sector in CY2020.  We calculate fair value for the shares as being around the ¥1,060 level, suggesting the potential for the stock to double from current levels during CY2020.  The shares have risen over 28% since late December last year: a performance only matched in the Japanese banking sector by <a href="https://www.smartkarma.com/entities/shinsei-bank-ltd" target="_blank" rel="noopener" data-smartkarma-citation="entities:16897:1">Shinsei Bank (8303 JP)</a>.  Yet we see the potential for further price appreciation from current levels.  Recent events supporting this thesis include the resolution of the Okano Family shareholding issue, and an upward revision to full-year guidance.  With the stock now trading around the ¥500 level, the stock looks poised for a re-assessment by investors.  Future positive catalysts may include details of the business alliance with the bank’s largest shareholder, the possibility of further upward revisions to guidance as the fiscal year-end approaches, and the potential for management to reinstate a dividend payout by fiscal year-end.That said, significant investment risks remain.  The story of Suruga Bank is a sad saga of a once highly-profitable bank that fell victim to fraud and falsification, and to a systemic breakdown in its own internal controls. Foreign investors deserted the bank in droves in 2018 and 2019 as core earnings collapsed and bad loans soared to double-digits.  Even now, credit costs remain high, the loan book is still shrinking, customer deposit withdrawals continue (although the pace has clearly slowed), the dividend is still suspended, and the bank badly needs a long-term viable business model if it is to survive as an independent entity.  The bank remains a pariah to many investors.  But in adversity lies opportunity.  At current levels, the stock remains seriously mispriced in our opinion.

We expect the stock price of Suruga Bank Ltd (8358 JP) to significantly outperform the rest of the Japanese banking sector in CY2020.  We calculate fair value for the shares as being around the ¥1,060 level, suggesting the potential for the stock to double from current levels during CY2020.  The shares have risen over 28% since late December last year: a performance only matched in the Japanese banking sector by Shinsei Bank (8303 JP).  Yet we see the potential for further price appreciation from current levels.  Recent events supporting this thesis include the resolution of the Okano Family shareholding issue, and an upward revision to full-year guidance.  With the stock now trading around the ¥500 level, the stock looks poised for a re-assessment by investors.  Future positive catalysts may include details of the business alliance with the bank’s largest shareholder, the possibility of further upward revisions to guidance as the fiscal year-end approaches, and the potential for management to reinstate a dividend payout by fiscal year-end.That said, significant investment risks remain.  The story of Suruga Bank is a sad saga of a once highly-profitable bank that fell victim to fraud and falsification, and to a systemic breakdown in its own internal controls. Foreign investors deserted the bank in droves in 2018 and 2019 as core earnings collapsed and bad loans soared to double-digits.  Even now, credit costs remain high, the loan book is still shrinking, customer deposit withdrawals continue (although the pace has clearly slowed), the dividend is still suspended, and the bank badly needs a long-term viable business model if it is to survive as an independent entity.  The bank remains a pariah to many investors.  But in adversity lies opportunity.  At current levels, the stock remains seriously mispriced in our opinion.

2020 High Conviction:  Suruga Bank (8358 JP) - Fortune Favours the Brave

Technical Analyst, Vermilion Research

Joe Jasper

Technical Analyst

Technical and Quantitative Research

Vermilion Research

Vermilion’s objective is to deliver timely, actionable, and unique technical research to professional investors through the application of our various technical indicators.

Our research strategists seek to highlight securities which we believe are at major inflection points, based on our various technical and quantitative indicators, and offer asymmetric risk/return profiles. Our unique research methodology, centered on relative strength, enables our strategists to deliver superior investment recommendations.

Our process begins by organizing the universe of actively traded stocks into discrete sectors, then into industry groups. We then apply our technical and quantitative tools to identify developing price trends. Once attractive trends are identified within a selected sector or group, we screen for individual stocks which we believe offer the best risk/reward profile. We provide a historical perspective that often reveals, through our long-term charts, how price patterns often repeat themselves over time.

Technical Analysis

TSE Tokyo Price Index TOPIX / Technical Analysis

Despite EAFE’s YTD outperformance relative to EM, EAFE and EM returns have generally been equal since August, shown by the stalemate in the EAFE vs. EM ratio. The U.S. dollar (DXY) is currently trading near support within the 16-17 month uptrend channel. Technicals suggest the most likely scenario is for the DXY uptrend to continue and for support to hold -- which would likely result in EAFE reasserting as leadership.  In this publication we highlight attractive investment themes and individual ideas across developed markets, with special attention given to Japan, Germany, Sweden, Italy, Spain, and Switzerland.

Despite EAFE’s YTD outperformance relative to EM, EAFE and EM returns have generally been equal since August, shown by the stalemate in the EAFE vs. EM ratio. The U.S. dollar (DXY) is currently trading near support within the 16-17 month uptrend channel. Technicals suggest the most likely scenario is for the DXY uptrend to continue and for support to hold -- which would likely result in EAFE reasserting as leadership.  In this publication we highlight attractive investment themes and individual ideas across developed markets, with special attention given to Japan, Germany, Sweden, Italy, Spain, and Switzerland.

Developed Markets Strategy: Stick with Japan

Japan

Concordia Financial Group, Ltd. is a holding company established through the merger of Bank of Yokohama and Higashi-Nippon Bank. The Company provides banking services and other financial services.

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Concordia Financial Group, Ltd (7186 JP)

Fukuoka Financial Group (8354 JP): When Approaching Icebergs ...

When approaching icebergs, a rear-view mirror is not much use in avoiding the danger.Fukuoka Financial Group (8354 JP) has announced a significant...

J. Brian Waterhouse

Japanese Banks: End of March Blues

Last week was an extraordinarily volatile period for Japanese bank stocks, with the sector rising around 14% after a protracted period of negative...

J. Brian Waterhouse

🇯🇵 JAPAN • IT’S A WRAP! Part 2: 2020-Q1 Results & Revision Scores

THREE-YEAR LOW - With Bridgestone (5108 JP)'s results and revision now added, our final tally for this season is a 196 basis point decline in our...

Campbell Gunn

2020 High Conviction: Suruga Bank (8358 JP) - Fortune Favours the Brave

We expect the stock price of Suruga Bank Ltd (8358 JP) to significantly outperform the rest of the Japanese banking sector in CY2020. We calculate...

J. Brian Waterhouse

Developed Markets Strategy: Stick with Japan

Despite EAFE’s YTD outperformance relative to EM, EAFE and EM returns have generally been equal since August, shown by the stalemate in the EAFE...

Vermilion Research

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