I’ve just updated Current Market Tactics–what DD’s earnings miss signifies

I’ve just updated Current Market Tactics  to address the question of what the market selloff induced by weak earnings from majore chemicals firms means.

post-earthquake supply disruptions from Japan

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It has only been a little more than a week since the devastating earthquake/tsunamis in Japan.  However, a lot more information about possible supply disruptions is available now.  As an investor, the main conclusions I see, based on what we know to date, are:

1.  Many of the disaster-affected plants that are sole sources for key components supply the auto industry.  A number of auto manufacturers have already announced that they may soon have to shut down either individual production lines or entire factories for lack of parts.  Although I’ve owned auto stocks from time to time, this is not an industry I’m particularly interested in or familiar with.  But one of the main reasons I’m not a fan is that the industry is characterized by chronic (and huge) overcapacity.  So far it doesn’t appear that there’s any one component in potential shortage that’s used in virtually every car in the world.  So the effect of plant closings will be market share shifts, not a shortage of cars or trucks.

2.  It’s possible that electric power will have to be rationed, at least in the Sendai area, for many months.  The Japanese government tendency is always to prefer industry over the consumer.  Public outrage over currency speculators who bid up the yen in the aftermath of the earthquake–they’re being described as criminals who exploit human tragedy, the moral equivalent of gangs that loot stores during a fire in the city–suggests there won’t be any popular opposition to this.  The practical questions for factories where the problem is power (not that the earthquake destroyed the machinery) will be how quickly power lines can be repaired and what the limitations of the Japanese power grid are in delivering electricity from other areas of the country. (I’m assuming that, as the latest reports are suggesting, the Fukushima reactor crisis is finally coming under control.)

3.  With one notable exception, the Japanese technology-related firms that have announced earthquake-related shutdowns make commodity products, like DRAM or NAND flash, where alternate sources of supply are available.  Prices may go up a bit but devices will still get made.

The one exception: bismaleimide-triazine  resin (BT), a compound used to glue semiconductor chips to printed circuit boards.  BT is used in all smartphones and tablets.  90% comes from Japan.  The largest producer, Mitsubishi Gas Chemical, which accounts for about half of what the tech industry uses, has shut down production due to earthquake damage.

The other major Japanese source of BT is Hitachi Chemical.  It’s plants are still operating.  But, according to the Financial Times, the BT made by different chemical companies isn’t simply interchangeable.  Output differs enough that at the very least a period of testing is required before you can use BT from another supplier. The Wall Street Journal says this process could take a month for most kinds of circuit boards.  For cellphones, though, because of their small size and the specific amount of heat a given chip may throw off, the entire design may need to be changed in order to accommodate a different flavor of BT.

But the main issue is there’s no way for the rest of the industry to double production overnight–which is what would be needed to keep cellphone production rolling along at the current clip.

Mitsubishi Gas Chemical will likely make an announcement about the extent of damage to its Fukushima BT plant in the next few days.  All we really know now is that production has been halted.

In the meantime, MGC customers are doubtless talking to Taiwanese and Korean suppliers of chemicals that they wouldn’t have given the time of day to a month ago.   And they may be seeing what they can do to get increased allocations from Hitachi Chemical (good luck with that).

The BT story bears close watching.  If MGC production isn’t restored soon, disruptions to the supply chains of phone makers whose products use the MGC output could be severe.  Pain will be felt not only by the phone manufacturers but by all their component suppliers, as well.

BASF: a chemical company’s view of 2010

Chemicals–not a fan

I’m not a big fan of chemical companies’ stocks.  This is partly because it’s a value investor’s industry, partly that I don’t know chemicals well enough.

My perception, though, is that it’s a hard industry to survive in, one dogged by chronic overcapacity.  Every ten years or so, chastened managements halt new capital investments for long enough to allow world demand to grow into existing capacity.  A boom follows for maybe two years.  But then somebody somewhere–be it China or the Middle East or someplace else, or a developed world player with unfamiliarly large cash balances burning a hole in his pocket–commissions enough new plant and equipment to create another decade’s overcapacity.  And the bust part of the cycle begins anew.

But I am interested in what BASF is saying

I like BASF.  True, I’m not sure I’d want to own the stock, even with the current dividend yield of close to 4%.  But the company has very savvy management.  It’s just in a tough industry to make money in.

I listened to the BASF yearend conference call over the weekend.  My purpose–to get the company’s view of what operating conditions would be like in 2010.  This is what I found out: Continue reading