Is Mitsubishi Back from the Brink?

Despite its return to profitability, the Japanese giant's reforms fall short

Mitsubishi Heavy Industries Ltd. is on track to do something few Japanese companies will manage this year: It expects to boost earnings substantially. That will mean a second year of profits after a two-year bath of red ink. More surprising is that the news comes after one of the worst industrial accidents in the 119-year history of this maker of everything from forklifts to liquid hydrogen rockets. On Oct. 1, a fire broke out aboard the Diamond Princess, an almost-completed luxury cruise ship MHI was building for Britain's P&O Lines. Despite the blaze, Mitsubishi will deliver the Diamond Princess early next year, and was even able to salvage a two-ship contract with P&O. "The harm done to our reputation is far worse than any direct costs," says company President Takashi Nishioka.

Notwithstanding the solid financial news, confidence in this bellwether of Japan's manufacturing prowess remains weak. Once a powerful engine of growth for Japan Inc., MHI has seen its stock price fall 33%, to $2.54, from its 12-month peak last April. That's 20% below the book value of its assets, according to Nomura Securities. The problem? Investors see Nishioka's plan to revamp the company as too cautious.

In 2000, nine months after Nishioka took over as president, MHI registered its first loss since 1964. As the biggest of Japan's heavy machinery makers, the head of the influential Mitsubishi keiretsu had been hit hard by Japan's economic malaise. And cuts in public-works spending, plus a stagnant defense budget, hurt its sales of bridges, tanks, and jets.

In his first year, Nishioka shook up MHI's languid corporate culture, pledging to shrink losses and trim 16% of the company's 38,000 workers by 2005, largely through attrition. This can-do attitude stood in stark contrast to the position of Kentaro Aikawa, who retired as chairman in 1999. Aikawa once famously announced: "We couldn't care less about return on equity."

Nishioka's work has yielded results. Although MHI remains far from its peak profit levels of the mid-1990s, thanks to $194 million in cost cuts and stronger sales of Patriot missile batteries and airplane parts last year, earnings are soaring. In the fiscal year ending in March, it expects sales of $21.9 billion, and profits of $375 million, compared with a $221 million gain the previous year. "The worst is over for Mitsubishi," says ING Baring Securities analyst Hideyuki Mizuno.

But Mitsubishi Heavy remains a conglomerate of wildly unequal parts. The low-margin manufacturing of humdrum equipment such as gas-turbine engines and printing presses still makes up 55.7% of sales--but only 29.6% of profits. Worse, MHI continues to support perennial money-losers such as air conditioners and machine tools.

Analysts say it should dump such dross and concentrate on its promising--and highly profitable--aerospace unit. That division makes F-2 fighter jets, commercial rockets, and crucial wing parts for Boeing Co. and Airbus Industrie jumbo jets. Last year, the division earned $277.5 million--42.4% of the company's total operating profit--on $3.9 billion in sales. "They're a world-class business in aero-engine manufacturing," says Roger Pratt, head of the Tokyo office of British engine maker Rolls-Royce PLC, which buys parts from MHI. Industry watchers say Nishioka should scale back and make aerospace his main business. "Mitsubishi Heavy isn't a very good $25 billion company, but it could be a very good $10 billion company," says Richard Roberts, analyst at Credit Suisse First Boston.

So far, Nishioka hasn't been willing to take such measures--largely because of optimism that demand for MHI's least competitive products will recover. While he's willing to streamline to stay in the race with competitors such as General Electric Co. and Hyundai Motor Co., he insists radical surgery to chop away at costs isn't the answer. Instead, he's taking smaller steps such as moving production of air conditioners offshore and closing a machine tool plant in Japan. "If a division has long-term prospects, there's no reason to abandon it," he says.

After a series of accidents culminating with the Diamond Princess, Nishioka also wants to change MHI's recent emphasis on quantity over quality. He says he'll concentrate on high-tech projects such as aerospace gear and power plants fired by liquid natural gas, and re-establish Mitsubishi Heavy as a brand name worth a premium. "Cost-cutting alone isn't the answer, because Japan can never beat the Chinese and South Koreans on price," he says.

Maybe so. But Nishioka must prevent the company from growing complacent now that it has fought its way back into the black. To do that, critics say, he needs to accelerate the reforms he started, cut his losses on unprofitable businesses, and convince customers they can count on quality. No small feat--but if Nishioka can take his reforms a step further, Mitsubishi Heavy could yet be a model of restructuring for all of Japan Inc.

By Chester Dawson in Tokyo

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