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War fears weigh as Japan rings in new business year

By Daniel Hauck

TOKYO, April 1 (Reuters) - With its car makers as strong as ever, electronics firms trimming fat and steel exports to Asia booming, Japan Inc might be tempted to just gaze at the cherry blossoms as a new business year starts.

On the surface, corporate earnings look hunky-dory. Japanese companies are expected to report a 23 percent increase in operating profits for the 2002/2003 fiscal year ended on Monday, with exporters such as Toyota Motor Corp poised for record results.

But this is no time for complacency.

Even Japan's healthiest firms will be vulnerable to economic slowdown in the United States and Asia, and must hope for a swift end to war in Iraq to book the small profit rises expected by analysts for the year from April.

Sectors expected to outperform, such as electronics, already have cut costs to the bone and now need to increase sales.

"Ironically, they could be hurt by the fact that they have already done so much restructuring and cost cutting," said Daiwa Institute of Research economist Hiroshi Watanabe.

"They don't have much left to cut to compensate if sales fall due to a longer war."

Fallout from the war also could be a death blow to Japan's struggling domestic-oriented industries, with little relief expected for a teetering banking system, the bloated construction sector, or smaller retailers hammered by deflation.

A consensus of forecasts from major financial institutions compiled by Daiwa Institute estimates Japan's top non-financial firms will see operating profits rise just 7.7 percent in 2003/04.

Some other analysts are not as optimistic, and banking woes as well as a dormant stock market are expected to cast a shadow over the world's second-largest economy.

ROSY SCENARIOS

It's easy to conjure up a rosy scenario for certain sectors if war in Iraq is short.

"Electronics companies will benefit from restructuring, and car makers are truly strong," said Daiwa's senior analyst Takeshi Naruse.

"There's good demand in Asia for materials like steel, while industries like steel, paper and cement have won price rises through alliances that have reduced the number of companies."

Daiwa expects Japan's steel makers to post the second-biggest operating profit gain of any sector in 2002/03, and follow it up with a 40 percent rise this year. The paper and pulp sector is expected to outdo it slightly with a 42 percent jump in 2003/04.

While foreign investors decry the lack of reform in many of Japan's bloated industries, the merger of NKK Corp and Kawasaki Steel Corp to form JFE Holdings Inc last year has helped the steel sector trim overcapacity and boost prices.

Restructuring is also key for Japan's electronics makers. Most analysts expect them to book major rises in operating profit after returning to the black in 2002/03 following huge restructuring losses and the info-tech downturn in 2001/02.

Tech firms will also reap the benefits of brisk demand for gadgets such as camera-equipped mobile phones and DVD recorders.

PROBLEMS

Even analysts who are guardedly optimistic about corporate Japan this year caution that some of its key industries may not be as strong as indicated at first glance.

The boom in steel exports to South Korea and China has tailed off slightly in recent months, and some worry about a speculative inventory buildup that could push down prices later in the year.

And with global sales by international heavyweights like Sony Corp and Toyota shouldering much of the burden for Japan's puny economic growth as the domestic economy sputters, even a short war in Iraq could be damaging.

"Overall I would be worried about exporters' earnings," said HSBC Securities chief strategist Garry Evans.

A lengthy war could also do enough damage to U.S. consumer confidence to hurt Japan's auto makers, which have countered slow business at home by grabbing more market share in North America.

"Given my bearishness on the U.S. economy, I think profits are likely to be weak in the auto sector this year," said Jun Terasaka, senior fund manager at Toyota Asset Management.

Analysts forecast average operating profit growth of 6.9 percent for the auto sector, a comedown from the estimated 24.6 percent for 2002/03 when Toyota, Honda Motor Co and Nissan Motor Co likely zoomed to record profits.

But Daiwa estimated earlier this month that operating profit growth at auto makers would drop by 4.6 percentage points from the original scenario if the Iraq war lasted six to 12 weeks.

Steel and electronics makers would take an even bigger hit if the war ran on that long, with Daiwa estimating operating profit growth at steel firms to deviate by 48.2 points from the consensus forecast and by 56.3 points at electronics companies.

DEBT MOUNTAINS, EMPTY BUILDINGS

After increasing efforts to clean up mountains of bad loans, banking giants such as Mizuho Financial Group Inc are set to post some of the biggest net losses in Japanese history, and analysts see no easier road ahead.

"All top banks will face even tougher financial conditions in the coming fiscal year," Hiroshi Hosoda, bank analyst at Tokyo credit agency Rating and Investment Information, said recently.

Two of the biggest bad-loan sources, real estate and construction, are also expected to face hard times.

With Tokyo facing a record glut of office space, analysts see operating profits in the real estate sector down 5.6 percent.

Japan's construction sector may eke out profit growth, but sales are expected to keep plunging. Too many struggling firms have been resuscitated by banks, preventing the clear-out needed for stronger firms to battle cuts in public works spending.

The troubled retail sector is somewhat further along than the builders in industry reorganisation, with a defined split beginning to form between winners and losers. The consensus analyst forecast was for a one percent profit rise this year.

But healthy large retailers like Aeon Co Ltd will face increased competition from the entry of Wal-Mart Stores Inc into Japan with its local partner Seiyu Ltd .

They will also be hurt by the measures that stronger industries have been forced to take to secure profits.

"One of the biggest risks is that what the restructuring firms have been doing to boost their results is also making it hard for consumers to open their wallets," said Daiwa's Naruse.

(Additional reporting by Nathan Layne and Chikako Mogi)