Regular Earnings Survey

FY09 Outlook: Modest Y/y Drop in Rec Profit, Thanks to Stimulus Measures, Cost Cuts

Sales to drop in double digits, but cost cuts to help limit rec profit decline to only 3%
Our FY09 forecasts call for an 11.5% y/y drop in sales, a 13.7% contraction in operating profit, a 3% decline in recurring profit, and a 595.3% rise in net income. These figures represent back-to-back declines at the top line and at operating and recurring levels. Firms will probably continue to feel the sting of the global financial crisis throughout FY09. Although sharp inventory cutbacks will play out at many firms in 1H, production will probably only recover gradually in 2H. The double-digit drop in sales will likely stem from (1) lower steel and global auto sales volume, (2) the strong yen, and (3) lower crude oil prices. Meanwhile, efforts to reduce costs across the board--beyond the usual moves to cut personnel costs and depreciation--should help limit the drop in operating profit to 13.7% y/y. At the recurring level, profit should check in only 3% lower, thanks mainly to the absence of year-earlier write-downs and impairment charges on facilities (result of changes in accounting standards in line with SEC reporting). We expect net income to turn back up on a significant contraction in extraordinary losses, as write-downs on investment securities run their course.

Fixed costs slashed even further than after bursting of tech bubble
Firms will likely step up reductions in fixed costs (sum of personnel expenses, depreciation, net financial expenses). We project a Y2 trillion (or 2.7%) y/y reduction in aggregate fixed costs--the largest cuts since after the bursting of the tech bubble in FY02, when firms trimmed 1.6% from fixed costs amid a sharp Vshaped recovery. Personnel cost cuts should be even larger than in FY02. Firms are apparently making progress in shrinking other cost items, such as sales/promotional expenses, transportation costs, and R&D (electrical/electronics, automobile, and precision instruments sectors could slash costs by Y600 billion from previous year).

Benefits from economic stimulus measures and high crude oil prices to drive largest profit gains
We see improvement in recurring profit (including narrowing of losses) in 12 of 28 sectors. We expect the largest y/y increases in recurring profit for electrical/electronics, electric/gas utilities, and petroleum. Recurring losses should narrow in the electrical/electronics sector (expect return to profitability at operating level), thanks to restructuring-driven cost reductions and ramped-up production after inventory cutbacks end. Electric/gas utilities profit should advance on cost pass-alongs under the fuel price adjustment system and improved nuclear power plant operating rates. Meanwhile, larger positives from inventory revaluation will likely support profit improvement in the petroleum sector. However, excluding such artificial boosts, adjusted recurring profit will probably drop 51%, stemming from earnings erosion in exploration/production operations and slimmer petroleum products sales volumes and margins. Elsewhere, we expect sharp declines in recurring profit for steel, precision instruments, and machinery. Steel makers will likely suffer as (1) inventory cutbacks and reduced production by clients substantially depress steel sales volumes and (2) the value of raw material inventories deteriorates (mainly loss of earlier inventory revaluation gains). For precision instruments, we see major drags on profit from weak demand for SPE and office equipment, as well as restructuring expenses at several sector names. Profit declines in machinery will stem mainly from reduced capex in auto- and tech-related industries and negatives from weaker demand for and lower production of construction machinery.

Rec profit to slip only 3%, thanks to boosts from stimulus measures, Chinese demand, inventory cutbacks
We have upgraded our earnings outlook from our 4 June report. We now see narrower declines in sales, operating profit, and recurring profit (project drops of only 11.5%, 13.7% and 3%, vs. previous forecasts of 12.1%, 21.8%, and 15.8% declines). Global economic stimulus measures should help prop up auto sales, and boosts from a solid Chinese economy and further progress in inventory cutbacks will help improve profit. Profit could even turn up y/y if the recovery in demand and cost cutting outpaces expectations.

Cost cuts prompt upgrades to manufacturer earnings outlooks
We raised our recurring profit outlook for 17 sectors. Manufacturers (total of 15 sectors in our survey) account for 14 of the 17 upgrades. We have reserved our largest upgrades for the automobile, electrical/electronics and precision instruments sector. Our raised forecast for automobiles factors in (1) boosts from scrappage incentive schemes and (2) larger-than-expected cost reductions. Elsewhere, we lifted our estimate for electrical/electronics to reflect (1) higher global demand for PCs and mobile handsets, (2) benefits from restructuring, and (3) larger-thanexpected cost reductions. Meanwhile, our higher profit forecast for precision instruments is based on improved profitability in digital camera operations, resulting from accelerated cost cuts. Note that we have substantially reduced our outlook for electric/gas utilities (raised fuel cost assumption), amusement (hardware and software sales estimates lowered due to economic doldrums), and freight transport/warehousing (poor profitability at marine transport firms due to weak demand and rising fuel costs).

Still look for profit rebound to pick up steam from 2H FY09
On a half-year basis, we call for sales to fall 20.9% y/y in 1H FY09 and edge down 0.9% in 2H. Operating profit should tumble 66.4% in 1H but climb 411.1% in 2H, while recurring profit should decline 72.7% in 1H but swing back into the black in 2H. Sales declines should contract meaningfully in 2H after production starts to recover, as firms wrap up inventory cutbacks and bottoming global demand reverses course. We also look for a handsome improvement in profit from accelerated cost reductions.