Trouble Looms for Japan Earnings After Worst Decline Since Quake

Japanese Firms to Revise Full-Year Forecasts
  • After terrible quarter, outlook for annual profit gain dimming
  • Stronger yen hammers manufacturers, while rates stymie banks

After first-quarter earnings in Japan wrapped up this month with the steepest plunge since 2011, the prospect for an increase in annual profits is about to get even dimmer.

Expect a round of corporate earnings downgrades in September, said Norihiro Fujito, a strategist at Mitsubishi UFJ Morgan Stanley Securities. Trends that slammed profit in the first quarter -- a stronger yen, negative interest rates and slumping China growth -- haven’t reversed. At stake is a second straight year of earnings decline that could bury Prime Minister Shinzo Abe’s push for companies to boost capital spending and raise wages to spur economic growth.

“A lot of companies may be lowering their forecasts in September,” said Fujito. A slower recovery in the U.S. economy than some had expected is also weakening the outlook for Japan’s carmakers and other exporters, he said.

As of the end of the first-quarter earnings reporting season in mid-August, Japan’s biggest companies were projecting aggregate net income of about 16.2 trillion yen ($162 billion) for the year ending March, a 7 percent gain from the 15 trillion yen the same firms reported for the previous 12 months. The estimate is based on projections by almost 200 companies on the benchmark Nikkei 225 Stock Average, compiled by Bloomberg. Analyst forecasts also show expectations for a gain.

For a story on the yen’s rise and the likely economic toll, click here.

One catch: Most of the forecasts were made months before the first quarter results were in.

With negative interest rates grinding away bank profits and a stronger yen bearing down on carmakers, aggregate operating income plummeted 17 percent in the June quarter, the biggest quarterly decline since 2011. That’s the year an earthquake in Fukushima and subsequent tsunami caused the yen to gain and stocks to drop.

The five biggest diversified lenders alone reported a combined 372 billion yen drop. That’s more than double the combined operating income of Sony Corp., Panasonic Corp., Nikon Corp., Casio Computer Co. and Pioneer Corp. Meanwhile, the six biggest carmakers reported a 130 billion yen decline, the next-largest decline by segment.

Some of the biggest Japanese names have already acknowledged a worsening outlook. Toyota Motor Corp., Canon Inc., Shiseido Co. and Fast Retailing Co. are among the companies that slashed their profit outlook for this year, citing the effect of a stronger currency on overseas earnings.

The Japanese currency has appreciated 2.5 percent against the dollar since the end of the fiscal first quarter in June. That’s in addition to a 17 percent surge between the beginning of the year and June 30.

Nor are banks expected to help make up for manufacturers’ declines.

“I don’t think there could be any chance for banks to improve their profitability,” said Nana Otsuki, chief analyst at Monex Group Inc., a Tokyo-based online securities firm. Negative interest rates, part of the Bank of Japan’s effort to stymie deflation, will continue to constrain banks’ margins, she said.

There is another reason to believe projections calling for an annual gain don’t broadly reflect Japan Inc.’s prospects. All the forecast increase can be accounted for by Toshiba Corp.’s rebound from an accounting scandal that led to a 460 billion yen net loss last fiscal year, combined with the reversals of annual deficits at three large trading companies hurt by declines in prices for commodities such as oil and steel.

Bull Case

Still, some see the Japanese currency reversing course and providing some relief for earnings.

Naoki Murakami, a strategist at AllianceBernstein Japan Ltd., said the yen may yet begin to weaken versus the dollar on the likelihood of an interest rate increase by the Federal Reserve.

“My view is for the dollar to strengthen against the yen from here, riding on the likelihood of a rate hike by the Fed, which will lead to a recovery in export earnings,” said Murakami.

Yen drops have been a reliable tailwind for Japan Inc. over the past three years, helping to power an equities rally. Yet even when exchange rates pushed profit to record levels -- as they did in fiscal 2015 -- many companies hesitated to follow Abe’s exhortations to raise wages and capital spending to spark the economy out of its decades-long funk. The first-quarter profit plunge this year underscores that such reluctance was probably warranted, as the yen also rises.

“Current yen levels are very challenging compared to what they were last year during the September quarter," said Shingo Ide, chief equity strategist at NLI Research Institute in Tokyo. "If the yen continues to trade near the 100 level to the dollar towards the end of October, companies will be forced to lower their outlooks."

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