The nonprofit financial think tank Planet Tracker has released a study asserting that Japanese companies highly exposed to seafood are beginning to suffer constraints from the country’s overfished resources and that their valuations over the last decade have declined as a result.

Titled “Against the Tide – The Japanese Seafood Industry Confronts Nature’s Limits,” the report is mainly aimed at institutional investors, with the hope that they will recognize that businesses built on a declining resource will eventually face difficulties and that they will use their influence as shareholders to push the companies toward better environmental practices.

Though some of the issues facing Japanese fisheries are also present in other countries, Japan was chosen as the focus of the report because of the importance of its market and the prominence of Japanese companies in the sector. Across the 100 largest seafood companies globally, no country is more represented than Japan.

“Against the Tide” is a follow-up to Planet Tracker’s “Perfect Storm” report, which urged banks and investors to take account of the hidden risk of unsustainable operations by Japanese seafood companies in their lending and investing decisions.

The current report focuses on the nine years between 2010 and 2019, and excludes 2020 because the effects of COVID-19 were likely to overwhelm other factors studied. It posits that despite overfishing causing a decline in the domestic seafood supply, most of the 70 seafood-related corporations listed on the Tokyo Stock Exchange have managed through a variety of strategies to grow revenue, profits, and market capitalization – obscuring a possible future reckoning. But those companies most exposed to seafood have seen their valuations negatively affected.

“When we wrote this report, we had in mind, ‘Let’s do a quick report showing how the fact that the wild catch is down in Japan has affected the financials negatively.’ Well actually, that’s not the case,” Planet Tracker Financial Research Analyst François Mosnier, the lead author of the report, said. “Management is perfectly aware of the problem and they have tried many different measures with success, and one of the key ones is increased processing. So you get more profit from less seafood, but at the end of the day, you still need to have some seafood to process. The point of this report is to say, ‘Well done, management. Given natural constraints, you recognized there was a problem, and solved the symptoms. But perhaps by addressing the root of the problem in the first place, you will have more success.'”

Mosnier said the seafood sector is not as healthy as it appears, as many companies have continued the growth that is attractive to investors by measures such as foreign expansion, acquisitions, vertical integration, cost-cutting and deleveraging. But the last three of these strategies may be reaching their limits. A deep analysis of 800 financial data points for the 70 companies found that many of those companies highly exposed to seafood, including seafood retailers, wholesalers, and producers, are already suffering from natural capital constraints (natural resources are often called “natural capital” in investment circles).

Mosnier said seafood producers generate average gross margins 12 percentage points lower than more general food producers, who are less exposed to seafood and the ratio of their enterprise value to earnings before interest and taxes (EV/EBIT) had declined from a multiple of 18 to 14 during the period, while that of general food producers increased from 7 to 11.

Among retailers and wholesalers, the average price-to-earnings (P/E) ratio of the seafood companies fell from around 24 to 16, while that of those dealing in general foods rose from 12 to 15.

While the poorer valuations of the companies strongly connected to seafood are not necessarily a result of declining fish stocks, it does show that investors view these companies as less attractive than their non-seafood-related peers, Mosnier said.

Companies with the highest exposure to seafood also had the highest exposure to very long-term debt: 91 percent of the seafood producers’ debt is due in 2030 or later, while the predictability of fish production and profits in the next decades is very limited.

The report includes a list of recommendations that Mosnier said would help Japanese companies align key financial indicators with sustainability goals. They are: Disclose seafood volumes handled by species and origin; Commit to reducing overfishing; Develop closed-cycle aquaculture operations, sustainable feeds, plant-based seafood, and lab-grown seafood, traceability solutions, and certified products; Reduce bycatch, environmental costs of aquaculture, and food waste; Gradually retire and write-off bottom-trawling fleets, freeze their footprint and, cease trawling in marine protected areas; Remove ghost fishing gear; Implement independently verified sustainability policies in both English and Japanese that inform corporate and M&A strategies; And consider participating in a blue bond scheme that would allow for a recovery in fish stocks based on a temporary catch reduction while increasing their returns.

For some of the recommendations in the report, such as closed-cycle aquaculture, examples of their application can already be found in Japan. Mosnier said retiring bottom-trawlers is one of the most difficult of his offered solutions to implement, as alternatives may be impractical on a fuel consumption basis.

“The conclusion seems to be ‘At the very least, do not expand your footprint. Stick to where you’ve already trawled,’” he said. “If that means you have a surplus of bottom-trawlers effectively, there are two things you could do. You could sell them, but then all you do is transfer the problem to someone and somewhere else, for instance, where the legislation is less environmentally friendly. So environmentally, you’ve solved nothing. Or you can retire them. And if you retire them, that means you have a one-year hit to your P&L, but it’s non-cash. It’s just an exceptional charge. And then you’re leaner because you have less capital employed. That’s an argument that resonated quite well with the financial community. We’re not saying for prawns or shrimps ‘Do not bottom-trawl,’ because an alternative is going to be very hard. But for species that could be caught differently, that is, when there is a commercially viable alternative, I think it makes sense.”

Mosnier said his most controversial solution is the idea of “blue bonds” that supplement cash-flow of fishing companies, in exchange for a temporary sharp reduction – of about 40 percent – in fishing in order to rebuild stocks. Models have shown that the ultimate return to the fishing industry would be positive – exceeding maximum sustainable yield (MSY) or “business-as-usual” scenarios, but the lack of income over the rebuilding period of several years would be difficult to bear in the short-term. The bonds would be paid back on a plan linked to increased income from improved fishing in the future.

As for actions that could be taken by the Japanese government, Mosnier said he would like it to confirm whether there is a quota for every species and whether or not current fishing levels meet MSY. He would also like the government to require companies to publish the volumes of seafood they catch. He noted that every four or five years, Nissui publishes a sourcing survey by large group of species – cod, herring, sardines, and salmon.

“If that was done every year for every large seafood company in the world, ideally with how much volume was fished in each FAO zone at least, that would be extremely valuable, because then investors could measure immediately their contribution to overfishing,” Mosnier said. “Sometimes these companies are suspected of contributing to overfishing. It could be that it’s not the case. Mandatory disclosure of something that’s already in your system – just putting it in your sustainability report – that’s a very easy win. But companies are worried about releasing commercially sensitive data. What we’re telling them is not disclosing is worse than disclosing something that does not show a high degree of sustainability.”

Investors from self-described “blue ocean funds” want to know which companies are overfishing and which companies are the best environmental performers, but it’s hard to tell which company does what, Mosnier said.

“These recommendations are meant for investors to have discussions with companies. And not all of them will be adopted by the companies we covered. It’s intended to be food for thought for both investors and companies. We also market this report to investors who are not focused on Japanese seafood at all, and we use this as an example that ignoring ‘natural capital’ does affect your financials and it affects them quite badly if you start to dig a little bit behind the veneer.”