Environmental-related Stocks

Opportunities and risks in the Japanese stockmarket

By David Hodgson

The Kyoto Protocol obliges governments to cut greenhouse gases. With oil over US$70 a barrel, we are likely to see a replay of what happened after the 1970s oil shocks. Market forces are likely to lead to increasing use of more fuel-efficient cars, solar power, liquid natural gas (LNG) and nuclear power to reduce emissions. Japan has world-leading companies in auto fuel-efficiency, solar power, LNG plant engineering and nuclear power. Other environmentalrelated opportunities are lighter weight materials such as carbon and titanium to make aircraft more fuel-efficient, recycling, water desalinisation plants and, with over-fishing and water acidification reducing marine resources, the fisheries sector.

In auto fuel-efficiency, Japanese companies such as Isuzu Motors Ltd and NGK Insulators Ltd have leading technologies in diesel. Diesel engines reduce carbon emissions because they have 30-45% higher mileage than petrol vehicles. In Europe, market penetration of diesel cars has grown to 50%, up from 15% in 1995, but is only 3.5% in the US. According to the consultants Ricardo, diesel cars in the US are likely to grow to 9% by 2012. It is estimated that if the US adopts diesel on the scale Europe has, then it would no longer need to be a net importer of oil. A catalyst for the take-off in diesel in the USA is tougher emissions restrictions from 2009. The European market is set to grow further with tighter ‘Euro V’ emission standards from 2010 and in Japan, the diesel car market is likely to follow. China is starting to tighten emissions regulations as well. Isuzu Motors is well-positioned to benefit from its alliance with Toyota to cooperate in diesel engines. NGK Insulators and Ibiden have leading global market shares in the growing market for diesel particulate filters which reduce soot from diesel emissions. Also in auto fuelefficiency, Hitachi Metals Ltd is a leading supplier of high grade metals that improve efficiency with resistance to high temperatures and sintering—for engine casings, piston rings, diesel turbochargers, wheels, aluminium castings and transmissions. Hitachi Metals recently acquired Neomax which produces neodium iron boron magnets for hybrid petrol-electric motors. Globally, hybrid cars such as the Toyota Prius are forecast to grow from 300,000 units pa to 1.5m by 2010.

Other areas where Japan leads the world are solar power, liquid natural gas and nuclear plant engineering. In the US, Senator Alexander’s wide-ranging Energy Act includes increasing solar power. California Governor Schwarzenegger has introduced legislation requiring that all new homes are solar powered with a target of 1 million homes by 2012. In Japan, the government has a long term plan for solar to become 50% of residential power. In Europe, Spain has made it mandatory that new homes have solar panels. Mizuho Securities forecast that the world solar power market will grow to 5.000 MW by 2010. This seems a conservative forecast because it is only equivalent to about 4 nuclear power stations. Tokuyama Corporation is one of the world’s largest quoted producers of polycrystalline silicon, the raw material for solar panels. Tokuyama, whose share price has already risen strongly, supplies all the major panel makers, including Sharp Corporation. Sharp is a diversified electronics company, so does not give pure exposure to the solar theme but, in the medium term, solar panels are likely to be an increasing proportion of its profits.

Natural gas used to be flared off. However, the economics of LNG have been transformed by the rise in crude oil prices to over $70 a barrel, leading to growth in international ship-bourne trade. Also, growth is being driven by environmental factors. LNG is a relatively ‘clean’ energy, more thermallyefficient than oil. A large number of LNG infrastructure projects are being built or planned, particularly in Qatar, Sakhalin, Australia, Indonesia and West Africa. Chiyoda Corp and JGC Corp have leading market shares in LNG plant engineering and have strong order backlogs. Another Japanese company, Hisaka Works Ltd is a world leading manufacturer of large plates for heat exchangers used in LNG plant.

Nuclear power plants have virtually zero CO₂ emissions. After the Chernobyl and Three Mile Island accidents, nuclear power construction went into decline. But with the surge in oil prices and concerns about global warming, the industry is starting to grow again. Toshiba Corporation, following its acquisition of Westinghouse, and Mitsubishi Heavy Industries are well-placed to benefit. President Bush has expedited the licensing of new reactors and there are now around 30 applications. Finland is constructing the first nuclear power plant in Europe since 1986. The UK government faces a decision to replace its ageing plants which provide 20% of the UK’s power. There are 5 new projects in Russia and 1 in France. Globally, there are 440 nuclear power plants and around 24 under construction. By 2020, demand may grow by 130 reactors. Asian countries are leading the growth with 4 projects under construction or planned in Korea, 8 in China, 1 in Vietnam, 3 in Indonesia and 9 in Japan. Other related companies are Hitachi Zosen Corp, which supplies vessels for fuel and spent fuel, and Toshiba Machine Co Ltd which has a 50% global market share in some machine tools used for some nuclear power equipment such as casings and turbine blades.

With an increasing number of companies establishing Corporate Social Responsibility departments, one of the first things they do is increase recycling.

Aircraft using lighter materials such as titanium and carbon fibre are more fuelefficient and enable airlines to reduce their carbon foot print. According to Mitsubishi UFJ Securities, a Boeing 737 uses 18 tons of titanium, a 747 43 tons and a 787 91 tons. An Airbus A-300 uses 17 tons while an A-380 uses 77 tons, so Toho Titanium Co Ltd seems well-positioned.

ISO 14001 requires companies to lower the environmental impact of its activities. The number of certified companies doubled from 2002 to 2004. With an increasing number of companies establishing Corporate Social Responsibility departments, one of the first things they do is increase recycling. The economics of recycling metals such as gold, silver, platinum and palladium, have been transformed by high metals prices. Companies such as Matsuda Sangyo Co Ltd, Dowa Holdings and Rasa Industries Ltd are seeing robust growth in their metals and electronic materials collection and recycling business. The business model is similar to traditional mining extraction but without the mines.

Carbon taxes: a risk for industries

Water, as a scarce resource, is becoming an important environmental issue. Water desalinisation plants are a growing business. The main market has been the Middle East and the China market seems likely to take off next. Japanese companies involved in supplying equipment for water desalinisation plants include Hitachi Zosen and Hisaka Works.

The market for disposal of toxic PCBs (polychlorinated biphnyls) is set to grow. Credit Suisse estimate the market will be ¥680 billion in 10 years. PCBs found widespread use because of their resistance to melting and fire retardant properties but they are toxic. In 2001, a PCB Disposal Law led to the establishment in 2004 of the Japan Environmental Safety Corp (JESCO) to take responsibility for disposal of PCBs. This will include 3.8 million pole-mounted transformers containing an estimated 292,000 litres of fluid and 340,000 general electric transformers with 20,000 tonnes of PCB. Nippon Soda Co Ltd has developed a sodium dispersion method using a dechlorination reaction to break the PCBs into biphenyls and salt. It is selling the process and associated chemicals to JESCO and electric power companies.

Another environmental issue is marine resources. Growing demand and tighter supply, reflecting over-fishing, declining fish stocks and quotas, is leading to a long term rise in prices, for example European cod, where over-fishing led to quotas and a rise in imports of white fish from 3 million tonnes pa in 1980 to 11 million in 2003. According to the United Nations, the world’s wild catch is expected to remain flat at 92-93 million tonnes pa in the long term. Nippon Suisan Kaisha Ltd, Japan’s leading fisheries company, is wellplaced with a global integrated network from upstream fishing rights to downstream processing and investments in fish farming, including salmon farming in South America, prawn farming in Indonesia, tuna farming in Japan and eel rearing in China.

Thus, environmental-related stocks present a spectrum of opportunities. However, there are also risks. If governments get serious about CO₂ emissions, they might introduce carbon taxes. Sectors with big carbon footprints include utilities, petrochemicals, airlines and cement (although the system would presumably involve credits for initiatives such as a cement factory in Saitama which recycles a quarter of Saitama’s incinerated municipal garbage ash as part of its manufacturing process). Nevertheless, carbon exposure is like an off-balance sheet liability that investors are starting to think about and require more disclosure by companies. Merrill Lynch estimate that at the current carbon price of €19 per ton, amounts could well account for up to 50% of earnings before interest and tax in the sectors mentioned above. Low carbon footprint stocks may command a premium if governments move to introduce carbon taxes.JI

The views expressed in this article are the personal views of the author. Shares can fall as well as increase in value and those investing do so at their own risk.

J@pan Inc Magazine, Nov/Dec 2007