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Sumitomo Mitsui Trust downgrades Japan growth to 17.8%

Masashi Oda, Chief Investment Officer, Sumitomo Mitsui Trust Group on the latest activity in Japanese equity markets…

Despite downward revisions to consensus forecasts, the Japanese equity market still offers an attractive forward PER of 12.1x: a historic low.  The market is also at a historical low relative to the US: the estimated PER gap between TOPIX and the S&P500 is now in negative territory, reflecting the relative outperformance of U.S. equities

Following May’s corporate earnings releases, our analysts have reviewed their FY2012 forecasts. While our initial view was that guidance from some companies was overly conservative, further analysis has led to reductions in some of the earnings growth forecasts.  We now forecast that the earnings of the SMTB Research Coverage (870 companies) will grow by 17.8% in FY2012, down from the 21.6% growth forecast at the end of April. The main reasons for the downgrade are i) the assumption of a weaker Euro against the Japanese Yen, which accounts for 1.0% of the downgrade, and ii) analysis and meetings with company management leading to revisions in expected sales and costs.

Sectors where we downgraded forecasts include electric power & gas, electric appliances and pharmaceuticals. The downgrades to energy companies resulted from a review of the utilisation rate of nuclear power plants and fuel expenses.  Lower earnings are expected in the electric appliances sector on the back of a weaker Euro, sluggish demand for TVs and a slowdown in demand for machine tools.  In the case of pharmaceuticals, the downgrade results from expected higher R&D expenditure and impact on sales from patent expiries.

Sectors where we upgraded our forecasts include the transportation equipment sector: analysis of recent sales data and meetings with company management led to our analyst team raising its global automobile  production forecast.

We expect to see higher earnings growth than the market consensus in the marine transportation sector, on the basis that companies are likely to benefit from a recovery in container shipping freight and a decline in fuel prices.  Meanwhile, lower than consensus earnings are anticipated in the chemical sector where we believe that tightening margins will reduce earnings.

An example of a company that we expect to surprise on the upside against both company guidance and the even lower market consensus is Ricoh, the office equipment and photographic instrument marker.  The upgrading of the impact from its corporate restructuring contributes to our positive view on the company. The unreliable track record of its guidance means that sell side analysts are generally skeptical; Ricoh has missed its guidance four years out of last five years.

Overall, about 30% of our earnings forecasts were revised downwards.  Despite this, the fundamental outlook remains positive and earnings are still expected to show double-digit growth in FY2012.

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