What’s Behind Japan’s Profit Rebound? Unsexy Companies Like Toray Little Known Abroad, Companies in More Pedestrian Industries Boost Economy Again

Author: Eric Pfanner
Originally posted: The Wall Street Journal

TOKYO—Corporate Japan is posting record profits again. It has companies like Toray to thank, again.

Toray isn’t a household name outside Japan. But unlike some such as Sony Corp. that are, Toray Industries Inc. is thriving, along with other companies in more-pedestrian industries that are helping lead Japan’s comeback from two decades of economic torpor.

Toray helped Japan out of crisis once before: Amid the devastation after World War II, the textile maker was among the big exporters that revived the economy. Today, it exports carbon fiber for Boeing airliners, fabric for Uniqlo underwear, absorbent elements for disposable diapers and hundreds of other materials.

Toray expects to report its highest net income ever in the current fiscal year. By contrast, Sony Corp. says it will report a ¥230 billion ($2.1 billion) loss. “There is always a need for our products in the long term,” says Toray President Akihiro Nikkaku of basic-materials makers. “It’s true,” he says, “consumers do not really know much about it.”

The travails of Japan’s famous consumer-electronics industry have fed the narrative of a Japan in decline. But the country is proving to have a resilient base in the more-prosaic companies and industries that are a big part of its profit comeback.

Net income at the country’s major corporations rose 69% to a record ¥25.3 trillion in the fiscal year ended in March from the prior year, according to SMBC Nikko Securities. Major manufacturers’ net income grew 116% to ¥12.1 trillion, and many companies are forecasting further gains for the July-September period.

Those corporate profits are a major factor behind the recent strength of the Nikkei Stock Average, which closed at 16,374.14 on Sept. 25, its highest level since 2007, before falling to 15,708.65 on Friday.

“Everybody wants to write Japan off, but it’s still the third-largest economy in the world, and we have to ask why,” says Ulrike Schaede, professor of Japanese business at the University of California, San Diego. “Everybody focuses on the zombie companies, but there are all these great firms, most of which no one has heard of. It’s a quiet revolution.”

Or a quiet restoration.

Japan’s postwar economic miracle was driven especially by companies that exported materials, parts and industrial products—not by consumer-goods companies.

Well into the 1960s, Japan’s top exports were steel, textiles, fish and ships, according to the Japan Foreign Trade Council. In 1962, consumer durable goods represented only 14% of Japan’s overall exports, according to the Japan Tariff Association.

Global perceptions of “Japan Inc.” changed during Japan’s bubble era of the 1980s. Consumer-electronics brands like Sony, Nintendo Co. and Panasonic Corp. were among growth leaders—along with auto companies—and came to symbolize Japan’s ascent abroad.

By 1986, consumer durables rose to 30% of Japan’s exports. Cars, office appliances, tape recorders and precision devices like cameras joined steel atop Japan’s export rankings.

But by 2013, consumer durables had receded to 16% of exports. Cars were still Japan’s top export. But they were followed by steel, electronic parts, auto parts and organic chemicals.

Sony’s fall from grace has been echoed at some other consumer companies. At Nintendo, sales fell 44% over the last three fiscal years to below the level in the year ended March 1999. A spokesman attributes the decline to the game industry’s volatility rather than any weakness in connecting with consumers.

In final consumer goods, Japan swung to a $52 billion trade deficit in 2012 from a $25 billion trade surplus in 2007. In contrast, Japan’s trade surplus in parts used in all sorts of manufacturing grew to $137 billion from $116 billion.

“Because Japan has clearly lost competitive advantage in consumer electronics” says Kathy Matsui, chief Japan equity strategist at Goldman Sachs , “it makes sense to go up the value chain and focus on high-end materials and high-value parts.”

The Nikkei’s rise also reflects the yen’s slump, which makes Japan’s exports more affordable in dollar terms and lifts the value in yen terms of overseas sales. That helps many parts providers, who tend to manufacture more in Japan than finished-goods makers.

Reflecting the pendulum’s swing back from consumer goods, some giants are returning to their roots. Hitachi Ltd. , Toshiba Corp. and NEC Corp., soon after the war, grew by exporting industrial products like locomotives, gas turbines and telecommunications equipment. By the 1980s, they had jumped on the consumer bandwagon, shifting some energies into TV sets, home appliances and, later, smartphones.

They suffered for it. Competitors in countries like South Korea and China eventually undercut their prices. Their smartphones, often designed for the Japanese market, never took off overseas.

Now the three have shed many consumer operations and doubled down on businesses like heavy machinery, industrial electronics and satellites. After posting cumulative losses of ¥985 billion for the four fiscal years ended March 2010, Hitachi swung back to a cumulative net income of ¥1.03 trillion in the four years since then.

Toshiba and NEC have shown similar, though less dramatic, swings. Hitachi didn’t respond to inquiries. Toshiba President Hisao Tanaka in May told analysts that the company intended to “accelerate our shift to b-to-b.” An NEC spokesman says the company “is clearly moving towards infrastructure investment.”

Panasonic’s remake is particularly striking. A consumer-electronics maker for most of its 96 years, it has quit the consumer-smartphone market, stopped making plasma-screen TV sets and sharply reduced its camera output. It says it sees greater opportunities in areas like auto parts and housing. Panasonic is a major supplier of electric-car batteries, agreeing to invest in Tesla Motors Inc.’s planned $5 billion Nevada battery plant.

For the latest fiscal year, Panasonic posted net income of ¥120 billion after a ¥754 billion loss a year earlier. Asked about its transformation, Panasonic points to President Kazuhiro Tsuga’s public comments in April, when he said the company’s strategic shift was progressing well.

Then there is the broad base of companies that are little known abroad. Japan hasn’t made a mark in smartphones. But parts suppliers like Murata Manufacturing Co., Nidec Corp. and Omron Corp. are benefiting from the tiny specialized parts they make for smartphones and other high-tech devices. The three posted strong gains in net income in the latest fiscal year.

In a Bain & Co. list of consistently successful companies—posting annual growth over 5.5% in sales and earnings over 10 years while delivering profits above cost of capital—about a third of the 42 Japanese companies listed were in behind-the-scenes industries like car parts, chemicals, construction and engineering. In the 1990s, none of these industries made Bain’s list.

The shift is toward “upstream” companies, says Shintaro Okuno, a Bain partner in Tokyo, especially parts makers. “t’s still manufacturing, but a completely different kind of manufacturing.”

Toray’s role among such companies was reinforced this summer when Keidanren, the Japanese business lobby, named Toray Chairman Sadayuki Sakakibara its head. He succeeded another leader in industrial materials, Chairman Hiromasa Yonekura of Sumitomo Chemical Co. The two previous heads were from Canon Inc. and Toyota Motor Corp.

Toray started in 1926 as a maker of synthetic fabrics and later branched into other fabrics and chemicals. Textiles were a big ingredient in Japan’s postwar rebound: In the 1950s, textiles and related products rose to as high as 40% of Japan’s exports, and Toray became one of the nation’s major exporters.

As Japan increased consumer exports, Toray, too, sought to get closer to the consumer with branded materials such as Ultrasuede, a synthetic fabric with a leather feel. But Toray continued to develop industrial materials.

Its relationship with Boeing Co. shows how decisions it was making decades ago—as consumer companies were ascending—are bearing fruit today.

In the 1970s and 1980s, when some carbon-fiber makers were quitting the business for lack of customers, Toray fine-tuned its technology and manufacturing. That gave it a global advantage when carbon fiber came into its own, says Yoshihiro Azuma, a Jefferies analyst.

In 2006, Toray struck a supply deal with Boeing set to run through 2021 for the 787 jetliner, in which carbon fiber is the main structural material. Expecting increased orders from Boeing, Toray recently announced plans to invest $1 billion in a new South Carolina factory. “It’s a great example of how basic materials can be so powerful that they can substantively change the world,” Mr. Nikkaku says.

“Toray has been a market leader and a valuable contributor to advancements in aerospace design and performance,” a Boeing spokesman says.

Long-term supply deals like this helped sustain Toray during Japan’s economic malaise. Sales dipped during the global recession, and Toray posted losses in the years ended March 2009 and March 2010. It has snapped back, recording a 23% net-income increase in the year ended March 31 from a year earlier on a 15% increase in sales to ¥1.8 trillion.

“With companies like this, the economy has legs to stand on,” says Jesper Koll, head of Japan equity research at J.P. Morgan Chase & Co. “Today it’s Toray, tomorrow it’s Olympus with a new medical device, the next day it’s Fujifilm.”

Over 70% of Olympus Corp.’s global sales are from medical devices, a spokesman says, and “our main business is no longer consumer products.” Fujifilm Corp. is expanding into areas such as health care, graphic systems and industrial materials.

Having expanded carbon fiber into everything from fishing rods to windmills, Toray is looking for new markets for it. This year, it bought Zoltek Companies Inc., a U.S. supplier of carbon fiber to the automotive business. It also makes materials used in semiconductor manufacturing, lithium-ion batteries, fiber-optic cables and polypropylene spunbond fiber, an absorbent material in disposable diapers.

Toray is also profiting in its oldest market: clothing. Uniqlo, the Japanese apparel chain owned by Fast Retailing Co. , has sold more than 400 million items in its Heattech line of T-shirts, underwear and other clothing made with a new Toray blend of polyester, acrylic, rayon and spandex. Uniqlo declines to discuss details of its Toray relationship.

“The long-term assumption here is that fiber is a growth industry,” says Toray’s Mr. Nikkaku.

Toray’s trade-off for long-term supply deals, some analysts say, is its modest profit margins. Its 7.6% return on equity in its most recent year is less than half that of some global chemical-industry leaders, they say.

“If we were to focus only on immediate issues, we would derail,” Mr. Nikkaku says. “We always look 10, 20 years ahead.” Toray’s shares are up 13% over the past 12 months, versus the Nikkei’s 11% rise.

Japanese suppliers of materials and components may eventually lose their global edge, some say. South Korea and China will eventually undercut Japanese parts suppliers just as they did with finished gadgets, says William Saito, a venture capitalist who advises the Japanese government on technology strategy. Japan needs to develop trendsetting consumer products or services to provide the profit margins the economy needs, he says.

Sony, meanwhile, continues to struggle in its consumer markets. In September, it said it expected to post a loss of almost five times what it forecast four months earlier for the current fiscal year as it wrote down the book value of its mobile communications unit.

It is edging out of some consumer businesses, recently selling its PC business and making its TV operation a free-standing unit.

And it is increasing its bet on high-tech components for other people’s products. While few outside Japan want to buy Sony’s smartphones, its image sensors for smartphone cameras are used even by Apple Inc. Sony is supplying them for the iPhone 6 and iPhone 6 Plus, says Chipworks, a patent-research firm. Apple didn’t respond to inquiries. Sony declined to comment.

In July, Sony said it would spend $345 million to increase sensor-production capacity.

Kosaku Narioka and Chieko Tsuneoka contributed to this article.

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