Japan’s Global Economic Implications

Baird’s Experts Assess the Continued Impact of Japan’s Tragedy

April 8, 2011

On March 11, a 9.0 magnitude seismic event off the coast of Honshu sent tsunami waves crashing into Japan. The devastation was massive, taking thousands of lives and ravaging infrastructure. Complicating matters further, the cooling system at Fukushima Daiichi nuclear plant was compromised by the quake, causing radiation to leak into the ocean and air.

As the rebuilding process continues, so do the broader implications for the global economy. To better understand the potential financial impact of this cataclysmic event, Baird offers the perspectives of four analysts from our industry-leading equity research team.

Energy Concerns
-Christine Tezak, Senior Research Analyst and David Parker, Senior Research Analyst

Japanese authorities continue to labor under a global microscope while struggling to bring the Fukushima Daiichi plant fully under control. Existing reactor operators are watching closely. The longer safety concerns surrounding the plant remain in question, the longer current nuclear projects around the world remain in a holding pattern – as does hope for a “nuclear renaissance.”

Meanwhile, regulators around the world are aggressively executing “reviews” of safety standards and emergency plans. In the United States, legislators on Capitol Hill were quick to convene hearings, and the industry was called upon to explain safety changes made since the nation experienced its own high-profile nuclear incidents, most notably a 1975 fire at the Browns Ferry facility and the partial core meltdown at Three Mile Island in 1979. U.S. Operating reactors have since undergone retrofits and upgrades including:

    • Enhanced battery capability for station blackouts (1988),
       
    • A hardened containment vent requirement (1992), designed to
      prevent hydrogen explosions such as those that occurred at
      Fukushima Daiichi), and
       
    • Redundant generators and pumps (post-9/11).

All current U.S. safety systems and other design criteria are under a 30-day and 90-day review by the Nuclear Regulatory Commission (NRC). This review will focus on updated seismic information for both existing and proposed plants. It is not clear what if any incremental changes will be required. Industry experts believe that the NRC could logically require backup systems to be augmented with additional generators, longer-lived battery arrangements or both. Such requirements would address manageability concerns for nuclear investments, specifically that a plant could be “cut off” from emergency services.

Alongside additional safety requirements at existing plants, nuclear technology in general continues to evolve. Industry experts believe next-gen nuclear technology most likely would have averted the nuclear crisis in Japan. Yet in spite of much safer new designs, new nuclear plant deployment in the United States has been slowed by low natural gas prices (made possible by prolific natural gas shale exploitation). In the face of these pre-existing headwinds and the continuing Japanese crisis, reactor vendor Westinghouse, lead project sponsor Southern Company, and the Nuclear Regulatory Commission (NRC) continue work on design certification and the combined construction and operating license application for the Vogtle Power Station. Both key approvals were scheduled for 2011, and no change to those schedules has been announced by the NRC so far.

While a nuclear renaissance was likely still years away in the United States, nuclear plants generate nearly 20% of the power we consume every day. The final conclusion to the quickly changing nuclear crisis in Japan will play a key role in shaping public sentiment and the regulatory future – both of which will greatly influence not only the prospects for new units, but the retention of existing capacity. In the mean time, natural gas will likely benefit from continued debate, as it remains one of the most attractively-priced fuels sources, has short construction lead times, relatively modest up-front capital expenditures and easier permitting processes.

The Technology Effect
-Tristan Gerra, Senior Research Analyst

As the world’s third largest economy, Japan produces some of the most technologically advanced electronics and automobiles and is a major consumer of semiconductor technology. As a result, the devastation wreaked by the quake and tsunami will have ramifications in this market space.

Japanese demand for semiconductors is expected to be down in the second quarter of 2011 and possibly extending into the third quarter, due to factory shutdowns for semiconductor manufacturing and testing, power outages, as well as transportation and supply chain disruptions.

Meanwhile, component shortages could benefit pricing and gross margins for semiconductor companies, notably those with commodity exposure in segments reliant on Japanese production. Those shortages are expected to impact the broader electronic supply chain, notably memory, LCD and microcontrollers.

Rebuilding in Japan is expected to have a positive impact on semiconductor demand starting in the fourth quarter of 2011 and continuing into the first half of 2012.

Markets affected so far include:

    • NAND flash: Production was minimally impacted, suggesting a low single-digit percentage impact on worldwide NAND production will be lost for April-May sell-through. NAND flash spot pricing faced a sharp uptick in expectation of some tightening in NAND flash supply, but has since stabilized. NAND flash contract pricing increased following the earthquake and is expected to see additional upside due to the impact of lingering supply concerns.
       
    • Optical disk drives (ODD): Component makers Sony, Renesas Electronics and Texas Instruments all suffered damage from the earthquake and had to temporarily halt production of ODD components.
       
    • Batteries: Kureha has a 70% global market share of an important polymer used in lithium ion batteries (used in Apple’s iPhone and iPod) and had to suspend production following the earthquake. 
       
    • Packaging and testing: The industry relies on Japan for manufacturing-use chemicals and materials such as bismaleimide traizine (BT) resin, epoxy molding compounds and solder mask.
        • Largest problem is the growing shortage of BT resin, which is used in many chip package substrates by back-end assembly/test firms like ASE, SPIL and Amkor (Mitsubishi Gas Chemical supplies ~50% of the worlds BT Resin). 
           
    • Silicon wafers: Major memory silicon wafer suppliers Shin-Etsu Handotai (~20% of global supply) and Sumco were forced to suspend production at their manufacturing facilities due to the Japan earthquake. 
        • Shin-Etsu supplies wafers to Hynix Semiconductor, Elpida Memory, Powerchip Technology, Rexchip Electronics, and ProMOS Technologies. 
        • Sumco supplies wafers to Samsung, Micron and Hynix. 
           
    • Flat panel industry: The impact on this industry is relatively limited as most of Japan's LCD fabs are far from the epicenter of the earthquake. 
        • There is still a potential impact on the supply of upstream raw materials for LCD panels, specifically for ITO material and NF3 gas which are key components in TFT-LCD panels and touch sensors. 
           
    • Mobile Phones: Components are likely to be affected the most given that Japan is a leading supplier of capacitors, filters and inductors used in mobile devices. 
        • Passive component maker Nippon-Chemi-con supplies 20% of the world’s aluminum electrolytic capacitors and reported damage from the earthquake 
        • Other Japan-based component suppliers: Murata Tome (EMI filters and inductors) and connector output from Tohoku Hirose.

Industrial Impact
-Rob McCarthy, Senior Research Analyst

The near-term impact on companies in this sector is expected to be modest, with few doing appreciable business in Japan and fewer still having significant operations in the disaster zone. Manufacturers that rely on Japanese suppliers for components (like electronic controls) could incur incremental expenses overcoming congested transportation hubs and/or securing alternative supplies.

As the rebuilding begins, however, increased demand for equipment could have a noticeable positive impact for companies with Japanese market exposure. Cranes, large excavators and wheel loaders will be extensively used for clean-up and demolition. Mobile crushing and screening equipment will also be needed. Portable power will also be critical, creating incremental demand for electrical generator sets, air compressors and high-force hydraulic tools and pumps.

Should increased safety concerns indeed lead to a slowdown in global nuclear plant construction, an incremental negative impact (mostly for cranes) could be felt. However, power generation capacity (whatever the fuel) will still ultimately need to be constructed as Japan rebuilds.

For real-time perspective on the events that shape the global marketplace, visit rwbaird.com.

This is not a complete analysis of every material fact regarding any company, industry or security. The opinions expressed here reflect our judgment at this date and are subject to change. The information has been obtained from sources we consider to be reliable, but we cannot guarantee the accuracy.