Japan machinery orders: defense the only bright spot in 2012

by SR on August 9, 2012

Japan machinery private-sector orders excluding ships and power generation equipment

  • Conclusion: no change in trend of weakness overseas with modest strength in Japan. The ESRI released Japan machinery orders this morning and the closely watched ‘core’ orders (i.e. private sector orders that exclude volatile orders for ships and for power generation equipment) rose by 5.6% in June 2012 compared to the previous month, to 709.6 billion yen. That is a seasonally adjusted figure and is shown by the red line in the chart above. Total orders rose by 7.4% sequentially, with public sector demand (on which more below) posting by far the biggest increase of 19.2% month-on-month. Overseas demand was notably weak, down 9.8% month-on-month. Manufacturing also slid 2.9% MoM, with non-manufacturing rising slightly by 2.6% MoM.
  • Approaching bottom for machinery stocks? If we look at the base figures free of any seasonal adjustment, orders for the January to June 2012 period reached 12.98 trillion yen, up just 0.1% compared to the same period in 2011. If it were not for a substantial increase in public-sector orders and particularly defense spending, total orders would be down several percent year-on-year. Overall then, an underwhelming set of figures. I continue to suggest a heavier weighting in auto-related stocks rather than machinery stocks, but after a set of poor Q1 results I feel we may be approaching the point where the bad news no longer affects machinery sector share prices.

Japan total machinery orders, cumulative in billions of yen

The public-sector riddle

If you look at the cumulative orders year-to-date for Japan machinery, the total comes to 12,979 billion yen, 0.1% higher than the January to June period of 2011. Overseas orders have fallen 4.7% and private-sector orders have fallen by 3.7%, so how come total orders have not fallen rather than being, effectively, flat compared to the previous year? The answer is that public sector orders have filled the gap.

First, let’s review what the orders actually mean. They are the result of a monthly survey taken from nearly 300 companies in Japan and collated by the ESRI department of Japan’s Cabinet Office. As machinery tends to have long lead times – typically 3 months or so but for many items much longer – it seems reasonable to use this as some indication of demand over the next quarter. Where does this demand come from? The chart below shows the main components.

Japan machinery orders by sector (% total)

So you can see that the private sector accounts for the largest part of orders, at 41.8%, followed by overseas orders at 39.9%. The public sector accounts for 13.7% – which seems quite large to me – and what the ESRI calls orders ‘through agencies’ is 4.3%. (‘Agencies’ does include trading companies and similar entities but is also just a catch-all for orders where the final user is not known.) The private sector and overseas demand dominate, but let’s look at the change in yen terms between the first six months of 2011 and the first six months of 2012.

Change in value of Japan machinery orders by sector vs previous year, January to June 2012 (billion yen)

As you can see, the change in total orders from January to June 2011 to January to June 2012 was insignificant – a piddling 7 billion yen. On the other hand the sectoral swings have been substantial. Private sector orders have fallen by 209.8 billion yen and overseas orders have fallen by 257.2 billion yen. Offsetting those declines are the 403.7 billion increase in public sector orders and a 70.4 billion increase in the agencies category. My first thought was that this public-sector order increase would be related to the rebuilding being carried out in the areas of Northern Japan hit by the earthquake and tsunami in March 2011. However, a check of the figures reveals that it is actually defense that has been the main swing factor.

Breakdown of change in Japan public sector orders by category

Orders from the Ministry of Defense rose by 292.7 billion yen, accounting for 72% of the total public sector machinery order increase of 403.7 billion yen. Orders from local governments did increase and presumably some of that is related to rebuilding efforts just mentioned. That’s a very substantial increase in defense orders, but I have no idea what is driving that, whether it will be sustained and I have only a hazy idea of which companies might benefit. I guess Mitsubishi Heavy would be one and perhaps small-cap Japan Aviation Electronics but defense is not something I know much about.

Previous post:

Next post: