- Despite the global depletion of fish populations from overfishing, it seems surprising that Japan’s seafood sector is increasingly generating revenue.
- Investors have rewarded these companies for using management strategies to offset the impact of depleted resources on their businesses, rather than for ensuring those assets stop being degraded.
- A new analysis by Planet Tracker finds that companies have used foreign expansion, acquisitions, vertical integration, cost-cutting and de-leveraging as strategies to increase their profitability.
- Companies should instead ensure that fishing quotas are set in line with scientific advice and not higher than maximum sustainable yields, and ensure that they eventually cover all species.
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.
What’s beneath the surface of Japanese seafood?
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.
The imminent cost of ignoring nature
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.
Related listening from Mongabay’s podcast: “Two tunas and a tale of managed extinction,” listen here:
Clearly, the environmental health and long-term financial performance of Japan’s seafood sector are inextricable. Thus, to ensure the longevity of the industry – and the natural resources which it inherently impacts – the five key financial indicators it uses must be rethought with sustainability at their heart.
Firstly, Japanese seafood companies can sustainably foster revenue growth with the development of closed-cycle aquaculture operations, sustainable feeds, plant-based seafood and lab-grown seafood and credible certified product, along with a reduction in bycatch and ghost fishing.
Secondly, growth in EBIT margins can be achieved in the short term through the implementation of traceability systems to reduce food recall, waste and liability costs. In the longer term, companies can look to disclose and reduce the environmental costs of aquaculture.
Thirdly, each company in the supply chain could improve operational cash flow by ensuring it reduces food waste – a widespread issue potentially evidenced by the rising inventories to sales ratios in each subsector.
Further, growth in returns on capital employed can be effectively pursued by simultaneously reducing overfishing and improving returns through blue bond schemes. Under these schemes, fishing companies temporarily and significantly reduce their wild-catch volumes – but investors finance the temporary loss in free cash flow, thus allowing for a recovery in fish stocks and higher catch level in the medium-term. In our modelling, the returns of such a scheme would be high for fishing companies, even though many challenges would need to be overcome.
Finally, growth in valuation multiples can be met by taking advantage of the market rewarding firms with high corporate sustainability performance. Disclosure of seafood volumes handled by species and origin, detailed plans on how to end overfishing, and implementation of independently verified sustainability policies (in both English and Japanese, to broaden the investor base) that inform corporate strategies would allow investors to understand and analyse the many natural capital risks that weigh on these companies, and how they plan to mitigate them.
Among seafood producers, Nissui, for instance, already partially discloses the volumes sourced and tends to acquire companies aligned with its sustainability strategy, but better disclosure is required across the board.
Analysts, investors, lenders, bankers and insurers of these companies can assist by understanding how defying nature can result in lower revenue growth, margins, cash flows and ultimately valuations and ability to repay debt for these companies. They can use their powers of engagement to encourage these seafood companies on the ways to align revenue, profit and cash flow growth strategies with natural capital constraints.
Governments, policymakers, fisheries agencies and regulators in turn could take meaningful steps to understand how the status quo is likely to negatively impact tax receipts, the balance of payments, value added (hence GDP growth) and employment if fish stocks continue to be depleted.
They can ensure that fishing quotas are set in line with scientific advice and not higher than maximum sustainable yields and that they eventually cover all species; encourage companies to disclose seafood volumes sourced and support initiatives that reduce overfishing. What’s more, they can assess the feasibility of a blue bond scheme that would allow for a recovery in fish stocks.
With these steps, Japan could take the lead in aligning its seafood industry with sustainability, so it can grow in a way that values nature, improves share price drivers, and protect investors along the way.
François Mosnier is a Financial Research Analyst at Planet Tracker, a non-profit financial think tank aligning financial markets with a sustainable future.