When I first started doing Asian quant factor research in the mid-1990s, I was surprised by how many companies had net cash on their balance sheets. Until then, I’d mainly focused on Australian equities and it was rare to come across companies with significant net cash holdings.
Over the years, there has been pressure on these companies to adopt a more efficient capital structure and, in so doing, increase their return on equity. In Japan, for example, Shinzo Abe made increasing corporate efficiency part of his successful December 2014 election platform. Earlier that year, the Bank of Japan announced that it would purchase ETFs tied to the JPX-Nikkei Index 400, an index which selects stocks based on their return on equity.
Despite these efforts, not much has changed. There continues to be a relatively large proportion of companies in Asia with net cash. And in many cases the net cash positions are high relative to market capitalization (Chart 1).
Chart 1: Net Cash Stocks
Source: FactSet, OQFM
While the capital structure of these companies may be suboptimal, they offer some potential advantages:
Downside protection given the ability to deploy the cash to deal with company specific and macroeconomic setbacks,
Cheap valuations based on enterprise value,
Potential to increase shareholder returns via buybacks, special dividends and/or increased dividend payout ratios.
However, these benefits can be negated if a company faces structural challenges. The company with the highest net cash to market cap ratio in our stock universe - Sankyo (6417 JP) - manufactures and sells pachinko machines. As quants we find the random distributions interesting generated by pachinko machines interesting. However, our interest isn’t shared by the Japanese population – pachinko parlor patronage has steadily declined since peaking in 1990.
Given this, it makes sense to focus on companies with robust growth profiles and Our Net Cash Alpha screen seeks to do this. More specifically, it screens for companies which:
Have significant net cash relative to their market cap,
Are cheap based on enterprise value metrics,
Are paying cash to shareholders and have strong dividend yields,
Have relatively strong historical and forecast growth factor scores.
While the Net Cash Alpha screen is incorporated into our systematic stock selection process, we believe it is important to get more colour on the stocks by analysing them individually. For example, often there can be an issue in the timing of cashflows which can result in a short-term spike in a company’s cash holdings. This is an example of our “micro” non-systematic overlay and the company notes shown at the bottom of this research note provide a good overview of the sort of issues we focus on.
We also deploy the Net Cash Alpha screen on a tactical basis following significant market downturns. A sudden deterioration in market sentiment tends to be accompanied by indiscriminate selling. All stocks – regardless of their risk profiles – are adversely impacted. Running the Net Cash Alpha screen during extreme market dislocations can identify attractive mispricing opportunities. This is an example of our “macro” non-systematic overlay and in the past we have used it to great effect.
Table 1 and the accompanying company notes include some interesting stocks which satisfy the Net Cash Alpha screen.
Table 1: Highlighted Net Cash Stocks
Source: FactSet, OQFM
China Communication Services (552 HK)
Extremely strong historical revenue growth. Revenue has increased consistently every year for the last 10 years. Forecast revenue growth is also strong as the company continues to benefit from 5G capex.
Strong recent positive earnings surprise.
Strong net cash position that has been increasing steadily and is currently close to the company’s market cap. The cash is real – it’s not due to advance payments from customers and there are no payables which will undermine the cash position.
Above average scores based on all the valuation factors we monitor. One year forward earnings yield is 13.9%. Given the large net cash position, it obviously looks incredibly cheap based on all enterprise value measures.
TS Tech (7313 JP)
Generating strong positive cashflows and net cash position has increased its cash balance every year for the last 10 years.
Recent positive earnings surprise.
Key customer risk with Honda accounting for a large proportion of sales but Honda owns 22.5% of TS Tech and is likely to continue sourcing car seats from the company.
Above average scores for all the valuation factors we monitor. Relative high dividend yield for a Japanese company (one year forward dividend yield = 3.7%) and one year forward earnings yield is 11.2%.
Hazama Ando Corp (1719 JP)
Volatile earnings history but profitability is generally improving.
Despite the large net cash holding, the company has a double digit forecast ROE.
Large recent buyback amounting to almost 10% of outstanding shares.
Consistent growth in dividends and one year forecast dividend yield is 3.7%, approximately 1.5 standard deviation above the average dividend yield for Japanese equities.
China Railway Signal & Communication Corp (3969 HK)
Raised approximately RMB 10.5b in July 2019 at a large premium to the H share price, significantly increasing its net cash position.
Strong historical revenue growth over the last 10 years.
Currently trading at more than a 50% discount to its A share.
All valuation factor scores are significantly above average. One year forward earnings yield is 15.9% and one year forward dividend yield is 8.7%.
China Mobile (941 HK)
Strong recent earnings surprise, resulting in significant EPS and DPS upgrades.
Recently filed a prospectus for listing A shares; it plans to raise USD 8.6b at a significant premium to its current H share price.
Based on the current share price, the dividend yield over the last 10 years comfortably exceeds 5%.
Along with the other major telecoms companies in China, it recently announced that it will increase its payout ratio and its one year forward dividend yield is 7.7%.
Genting Singapore (GENS SP)
Covid recovery play which is still trading well below its pre-pandemic price.
Dividends have been cut following Covid but dividend yield prior to the pandemic was approximately 5%.
Cheapest casino stock in Asia based on enterprise value metrics.
Qingdao Port International (6198 HK)
Revenue has grown every year consistently over the last 10 years.
Trading at more than a 40% discount to its A share price.
In early 2019, the company listed its A share at a significant premium to its H share price, resulting in a strong net cash position. Since then, it has increased its cash holding due to strong cashflows.
Above average scores for all valuation factors. One year forward earnings yield is close to 20%.
PAX Global Technology (327 HK)
Share price has more than doubled over the last 12 months, but net cash still represents approximately one third of the company’s market cap.
Net cash holding has steadily grown over the last 10 years and is not due to cashflow timing issues. The cash is real.
Above average scores for all growth factors.
Revenue has grown consistently every year for the last 10 years and forecast revenue growth over the next 3 years is more than 14%pa. The company is a beneficiary of the trend towards cashless sales.
The company has been winning market share but is significantly cheaper than its global peers.
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