JAPAN EARTHQUAKE TO IMPACT INDUSTRY UNTIL END OF THE YEAR

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Date: Wednesday April 27, 2011 08:24:46 am
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    JAPAN EARTHQUAKE TO IMPACT INDUSTRY UNTIL END OF THE YEAR

    Industry Impact
    Because office equipment such as printers, MFPs, and supplies are typically shipped by sea, the port situation along Japan’s northeastern coast presents some problems. First, we expect that it will be difficult for Japanese original equipment manufacturers (OEMs) to quickly shift production to lines outside of Japan. Critical parts manufactured domestically cannot be moved easily from Tohoku to other parts of Japan—never mind being shipped overseas. Second, the availability of hardware and supplies will soon begin to dry up. The first post-quake shipments began arriving in the United States in late March and in Europe in early April. So far, shortages have been reported for only certain supplies, but additional shortages will almost certainly come. The problem has yet to become critical though because a certain amount of product was already en route to foreign markets—or sitting in warehouses—prior to the earthquake.

    Japan’s shipping industry has been affected by the earthquake and tsunami. It will take some time for the imaging industry to deplete inventory in warehouses and shortages to occur. Image source: Photos.com.

     

    While other OEMs could be adversely impacted by shortages, the three firms hardest hit by the earthquake so far, at least in our assessment, are Canon, Epson, and Ricoh. All three operate substantial production units in the earthquake zone, which caused problems because these facilities were closed in the days and weeks following the disaster. While many plants have been reopened, certain critical units have yet to be brought back online or production levels remain limited. Other OEMs have less mission-critical assets in the area such as sales offices or distribution centers that have been damaged. Manufacturing remains limited at these firms, however, because of the reduced availability of raw materials and finished parts and limited access to electricity.

    Eight Canon factories in the Tohoku region went offline immediately after the quake. The closures included certain operations such as Fukushima Canon, a manufacturing subsidiary that produces inkjet print heads, printers, and ink tanks. Another mission-critical company forced to suspended operations was Canon Chemicals, which makes toner cartridges and chemicals such as polymer components. Most of Canon’s factories had reopened by early April, although production was restricted because of the limited availability of parts and power.

    The earthquake also forced five Epson plants in northeastern Japan to shut down. The firm quickly reopened two of the factories, and, by the end of March, it had partially resumed manufacturing at two other facilities. Production at all four Epson facilities was suspended again, however, when the Tohoku region was rocked by a 7.4 aftershock on April 7, which knocked out power to 2.61 million homes. Epson reported on April 12 that operations at the four plants had resumed. The firm warned, however, “Production may be affected by issues relating to procuring certain components,” indicating Epson has yet to regain its full manufacturing capabilities. Production of powered metals, for example, at Epson Atmix has not resumed since the initial quake in March. Likewise, Epson Toyoco’s Fukushima Plant, which manufactures crystal devices, has been closed indefinitely because it is located within the evacuation zone of TEPCO’s damaged reactor.

    In March, five Ricoh subsidiaries were closed including Ricoh Optical Industries, Hasama Ricoh, Tohoku Ricoh, Ricoh Printing Systems, and Ricoh Unitechno. Rolling blackouts limited production at Ricoh’s Atsugi, Gotemba, and Numazu plants. The firm said on April 7 that operations at most of the plants had been normalized, but several units were being brought back online more gradually. All lines at the Hasama Ricoh factory, which manufactures parts, were slated to be running by April 8, while all lines at the Ricoh Printing Systems plant, which makes production equipment, were expected to be running by April 15. Tohoku Ricoh in Miyagi was expected to produce parts by?April 11, but this facility’s production of toner is not expected to resume until early May.

    No One Escaped Unscathed

    While the three OEMs discussed above may have been the hardest hit, most hardware producers are coping with some sort of disaster-related problems. Oki Data, for example, said on March 17 that its operations had been “relatively unaffected,” but its plant in Fukushima, which makes hardware and consumables for the Japanese market, had been damaged. Oki suspended operations at the facility after the earthquake, but production partially resumed as of March 16. While it did not specifically mention its printer and copier plants, Kyocera said on April 4 that by the end of March all of its production facilities were back online, suggesting there had been some disruptions.

    Konica Minolta said that one of its sales branches in the region had suffered damage, but other undamaged sales branches were handling the services it provided. In a letter to customers released on March 28, President and CEO Shoei Yamana said that consumables production had not been affected. Although he did not say Konica Minolta was experiencing any problems with hardware production, he indicated that the firm was exploring the possibility of moving more machine manufacturing to China. “There are no adverse effects on our production capabilities in China as of now,” said Mr. Yamana. “We are still checking as to whether we will be able to continue supplying necessary parts and raw materials to our Chinese production facilities.” It is unlikely that much more production can be shifted to China, however, given the difficulties in moving freight noted above. Konica Minolta’s supply of toner has been impacted by electrical outages at its Kofu Factory, but it has since begun to generate its own power. The supply of certain chemicals, however, appears to be threatened.

    Other OEMs report that certain factories located outside of the Tohoku region are operating, albeit sometimes in a diminished capacity because of the limited availability of power or parts—or both. Moving freight to ports and shipping products overseas may also present a problem. Even if there is no further damage to the power grid from aftershocks, load balancing is likely to become an issue as more homes and business are brought back online, and rolling blackouts may return.

    Based on current conditions, an analysis of power supply for the manufacturing industry published by Citigroup Global Markets on April 1 concludes, “There is no prospect for an end to supply shortages.” In the best-case scenario, which assumes TEPCO’s damaged thermal plants can be brought back online along with nuclear plants other than in Fukushima, Citigroup’s analysis suggests the power company will be able to meet only 70 percent of the demand from July through September, not reaching 100 percent until October to December. In its pessimistic scenario, Citigroup assumes that restoration of thermal and nuclear capacity “does not go as well as TEPCO expects,” and warns that under this scenario, “supply shortfalls will still be with us through summer 2012.”

    TEPCO’s Fukushima nuclear power plant before the earthquake. Aside from the immense dangers posed by the damaged plant itself, Japan faces a challenge in managing its power supply as a result of the damage done to this and other facilities.

     

    Chemical Supplies May Be Dwindling

    Some of the chemical manufacturers that produce products for use in digital imaging devices were also dealt a punishing blow. Mitsubishi Chemical’s Kashima plant is a major source of ethylene, a vital raw material for polyester resins, as well as styrene and polypropylene, which are key components in styrene-acrylic toner polymers. On March 16, Mitsubishi Chemical reported that the plant had suffered extensive damage. In addition to the harm done to the facility itself, the company said its piers and roads were also wrecked and “delivery or shipments of cargo would be next to impossible.” An April 8 update from Mitsubishi Chemical says that the company has restored its on-site power generation at the Kashima plant and that it expects to resume production of ethylene, polypropylene, and polyethylene at its number-two facility around May 20. Production of these and other chemicals at its number-one facility at the Kashima plant is not scheduled to resume until June 27.

    Styrene, ethylene and propylene are commodity chemicals and can be sourced from other facilities, but Mitsubishi Chemical’s Kashima plant is of critical importance to the digital imaging industry. It is located close to the OEMs’ plants in the Tohoku region and produces many raw materials for toner.

    Other ethylene and propylene plants in Japan have been affected by the disaster, but not as deeply. At a minimum, capacity will tighten and prices are likely to rise. Sanyo Chemical, for example, produces resins for mechanically ground toners and water-soluble resins at Kashima. The firm has resumed limited operation at the plant, but there have been setbacks. Sanyo Chemical reported that aftershocks on April 11 and 12 disrupted its production lines because of a short-circuited transformer. On April 19, the company said the bad transformer had been replaced and limited production had resumed.

    Kao Corporation is another key Japanese imaging chemical producer with assets in Kashima. A research report published by Citigroup Global Markets Japan on April 8 says that Kao supplies Canon, Fuji Xerox, Konica Minolta, and Ricoh with resins and other chemicals manufactured in its now-damaged plant. According to Citigroup, “Kao has yet to resume operations at its Kashima plant although it announced plans to restart in mid-April.” The report said that OEMs are successfully shifting toner production to suppliers outside of Japan including Kao, which has assets around the world. Citigroup warned, however, that there may be problems with the availability of finished chemical toner and resins if Kao is unable to restart production at the Kashima facility.

    We should point out that Mitsui Chemical, a leading Japanese toner component supplier, appears to have dodged a bullet—at least in terms of its imaging chemicals business. In an earlier briefing, we speculated that Mitsui’s resin production could have been affected because it has operations at Kashima. We have since learned, however, that Mitsui does not produce toner components in Kashima. Resins are produced at other facilities in Japan such as Mitsui’s Mobara plant, which was shut down following the earthquake but is now back in operation.

    The Aftermath

    We have already begun to hear of supplies shortages for Canon machines, and similar news regarding supplies from other OEMs is all but assured. The imaging products wholesaler Image Star told customers on April 7 that the earthquake had resulted in a growing scarcity of Canon cartridges. The firm said, “This situation will only continue to worsen over the next few months as the damage is assessed and repaired.” Because allocations increased Image Star’s cost, the wholesaler said it has raises prices on all Canon items. Days later, HP told its toner cartridge customers that dozens of LaserJet cartridges, which are produced by Canon, were being place on “managed allocation” (see “HP Warns Distributors That Japanese Earthquake Will Impact Toner Cartridge Availability”).

    Financial analysts appear to be divided on their assessments of Canon. On April 5, Bloomberg reported that a Barclays analyst issued a report saying Canon’s earnings will be 27 percent lower than original estimates for the year. “Extensive damage at Canon’s plant in Utsunomiya, Tochigi prefecture, and difficulty in getting parts and materials will likely pressure production of cameras, lenses, copiers and chip-making equipment, according to Barclays,” the Bloomberg report said. Citigroup, however, recommended buying Canon if shares are “sold off on concerns over near-term earnings.”

    There are ample indications that other toner cartridge shortages will arise as we move into May. Tohoku Ricoh has been offline since the earthquake and is not expected to resume operations until May. Even after the unit is up and running, we suspect the firm will have difficulties sourcing raw materials such as resin given that key producers like Sanyo and Kao are capable of limited production at best. Shortages of Konica Minolta’s Simitri chemical toners are also likely because of damage sustained by Japanese chemical manufacturers like Kao.

    Citigroup says that Fuji Xerox may be able to avoid toner production problems because it has enough resins on hand to last a couple of months. The situation at Fuji Xerox could deteriorate, however, if supplier production does not resume. Xerox appears to be bracing for shortages and higher costs for products from Japan (see “Xerox Reports Strong Q1, Reassures Investors about Impact of Earthquake in Japan”). In a prepared statement regarding the firm’s first-quarter earnings, Chairman and CEO Ursula Burns said, “Due to increasing costs and uncertainties in supply chain issues along with the pressure on Fuji Xerox’s business in Japan, we’re taking the prudent approach to provide a broader range than usual for our second-quarter earnings expectations.” Ms. Burns added, however, that the company is committed to “delivering on our full-year guidance.”

    Hardware production could also be curtailed over the next few months. Citigroup estimated in a recent report that there are over 2,000 different components used to manufacture a copier, and there is a risk that materials used to make these components may become hard to find. If chemicals to make coatings for OPC drums, for example, become scarce, these chemicals could prove harder to find than resins. Moreover, we expect the availability of solid-state components may be limited because many plants that produce silicon wafers were located in the northeast region of Japan and have suffered damage. Other facilities outside of the region have struggled with losses of power. The same may prove true with the production of passive components like capacitors.

    In a research note published on April 6, analysts at Cross Research indicated that no serious shortages will hit the channel until May or June. At that time, the firm says Japanese firms may leverage air freight “either to speed delivery from Japanese plants or for shifting existing inventory around to alleviate shortages to manage inventory.” Shipping by air now seems to be a viable alternative to overseas shipments. After encountering initial quake-related difficulties, airfreight firms like UPS and DHL are now servicing all of Japan including the battered region. Cross Research asserts that if a shift to airfreight is required, it will have some impact on gross margin.

    We expect that the industry will be feeling the effects of the earthquake and tsunami for the rest of the year. Moreover, because the disaster has thrown into stark relief the problems that can result from an attenuated supply chain when disaster strikes, we think that recent events in Japan will prove to be a game-changer in the way firms manage inventory.

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