Regular Earnings Survey

FY09 Outlook: Double-digit Growth in Recurring Profit Despite Double-digit Decline in Sales

Forecast 12% rebound in recurring profit, with trimmed costs and fading one-offs to offset double-digit decline in sales
Our FY09 forecasts call for an 11.6% y/y drop in sales and a 3.6% slide in operating profit, but a 12.3% rebound in recurring profit and a 667.2% surge in net income. Although 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 weaker demand, the stronger yen, and lower crude prices. However, management teams proved nimble and effective in paring costs on all fronts, which should cap the operating profit contraction in the lower single digits. The absence of one-off costs (restructuring, etc.) at firms reporting under SEC guidelines should have a positive impact on recurring profit, for which we envision double-digit growth. We envisage a sharp jump in net income, thanks 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 just over Y1.76 trillion in fixed-cost cuts (sum of personnel, depreciation, and net financial expenses), but firms are also seeking to rein in R&D, as well as advertising and promotional outlays. SG&A expenditures fell an unprecedented 10% y/y, or upward of Y5.7 trillion in 1-3Q FY09 (Y2 trillion in 1Q, Y2.1 trillion in 2Q, and Y1.7 trillion in 3Q), and we see room for further cuts in 4Q.

Recurring profit to shrink in majority of sectors, but see return to black for automobiles, electrical/electronics
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 (as inventory cutbacks end), 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 forex 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 reductions in expressway tolls and the H1N1 flu virus have also generated significant headwind. We forecast profit contraction at precision instrument makers due primarily to slack demand for office equipment and SPE, and restructuring costs at certain players.

Now foresee recurring profit growth, assuming manufacturing drives improvement
We brightened our forecasts at all levels, and now envision an 11.6% fall in sales (previous forecast, 11.7% fall), a 3.6% decline in operating profit (vs. 8.2% decline), and 12.3% growth in recurring profit (vs. 4.4% increase). The improved outlook reflects upgrades to manufacturers, which outweighed downgrades to nonmanufacturing sectors. We raised our estimates for manufacturers primarily to reflect upward revisions to cost reductions and our demand outlook for automobiles and electrical/electronics.

Upgrades spreading to non-manufacturing sectors
We raised our recurring profit forecasts for 18 sectors (vs. 12 in Dec survey), upgrading 12 of the 15 manufacturing sectors, and six of the 13 non-manufacturing groups. Manufacturing sectors were the main impetus behind the profit upgrades as in our previous survey, but non-manufacturing sectors accounted for the majority of the rise in the number of upgraded sectors, suggesting broader economic recovery. Automobiles, electrical/electronics and precision instruments nabbed the largest upward revisions. We upgraded automakers to reflect higher-than-expected sales volume (fueled by scrappage incentives), and (2) the unanticipated scale of benefits from cost cuts. The upward revisions to electrical/electronics names owe largely to our brighter demand outlook for LCD TVs, PCs and mobile phones. We raised estimates for precision instruments to reflect robust demand for digital cameras and LCD materials, sharp recovery in SPE demand, and additional costcutting benefits. The top upgrades for non-manufacturing sectors went to nonbanks, electric & gas utilities, and retailing. Meanwhile, we downgraded profit estimates for passenger transport (given weak demand for air travel), amusement (based on our downgraded outlook for hardware and software amid slump in consumer spending), and construction & home fixtures (assuming wider property write-downs).

Still see recovery accelerating from 2H
We envision flat y/y sales in 2H FY09 vs. the 21.8% fall in 1H. Meanwhile, we forecast aggregate operating profit to surge 441.9% after the 58.8% y/y setback in 1H, and envisage a return to the black after year-earlier recurring losses (64.5% 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.