Daily Thematic: Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX and more

In this briefing:

1. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX
2. Thai Macro Watch: Traditional ‘Weak Oil’ Plays in Thailand
3. Japan: 2018 Sector Review – Down, Down, Deeper & Down
4. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)
5. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

1. Big Trouble in Little Stocks? Maybe TSE Mulls Changing TOPIX

A Nikkei Asian Review article on 21 December titled  Tokyo Stock Exchange’s big board about to get a lot smaller suggesting the TSE would boot up to 1500 stocks from TOPIX, which now boasts 2130+ members – far more than major indices in other developed markets. 

Since November, a dedicated internal panel (“Advisory Group to Review TSE Cash Equity Market Structure”) has been addressing the issues, trying to make Tokyo’s stock market more attractive for international investors. Some of the proposals raised include a market cap cutoff of ¥50 billion or ¥100 billion of which there were on that date 1,000 companies and 620 companies respectively. 

The same day, the TSE released a  Consultation Paper “Review of the TSE Cash Equity Market Structure”. There is the Paper and the Data presentation which accompanies it. And the Consultation Paper invites public comments through 31 January (contact the Listing Department at [email protected]).

The introduction makes clear the goal. The part below is underlined in the original document.

Taking into account the role the market structure plays, it is important that TSE reviews the market structure in order to further incentivize listed companies to proactively improve their overall value as corporation, in addition to further attracting diverse global and domestic investors by providing attractive investment opportunities. Conducting a review of the market structure, with the aim of supporting the se roles, will further contribute to the development of a sustainable capital market, and by extension, the wider Japanese economy.

That paragraph tells you all you need to know.

It Has Been Decided That Something Must Be Done So Something Will Be Done.

The Consultation Paper and the Data presentation accompanying it discuss the current market structure (with four “listing” markets including the TSE1, TSE2, MOTHERS, and JASDAQ (including sub markets), making it clear that…

• biotech companies which need R&D capital should be allowed to list in order to raise capital, but pointing out that small companies which are already in existence for many years which list just because they want to are not 
• the requirements for reassignment from JASDAQ, MOTHERS or TSE2 to the First Section (the “step-up market” to which all major companies should aspire) are too low, and many companies which should not be admitted to the top ranks because of weak internal management structure or corporate governance end up there anyway,
• delisting requirements and procedures may not function properly and should be reviewed,
• the ability for shareholders to trade the “pink sheets”, “green sheets”, or delisted stocks is insufficient.
• the requirements for listing and liquidity on JASDAQ are insufficient.

I would note that the Consultation Paper does not address the ¥50 billion or ¥100 billion question.  The fact that the Nikkei does so tells you where they want to go with this. 

• The TSE is not suggesting that small companies shouldn’t be allowed to list. 
• The TSE clearly defines three types of companies – 1) risky companies without profits but great need for capital to grow, 2) established companies where capital need is lower and market investment may be made by more risk-averse investors, and 3) the “step-up market” – the big leagues.
• The Paper asks investors what should be the listing criteria for each group and the treatment of those companies which no longer meet the listing criteria. Then it asks about delisting criteria. 
• Effectively, the goal of making such changes to minimum market cap would be to…
  • make TOPIX (which is an index consisting of all members of the TSE First Section) a “better” index which would look more like the S&P500. That would make TOPIX more like the indices commonly used by foreign investors – such as MSCI Japan and FTSE Japan.
  • provide two markets for smaller companies – one for growth companies without profits or track record and one for established companies with a track record. 

The “Call for Comment” questions in each section point you to the overall conclusions and destination and ask you, the investor, what limits should be placed to light the way there. Investors with an interest in market structure should think about how best to respond.

• Should parent-controlled subsidiaries be allowed to list when the parent owns more than 50%?
• Should all TSE1 companies be required to release extensive company data and documentation online? in English?
• Should companies which breach the public trust through scandal – such as Seibu Rail, Kanebo, and Olympus years ago or Toshiba more recently – be permitted to stay listed? (Seibu and Kanebo were delisted, Olympus and Toshiba stayed listed)
• What constitutes a situation where delisting should be mandatory?

The language of the Paper and the way the Call for Comment questions are framed tells me the “results” are already known and the results of the Public Comment period will simply be flavoring.

There will be a three-tier market – something akin to MOTHERS, something akin to TSE2 for “established companies”, and something like the TSE First Section which will be beefed up (stricter criteria) and slimmed down (fewer companies). 

Whether governance is improved through limits on subsidiary holdings by parent companies, or criteria for independent directors, or more extensive documentation (and in English) is up to investors. If they make enough noise, this could happen. 

Most important for traders and investors are the market impacts from potential changes to TSE First Section. If the TSE mandates that listing requires companies to have a market cap of  ¥100 billion, the change…

1. will have a profound effect on the supply/demand metrics for a large number of companies. THAT will create dislocations.
2. possibly prompt consolidation over time. The limited ability of small companies to access TSE1 listing because of insufficient size or dollar value of daily liquidity may cause mergers.
3. could have profound effects on the Nikkei 225 if done right. 

2. Thai Macro Watch: Traditional ‘Weak Oil’ Plays in Thailand

As the US turns into a net exporter and weaker Chinese economic outlook looms, oil prices have tanked quickly. While QE unwinding will continue to weigh down share price performance for Thai equities in 2019, we do believe a few areas could benefit from lower energy costs on the earnings side.

• Consumer goods. Lower energy cost leads to higher disposable income. BJC, which sells consumables like potato chips, comes to mind.
• Retailing. Retailers that sell bigger items and provide parking space like BJC’s Big C and Robinsons benefit on the revenue side, while CP All’s 7-Eleven can expect to see cost reduction.
• Airlines & other tourism stocks. The cost savings for airlines is arguably bigger than any other sector could expect to enjoy. If they cut down ticket prices to compete, it will spill over to other areas of tourism, such as airport and hotel operators.
• Media. Improving consumer sentiment prompts new purchases and encourages businesses to advertise more. If we had to pick one, we’d go with Major this time. We also hold this stock for good measure.

3. Japan: 2018 Sector Review – Down, Down, Deeper & Down

Source: Japan Analytics

DOWN, DOWN, DEEPER & DOWN – Japanese equities were as unfashionable as the venerable ‘Quo’ in 2018, although all of the year’s decline occurred in the fourth quarter. Our All-Market-Composite fell by 16.1%, only three sectors – REITs, Utilities and Telecoms – rose and four sectors – Metals, Building Materials, Technology Hardware and Machinery – fell by more than 30%. All of the sixteen outperforming sectors are domestically-orientated, and only two – Other Commercial Products and Other Consumer Products are manufacturing sectors. With no end in sight to the Bank of Japan’s accommodation, interest rates remained at historically-depressed levels and provided no respite to financial sectors. Construction and Building Materials declined as the pre-Olympic construction order cycle peaked out, although Real Estate outperformed as office vacancy rates and rents reached three-decade new lows and new highs, respectively. The largest fourth-quarter declines were in the Energy, Internet, Information Technology and Commercial Services sectors and now offer some attractive stock-specific opportunities.

4. Japanese Banks:  These Lifeless Things (The Ozymandias Syndrome)

Japanese bank stocks performed so poorly in 2018, with the Topix Bank Index falling 25.7% while the overall market declined by a lesser 16.4%, that some may be tempted to speculate that Japanese banks might be a key sector in leading a market recovery in 2019. We don’t think so. The fundamental outlook for banks’ profits remains clouded by a strengthening Yen against the US$, declining revenue growth, anaemic manufacturing sector loan demand, relentless downward pressure on net interest margins, weak fee business, rising valuation losses on both stocks and bonds, and ‘normalising’ credit costs. Simply put, there are no growth catalysts to drive the Japanese banking sector forward on a sustainable basis in terms of stock price appreciation. This all adds up to uninspiring valuations, even at current levels.  ‘Caveat emptor! (May the buyer beware!)’ remains our key recommendation to would-be investors in Japanese bank stocks for 2019.

5. Global Semiconductor Sales Fall In November 2018. This Is Not A Good Sign.

The Semiconductor Industry Association (SIA) just announced that worldwide sales of semiconductors reached $41.4 billion for the month of November 2018, an increase of 9.8% YoY, but down 1.1% MoM, the first such decline since February 2018. While the decline is modest and total 2018 total semiconductor sales are on track to reach ~$470 billion for a YoY increase of 15.7%, any decline in what should be peak holiday season is not a good sign. 

Semiconductor sales historically track Wafer Fab Equipment (WFE) sales with a roughly six month time lag. North American WFE sales have been declining each month for the past six months meaning that this latest semiconductor MoM sales decline is right on schedule.  

Leveraging a decade’s worth of historical data, we analyse two key questions that are likely on every investors mind. Firstly,for how long should we expect semiconductor sales to continue their decline. Secondly, how steep should we expect that decline to be?