At a glance, Japan’s seafood sector is a financial success story. Indeed, between 2010 and 2019, the 70 publicly-listed companies exposed to the sector on the Tokyo Stock Exchange enjoyed both rising profits and share prices. The country also dominates the global industry: you will find more Japanese entities in rankings of the top 100 largest seafood companies in the world than any other nation.
For some, however, these signals of a thriving market raise questions. In an environment of declining seafood consumption and production and in a context of overfishing and depleting fish stocks, it is remarkable that Japan’s seafood sector is increasingly generating revenue. Thinking this contradiction warranted further investigation, at Planet Tracker, we decided to explore exactly why the Japanese seafood industry was reporting such profitability.
Our analysis revealed that the apparent financial health of the sector is largely the result of short-term measures to bypass natural constraints. What’s more, we found that these measures are so short-term that they are, in fact, already reaching their limits. In other words, though the financial effects of environmental risks facing the Japanese seafood sector may be currently largely hidden, it will likely not be long until they rise to the surface.
Japanese seafood is a striking lever to illustrate how the interplay between financial performance and natural capital can have resounding implications for the real economy of a G7 nation – and how sustainable business practices can be leveraged to expand the indicators which mitigate these risks and build the resilience of a key industry and its investors.
To explore why the Japanese seafood industry is reporting steadily increasing profits while overfished stocks are at an all-time high, we analyzed more than 800 financial data points for each of the 70 seafood-exposed companies on Tokyo Stock Exchange covering everything from inventories level to cash spent on acquisitions.
It became clear the way in which these companies report and address financial performance allows them to show growth while not having to recognize natural constraints. Indeed, environmental issues, such as Japan’s declining wild catch and aquaculture output, are simply not captured by the five financial indicators that seafood investors primarily care about: revenue, EBIT margin, operating cash flow, return on capital employed and valuation multiples.
Seeking to perform on these indicators, these companies have used foreign expansion, acquisitions, vertical integration, cost-cutting and de-leveraging as strategies to increase their profitability.
Indeed, the proportion of assets held abroad by the companies almost doubled between 2010 and 2019, to reach 10% on average. As a result, foreign revenue grew eight times faster than domestic revenue over the 2010 to 2019 period, partially helped by favorable currency fluctuations. Overall, these companies grew revenue by an average of 2.1% per annum (p.a.) despite the decline in seafood resources. Mergers and acquisitions (M&A) contributed an estimated 11% of that growth.
Demanding performance on these metrics means that investors have implicitly rewarded Japanese seafood companies for using management strategies to offset the impact on their business of depleting nature-based assets, rather than for ensuring those assets stop being degraded. It has also been masking the long-term environmental risks these companies currently face, and which could eventually lead to the collapse of the resource which they depend on.
This is particularly relevant now, as these strategies are approaching their limits. Though foreign expansion and additional acquisitions are still possible, debt levels cannot be substantially lowered anymore to decrease interest costs. There are also limitations to both vertical integration and cost-cutting tool. Perhaps more importantly, our analysis revealed that nature has, in fact, already been affecting the financials, despite managements’ best efforts.
For instance, domestic sales at seafood retailers and wholesalers have trended down, due to overfishing leading to decreased seafood volumes, and further amplified by a change in diet away from seafood. In Japan, this has meant average producer prices of seafood are declining. In contrast, the more diversified food retailers enjoyed solid revenue growth.
Seafood producers, too, already generate average gross margins 12 percentage points lower than the more general food producers, who are less exposed to seafood. Cash flow conversion at seafood producers is also by far the lowest within the sector – which is often due to changes in the value of biological assets (i.e. change in the price of fish grown in farms).
Due to this decline in seafood volumes, seafood retailers and wholesalers are heavily divesting from seafood – but are no longer able to cover the costs of their investments through their operational cash flow alone. Those Companies with the highest exposure to seafood have the highest exposure to very long-term debt. 91% of the seafood producers’ debt is due in 2030 and beyond, while visibility on fish production – and therefore profit generation – in the next decades is very limited.
Note: François Mosnier is a Financial Research Analyst at Planet Tracker, a non-profit financial think tank aligning financial markets with a sustainable future.
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