Radical Ideas on Financial Innovation- will this Japanese company be open to my ideas?


For the past few weeks, i have been interested in getting my hands on some undervalued Japanese companies to diversify my very focused "ASEAN" portfolio. You might ask, why of all countries, it must be companies coming from Japan?  Well, firstly thanks for asking and secondly it because of the Nikkei has fallen quite significantly and many Japanese companies in my view are now undervalued. 

The Japanese market currently trades on a price-to-earnings ratio of 19.4, way below its long-term average of 45.3. In addition Japanese companies are displaying strong earnings growth at present.
Another way of assessing whether the Japanese stock market is undervalued, is using the price-to-book ratio. The price to book ratio (Benjamin Graham's favorite ratio) measures the value of a company's shares against the value of its assets. In many cases Japanese companies actually trade below the value of their assets, and as a whole the Japanese market has a price-to-book ratio of just 1.02, significantly lower than other Asian markets. This again points to Japanese shares being good value at present. And if that is not enough, let's turn our attention to the Japanese government; the latter is planning to raise the national sales tax to 8% from 5% by early 2014. The government also plan to raise the consumer tax to 10% by October 2015 as it believes that raising tax will help pull the Japanese economy out of deflation and reverse decades of falling prices. The upcoming tax increases should encourage households to bring forward planned expenditure and boost the economy in the short run. Factoring in the recent sell off, Japanese companies are now saying "ohayou gozaimasu" to me.
With that, let me share with you one Japanese company that i am looking at. The company is called Yamaha Motors. I like the company because the business model is simple to understand, their motorbikes are selling like hotcakes in India, they shifting their manufacturing facilities to China (doing so, reduces manufacturing cost-so investors should expect higher margins) and they are coming up with close to 200 over new products to tackle the demands in both their developing and developed markets. Essentially, Yamaha Motors is now becoming a fast growing company; an old company evolving into a power house-  kicking up expenditure and accepting younger talents into their management. 
But like any fast growing companies, there are risks involved and finance is one of the key risks that if left unchecked, would result in disastrous consequences. As a shareholder of Yamaha Motors, i feel that it is my duty to not only provide solutions to these financial risks, but also think of ways to help the company improve on its balance sheet as well as its net profits. The CEO is open to ideas and wants to hear from stakeholders. I jump at the opportunity to do so, 
These are the problems i see.
1) Expensive hedging done by the company to deal with currency transactional risk
2) Reigning in on raising receivables; so as to reduce the probability of incurring bad debt increases 
3) Not optimizing taxes savings 
And these are my solutions 
Idea 1: Establish a free currency hedge system for Yamaha Motors


Reason: One of the main risks that the company faces is the appreciation of Yen; Yamaha motors has high transactional exposure to currency rates in its developed and emerging market motorbike and marine operations given near total export supply out of Japan. According to the company’s annual report, most of the motorcycles and outboard motors sold in volume by the group in North America and Europe are manufactured in Japan and exported as completed products. Therefore, fluctuations in the exchange rates of the Japanese yen against major currencies, such as the U.S. dollar and the euro, significantly impact not only the group’s sales, but also profits and other results. The main point here is that the appreciation of the yen against other currencies has a negative impact, while the yen’s depreciation positively affects the group’s business performance. From my observation, the company has a relatively high exposure to the euro as a percentage of earnings at a 0.6% change for each one-yen change in the yen/euro rate.

How:  To establish a free hedge system for Yamaha motors begins by investing the excess cash that the company has into a risk free Japan Treasury discount bill, as seen in the picture.  For simplicity sake, I picked the discount bill with a 1 year horizon; quoted at 0.065%.




Assuming the same discount bill is available in 2014, using Yamaha Motor’s excess cash of 115,918m (Yen) and investing it into this discount bill. Approximately 75.348m Yen (115,842.65 yen is invested into the discounted bill) can be used for hedging. This 75.348m is deemed as “risk free” and the company will receive back the full 115,918m after the discount bill has matured in a year’s time. Taking the 75.348m yen, this amount can be used to take hedge position in currency forward contracts (such as taking a straddle position) or the hedge position can be magnified using currency warrants.         

 Idea 2: Further reduce Yamaha Motor’s account receivables

Reason: By further reducing account recievables, the company is able optimize its cash convetion cycle and increase cash flow.  Many big companies in Singapore reduce their recieveables through a  global bank; they take advantage of the transaction banking services that global banks provide. As such, I see an opportunity for Yamaha Motors to likewise take advantage of such services; especially since the company has more than 46% of its revenue derived from Asia and it is expanding fast into less credit worthy nations like India (refer to the 36.8% jump in motorbike/scooter sales in India) 
    
How:  Having done a summer internship under Citigroup Inc transaction banking service department; my understanding is that Global banks like Citigroup provide services like cash management solutions (provision of domestic and multicurrency accounts together with payment and collection capabilities) and factoring services- also known as account recieveable financing.  This is how it works:
For example: Yamaha Motors India arm can submit the receivable invoices to Citibank India; the bank collects a small fee, buy ups all those invoices (the default risk-potential bad debts are all being transferred)  and pays Yamaha in advance. The bank then takes ownership of those receivables.  
This type of financing will help the company to free up capital that is stuck in accounts receivables. With the advance cash flows, it can be used to pay off debt, purchase new technology and hire new employees.
There are many other global banks that Yamaha Motors can consider besides Citigroup. JPMorgan, Wells Fargo and Sumitomo Mitsui Banking Corporation are some banks that come to mind. These other banks also provide inventory financing (buys up your inventory) and does “securitization”; all of which can likewise free up more cash flow for the company.  

3 idea: Reducing corporate tax, through increasing depreciation expense innovatively
  
Reason: Japan’s corporate tax rate stands at 38.01% as of FY2013; although Prime Minister Shinzō Abe plans to reduce corporate tax rate in the near future, the consensus among economists is that the reduction will be modest at best. Looking at Yamaha Motor’s financial highlights; the company’s depreciation has been decreasing over the years.

And not surprising; the company’s cash flow has been decreasing as well (see chart below). Depreciation expenses for FY2013 are estimated to be about 34.0 billion yen and the company is estimated to paid 16 billion yen on tax alone for FY2013. Therefore, in my opinion, it would be financially prudent for Yamaha motors to increase its depreciation expense, so as to delay tax and improve its cash flows.


How: My suggestion for the company is to invest in new technology; perhaps in to the area of green technology.  There are many why Yamaha Motors should invest in Green waste technology*. Firstly, my assumption is that being a big motor vehicle manufacturing company, there should to be a lot of waste produced in the manufacturing of these products, green technologies like STX multi feed helps to recycle such waste (be it left over rubber, unused mental parts) and turn them into useful recycled products.  Secondly, accounting standards have yet to catch up with allocated deprecation rate for such new technologies. By investing into these green technologies, the company is able to increase its depreciation expense according to its financial plans. Lastly this strategy bonds well with President Hiroyuki’s New MTP for the company (which is to increase the investment ceiling by ½ of the company’s net income page 26 of Yamaha Motor’s annual report) and it is in line with the management principal which is fulfilling social responsibilities globally- showing concern for the environment.

Similarly, if any of your holding companies are having similar problems (exposure to multiple currency risks, raising receivables etc) , such ideas can also be brought up during AGM. Talk to the CFO about such things, instead of just growth and expansion. 

All these ideas will be translated to Japanese and i will email it directly to the management by the end of this month February. If you have any comments or found any loopholes with the ideas above, do email me at nwcigotbetter2009@live.com or facebook me at https://www.facebook.com/rex217. Would love to hear from my readers. :) 
     
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