Regular Earnings Survey

FY09 Outlook: Return to Recurring Profit Growth on Steeper Cost Cuts

Forecast 4% recurring profit rebound on cost cuts, fading one-offs
Our FY09 forecasts call for an 11.7% y/y drop in sales, an 8.2% contraction in operating profit, 4.4% growth in recurring profit, and a 633.7% surge in net income. While we anticipate a second straight year of declines at the top line and operating level, we see recurring profit and net income reversing course after recent setbacks. The primary backdrop for 1H was the sharp appreciation of the yen and a steep drop-off in demand due to the global economic slump. However, we foresee earnings stabilizing amid support from various government stimulus measures, corporate cost cuts and a fading impact from production cutbacks and inventory liquidation. Our forecast calls for a double-digit fall in sales due primarily to shrinking automobile and steel sales volume, the strong yen and falling crude prices. However, management teams proved nimble and effective in paring costs on all fronts, which should cap the operating profit contraction in the upper single digits. The absence of one-off costs (restructuring, etc.) at firms reporting under SEC guidelines should have a positive impact on recurring profit, which we see turning up slightly. We envisage a sharp jump in net income, however, due in part to an easy comparison after the rash of securities write-downs in FY08.

Meaningful boost from SG&A cuts
Our FY09 forecast already assumes Y2 trillion in fixed-cost cuts (sum of personnel, depreciation, and net financial expenses), but firms are also seeking to rein in R&D (foresee combined y/y decline of Y700 billion for automobiles, machinery and precision instruments), advertising and promotions. SG&A expenses fell an unprecedented 10% y/y, or Y4 trillion in 1H (Y1.9 trillion in 1Q and Y2.1 trillion in 2Q), and we a possibility of additional cuts in 2H.

Recurring profit to shrink in majority of sectors, but see return to black for automobiles, machinery
We call for recurring profit growth in 11 of the 28 sectors in our survey, with electrical/electronics, automobiles and electric & gas utilities leading the pack. The electrical/electronics and automobile groups seem poised for a return to the black backed by increased production (following end in inventory cutbacks), restructuring benefits, and continued efforts to trim input costs. At electric & gas utilities, we see a favorable benefit from the rate adjustment system (tied to prevailing fuel, gas and yen markets) and improved operating rates at nuclear power facilities fueling profit expansion. Meanwhile, we envision the sharpest profit falls in the steel, passenger transport, and precision instruments industries. For steel makers, we expect a steep decline in sales volume due to production and inventory cutbacks at customers, as well as a diminished benefit from inventory valuation gains. Passenger transporters are contending with sluggish demand, particularly for business travel, the core market. Temporary expressway toll cuts and the H1N1 flu virus have also generated significant headwind. Our forecast for profit contraction at precision instrument makers primarily reflects a slack market for office equipment and SPE, as well as restructuring costs at certain players.

Now foresee recurring profit growth, assuming manufacturing drives improvement
We now envision an 11.7% fall in sales (previous forecast, 11.5% fall), an 8.2% decline in operating profit (previous forecast, 13.7% decline), and 4.4% growth in recurring profit (3% decline). We downgraded sales estimates, primarily at nonmanufacturing players, which depend heavily on domestic demand. Meanwhile, we upgraded our profit forecasts, primarily for the manufacturing group, to reflect cost reductions and our upwardly revised demand outlook for automobiles and electrical electronics.

Profit upgrades centered on automobiles and machinery
We raised our recurring profit forecasts for 12 sectors, upgrading 11 of the 15 manufacturing sectors, vs. just one of the 13 non-manufacturing groups. As in our previous survey (compiled Sep), the manufacturing sector drove the profit upgrade. Nabbing the largest upward revisions were automobiles, electrical/electronics and chemicals. Automakers benefitted from additional cost reductions and higher-than-expected sales volume thanks to scrappage incentives. Electrical/electronics names rated an upgrade in view of our brighter demand outlook for LCD TVs, PCs and mobile phones, in addition to the unanticipated scope of restructuring benefits. Quicker-than-expected recoveries in automobile and electrical/electronics demand extended to chemical makers, which count these industries as core markets. Meanwhile, we downgraded profit estimates for petroleum, amusement, and passenger transport sectors to reflect deterioration in refining margins, downward revisions to our software/hardware sales volume outlook, and slumping travel demand (particularly in core business market).

Still see recovery accelerating from 2H
We envision a modest 0.1% y/y fall in sales 2H FY09 vs. the 21.8% fall in 1H. We forecast aggregate operating profit to surge 400% after the 58.8% setback, and envisage a return to the black at the recurring level following the 64.5% y/y profit contraction in 1H. Sales should level out in 2H amid an end to production/inventory cutbacks and gradual recovery in the global economy, setting the stage for improved earnings as cost reductions continue to bear fruit.