Oddbox 25

Week Ending 10th May, 2009

April Showers Augur A Dry Summer?

After the long holiday, the Japanese stock market opened on Thursday by
jumping to the biggest one day point rise this year on the back of
diminishing anxiety toward the US financial system from the results of the
stress tests. One Japanese broker was quoted as saying, “the excessive cuts
in production and capital spending based on Depression-like scenarios are
gone, and the economy is returning to normal”. But are they? It seems as
though that broker was reading only the good news. The first data for April
released this week could be sending cause for hesitation.

Korea and Taiwan have published their trade data and China’s Shenzhen
Port has released its container throughput figures as well. These data tip
more to a stabilisation of global trade than a follow-through of the recent
recovery into a normal pattern of growth.

Whilst we have witnessed some green shoots of growth based on positive

Asian demand, especially from China, a wider spread of recovery across the
world is not yet apparent. This sense of a lack of wider recovery was borne
out by the corporate results released in Japan on Friday expressing a worse
performance in Q109 than had been expected and some lowly forecasts for
the coming financial year. Let us see if we can fathom what is going on.

Japan

On Friday, Toyota Motor reported a net loss for the fourth quarter to the end
of March of JPY765.8bn, or about US$7.74bn, one of the largest quarterly
losses ever posted by a Japanese manufacturer.

This Q1 loss was worse than GM’s and brought the company’s full year
results to a net loss of JPY436.94bn, its first in 59 years, causing Toyota to

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reduce its FY08 annual dividend to JPY100 per share from JPY140 in
FY07, its first dividend cut since the fiscal year ended March 1995.

Sales revenue in the fourth quarter (January to March) declined a massive

-46% yoy to JPY3.536tn from JPY6.567tn a year earlier. Toyota sold
7.57mn vehicles globally for FY08, down from 8.52mn vehicles in FY07, as
sales deteriorated across all regions. Toyota even experienced a fall in sales
in China for this year so far, despite an overall rise in auto sales there.

For FY2009, Toyota is forecasting an operating loss of about JPY700bn,

even worse than FY08. Toyota expects its worldwide sales to fall a further
1mn units to 6.50mn vehicles as it forecasts a -16% yoy drop in sales in
North America, a -13% yoy decline in Europe and, unexpectedly, a -16%
yoy fall in Asia. This latter figure suggests that there is something wrong
with Toyota’s model mix in the current economic circumstances.

The automaker has built its future around hybrid vehicles such as the Prius.
Such vehicles were highly relevant during the recent period of high oil
prices last year, but at current oil prices are less so. Such vehicles have
complicated software and drive-trains and sell at a premium. Thus, they
have only been released in developed markets until now. To place hybrids at
the heart of its global range, Toyota announced plans to double the number
of markets for these vehicles to 80 countries, including some African
nations. Meantime its competitors, especially Honda and VW, are focusing
on improving the efficiency of traditional drive trains. Toyota’s hybrid
vehicle strategy is a big bet and its success will depend on the behaviour of
oil prices in the coming 12 to 24 months.

Another issue is that Toyota’s shares of key expanding economies are not
substantial, being 6% in China and less than 3% in India and Brazil. So, on
the one hand, Toyota still has lots of room to grow in these key emerging
economies, but it is not well positioned to take advantage of them at this
moment of weakness everywhere else.

Toyota will step up cost-cutting efforts with the aim of returning to the black
in the year ending March 2011. The company plans to slash its consolidated
capital investment by 36% to JPY830bn, although within that total,
allocations for Asia are expected to rise by a little more than 20% to
JPY70bn.

Interestingly, Toyota has set its assumed exchange rates for FY2009 at
JPY95 to the dollar and JPY125 to the euro, both higher than the current
exchange rates, indicating a bias to appreciation of the Yen. Several other

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major companies have given Yen forecasts of JPY90 to JPY95 in their
FY2009 forecasts, indicating the same view of a stronger Yen.

Electronics giant, Toshiba, said Friday that it swung deep into the red in the
fourth quarter of the fiscal year ended March and warned it won't return to
profit this year. It experienced a JPY343.6bn (US$3.5bn) net loss for the
fiscal year ended March, compared with a JPY127.4bn profit a year earlier.
It was the company's biggest loss ever and its first annual net loss in seven
years.

For the year that started April 1st, Toshiba said it expects a net loss of
JPY50bn. It plans to raise about JPY500bn of capital through an offering of
stocks and subordinated bonds to strengthen its financial standing with the
intention to accelerate its restructuring efforts, its first public share offering
in 28 years. For the year ending March 2010, Toshiba expects to turn a
JPY100bn operating profit thanks to JPY300bn of reductions in fixed costs.

In contrast to the troubles besetting the five major electronics companies,

the leading games console and software maker, Nintendo, announced net
profit in the fiscal year ended March of JPY279.2bn, up +8.5% yoy, and
forecast growth in net profits in FY09 of +7.5% yoy to JPY1.80tn. Those
forecasts are based on the dollar being worth an average of JPY100, and the
euro about JPY130. The video game industry is obviously proving to be
relatively recession-proof as families rely on home entertainment more than
in the good times.

Leading air conditioning company, Daikin, posted operating profit of

JPY60bn for the year ended March 31st, falling 53% yoy, its first decline in
15 years. With more than 60% of its sales revenue earned abroad, Daikin’s
profits are sensitive to currency movements. It is assuming exchange rates
of JPY90 to the dollar and JPY120 to the euro for the current fiscal year,
giving a conservative tone to its projections. FY09 sales are expected to fall
10% to about JPY1.08tn and group operating profit is expected to tumble
33% to about JPY40bn. Daikin is counting on the need for companies to
improve energy efficiency as the reason for positive replacement demand.

China

There is a growing evidence this week that, although the macro indicators
point to recovering strength in China’s manufacturing sector, there is a
widening differential in performance between companies serving domestic
and external demand.

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The Markit-CLSA manufacturing PMI jumped 5.3 points to 50.1 in April,
moving into expansionary territory for the first time in nine months.
However, the export order component remained below 50, rising 7.4 points
in April to 48.8. This means that both of China's PMI series (the NBS PMI
and Markit-CLSA PMI) are now sending the same signal of industrial
expansion.

Yet, at the same time, the rhetoric of various central government agencies is
turning more uncertain, maybe even negative. The People’s Bank of China,
in its quarterly report, acknowledged that the recovery in the domestic
economy is still tentative and the external environment remains challenging.
In addition, Vice Premier Wang Qishan, who was in Europe last week for
trade discussions with the EU, said in a signed article published in the
Financial Times on Friday that the global financial crisis is spreading and
the global economy will get worse before it gets better. China’s policy
makers seem for the moment to be sending out a message to dampen
expectations. Is there good reason for this change in tone?

Whilst China’s actual trade figures for April will not be published until next
week, the port of Shenzhen has published container throughput figures for
April that indicate the recovery of trade has stalled. Volume momentum
tailed off in April evidenced by container throughput run rates stabilising at
low levels. The monthly container throughput of Shenzhen was -21.5% yoy
on average in January and February, and -21% yoy in both March and April,
suggesting that underlying external demand remains weak. No figures have
been published yet for container April’s throughput at either Shanghai or
Tianjin.

Repositioning of empty containers back to China has eased off since trade
collapsed last October, and this has been confirmed in the activities of
CIMC, the world’s largest manufacturer of containers based in Shenzhen.
All CIMC’s plants for the manufacture of dry containers have remained
closed since October 2008, with no production having taken place.
Typically, CIMC manufactures 500,000+ teu of dry containers per quarter to
fill the gap between repositioned empty containers and demand for new
boxes. CIMC’s orders for specialized and refrigerated containers were down
over 50% yoy in Q109.

Taking these different reports together, it appears that exports out of the
Pearl River Delta region have stabilized at a level about 20% below last
year’s and external demand remains muted. This conclusion is echoed by a
report that the Canton Fair, the largest trade fair in China, which closed on
Thursday, saw export orders for the coming months down -17% yoy.

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A spokesman for the China Electricity Council stated that China's power
generation is likely to have fallen by about -4% yoy in April based on the
monthly trend, indicating a level of demand similar to the same time last
year. Power generation dropped on average by -3.5% yoy from April 1st to
10th when compared with the same period last year and by -3.9% yoy from
April 11th to 20th. Whilst these figures are for the whole of China and look
reasonably wholesome, it was stated that power generation in Guangdong
province fell by -18.5% yoy and in Jiangsu province by -10.2% yoy. Thus,
power generation statistics indicate weakness in the export regions of the
Pearl River and Yangtze Deltas, meaning that the recovery is taking place
elsewhere in China.

Part of the domestic recovery was in the automobile sector. March new auto
sales, including commercial vehicles, rose 5% yoy to 1.11mn units, a record
high for a single month. Car sales for the quarter reached 1.99mn units, up
8% yoy, driven by sales of compact models for which the purchase tax was
halved to 5% in late January. Sales of such cars soared by 22% yoy.

The National Development and Reform Commission (NDRC) announced

targets for the eradication of more obsolete industrial plants over the next
three years with the focus this year being on energy conservation and
emission cuts. These include closure of 72mn tonnes of obsolete iron
capacity and 25mn tonnes of obsolete steel capacity by 2011, all blast
furnaces smaller than 300 cubic metres and electric arc furnaces smaller
than 20 tonnes, 300,000 tonnes of obsolete copper-producing capacity,
600,000 tonnes of lead capacity and 400,000 tonnes of zinc capacity.

The NDRC also announced plans to close down all oil refineries with an
annual processing capacity below 1mn tons by the end of 2011, in line with
the plan for the petrochemical sector announced in March.

On the stock markets, statistics from the China Securities Depository and
Clearing Corp as of the end of last year indicate that institutional investors
overtook individuals to become the major participants of China's stock
markets for the first time. Institutional investors held 54.62% of the market
value of all tradable A shares, up 5.91% yoy. However, it appears that some
of this increase in institutional holdings was caused by the transfer of
tradable shares at the end of their lock-up periods under the reform of non-
tradable shares from state entities to institutional bodies such as pension
funds.

The NDRC published details of its domestic fuel pricing policy announced
in January. Domestic fuel prices would be adjusted up or down when global
crude prices reported a daily fluctuation band of more than 4% for 22

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working days in a row. The commission said refiners would be allowed to
enjoy “normal” profits when global crude prices are below US$80 per
barrel, but would face narrower profit margins when the price of crude rises
above US$80 per barrel. Fuel prices would not be allowed to go further up
when crude prices rise above US$130 per barrel, and fiscal and tax tools
would be used to ensure supplies and a reasonable return to the refiners.

The arrival of the H1N1 flu in China and Hong Kong has provoked a sharp
response from local health authorities, which imposed tough quarantine
measures on all those involved in close proximity to the infected persons.
The global media has portrayed these isolation measures as an over-reaction
to the threat. But for those of us who lived through the SARs crisis, the
government’s response is warranted until we know for sure the severity of
the disease and its morbidity rate. A repeat of the lack of an early response
in the SARs episode must not be allowed to happen.

Big Brother, Little Brothers

In further signs of coming together, the

State Council on Monday approved the
formation of an economic zone on the
western side of the Taiwan Straits (see
map).

This plan has apparently been under

consideration since 2004. The proposal is
designed to attract businesses from Taiwan
and promote cross-Straits exchanges.

In an unexpected announcement, Taiwan's National Communications

Commission (NCC) has indicated that the existing regulations do not allow
Chinese enterprises to invest in any Taiwan-based telecom carrier that has
set up its own operating infrastructure. This announcement effectively
means that China Mobile's planned investment in Far EasTone requires the
Taiwan government’s changing of the law if the investment is to proceed.

April Trade Accounts – Korea and Taiwan

Both Korea and Taiwan publish their trade accounts within the first week of
each month, and these provide us with an early read on the state of global
trade.

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 Korea’s trade figures for
April (see chart on left)
show that exports fell
-19% yoy in April to
US$30.7bn and imports
dropped -35.6% yoy to
US$$24.7bn, giving a
record high surplus of
US$6.0bn in April. This
surplus follows on from
a US$$4.3bn surplus in
March. Exports rose +7.9% mom in April, and now reflect the same level as
was seen in H107.

Taiwan’s trade figures for April show that exports fell -34.3% yoy to
US$14.85bn and imports dropped -41.2% yoy to US$12.71bn, giving a
trade surplus of US$2.14bn. Exports fell -4.7% mom, and reflect levels seen
in early 2005.

Frankly, the Taiwanese export figures are disappointing and seem to tell the
same story as the movements of containers out of Shenzhen - that the
recovery in exports is forming a plateau, at least in the short term.

Regional Technology

The two major Taiwanese semiconductor foundries, TSMC and UMC

announced very positive jumps in their April sales.

TSMC’s April sales totalled NT$21.75bn (US$658mn), an increase of

+59.7% mom. Nevertheless, on an annual basis, the company saw a -22.6%
yoy decrease.

UMC’s April sales totalled NT$6.88bn, an increase of +51.44% mom. On an

annual basis, the company also saw a narrower drop of -10.29% yoy.

There is one Taiwanese semiconductor manufacturer that has ridden through

this crisis on the crest of a wave, and that is Macronix. The company plays a
key part in the Nintendo supply chain, specializing in NOR flash memory
where prices have held up compared to NAND and DRAM. Macronix
announced sales of NT$1.9bn (US$57.7mn) for April 2009, an increase of
+5.4% mom and +11.4% yoy. Macronix has given a positive outlook for its
second-quarter performance, estimating 36-38% in gross margins, an overall
utilization rate of 85-90% and a 25-30% growth in unit shipments,
supporting Nintendo’s contention that profits will rise this year. Macronix’s

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main competitor is US NOR manufacturer, Spansion, that filed for
insolvency in March. This may benefit Macronix going forward.

Regional Stock Market Performance

Regional and global stock markets have continued to rally this week on the
back of positive sentiment on global recovery and the news out of the US on
the bank stress tests.

Given the evidence expressed in this Oddbox, albeit on a small sample, it

seems that momentum in the growth of global trade has tapered and we
should pay attention to the mainland leadership’s words of caution. It would
be Polyanna-ish to suggest that the recovery from this global recession will
be in a straight line. It will be more like two or three steps forward and one
or two steps back, and so on.

The data suggests that we are about to take a step back. It is, therefore,
possible that the markets could be spooked by a bad Chinese trade number
this coming week.

This does not mean that the green shoots are shrivelling. It just means that
we are experiencing an April (data) shower. The more relevant question
seems to be will it be one, two or three months before we start to take steps
forward again?

Conclusion

So as we look back at last week, we see:-

• Considerably worse than expected results and outlook from Toyota

• Worse than expected results from Toshiba
• Excellent results from Nintendo pointing to a change in consumer
habits in favour of home entertainment
• A positive outlook from global air conditioning leader, Daikin
• The Markit-CLSA manufacturing PMI for China moving above 50,
pointing to further expansion in the mainland economy
• Government and Central Bank rhetoric in China turning cautious
• Trade figures for April from Korea and Taiwan blended with figures
on China’s movement of containers out of Shenzhen Port and the use
of electricity in the Pearl and Yangtze deltas pointing to a stall in the
recovery of exports; this will be confirmed or denied by the trade
figures that will be released during this coming week

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 • Sales in the mainland automobile sector accelerating in March to
+5%yoy
• The NDRC has announced plans for the closure of sub-optimal
capacity in the iron and steel, copper, lead and zinc sectors, and also
in the petrochemical and refining sector
• The State Council has approved the formation of an economic zone
based in Fujian province to increase the integration of the Taiwanese
economy into China
• Regional stock market performance is beginning to look frothy and
could suffer a setback if China’s April trade figures disappoint

So the message this week is one of tempered optimism. Stabilisation has

been achieved, but recovery away from China and its satellite economies in
the region seems more modest for now than previously indicated by the
data, with a lack of follow through in the region’s exports.

The excellent sales results from some of the region’s tech companies, such
as TSMC and UMC, give cause for optimism. But much of the underlying
demand is focused on products that are “relevant” to the current economic
conditions as discussed in last week’s Oddbox. The divergent performances
of Honda vs Toyota and of Nintendo vs Toshiba are cases in point of
relevant vs weak product ranges within the same sector. The “recovery” is
still concentrated.

The outlook for the Japanese Yen over the next year is unclear. The various
Japanese companies that have reported results have mostly based their
FY2009 profit guidance on a forecast Yen rate of 90-95 to the US Dollar,
higher than the current rate of JPY99. They seem to be saying that they do
not see the return of the Yen carry trade in the next 12 months. But the
markets seem to be saying that JPY100 will be correct. Let us wait and see
who is proved correct. The speed of Japan’s recovery hangs on this single
factor.

For this next week, much depends on the signals to be found in China’s
trade figures that will be announced this week.

(RH 10.May.09)