AIR: Japan Much Better Positioned in 2006 than in 2002
The Australasian Investment Review describes how Japan in 2006 looks a lot better than it did in 2002. Four years ago, whatever growth Japan experienced was export driven. Both capital investment and real estate remained in the doldrums, Japan's credit rating was lousy, and foreign investment was miniscule. On the political front, Prime Minister Koizumi was faring poorly, and his economic reform program was going nowhere.

Fast forward four years and Japan's GDP growth had recovered powerfully, with some economists predicting expansion of as much as 3.6% this year. Workers' wages are up, deflation appears to be beaten, and retail sales are starting to grow. Koizumi will soon leave office with important achievements, notably post office privatization.

AIR also says there has been a shift in the Japanese personality, with a greater willingness to take risk and open new businesses. We're less sure about this thesis. It seems we've been hearing about the changing Japanese mentality for a long time. Increased entrepreneurialism my simply be a reflection of reduced opportunities and security in Corporate Japan. While workers may have accepted the end of the lifetime employment system, they have hardly embraced it. Indeed, according to at least one survey, most young workers value teamwork more than individual accomplishment. And although AIR cites Takafumi Horie favorably as representative of the new breed, the joy that the Japanese media had at his (and, more recently, Yoshiaki Murakami's) downfall makes one wonder at whether the press, and Japanese society as a whole, are eager to celebrate a different breed of Japanese.

Toyo Keizai Issues Revised Sector Outlook

Toyo Keizai has issued its revised Kaisha Shikiho, which has yearly profit forecasts for key sectors (paid subscription required). According to the summer edition published on June 15, operating profits of all Japanese companies (excluding financials) are expected to be up 5.0% in fiscal 2006, compared with a 10.4% increase for fiscal 2005, while net income is slated to rise 7.9% versus 42.8%. The anticipated advances also represent a significant softening from the previous forecasts in March, which were 7.2% for operating profits and 12.4% for net income.

Overall, although the benefits from high natural resource prices that "upstream" (production) sectors have enjoyed should taper off, mid- and lower stream (refining and processing) sectors are expected to show stability. High oil prices and yen appreciation, as well as the expected termination of the BOJ's zero-interest rate policy, are minuses for the majority of sectors. Nevertheless, strong capital investment, higher consumption, and expanded exports continue to bode well for steady profits in many industries. Although the recent weakness in the market has invited some nervousness, looking at company results alone, the path ahead seems stable.

Notably, most of the deterioration has been in the manufacturing sector, whose operating profits are now expected to be up 4.6% versus 13.2% previously. In contrast, the nonmanufacturing forecast has remained about the same, dropping only slightly to 5.6% from 6.1%.

Within the TSE's 33 sectors, eight are expected to show operating profit decreases: mining, medical supplies, oil and coal, rubber, steel, land transportation, marine transportation, and electric and gas. The decrease in oil and coal reflects lower expected profits from inventory valuations, while the fall-off in steel is due to decreased raw material inventory profits as well as less robust business conditions. Similar reasons will limit profits for nonferrous metals. Rubber products will be hurt by higher costs for natural rubber and oil. There are industry-specific reasons for the declines in land transport, marine transport, and electric/gas, but all will be negatively affected by higher oil prices. In medical supplies, the biannual reduction in prices occuring this year will impair results.

On the other hand, the airline, glass and ceramics, fisheries and agriculture, real estate, financials, textiles, machinery, retail, precision instruments, electrical goods, and wholesale sectors are expected to do well. Operating profits for airlines are expected to rise 44%, although much of that is due to the return to profit of JAL, which recorded a big loss in the previous year. Fisheries and agricuture similarly reflect better comparisons from the previous year, when fish costs were high and market conditions weak.

On the other hand, an anticipated 23.5% advance for glass and ceramics is due to greater demand for flat-screen TVs; the purchase of Britain's Pilkington by Nippon Sheet Glass is another special factor in the mix. In textiles, materials with high functionality and product for cars create favorable conditions for the industry. Healthy capital investment brightens the picture for real estate, financials, machinery, and precision instruments. Electrical instruments and retail will be supported by strong personal consumption, and the wholesale sector will benefit from continued strong demand for energy resources.

However, the auto sector will be sluggish, with only a 0.6% gain expected. While in the last term the sector boosted the economy with an 18.4% increase, this year a higher yen and greater raw material costs, as well as bigger customer rebates, will damp down profit growth. Nevertheless, car companies are using a Y110 to $1 rate, and that may be conservative. The financial sector is expected to remain solid, rising 3.4%.

Currently, the forecast for operating profits for all firms (excluding financials) for fiscal 2007 is +9.0%, representing a return to stronger profit increases. Fiscal 2005 earnings were unusually good, leading to expected difficult comparisons for 2006, which are also unusually affected in some sectors by a high-cost environment. With the return of more normal profit levels, and likely higher revenues and lower costs, comparisons for fiscal 2007 should be easier. All sectors in 2007 are expected to post gains.

(Please note that the original Japanese version contains tables for March 2006 results and March 2007 and March 2008 estimates, as well as the traditional "weather map" showing clear or cloudy skies for each sector.)

Japanese Trading Firms Taking Greater Control of Anime Distribution
The big sogo shosha are increasingly involved in distributing anime and manga to overseas markets. A Mitsubishi subsidiary has acquired an interest in anime producer/distributor Geneon Entertainment USA, and Mitsui has taken a small piece of movie distributor Shochiku. Mitsubishi has established a Y2 billion fund with Dentsu Inc. for investing in anime; Itochu is producing anime with Time-Warner; and Sojitz has invested in the production of Backegammon, an anime series aired by the TV Tokyo Corp.

More Capacity, Faster Orders at JASDAQ
By December, JASDAQ intends to double the number of orders it can handle per minute to 16,000, thus increasing both its capacity and speed.

Positive Turn in Japanese Debt
Japan's national debt rose 5.9% year over year in the first quarter of 2006, compared with a 11.2% advance the year before. Nevertheless, Japan has made relatively little progress in reducing the amount of debt outstanding, and concern remains that high levels of government borrowing infringe on the financial health of Japanese companies. (Bloomberg)

British Media Assess Japan
On June 8, six journalists from the British media participated in a symposium organized by Keizai Koho Center with the theme "The United Kingdom and Japan Viewed by British Journalists." Here are some points the speakers made:

• Confidence in Japan's economy is high, but dangers lurk, including "a risk of complacency and lack of ambition." Japan shouldn't settle for relatively low growth and productivity.
• Based on recent experience, many observers believe Japan is due for a slowdown. But economies are more stable than they were 40 years ago. Britain is in its 14th straight year of growth, and Japan can similarly continue to expand.
• Taxes must rise to offset unhealthy high levels of debt. Japan should thus continue to keep interest rates very low to stem a recession.
• Some large Japanese firms are returning to their old bad ways, eg, they are reducing profitability by fighting to preserve market share in segments they should give up.
• In today's fast-paced business environment, Japan's traditional long-term approach may not servie it as well as it has in the past.
• Except for the big exporters, much of Japanese business remains inward-looking.
• Japan's scientific institutions are too parochical. There are too few Japanese scientists working overseas, and too few foreign scientists working in Japan.
• The Japanese language will continue to be a major barrier to foreigners settling in Japan and climbing the ladder in Japanese companies.

Hu-Management Japan Will Be Wholly Owned Sub of Goodwill
Goodwill Group (4723) has announced that in November outplacement firm Hu-Management (4778) will become a wholly owned subsdiary . The company's operations will be integrated, increasing their competitive strength. Goodwill is Hu-Management's leading stockholder, with 67% of the shares; the Murakami Fund ranks second, with 17%.

Rapid Growth of Japan Private Equity Funds

From Reuters:

Private equity firm Carlyle Group has raised nearly $2 billion for buyouts in Japan and is set to close the fund shortly, underscoring investors' growing appetite for the asset class, industry sources said on Tuesday. This would be the biggest buyout fund ever destined for investment in the country, topping a $1.2 billion fund raised by Carlyle's [CYL.UL] U.S. peer Ripplewood in 1999.

The number of such funds and the amount of capital in them have grown solidly in recent years. The buyout firms purchase apparently undervalued companies, restructure their businesses, and then sell them three to five years years later at a premium. The additional monies for Japan reflect a broader interest in investments for all of Asia.

Emerging Growth Stocks Using Warrants More to Get Funds;
Large Issues Causing Stock Price Drops
The practice of by emerging growth companies of selling warrants to specific investors to acquire funds is growing. Originally warrants were sold with the purpose of acquiring funds for growth, but now companies in the red are issuing them too. The stock price of many issuing companies have fallen as investors worry about the dilution of per-share earnings, and concerns about their use are growing.

Kaisha Shikiho Reduces Profit Forecasts for Japanese Firms
According to the new edition of Kaisha Shikiho, Japanese companies (excluding financials) will post a 3.4% increase in consolidated operating income for the March 2007 year, and a 9.3% advance in net profits. These figures are below the comparable forecasts in the previous issue published three months ago, which were 7.0% and 13.6%. A report by Daiwa Institute of Research published in early June found the same trend of a slowing in momentum.

Japan's Interest Rates Expected to Head Higher
Roger Bootle of Capital Economics has an interesting analysis and forecast for Japanese monetary policy in the Telegraph. He argues rates are headed progressively higher:

The upshot is that I expect the Bank of Japan to raise interest rates steadily. And the first increase could come as early as next month.

Japan has been growing at a trend rate at or above 1.5% for three years, which has firmed prices and tightened labor markets. In this environment, Bootle says the direction of rates is not in doubt; the only questions are how much and when.

Bootle says that the assumption of "normal" level of 1% for Japanese interest rates that has recently been bandied about is mistaken. Adding core inflation of 0.8% to real GDP growth of 2%, Boodle comes up with a "normal" rate of 3%. Thus he thinks the BOJ will raise rates steadily and soon. Boodle further argues that this policy will likely have the positive effect of allowing China -- and, in turn, Korea and Taiwan -- to let their currencies appreciate.

Overseas Dividends Rising Rapidly for Japanese Firms
Japanese companies are receiving a lot more income from their overseas operations. Profits from overseas subsidiaries that are not re-invested locally are returned to the parent company in the form of dividends and technology licensing fees. Based on calculations using BOJ inflow/outflow statistics, overseas income rose 52% in the first quarter of 2006 to Y1.3 trillion. For the full year, overseas income is expected to increase to Y5.8 trillion, up Y2 trillion from year-earlier levels. The extra inflows accompany an expansion in overseas production in manufacturing sectors, including autos and electrical goods 日経.

UNIQLO and Toray Tie-Up
UNIQLO of the Fast Retailing group (9983) and textiles maker Toray (3402) have agreed to a tie-up to develop and produce clothing for UNIQLO stores. The agreement will secure for UNIQLO a stable source of cutting-edge product, as the two firms collaborate from the raw material through sales stages to bring fashionable clothes to consumers. UNIQLO had been making separate purchase orders from Toray to the tune of Y10 billion to Y20 billion a year, but the new agreement should bring the total business between the two firms to Y100 billion over the next three years. (日経).

Kiplinger Bullish on Japan
This long piece from Kiplinger's is highly positive on Japanese equities:

The Tokyo Stock Exchange index has doubled in three years, but we still see value. On the basis of price-to-book-value and price-to-cash-flow ratios, stocks are cheaper in Japan than in the U.S. and Europe. Price-earnings ratios are
slightly higher, but that's mainly because earnings have been depressed. They are now rebounding smartly.

The article highlights the strong points of the Japanese economy (demand from China, healthier banks, the return of a little inflation) and describes some ways to invest in Japan for individual U.S. investors.

KDDI Apologizes to Customers, Shareholders for Information Theft
At KDDI's annual meeting, the company's president apologized to customers and shareholders for the leaking of personal information of four million customers of its direct online service DION. The unauthorized release included full names, addresses, and telephone numbers. Police have arrested two men in connection with the incident.

BOJ: Zero Interest-Rate Policy Maintained
With all of its members voicing their agreement, the BOJ has decided to maintain its zero-interest policy. Although prices are climbing, there isn't a danger of much higher price levels. It also appears that the BOJ took into account the uncertain outlook for the US economy, as well as the recent rocky stock markets.

Who Will Suceed Koizumi?
According to Tom Plate in the Korea Times, Japan is feeling neglected these days, as the focus in Asia moves to China. Nevertheless, Japan still has the world's second-largest economy and far exceeds its "big brother" in economic might. With Prime Minister Koizumi scheduled to step down in September, interest in potential successors is building. Although Shinzo Abe has the strong will of Koizumi, he is also burdened by his apparent intent to continue the practice of war-shrine visitations that has cost Japan diplomatically. Abe has recently been ambiguous on these visits, but there is a sense in the Japanese public that Yauso Fukuda -- "an older, quieter, more diplomatic transition figure" -- may be more appealing at this stage of Japan's history. On the downside, Fukuda is likely to be a less compelling and hard-driving leader than Koizumi, while Japan still requires a strong prime minister to push through substantial reform.

NRI: Big Firms' Profits Up 6.9% in Fiscal 2006
Nomura Research Institute's survey of 380 large Japanese firms indicates that ordinary income will be up a combined 6.9% in fiscal 2006. That would make the fifth straight year of higher profits, the first such period since 1976-1980. Financial firms and various segments in the manufacturing sector will lead the way.

Near-Zero Japanese Interest Rates Will Prop Up Global Equities
Underlying the recent decline in global stock markets has been the change in monetary policy at the BOJ, says The Times (London). Japan is ending its "quantitative easing" policy, which seemingly forehadows higher interest rates. But according to The Times , it's likely that "...Japan’s short-term interest rates will remain near zero for another year or so and, even more importantly, that they will not rise above 1 per cent for the rest of this decade." Their logic is (a) interest rates won't be budged upward for some time, according to Japanese policymakers; (b) slower growth in the US and Europe will give them pause about increasing rates too soon, and (c) Japan's GDP growth rate and inflation levels imply a natural interest rate of 1% a year or below until the end of 2007. After that, higher tax rates loom and the Japanese government will want to keep rates low for fear of causing recession. All this means sustained low rates, which will underpin high equity prices worldwide.

CS Raises Rating on Nisshin Kogyo
On June 5, Credit Suisse raised its rating on Nisshin Kogyo (7230), a brake components manufacturer, from neutral to outperform and set a target price for the shares of Y2,450. In its report, CS said that the company's Indonesia business was firming, and the risk of a big loss was declining. So while it lowered its operating profit estimate, it raised its expectations for the company. (Toyo Keizai, subscription only)

Fund Manager Murakami Arrested on Insider Trading Charges
Yoshiaki Murakami, whose efforts to unlock value in Japanese companies made him a hero to investors and a villain to many Japanese executives, was arrested on June 6 on suspicions of insider trading. In a nationally televised news conference, Murakami said he had continued to accumulate shares of Nippon Broadcasting System (NBS) after he had been told by Livedoor chief executive Takafumi Horie that he intended to launch a takeover bid of NBS. Murakami said that, after reviewing Japan's insider trading rules, he thought his actions could be interpreted as a violation, even though he had no intention of breaking the law.

UPDATE 6/09/06 Some investment professionals are viewing the arrest as a positive development. They say the arrest shows that market regulation is working, and that the fact that such an important figure could be arrested is evidence that authorities are willing to go after the big fish. The arrest is also being cited as proof that, in an environment of increasing day trading on rising M&A activity, regulators are willing to take aggressive action to limit dodgy trades. Other investors remain suspicious, however, and believe it was Murakami's efforts to make Japan's stodgy stock markets more like America's that did him in. Regardless, the immediate reaction by Japan's markets has not been good, with huge sell-offs as foreign investors pull money out of Tokyo.

Japanese Recruitment Firms Moving into China, India
Japanese recruitment firms like Persona and Staff Service Holdings are expanding their operations in China, India, and other developing nations. They seek to secure technology staff for Japan-related businesses and diversify their revenue streams in an industry strongly affected by the prevailing economic environment (Nikkei, 6/1/06).