The four major property and casualty insurance companies reduce their holdings of Honda, is the "strategic reduction" of Japanese stocks a medium-term positive?

With the acceleration of the "日特估" reform, Japanese companies are complying with regulatory requirements by abandoning the long-standing "cross-shareholding" strategy. Morgan Stanley believes that after the cross-held shares are sold, space can be freed up for share buybacks, further creating shareholder value.

Four Major Insurance Companies to Sell Honda Shares

Media reports on Tuesday indicated that Tokio Marine Holdings, Sompo Japan Nipponkoa Insurance, and Mitsui Sumitomo Insurance under MS&AD Insurance Group will strategically reduce their holdings in Honda.

Together with other financial institutions planning to strategically reduce their holdings in Honda, the total amount of Honda shares to be sold is approximately 500 billion Japanese yen (about 3.1 billion US dollars) based on the current stock price. To avoid impacting the stock price, the sales will be conducted in batches.

Honda has announced plans to repurchase up to 300 billion yen of shares within this fiscal year to absorb some of the impact from the strategic reductions.

Securities filings show that as of March this year, these four insurance companies or their parent companies held over 300 billion yen of Honda shares, with Tokio Marine Holdings holding 161 billion yen, Sompo Japan Nipponkoa Insurance holding 81 billion yen, Mitsui Sumitomo Insurance holding 73 billion yen, and Sompo Japan Nipponkoa Insurance Japan holding 28 billion yen.

The total cross-shareholding amount of these four insurance companies is 900 billion yen, with Toyota, Shin-Etsu Chemical, and Itochu Corporation having the heaviest positions.

Honda's cross-shareholding list also includes nearly 50 companies, including Renesas Electronics, Mitsubishi UFJ Financial Group, and Tokyo Kaijo Holdings.

Cross-shareholding, where companies hold each other's shares, is a symbol of interdependence among Japanese companies and has long been seen as a way for Japanese companies to strengthen business relationships. However, some analysts believe that strategic shareholdings have dragged down corporate management efficiency and capital efficiency, suppressing the valuation of Japanese stocks.

In December last year, with the acceleration of the "日特估" reform, the Japanese Financial Services Agency requested these insurance companies to accelerate the divestment of cross-shareholdings. The four major insurance companies are required to completely divest their cross-shareholdings in the medium to long term.

Strategic Reductions to Open Path for Buybacks

Although Honda's stock price temporarily declined due to the news of insurance companies reducing their holdings, in the long run, the dismantling of the cross-shareholding system is a significant positive for Japanese stocks.

A previous article by Wall Street Journal mentioned that according to Morgan Stanley's analysis, by the end of the 2023 fiscal year, the total market value of strategic shareholdings had increased from 51 trillion yen a year ago to around 60 trillion yen, accounting for approximately 10% of the Japanese stock market size. This also means that if these holdings are reduced, a large amount of stocks will flow into the market, thereby increasing market liquidity.

Morgan Stanley points out that strategic reductions can not only bring cash flow to holding companies but also improve the company's ROE and capital efficiency through share buybacks, creating shareholder value. At the same time, companies being divested may also respond to the market impact of the divestment through buybacks, which is also beneficial for improving ROE JP Morgan expects that if the strategic shareholding of Japanese companies decreases to the current level by 20% over the next five years, the ROE of these companies is expected to increase by more than 1 percentage point.

In the 2023 fiscal year, Japanese companies' stock repurchase scale reached 9 trillion yen, far exceeding the strategic reduction of 4 trillion yen, demonstrating a strong willingness of companies to use the cash from reductions for self-repurchase.

It is worth noting that in the 2022-2023 fiscal year, 50% of companies repurchased more shares than the cash obtained from reducing strategic holdings after the reduction, not only enhancing the capital efficiency of the companies but also conveying confidence in their own value to the market.

JP Morgan also stated that the third wave of strategic reductions in Japanese stocks began in 2024, and the bank believes that this may be the final stage of strategic reductions for Japanese companies.

Data shows that during the period from fiscal year 2015 to 2017, the annual reduction speed of strategic holdings was approximately 2 to 3 trillion yen, and starting from the 2018 fiscal year, this speed has increased to 3 to 4 trillion yen. If the reduction speed of the 2023 fiscal year (about 4 trillion yen) continues, it will take approximately 15 years to complete all reductions.

However, considering the proactive actions of major reduction parties such as Toyota and non-life insurance companies, as well as the disclosure investigation that the Japanese Financial Services Agency is about to launch, JP Morgan expects that this timeline could be shortened to 5 to 7 years