Sayonara To Japan's Profits
Kakaku hakai. Price destruction. That's what the Japanese call the deflationary force tearing through their economy. It's a self-reinforcing, potentially catastrophic pattern. The recession drags on and confidence evaporates. Banks don't lend, and consumers don't buy. Demand for everything from new houses to machine tools to cars evaporates. As prices slide, profits dwindle. And the pain for Japan and all of Asia just keeps building. "There is no event more important than a restoration of Japan's economic growth," says Thomas S. Foley, U.S. Ambassador to Japan.
That's unlikely in the near term. Instead, investors are bracing themselves for the latest indicators of Japan's woes. They already know the economy contracted at a worse-than-expected 3.3% annualized rate in the latest quarter. What worries them now is how much that contraction will hit the upcoming profit announcements for the big companies. The early signs foretell a woeful earnings season, for two reasons. One is the dismal state of the domestic economy, which is dragging down local businesses in transportation, construction, and retailing. The other reason is more alarming: Export markets in key areas such as memory chips and steel are now too weak to bail out some of Japan's biggest multinationals and compensate for their setbacks at home.
"WORST TIME." The result, according to HSBC Securities Japan Ltd., is that earnings at companies listed in the first section of the Tokyo exchange may drop an average of 33% for the year ending next March. "Everyone is being dragged down," says Jason James, head of research at HSBC Securities in Tokyo.
That includes blue-chip electronics companies. They once considered themselves recession-proof, with product lines so broad and deep that some division was always generating profits to offset a slump somewhere else. Not anymore. Global prices of memory chips have dropped 30% this summer, hurting Hitachi, Toshiba, and NEC. Meanwhile, domestic demand for such steady moneymakers as power plants, mainframe computers, and telecom equipment is deteriorating fast. Machinery orders are suffering the worst double-digit declines since 1994. And prices have tumbled in consumer products, including TVs, household appliances, and personal computers, that would normally prop up earnings.
The profit shortfalls are already showing up. For the year that ended last March, Hitachi lost $1.8 billion on revenues of $59 billion. Only days later, Japan's second-largest electronics group, Toshiba, warned that it expects half-year net losses of $185 million on $18.5 billion in revenues. The world's second-largest chipmaker, NEC Corp., may have half-year net losses of $74 million. "This is the worst time for Japan's electronics and communications-equipment makers since World War II," says Kazuo Kumagai, an executive managing director at Hitachi. "We are no longer strong enough to cover our losses." Hitachi believes it cannot avoid cutting 4,000 workers from its payroll.
Global gluts have also started to threaten the big players in petrochemicals, textiles, and steel. Japan's steelmakers are exporting stainless steel to customers in Southeast Asia at prices 66% lower than last year, according to Jardine Fleming Securities. "It's almost a trade war between Japanese, Korean, and Taiwanese steelmakers," says Atsushi Yamaguchi, steel analyst at Jardine. Japan's total crude steel production has sunk to 94 million metric tons, its lowest level since 1971. Japan's six largest steelmakers are looking at big annual losses. "The red ink is flowing," says Shoji Miyako, a manager at Nippon Steel Corp., which may post up to $188 million in losses.
Desperate times have already forced Japan's auto makers to take desperate measures. Car dealers are offering discounts of up to $2,500 on new models. Yet sales remain stagnant, and disadvantaged players such as Nissan Motor Co. and Mitsubishi Motors Corp. still suffer. Nissan is selling assets, such as its stake in a big Tokyo ad agency, to help it move back into the black. Mitsubishi hopes to limit its losses to $47 million this year, though analysts think that number could balloon to $370 million. Now, truckmakers Hino Motors Ltd. and Nissan Diesel Motor Co. are also issuing profit warnings. For the first time in 32 years, analysts expect Japanese companies to buy fewer than 100,000 new trucks this year. "The break-even point is 110,000," says Koji Endo, automotive analyst at Schroders Japan Ltd. "At 90,000, no truckmaker can make money."
Nasty surprises could also come from the beleaguered banking sector. The current struggle to merge troubled Long-Term Credit Bank of Japan Ltd. with Sumitomo Bank Ltd. is grabbing most of the headlines. But Fuji Bank Ltd. will probably need a $1.5 billion capital infusion by the end of the fiscal year. Credit agency Standard & Poor's has downgraded its outlook on Fuji, Dai-Ichi Kangyo Bank, Industrial Bank of Japan, and Sanwa Bank to negative from stable since the recession has created new problem loans for them.
It's possible that some good may come from all these profit disappointments. The best outcome would be that companies get serious about restructuring. Many seem to have given up on being rescued by Japan's recovery, so their managers may realize there is no way out except to sell off unneeded assets, shutter plants, and boost productivity. For the moment, manufacturers are pulling the plug only on overseas operations. Hitachi and Matsushita Electric decided this month to shut down semiconductor factories in the U.S., and Fujitsu will be closing a memory-chip plant in Britain. But things may get bad enough to force plant closings at home, too.
PLAYING GAMES. An added source of pressure is an upcoming change in accounting rules. Japanese companies have ignored signs of trouble in the past by shifting losses out to their myriad subsidiaries or by playing games. Sometimes a slumping manufacturer, for example, will force sales subsidiaries to buy more of their products than they need so the manufacturer can book a sales increase.
Such maneuverings have largely gone unnoticed, because the government does not require companies to consolidate the losses and profits of all subsidiaries in one statement. But in less than three years, consolidated reports will become mandatory. At that point, losses that look bad now would appear even more dramatic, and stock prices would plunge even further.
Something's got to give. "Japanese companies can no longer hope to solve their problems in the same way as they have done before," says Toshikazu Uchikoshi, a senior analyst at Daiwa Institute of Research. But there will be a lot more pain before Japan Inc. re-creates itself.