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Pretax profits down over all firms in July-September quarter; is the business cycle turning?

While calculations made earlier this week by the Nikkei showed that pretax profits at listed firms were up 10.9 percent in the first half of the current financial year, data released by the Ministry of Finance on Monday showed that the total pretax profit of firms in all industries was down 0.7 percent in the July-September quarter. This was the first decline seen in five years.

More worryingly for the government is the effect that decreased earnings seems to be having on its own coffers: In October, corporate taxes were 2.3 percent lower than a year ago, although revenues from sales taxes were up 2.0 percent (more on this report in an upcoming post).

The ministry’s report pins the decline on higher oil prices and increased costs for raw materials of other kinds. That seems to be backed up by the fact that manufacturers saw a 3.6 percent fall in pretax profit, while nonmanufacturing firms experienced a 1.5 percent rise.

Digging through the data, we see that nearly every measure of assets has entered decline. I have charted three for this post, though hope to look further into the information (Click the individual images to enlarge - units are in hundred million yen). All three charts show total figures for all firms. Separating firms by size and whether or not they are manufacturers will certainly yield further insight.

As we can see, cash and deposits at all firms remains quite a bit higher than it was in April 2003. However, given that capital spending has slowed for the past two consecutive quarters (by 4.9% and 1.2%), this might be a sign of worry. While capital spending was up in 2005/6, we saw the rate of cash and deposits hardly move. If firms have decided to start saving cash as reserves again, this might indicate some uncertainty over the future course of the economy. Higher oil and raw materials prices will do little to assuage such worries. At the same time, we have seen a drop in cash and deposits in the last quarter, although it is still too early to judge whether or not this is significant, and we should keep an eye on it.

Second, we have holdings in land assets. Here we see a large overall decrease since the beginning of FY2004. It seems that firms unloaded quite a bit of land assets in the beginning of the FY2005, which would coincide with the drive in investment purchases and surge in land prices that we currently see in the major cities. After bottoming out in the early summer, it seems that firms have increased the size of their land assets in the July-September quarter, which may imply that there are still some bargains to be had out there. Or, as in the case of investments, firms might be later to the table in terms of buying land for speculative purposes. We would have to make one heck of a large survey to find out all of the motivations behind the increase in land assets (or is it much in part due to an increase in land values?) in order to see what’s completely behind these numbers

Finally, I looked at investments and other assets. This chart shows a clear increase over April 2005 to April 2007 - which coincides with a slight delay against the last stock market rally - and a slight decrease in the first two quarters of FY2008. This reduction in holdings - or the value of holdings - makes sense, as it’s starting to look as though the Nikkei will finish below its opening in 2007, which indicates that firms should be following suit and selling off, and should be slow to react to any re-entry positions. However, we do know that cross-holdings are on the rise, which seems to indicate that firms are investing more as part of a strategic business aim rather than for investment or speculative purposes.

That’s all I have space for here. Would be good to go a bit deeper and separate each asset by the various categories, but looking at the numbers indicates that we would see the same general figures: Asset holdings peaking in the last financial quarter of FY2007 and on the decrease (though generally slight) since then. The numbers also seem to agree with my take on the most recent Tankan survey that things look much better for nonmanufacturers than manufacturers over the coming four quarters and that manufacturers could slide into negative territory. With profits forecast to be down even at listed firms over the next two quarters, this is worrisome news indeed for Japan Inc.

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