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Weighing the Industry Impacts from the Japan Disasters

Jason Stipp

Jason Stipp: I am Jason Stipp for Morningstar. We've all been carefully monitoring the profound human impact of the natural disasters in Japan. Morningstar analysts have also been carefully examining the potential business and industry impacts from the events overseas.

Here with me to talk about some of those findings is Adam Fleck. He is an associate director of research in Morningstar's equity research team. Thanks for joining me, Adam.

Adam Fleck: Thanks for having me, Jason.

Stipp: There are several different industry areas that could potentially be affected here. I think the one that's top of mind for a lot of market watchers right now is the nuclear space. Obviously, situation is still unfolding and is very worrisome in Japan, but I wanted to discuss with you what you're thinking about the future for this particular industry and the different sub-industries that participate there, starting first with utilities.

So I know that there have been talk of a nuclear renaissance before this that has a cloud over it certainly now. How are you thinking about utilities, given the events that have unfolded in Japan now?

Fleck: Sure, I think the nuclear renaissance is something we have been monitoring very closely, but nonetheless I think right now what we're facing on the utility side is increased cost--potentially increased licensing cost, increased safety cost, and uncertainty regarding the feasibility of nuclear, not only here in the U.S., but in large growth markets like China, for instance. China doesn't necessarily always follow public opinion, but nonetheless, the increased cost and engineering behind that could definitely impact the market there as well.

There are several companies here, such as Exelon, that already have nuclear plants in place; those don't look to be jeopardized, but a company like Entergy, which has been hit because of its negotiations with the Vermont state government could be an area where you could see some tailing off of nuclear.

Stipp: So certainly company-by-company the impact could be different depending on the situation there.

Another area in this space is the engineering and construction firms that help to plan, design and build these plants. How are you thinking about those companies in light of these events?

Fleck: Well, again, it's certainly going to crimp their market potential. A company like Shaw Group, which is very heavily exposed to the nuclear markets, could see some weakness in demand, and again the uncertainty there has beaten down the stock quite a bit.

Stipp: The last one I know that you guys have looked at are the providers of the power equipment. So I know GE stock, when this news came out last week and early this week, took a hit because they had been involved in some of the design of the power equipment that's used in these plants. What are you thinking about these companies?

Fleck: I think it's a less of a negative effect there. GE did take a hit. They helped design the nuclear plant in Japan that's having trouble. Nonetheless, they have come on and said through a press release that they are not on the hook for any liability costs.

In fact, if you look across the space like Alstom, or GE, or someone like that, most of the companies cover the broad spectrum of the electrical grid and the solutions for power, and in fact in a lot of cases nuclear is not even the highest-margin product. So if you see the end of the potential nuclear renaissance and a sentiment change back to more traditional power sources, GE actually might be positively affected by that mixed shift.

Stipp: So following on the discussion of the nuclear--coal could potentially be a beneficiary if we do see less demand for nuclear power in the future. You have somewhat of a differentiated take depending on time frame for coal? Could you explain a little bit of what's behind that?

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Fleck: Sure, in the near-term I think that it could be definitely negative. Japan is responsible for about 20% of world coal imports, and it's the world largest importer of coal. A lot of that coal goes into power generation, obviously, a lot of it goes into steel production. Japan is the second-largest steel producer in the world. As they have rolling blackouts throughout the country, they are likely to see steel mill shutdowns. Of course they are shutting down some of their coal-powered facilities. You could see a drop-off in coal volumes here in the very near-term.

Stipp: In the intermediate term, though, might we see some more coal energy come online both in Japan and potentially globally, as there is some question about the nuclear plants and wanting to maybe have some more coal to offset plants that might be closed or shutdown for inspections or something like that?

Fleck: That's exactly right. Obviously, sentiment change, again, going back to coal would be definitely a benefit for the coal producers.

Stipp: Then long-term, do you think that we will see, over time, a shift to other power that could potentially benefit coal and other sources of energy?

Fleck: Yes, I think that's definitely that case. As a country like Japan, which is heavily reliant on nuclear, or France, in U.S., could potentially go back to more traditional sources of power. I think that you definitely could see coal miners or even oil producers, diesel producers, benefit from that.

Stipp: Switching to another industry: autos. This is one where Japan obviously has a couple of marquee names in the auto industry. Can you explain a little bit about how you are thinking about those names as well as U.S. names in light of the incidents that happened in Japan?

Fleck: Sure. I think it's not as much of a long-term effect. It's more of a short-term effect. A lot of it depends on the supply chain issues in Japan. We're not really seeing so much--for instance, for Toyota, which produces a lot in Japan, Honda produces a lot in Japan, although it is a little better positioned. We're seeing not necessarily plant shutdowns on the OEM level. We're seeing issues potentially with suppliers. We're seeing issues with the transportation infrastructure in Japan that could be shut down, and of course there is always the port issues of getting product out of Japan. So far, a company like Maersk, which is the world's largest container shipping operator, has noted that six of their nine ports are operating [in Japan], including Tokyo.

Stipp: So, it's actually not necessarily that the plants have a problem but getting the parts around and getting things shipped out of Japan could be an issue for a little while.

Do you see that there could be some winners from this on the U.S. side, with some automakers that have been trying to compete with Japan for a while and started to gain some headway. Is this a chance for them to maybe even gain some more ground against their Japanese competitors, at least in the short term?

Fleck: Sure. I think in the short-term, in the U.S. market specifically, Ford, GM, Chrysler are very large winners here. Again, Honda produces actually a pretty good amount of their U.S. production in the U.S., but Toyota imports quite a bit more. In fact, Toyota imports all of its Lexuses outside of the crossover RX model. Now, the RX is very popular here. It's made in Canada, but nonetheless, you could see some winners there on the luxury side--not only from the U.S companies but European companies like BMW as well.

Stipp: Okay, last area I would like to cover with you is construction equipment--another area that you folks looked at in your recent research report. It seems like conventional wisdom would suggest that once we get past--and we all do hope that we can get past--some of the near-term crisis situations in Japan, that there will be some rebuilding there. Obviously, there will have to be. Construction equipment could benefit from this, yes?

Fleck: Yes, definitely. The largest construction equipment manufacturer in the world is Caterpillar based here in Illinois. The second largest is Komatsu, which is based in Japan.

Komatsu has had a real stranglehold on the Japanese market, but one of their factories--they have several factories across Japan, obviously--but one of their factories is only about an hour away from the nuclear facility that is so badly damaged. And again, with the parts issue, supply issues, infrastructure issues, if they are not able to meet the rebuilding demand, Caterpillar could have an opportunity to come in there and maybe steal a little bit of share, which eventually could lead to a longer-term push in Japan. And of course, China being such a strong growth market from the infrastructure standpoint, if Komatsu has to divert a lot of capacity towards the Japanese market, it could present an opportunity there for Caterpillar as well.

Stipp: All right, Adam, thanks so much for your insights and the context around some of the business impacts of the situation in Japan, and for joining me today.

Fleck: Thank you very much.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.