Nikkei 225 dividends poised for upside on conservative guidance

Wednesday, January 31st, 2018

 Nikkei 225 aggregate dividends are estimated to grow by 12.3% to reach JPY 8.2tr in 2017.

 At least 25% of the companies deviated from their dividend guidance over the last three years, with the majority paying a higher actual amount.

 Nikkei 225 DIPs registered a higher growth rate amid FX volatility during Abe’s reign.

 Conservatism and reform on corporate governance mitigate the dividend downside risk in .

Aggregate dividends from Nikkei 225, one of Japan’s benchmark indices, are on track to reach multi-year high of JPY 8.2tr in 2017. On the back of favourable tailwinds stemming from a robust economic outlook and weak , we are expecting the positive momentum to continue through 2018, and are forecasting dividends to grow by another 9.6% to around JPY 9tr in 2018. We highlight that this is a conservative projection as we based our estimates on the company’s guidance where available.

Nikkei 225 aggregate dividends (JPY bn)

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Nikkei 225 Dividends

Source: IHS Markit, FactSet *Based on current index constituents According to our study, at least 90% of Japanese companies have the practice of delivering some form of guidance up to one year in advance, providing level of certainty to the amount of payouts for a particular year. However, there are some

Confidential | Copyright © 2018 IHS Markit Ltd Dividend Forecasting

companies that had consistently deviated from their guidance in recent years, resulting in a modest deviation between the amount guided by companies and actual dividends. Specifically, actual dividends were 2.6% higher on average than guided dividends in 2015 and 2016. More importantly, for the remaining 10% of Japanese companies that provide partial or no guidance for their dividends, their unguided dividends accounted for around 18% of the aggregate dividends in 2015 and 2016, and include notable companies such as Fanuc Corp., Motor Corp. and Motor Co. which are three of the heavyweight stocks within the index. Lastly, as an export driven economy, earnings from Japanese companies will inevitably be affected by the volatility of the Japanese yen. The depreciation of the Japanese yen in recent years raised the profitability of Japanese companies, and shareholders were rewarded with more generous dividends accordingly. However, we noted that Dividend Index Points (DIPs) registered growth consistently on a year to year basis, regardless of how the Japanese yen fluctuated due to various reasons, such as the tendency to provide stable shareholder returns and the practice of paying dividends progressively. In essence, DIPs growth is shown to be weakly correlated with FX movements in recent years.

First component of risk: Deviation from company guidance At least a quarter of the companies deviated from their guidance in 2015, 2016 and 2017, and we observed that more than 90% of these deviations were attributed to higher actual dividends paid. This suggests that guided dividends encompass a lower level of volatility, and management teams demonstrate conservatism in their dividend guidance. Elsewhere, the majority of the deviations from guidance were found to be within the margin of 20% on a per-share basis. That is, the deviations in 2015 (77%) and 2016 (86%) are within 20% of the actual dividend amount. We also see no particular focus on any sector as companies whose actual dividends differ from guidance came from industries across the spectrum. In our study, we found that among Nikkei 225 index companies that had been part of the index between 2015 and 2017, around 8.4%, or 19 of the companies consistently paid dividends that exceeded their guidance. Aggregate dividends from these companies amount to JPY 608.8bn in 2017 and we noted that actual dividends are around 13.8% higher on average than their guidance in recent years. To reduce mispricing and optimize performance, it is important for traders to incorporate the possibility of these companies announcing a dividend that is higher than its guidance going forward. If any of these companies are expected to outperform their guidance significantly, the historical trend could make a compelling case for higher actual dividends. Degree of outperformance from companies that consistently outperform their dividend guidance (per share basis)

Stock name 2015 2016 2017

Aozora Bank 4.26% 3.70% 5.56% Industries 35.29% 8.70% 8.00%

Denka Co 3.85% 3.70% 21.43%

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Kikkoman Corp 20.00% 20.00% 5.26% Holdings 21.05% 7.27% 5.97%

Mitsubishi Chemical 7.69% 6.67% 22.73%

Mitsubishi Estate 15.38% 20.00% 21.05%

Mitsui Chemicals 16.67% 12.50% 12.50%

Mitsui Fudosan 12.00% 6.67% 5.88%

MS&AD Insurance 10.94% 23.53% 17.39%

Nissan Chemical 17.65% 4.17% 11.11% & Co. 7.69% 3.03% 5.56%

Sumitomo Heavy 16.67% 14.29% 13.33%

Suzuki Motor 33.33% 6.25% 46.15% Taisei Corp. 42.86% 46.15% 22.22% Corp. 14.75% 2.56% 4.65%

Tokio Marine Holdings 16.22% 4.17% 3.39%

Tokyo Electron 19.05% 31.15% 19.86%

Toto Ltd 3.70% 6.25% 1.45%

Source: IHS Markit, FactSet, Nikkei *Highlighted cells denote differences between actual and guided dividends that at least 20%. Conversely, there are no companies that consistently paid dividends lower than their guidance since 2015. Moreover, in recent years, the limited amount of occurrences where actual dividends are lower than guided dividends showed that while management teams are conservative, they are adverse to negative surprises, and are likely to reward shareholders on a consistent basis. For instance, even though Sumitomo Metal Mining and Mitsui Mining and Smelting Co. reported losses and performed below expectation in FY16, these companies delivered dividends that are consistent with guidance. This phenomenon was consistent across companies in other sectors such as and Showa Shell Sekiyu KK. From the discussion here, we can conclude that more often than not, companies are likely to pay higher dividends when results exceed expectations, but are likely to keep dividends flat when results underperform.

Second component of risk: Unguided dividends In addition to the companies mentioned above, the other component of risk that pertains to Nikkei 225 dividends is the uncertainty stemming from the companies that do not provide dividend guidance. We deem this as the risker component, as changes to dividend policy, and any intention to re-initiate or suspend dividends, can be highly unpredictable. For instance, the unanticipated jump in Fanuc Corp.’s target payout ratio accounted for a significant portion of the disparity between our

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projection and actual dividends in 2015. While companies tend to adhere to their dividend policies, this uncertainty can be exacerbated by companies who deviate from their target payout ratios, such as Toyota Motor Corp. In the table below, we highlight the top five single-name contributors to 2018 aggregate dividends which do not typically provide any amount or split guidance for their upcoming dividends. Together, these companies are projected to pay JPY 1.34tr in aggregate dividends, and are expected to contribute about 15% of 225 dividends projected for the current year. Companies that do not provide amount or split guidance (in JPY m)

2017 2018E % of projected 2018 Stock name % change Dividends Dividends aggregate dividends

Toyota Motor Corp. 620698.0 701544.5 13.0% 7.83%

Nissan Motor Co. 197536.7 230029.0 16.4% 2.57%

Canon Inc. 194352.0 226739.0 16.7% 2.53%

Fanuc Corp. 91969.4 110804.1 20.5% 1.24%

Nomura Holdings Inc. 70188.0 72871.3 3.8% 0.81%

Source: IHS Markit, Factset

Toyota Motor Corp. is the largest contributor to Nikkei 225 aggregate dividends which does not have a history of providing forward guidance. For the year ahead, we expect to see a slight increase in dividend per share (DPS) from the auto maker and are forecasting full year DPS to tick upwards to JPY 215. On a full year basis, we are expecting Toyota to pay JPY 701.5bn in dividends. In H1 FY18, operating income dipped 1.8% to JPY 1.10tr, as increases in marketing costs and other expenses eroded benefits from cost reduction effects and positive FX effects. Going forward, we expect annual DPS growth to average about 5% in the medium term, in line with the automaker’s medium to long term payout target of 30%. Nissan Motor Co. has a history of paying stable and increasing dividend over recent years and has maintained a realized dividend payout ratio that is generally higher than its stated target for the period. Although the automaker pays dividends semi- annually, Nissan maintains a practice of guiding only its annual dividend amount and not its split ratio. The company is guiding a further increase in dividends this year even though FY18 profits are expected to slump more than 19%, dragged by an increased raw material costs and expenses, as well as one-off costs from a legal settlement. However, top line expansion continued on a steady uptrend, boosted by a 34% jump in domestic retail sales volume for the period. Going forward, IHS Markit is forecasting steady growth in volumes until 2021, with an average annual sales volume of nearly 5.4 million units, driven largely by volumes from North America and Greater China (contributing nearly 60% of total sales volumes). In view of current market expectations for continued earnings expansion, we continue to remain optimistic for increasing dividends ahead, in line with the company’s performance-linked policy which currently targets a 30% payout from net income. We are expecting Canon Inc to pay JPY 170 per share in 2018, which will aggregate to JPY 226.7bn. Based on guided earnings of JPY 259.32 per share, this translates to a payout ratio of around 66%, which is consistent with the payout range demonstrated in recent years. Our forecast reflects our expectation that the

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company will raise its dividends for the first time since FY14, buoyed by the positive outlook over the short term. In the current medium term plan, the management indicates its aim to reduce its costs to generate a higher profit margin, and will expand its focus to other business areas. Earnings estimates are in line with this projection, as earnings are projected to grow by 7% on average over the next three years. Coupled with its strong financial position which will provide management with financial flexibility to pursue potential growth opportunities, we are bullish about the company outlook and its ability to raise dividends in the forthcoming years. is one of the three financial companies that do not provide guidance for its upcoming dividends. The financial holding company aims to pay 30% of its profits to shareholders in dividends and has adhered to this policy since FY14, except in FY16 where earnings per share slumped 41% due to the drop in oil prices and increased in volatility in the market. Barring any unforeseen circumstances, we are expecting an uptrend in the dividend trajectory in the forthcoming years, supported by positive earnings outlook and its robust financial position as reflected from CET 1 ratio of 17.1%. On a per share basis, we are forecasting Nomura Holdings to pay JPY 21 per share in dividends in 2018, which will aggregate to JPY 72.8bn. Fanuc Corp. is one of the top heavyweight stocks that does not provide any company guidance for its payouts. However, we see a relatively low risk of deviation from our forecast for this name, as the company adheres religiously to a fixed payout ratio, which was doubled to 60% in FY15 and maintained to date. In H1 FY18, the interim dividend per share was lifted by 43% to JPY 265.45 after the robot maker posted a 42.5% surge in net profits to JPY 85.8bn, driven by strong performance across all segments and a strong tailwind in its robomachine division based on solid demand from the automobile and IT sectors. With its full year net income projected to be 29.1% higher at JPY 164.9bn, we forecast another hike for its upcoming final dividend.

Relationship between strength of Japanese yen and DIPs Given optimistic outlook and tendency for Japanese companies to pay an actual dividend that is higher than guidance, investors can take the opportunity to get exposed to dividend risk by trading the Nikkei 225 Dividend Index Futures on the Singapore or . The value of the futures contract is calculated by converting dividends paid to index points, i.e. Dividend Index Points (DIPs), and allow investors to take on dividend risk without any exposure to price volatility. Using DIPs reported since the onset of the Global Financial Crisis, we show that the strength of the Japanese yen has little impact on the dividends paid in Japan. Essentially, the theory that a stronger yen would result in lower profits and lower dividends (DIPs) does not seem to manifest vividly in our study. We believe that the appointment of the current Prime Minister, Shinzo Abe, and his policies on corporate governance played a significant role in the outsized rate of dividend growth since his first appointment into office.

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Abenomics – a boon for dividend growth

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Abe Election Wins USD/JPY (LHS) NK225 Annual Realized DIPs (RHS)

Source: IHS Markit, FactSet, Nikkei refers to key economic policies advocated by the incumbent Japanese Prime Minister, aimed at spurring economic revival for the nation suffering from a decades-long deflationary cycle. Since Abe first took office after the 2012 general election, we have seen an astounding growth in DIPs on the Nikkei 225, with a compound annual growth rate (CAGR) of about 13.1% till date, topping an estimated 371.05 points in 2017, compared to the 8.7% CAGR over the preceding four years before the 2012 election. This suggests that Abenomics’ “Third Arrow” – one that is focused on corporate reform in Japan – might have hit its mark. Efforts to drive structural reform and make companies more attractive to shareholders include the launch of a new JPX-Nikkei 400 index in 2013 with profitability, shareholder return and corporate governance measures included as key index selection criteria. Being excluded from the index gives management teams an impetus to improve on these metrics. Average 3-Year ROE across Japan

14.00% 12.50% 12.50% 11.70% 12.00% 11.10% 11.20%

10.00% 8.20% 8.30% 7.60% 8.00% 6.80% 6.00% 7.76% 7.63% 6.00% 7.28% 6.24% 5.57% 4.00%

2.00% FY13 FY14 FY15 FY16 FY17

JPX-Nikkei 400 constituents 1st Section issues Nikkei 225

Source: Nikkei, Factset

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The introduction of JPX-Nikkei 400, together with the influx of activist investors has prompted companies to step up shareholder returns through increments in cash dividends and share buybacks to improve Return On Equity (ROE), which has generally improved across the Japanese listed company universe since FY13, when the index was first launched. Indeed, ROE for Nikkei 225 rose by 37% over a five year period, from 5.57% in FY13 to 7.63% in FY17. Some companies such, as Fanuc Corp., as elaborated on in the earlier section, had taken significant steps at improving payouts. has also been raising its payouts aggressively and has almost doubled dividends since 2012, in line with their target of achieving a level “comparable with global FMCG peers”, which suggests a target payout range up to 55%. However, we see further headroom for dividend growth, considering the relatively low average payout ratio and yield in Japan compared to other developed regions like Europe and US which has an average payout ratio of more than 50% and between 40%-50% respectively over recent years.

No profits? No worry In the graph labelled “Abnomenics – a boon for dividend growth”, we also take a closer look at the relationship between the USD/JPY and dividends on the Nikkei 225. Being an export-dominated country, yen strength tends to have a direct negative impact on corporate profits and should consequently impact dividend payouts as well. However, we observe that Nikkei 225 dividends have a strong upward sticky characteristic. Notably, dividends tend to remain on a flat or positive growth trend – a clear reflection of the underlying policies of Japanese companies that value stability. This is in line with the target payout range prescribed by some companies, which enabled them to vary their payout ratio in accordance to their profitability, and in other cases, consistent with the policies that indicate the company’s intention to pay stable dividends. This effect was especially pronounced in 2016, where Nikkei 225 DIPs ended the year marginally higher than the previous year, even though the yen gained more than 16% on the US Dollar over the first nine months of the year, showing that companies shy away from dividend cuts even when corporate profits fell almost 20% on a per-share basis in the same period. Household names, such as Mitsubishi Corp. and other companies in sectors which have a more volatile earnings performance (such as the banking sector) tend to practice a policy of maintaining a minimum DPS to buffer dividends from the volatility of reported profits. Subaru Corp. maintained a flat dividend over FY16/FY17 even though earnings fell more than 35%, hit by an increase in quality- related costs and FX losses. Similarly, – better known as the holding company of Uniqlo, maintained a stable payout in FY16 even when it saw earnings fall by 59%, attributed to negative FX effects and the recording of asset impairment losses.

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Marvyn Hoi, CFA +65 6922 4308 [email protected]

Chong Jun Wong +65 6922 4257 [email protected]

For further information, please visit www.ihsmarkit.com *All dividend data is provided by IHS Markit. All supplementary data, such as number of shares, is provided by FactSet. All data is correct as of 15th January 2018. *For companies that have yet to announce their dividends for FY17, we assume that they will pay the amount guided as actual amount.

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