As noted in our recent piece on Japan's GDP results, equity investors should not fret too much about weak macro data, as Japanese companies have been able to overcome such for nearly a decade through rationalization and improved corporate governance. Indeed, the just-released 3QCY14 data on overall corporate profits (not just of listed companies) showed that the pretax profit margin's four-quarter average hit a new high of 4.84% despite the poor GDP data.

On a YoY basis, pretax profits rose 7.6% despite the weak economy, so if the economy rebounds significantly in the 4QCY14, as we expect, profits should improve even further. Note, however, that the 4QCY13 and the 1QCY14 will be a very high base of comparison due to surge in consumption prior to the VAT hike. Thus, although the profit margin's increase is no longer parabolic in nature, we expect that it will expand further in coming two quarters, which should further prove that Japan's structural profitability trend continues upward.

As we have noted before, forex-related export profits are not the only driver of improvement, as the profit margin of services industries also remained near a record high level, as shown in the second chart below:

Four-quarter Average of Pretax Profit Margin vs. Japanese Nominal GDP YoY Growth
(for all non-financial companies, not just listed ones)

Four-quarter Average of Pretax Profit Margin vs. Japanese Nominal GDP YoY Growth (for all non-financial companies)

Sources: Japan Ministry of Finance, Bloomberg, data through CY3Q14

…and just for Non-manufacturers (excluding financials):

Four-quarter Average of Pretax Profit Margin vs. Japanese Nominal GDP YoY Growth (Non-manufacturers)

Sources: Japan Ministry of Finance, Bloomberg, data through CY3Q14

Conclusions

  1. Profit margins are moving structurally upward and are even far above "bubble era" levels due to improved corporate governance.
  2. Abenomics is having a strongly positive effect on profits due to the normalized Yen, couple with meaningful labor and tax reforms (liberalization of part-time workers, reduction of "re-construction taxes" etc...)
  3. We believe that further deregulation and an improving economy will gradually push profit margins even higher.