Komatsu Ltd (ADR) (KMTUY), Hitachi, Ltd. (ADR) (HTHIY): What China Means for Japan’s Industrial Giants

Japan’s NIKKEI 225 (INDEXNIKKEI:NI225) has had no equal this year, rising to star-studded gains of more than 25% year to date. The index had a tough time getting anything going this week, hanging flat over the past five days despite a great Friday that saw the Nikkei jump more than 2%.

You can thank an unlikely source for that end-of-week gain: China. China’s economic slowdown has hit many stocks hard, but Japan’s avoided much of the damage, as it’s risen behind the falling yen and Prime Minister Shinzo Abe’s stimulus. However, many of Japan’s top companies are still looking to China for growth and wealth. If China’s slumping economy can find its feet — and these two Asian powers can ward off rising political tensions — both economies (and investors) will be better off.

A hard ride for Japan’s industrial giants
China’s preliminary purchasing managers index reading from HSBC and Markit showed a strong uptick into expansion territory for August. That might not mean a ton for Japan’s overall economy, but for select manufacturers relying on China for growth, it’s a huge boost.

Take Japan’s Komatsu Ltd (ADR) (OTCBB:KMTUY), one of the world’s largest construction equipment manufacturers. The weak yen has helped many international companies welcome stronger bottom lines from overseas sales, but even for Komatsu — a company that has indeed been helped by the yen’s plunge against the dollar — the mining industry’s doldrums and China’s slide have hit sales far more than the company’s earnings have been helped by the yen. Considering China makes up 8% of Komatsu’s sales, the company has a lot to lose if the world’s second-largest economy remains mired in its slump.

It hasn’t just been Komatsu Ltd (ADR) (OTCMKTS:KMTUY). Manufacturers across Japan have suffered through China’s slowdown. Hitachi, Ltd. (ADR) (OTCMKTS:HTHIY), one of Komatsu’s toughest rivals and Japan’s second-largest heavy equipment manufacturer, saw its operating profit fall by around 28% for the first quarter, with the yen’s decline not enough to outpace weak sales. Hitachi believes a Chinese rebound is on the way soon, and both Komatsu and Hitachi, along with others in the manufacturing space, have maintained rosy full-year profit outlooks.

Hitachi, Ltd. (ADR) (OTCMKTS:HTHIY)’s lofty projections of a rebound won’t matter if Japan and China can’t settle their differences, however. China’s Commerce Ministry reported that trade between the two Asian powers declined nearly 9% through the year’s first seven months. Some of China’s reduced imports from Japan have come as a result of economic slowdowns elsewhere in the world — particularly Europe — but the countries’ war of words over the contested Senkaku Islands has been raging long enough that it’s affecting businesses and investors alike.