Hitachi May Be Too Hot to Hold

| About: Hitachi Ltd. (HTHIY)
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By Jack Barnes

Hitachi Ltd. (HIT) is a prime example of a company heading in the wrong direction. The company made the No. 4 reactor at Japan's troubled Fukushima Daiichi power plant, and over the next six to 12 months, it's going to be thoroughly distracted by the emergency work necessary to decommission the plant. Other planned projects already have been delayed or cancelled altogether. Since real financial risks to the company outweigh any potential gains, Hitachi Ltd. is a "Sell."

Here's a quick overview of just some of the things that will hurt Hitachi's performance in the near term:

  • Seven domestic manufacturing plants were damaged by the March 11 earthquake and tsunami.
  • Five other plants have been shut down due to electricity supply issues.
  • Rolling blackouts could last for years in core production areas of Japan.
  • Resumed production is drawing down inventories of spare parts.
  • Hitachi's balance sheet is already fully leveraged.
  • The company's cash will go to rebuilding instead of being used for acquisitions or being paid back to investors.

Taking a Hit

To begin with, the earthquake and tsunami directly affected Hitachi's operations by damaging seven local production plants. Another five plants were shut down due to rolling blackouts. Making matters worse, Japan will be experiencing rolling blackouts in parts of the nation for the next few years. If the country were to build new natural gas power plants from scratch, it would take two to three years to replace the lost capacity at Fukushima alone.

So Hitachi will need to redesign its factories to run on company-produced electricity if it hopes to get its fleet of factories back online.

In addition to directly affecting Hitachi's operations, Japan's mega-disaster has put the company's future growth plans on hold. In 2007, Hitachi formed a joint venture with General Electric Co. (NYSE:GE) to produce a new generation of nuclear reactors. The partnership had planned to procure 38 new reactor projects around the world over the next two decades. But that is all on hold now as the world reevaluates the risk posed by nuclear power plants.

"We have to review (the projects)," Hitachi President Hiroaki Nakanishi told Asahi Shimbun in an interview. "We need to equip the reactors with features that will never fail to activate minimum emergency procedures despite a tsunami comparable to or more powerful than the latest one."

All of this has taken a toll on Hitachi's balance sheet, as the company has had negative leveraged cash flow over the last 12 months. The balance sheet is already fully leveraged, with Hitachi holding more than $33 billion in gross debt.

This is something we should pay attention to. Hitachi will struggle to generate earnings in the near to medium term as it grapples with handling its cash flow needs while rebuilding its damage infrastructure.

Hitachi's fiscal year ended March 31, but the company has not yet announced a date for its earnings report. Most analysts believe the report will show the "considerable" impact last month's disaster has had on Hitachi's business, but will lack any guidance because the full extent of the cleanup and repair are hard to know.

That could mean big trouble. "In Japan, investors trust companies more than analysts' reports; that's why it's such an extremely important thing," Masayoshi Okamoto, head of dealing at Jujiya Securities, told Reuters. "If the companies aren't able to show their earnings, the basis for investment in their stocks completely disappears."

Hitachi shares have traded between a low of $35.53 on July 1, 2010, and a high of $65.29 on March 7, just before the quake. The stock is currently trading in the $48 dollar range, so it's possible we'll see it test that low.

Even more troublesome is that the entire Japanese stock market could be in for a decline. "The Nikkei is heading for a second dip after the quake, and will likely hit a double bottom between April and June as operating losses for that period, particularly among automakers and electronics firms, are going to be severe," said Masayuki Kubota, a senior fund manager at Daiwa SB Investments Ltd.

So let's step out of the way of the upcoming double dip in expected Japanese gross domestic product results of this spring and summer.

Disclosure: None

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