Electronics stalwart Toshiba (TOSYY) said on Dec. 13 that it is preparing for an early return to the First Section of the Tokyo Stock Exchange. Investors should get on board now for a likely boost in the stock price as a result, with past instances of re-inclusion leading to rallies of as much as 40%.
The TSE announced proposed rules changes to its listing requirements on Nov. 29 that would apply in February 2020. They make it highly likely that Toshiba, which says it will apply to reenter the First Section "as soon as possible," will meet the new standards.
The First Section is the "Who's Who" of Japanese equity trading. Comprising 2,157 large-cap shares as of Dec. 18, it includes all the major public companies in Japan. There are only 488 companies in the mid-cap Second Section of the TSE.
Getting demoted out of the First Section only happens when a company runs into serious trouble. Typically they would have to stop reporting earnings in a timely manner, and see trading in their shares decline to insignificant volumes.
Although its shares are still heavily traded, Toshiba was demoted to the Second Section in August 2017 after an accounting scandal. The company came close to being delisted entirely from the stock exchange, having stopped receiving its accountant's approval of its accounts. In 2015, it admitted to a US$1.2 billion cover-up in which it had overstated profits for seven years.
Adding to Toshiba's woes, it took a US$6.2 billion hit to earnings in 2017 after shocking losses at its Westinghouse operation in the United States that builds nuclear power plants. That saw it miss deadlines to file earnings. Only after the TSE was satisfied it had improved its internal financial controls was it removed in October 2017 from its watchlist of companies facing delisting.
The key to getting back into the First Section is not the reputational boost, although that's significant. More important is the fact that many index trackers follow the Topix index, which is made up of all the stocks in the First Section.
So many exchange-traded funds and other funds will have to buy Toshiba if they're seeking to replicate the performance of the Topix. Toshiba would also become eligible to be included in the Nikkei 225 index of the 225 most important public companies in Japan at the annual review of the composition of the index, which Nikkei does in October each year.
"We think Toshiba has potential to become a [Nikkei 225] candidate as it has high liquidity, one of the factors on which selection is based," the brokerage Nomura notes in a report.
Topix inclusion is a surer thing. Historically, company share prices have received a boost when the stock gets included in the Topix, but an even bigger boost at the time that the company applies to get included in the First Section.
The only two companies to get reinstated to the First Section since 2000 are electronics maker Sharp (SHCAY) and consumer-credit issuer Orient Corp. T:8585. Most companies experience removal from the First Section simply as a step on the way to oblivion for a struggling company.
The application review process for the TSE to reinstate a company to the First Section normally takes about three months. If the application gets approved, the company is normally reinstated within one to four weeks. There's then a liquidity-factor adjustment, which sees the new First Section company included in the Topix at the end of the month following re-inclusion.
There's about ¥55 trillion (US$502 billion) in assets that tracks the Topix: quite the weight of money. The buying demand creates about an extra 12 days of buying demand in new volume as the company rejoins the First Section, followed by another extra four days of buying demand as the liquidity-factor change occurs and the stock is put back into the Topix.
On the day immediately after re-inclusion in the First Section, stocks jump on average 5%. Sharp continued to outperform the Topix for the next month as well. Orient took some time to catch up with the Topix, but 35 or so days out from its inclusion it too was trading above the index as a whole. This outperformance was small but significant, around five percentage points.
It's highly likely Toshiba will be a similar outperformer. But the share price response is far greater as the application is made and gets processed.
Sharp shares rose 40% in the four months prior to the filing of its application to return to the First Section. Orient shares rose 40% in the three months running up to its application. So it is now, when Toshiba appears ready to apply for reinstatement, that investors should get in on the likely share price advance, rather than buying on the fact of its acceptance.
Neither Sharp nor Orient has been accepted back into the Nikkei 225 fold. So that step is far from certain. But it looks very likely indeed that Toshiba will regain its rightful place among the list of Japan's major corporations.
Look for that First Section and Topix boost to lift Toshiba shares from now into the spring of 2020. By summer, Toshiba should be back in the First Section, and the Topix, and trading on its own merits without the benefit of any "passive boost."