Facing an Auto Slump, Japan Lifts Capacity

In the midst of a dramatic earnings slump, Toyota (TM), Nissan (NSANY), and Honda (HMC) are ramping up production fast. Not in the U.S., their most profitable market, but back in Japan, where domestic auto sales just hit a 25-year low.

Every major Japanese automaker is building plants at home or adding capacity to existing ones. A Toyota subsidiary is constructing a 120,000-car plant in Miyagi, north of Tokyo. It's Toyota's first such plant in Japan since 1993. Nissan, which not so long ago was slashing production in the country, is expanding capacity by 22% at its Kyushu factory. Honda is spending $1.5 billion on a new factory and engine plant in Saitama, just outside Tokyo. "The time has come for our Japan operations to once again take the initiative," Honda President Takeo Fukui told reporters on May 21.

Why all the outlays? After all, Japan's carmakers have long had a policy of opening plants in overseas markets to avoid import duties and to hedge against currency gyrations. Japan remains an expensive place to make cars, with wages 10 times higher than in China. A shrinking population is causing labor shortages. The yen's recent 15% surge against the dollar makes Japan-made cars even pricier. Throw in contracting domestic sales, and the moves seem to defy business logic.

STILL A GOOD DEAL

One explanation is the flexibility that the investment brings. Japan's high-tech plants excel at switching production from one model to another. That's especially useful when auto demand is sinking or flat in mature markets but surging in the Middle East, Russia, China, and India. Nissan's Kyushu plant, for example, exports to 160 markets and produces eight different models on a single production line.

Anxiety over quality is another factor in the increase of production back home. In recent years, Toyota has had to issue numerous recalls, while Nissan's Canton (Miss.) plant became notorious for its defects during a production speedup. Executives are loath to admit that one plant is better than another, but Japanese makers' domestic factories score higher on quality than equivalent plants overseas.

Japanese engineers and workers, while more expensive than their counterparts in developing markets, are still a good deal. One reason is that Japan's wage levels, after barely rising in a decade, are not as high as they once were relative to other developed countries. According to consultant AlixPartners, Japanese industrial workers in 2006 made around $22 an hour, just two-thirds the level in Germany. Moreover, it's still rare in Japan for workers to switch from one automaker to another, so a well-trained, seasoned workforce is a given. "It's not so expensive in Japan, and when you consider the quality, motivation, and diligence with which people work, the value-for-money is unbeatable," says Markus Schdlich, president of Karmann Japan. In December, Karmann, a German company that makes convertibles under contract for Audi, Mercedes (DAI), and Nissan, will begin production at a factory in Japan.

The notion of mother plants, which test new technologies that later filter out to plants worldwide, remains strong. Fukui predicts Honda's Saitama plant will set an example for its plants globally. Labor productivity is expected to be 20% higher than in existing plants, thanks to greater automation and advances in welding and painting. Honda aims to cut the amount of energy used to produce each car by more than 30%. Honda and its Japanese rivals are not abandoning their plan to make cars around the world. But they are strengthening Japan's role as the essential benchmark.

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Exxon Mobil: A Great Big Buy

John D. Rockefeller, and the heirs to his Standard Oil fortune, would probably all agree on one maxim: Nothing succeeds like success. And so, no doubt, does the management at the company that is the direct descendent of the oil colossus: Exxon Mobil (XOM).

Success, in fact, is what greases the wheels of Exxon Mobil, the world's largest publicly owned integrated oil company. It has been piling up billions upon billions of dollars each year in eye-popping profits. Even some current-day members of the Rockefeller family couldn't budge the company (BusinessWeek.com, 5/28/08) off its chosen path when they tried to push the oil giant's focus toward alternative and renewable energy and split the role of chairman and chief executive officer. Rex Tillerson, current holder of both those titles, would have had to give up the chairmanship of the company's board.

Not So Ho-Hum

To be sure, Exxon Mobil's shareholders should be a happy bunch. The company racked up a record $40.6 billion in profits in 2007 on sales of $358.6 billion, on top of $39.5 billion in 2006 on sales of $335.1 billion, and $36.1 billion in 2005 on sales of $328.2 billion. Since Tillerson's elevation to chairman and CEO in January, 2006, the stock climbed from 55 a share to 96 on May 21, 2008, before easing to 85 on June 3. So it wasn't much of a surprise when shareholders backed management's strong stand against the Rockefeller proposals.

But the real story here is why Exxon Mobil, which is a mainstay in almost every institutional investor's portfolio, remains an attractive stock—and a must-own for long-term investors. True, a big oil tanker is hard to turn quickly when the waters get rough, and with Exxon Mobil's broad base of shareholder ownership —with a huge market cap of $467 billion—you can't expect to see the company's stock make sharp, spectacular upward moves. But it's the company's sheer size, and predictable profitability, that make it an attractive choice in a dicey market.

Even so, or maybe even because of those reasons, some analysts regard Exxon Mobil as a ho-hum stock. Of the 19 major Street analysts who follow it, 10 rate it a hold against nine who recommend it as a buy. But what's noteworthy is none rate it a sell.

So why buy the stock if you don't already own it, or why buy more when you already have shares? One basic reason: The giant oil company is still very much undervalued.

Oil Price Effect

Richard Helm, a senior vice-president and portfolio manager at Cohen & Steers Capital Management (CNS), says that for such a huge company with oodles of cash on its balance sheet (some $34 billion), Exxon Mobil is one of the cheapest energy plays. For one, the stock now trades at just 10 times 2008 estimated earnings of $9 a share. That is about in line with, or less than, its smaller peers. Helms figures that this year the stock could hit 102 a share. Exxon Mobil is one of the top 10 holdings in Cohen & Steers' portfolio.

There are many other reasons, he says, why he considers Exxon Mobil an attractive value. Per-share earnings, for one, have been on a fast track, rising from $1.69 in 2002 to $7.28 by 2007. And its stock has raced up from 30 a share in 2002 to 85 as of June 3, 2008. The company's return on equity has vaulted to 34.5% last year, from 26% in 2006. And dividend growth, a number that Helms pays attention to, is at a yearly clip of 9.1%, with the shares yielding 1.7%. Its fat cash hoard enabled Exxon Mobil to buy back about $8 billion of its stock in the first quarter of 2008.

True, much of its huge profits are currently driven by skyrocketing crude oil prices. But even if oil prices moderate, Exxon Mobil's awesome earnings aren't likely to crash, Helm argues.

Here are some numbers he believes are important to consider: In 2007, 83% of the company's total revenues came from its downstream, or refining, operations, which accounted for just 23.6% of net income. On the other hand, oil and gas production, or upstream, activities accounted for only 7.3% of revenues but generated a whopping 65% of profits, mainly due to the jump in oil prices. He argues, however, that even when the price of oil moderates, Exxon Mobil's refining operations could well produce increased earnings. As of 2007, it owned interests in 38 refineries worldwide.

Outperforms the S&P

As one of the world's largest oil and gas producers, Exxon Mobil owns the largest portfolio of proved reserves and production in North America, and is the largest producer of oil and gas in Europe.

One important issue for oil producers is the life of its reserves and how fast they can be replaced. Helms notes that compared with its peers, Exxon Mobil's reserves have a longer life, which he estimates at about 14 years, one of the highest in the industry. The company increased its capital expenditures to $25 billion in 2008, from $20 billion in 2007.

Exxon Mobil replaced its 2007 production by adding reserves from Europe, the Middle East, North America, and West Africa, according to Robert Mitkowski of Value Line (VALU). He considers Exxon Mobil's shares timely for purchase by conservative investors, because of the company's strong finances. Its commitment to increased research and development, he adds, means the company will probably participate, if not lead, in any major industry shifts, such as advanced fuel technology. "The company's position as a mainstay in the energy field appears assured for years to come," says Mitkowski.

With its size and dominance in the energy industry, not many investors realize that Exxon Mobil's stock has outperformed the Standard & Poor's 500-stock index in the past 19 years. That's an impressive score, and it's likely the oil behemoth could continue to outpace the stock market in the years ahead.

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Why Yahoo’s Yang Is Holding Out

Why Yahoo's Yang Is Holding Out

For more than a month, Yahoo (YHOO) co-founder and Chief Executive Jerry Yang has endured a withering attack by shareholders who say he let a $47.5 billion acquisition bid by Microsoft slip through his fingers. The apparent obstinacy, which Microsoft (MSFT) says fueled its decision to walk away on May 3, was laid bare in a shareholder lawsuit. The documents, unsealed June 2, allege Yang and Yahoo's board created deal-killing measures, including an expensive employee severance package.

On June 3, corporate raider Carl Icahn joined the pile-on. Icahn, who's trying to win seats on Yahoo's board in hopes of reigniting a Microsoft-Yahoo merger, echoed the lawsuit's charges that "Yang's deep hostility toward Microsoft" and his "defensive and self-interested conduct" scuttled the deal. Icahn also told The Wall Street Journal that if his proxy campaign is successful, he'll try to oust Yang, whose company's stock has plummeted from 33.63 a share on Oct. 26 to 26.15 on June 3, a drop of more than 22%.

Protective Stance

The big question in the minds of shareholders—from institutions such as Capital Research Global Investors and Legg Mason Capital Management to Icahn and the many hedge fund investors hoping to make a quick buck on a Microsoft deal—comes down to this: Why has Yang remained so recalcitrant in holding out for a better deal?

It turns out Yang has a number of reasonable justifications for resisting Microsoft's unwanted advances. And according to analysts, sources close to Yahoo, and people who know Yang, the reasons behind his surprisingly spirited negotiating stance go well beyond those often cited in news reports and lawsuits, such as Yang's emotional attachment to his company, his deep-seated hatred of Microsoft, or a desperate desire to cultivate a legacy as an Internet visionary.

The overriding reason for the board's four-month-long-and-counting holdout against Microsoft's offers is simple, according to people familiar with Yahoo's thinking, who insist neither Yang nor the board is inalterably opposed to a deal: The company wants more money. But what that means is more complicated than merely asking Microsoft to bump up its offer by a couple dollars a share.

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Fly the Shrinking Skies

To fully appreciate the impact soaring oil prices have had on the beleaguered airline industry, consider that U.S. carriers will likely spend $60 billion on jet fuel this year—four times what they paid in 2000. Because of the fuel spike, airlines now lose an average of $60 per roundtrip passenger, a slow bleed that puts the industry on pace to hemorrhage a record $7.2 billion in 2008. "No airline that is unhedged [on fuel] is prepared for the current operating environment," says Gary Kelly, CEO of Southwest Airlines, which is profitable thanks to long-term fuel contracts.

Sure, this isn't the first time U.S. carriers have hit a rough patch. But unlike the crisis that followed the 2001 terrorist attacks, which pushed four of the six largest airlines into bankruptcy, this crunch has the potential to reshape the industry profoundly in coming years. Airline experts envision a future with far fewer carriers. And those that survive will have to rethink every facet of their business, from how they price tickets to where they fly. "I think the industry is going to look more like Europe: a couple of far-flung carriers and then a bunch of little guys," says Roger E. King, airline analyst for Credit-Sights, a New York research firm.

If oil prices remain lodged in the triple digits—well above the $80-$90 breakeven level for most airlines—that will speed the shakeout already under way. While many carriers have in the past exploited bankruptcy to cut costs, experts say any airline that falls into Chapter 11 this time will find investors unwilling to finance a turnaround. Then the only route is liquidation, a fate that has befallen three smaller carriers this year. "I think there's a real risk here that some airlines just go away," says a senior executive of one top-tier U.S. carrier.

Once the wrenching wave of failures and consolidation subsides, analysts envision an industry with two majors—most likely the combined Delta (DAL)-Northwest (NWA) and perhaps a merged American-Continental (CAL)—along with a few discount players like Southwest.

The oil shock could also prompt Washington to drop its long-standing resistance to foreign ownership of U.S. airlines. Such a change would usher in a new generation of truly global carriers. British Airways (BAB), for instance, has long had designs on American, while Luft-hansa Airlines (DLAKY) could seek a tie-up with JetBlue Airways (JBLU), in which it already owns a 19% stake. "The U.S. airlines badly need more capital to survive, and the only players with the resources to buy in are the [cash-rich] European carriers," says Robert W. Mann Jr., an industry consultant in Port Washington, N.Y.

Consolidation will come at a cost, though. Experts believe that for the U.S. industry to shrink to a size that would allow carriers to earn a profit, there will have to be capacity cuts on the order of 20% to 25%. The biggest losers would be smaller cities, like Cedar Rapids, Iowa, and Baton Rouge, La., that became accustomed to dozens of daily flights. But $130/bbl. oil has made the smaller jets carriers typically deploy on these routes uneconomical; airlines are likely to fly one larger plane each day. They may also cut back nonstop transcontinental flights, since these are more costly to operate.

The era of cheap flights, which has seen fares fall more than 50% in real terms since deregulation in 1978, will end, too. Airlines will have to find ways to wring more money out of each passenger. That could include premiums for choice window, aisle, and exit-row seats, or introducing new classes of service, each with its own menu of benefits.

Still, that would amount to chump change compared with what airlines could save if they could lower the costs of operating their fleets of fuel-guzzling jets. Boeing (BA) has seen torrid demand for its new, carbon-fiber 787 Dreamliner, which claims fuel savings of 20%-22%. But that jet is built for long-haul routes, and no similarly revolutionary designs are expected for the domestic market for at least 15 years.

Meanwhile, carriers are exploring other ways to reduce their reliance on jet fuel, a kerosene-like oil that currently costs $4.09/gal., up 98% in the past year. Developing an alternative hasn't been easy. One obstacle: Most biofuels freeze at high altitudes. Yet in a breakthrough, Virgin Atlantic Airways in February conducted a test flight of a Boeing 747 running on a blend of oils from coconut and Brazilian babassu trees. "Things have evolved very rapidly. Our guess is that in five years, we could have commercial biojet fuels on the market," says Billy Glover, Boeing's managing director for environmental strategy. Projected cost: about $2/gal. These days, that would be enough to make many an airline executive go out hunting for coconuts.

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Speculation_but Not Manipulation

How to Get Rich_and Notorious

The late afternoon sun hits the lake outside Felix Dennis' Connecticut cottage in a particularly picturesque way, but the 60-year-old serial media entrepreneur and founder of Maxim is oblivious to it. He's swaying back and forth in his living room, eyes closed, fingering an air guitar to a CD that's replaying one of his performances at the Mustique Blues Festival. Loudly.

I'm collapsed in a chair by the fireplace. I think I'm supposed to join in, but I don't. I can't. We've had three and a half bottles of wine since I arrived here for a simple Sunday lunch. Then Dennis moved on to postprandial Scotch. I didn't. I couldn't. Standing upright could get complicated. Judging from the tapes, at this point, simple speech is pretty complicated.

I'd come to interview Dennis—an eccentric tycoon even by the standards of "eccentric tycoons"—about his career in media and the upcoming publication of How to Get Rich, a rather engaging and blunt self-help book. As defined in his text, "rich" starts at a total asset value of $30 million. Dennis puts his own wealth between $400million and $900 million; the London Times pegs it around $1.5 billion. His estimate would be higher were it not for his prodigious spending. In the book, he invents the statistic, Lifetime Spending Total, or, naturally, LST. His own, he says, is "eye-watering"—in the hundreds of millions of dollars.

Some background on the squat, bearded Dennis: He was briefly jailed in his native England in 1971 after losing an obscenity trial concerning his counterculture magazine, Oz. He grew up in a house, he writes, in which straitened circumstance sometimes required using torn newspapers as toilet paper. In his fifties, he became a published poet. He openly admits to having spent several years overindulging in crack cocaine. He has written what must be the only self-help business book that contains sentences such as: "If it flies, floats, or fornicates, rent it. It's cheaper." (Dennis is unmarried and proudly non-monogamous.)

And, oh yeah, he recently confessed to murder. In his last major interview, which appeared in The Times of London in early April, he shocked the reporter by saying he had once pushed a man off a cliff. When the journalist asked in a follow-up interview if he had done it, Dennis said, "It's a load of hogwash. I was drunk," and he withdrew the confession "unconditionally." Still, his remarks reverberated, and his sub- sequent statements didn't help. In a lecture delivered to students at Columbia University Graduate School of Journalism later that month, which I attended, Dennis said no one had bothered to check the date the Times published its piece—Apr.1, he said, (as in April Fools'). Actually, the story ran on Apr.2, and the interview itself took place in late 2007—a fact that I, and other reporters, noted the next day. In our interview, Dennis now says that the story was published online on Apr.1, although I can't find any evidence that it was. "The story speaks for itself. Mr. Dennis spoke for himself. The reporting provides the full context of his comments," said a Times spokesman.

I am perfectly happy to believe that Dennis concocted his tale for the sake of shock, or outrage, or something. All the same, I made sure that several people knew where I was lunching in Connecticut.

Dennis made his pile in an old-fashioned way, by starting and selling ink-on-paper businesses, generally in corners shunned or overlooked by more established publishing houses. (His first big success piggybacked on the kung fu craze that erupted after the death of movie star Bruce Lee, publishing Kung-Fu Monthly in multiple countries.) He's most famous in the U.S. for the lad magazine Maxim, which he sold last year, along with two other mags, for what was reported to be around $240 million. But more of his money likely has come from computer magazines, which he began publishing in Britain in 1978, and from his share in computer retailer MicroWarehouse.

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Kicking the Tires at Ford Motor

It isn't raining but pouring bad news at Ford Motor (F). The automaker's stock, which sold as high as 67 a share some 10 years ago, tumbled to a new low of 4.95 on Mar. 17, 2008. It has since inched up to 6.75 as of May 30, but that's still an awfully low price. At that price—less than the cost of two gallons of gasoline—Ford stock is a fire-sale bargain.

Don't take it from me. Listen to a person who knows the auto industry well: activist and veteran investor Kirk Kerkorian, who intends to buy more Ford shares to add to his current 4.62% stake in the company—at a higher price. And bear in mind, if the stock continues to wallow at this depressed level, expect at least one more activist investor to jump in, according to some Street sources.

One hedge fund manager, who declined to be named, makes this observation: "Ford is a natural target for the activist fund managers—it has a huge brand name known worldwide, in an industry that has been smacked down but whose prospects would be enormous once the U.S. economy recovers from its current malaise." This pro also points to new products in Ford's pipeline that should lift the company toward a recovery when they hit the market, and to "serious and determined" efforts by management to turn the ailing company around. The manager predicts that one or two other activist players are eyeballing the situation very closely and could pounce on the stock at any time.

Kerkorian to the Rescue

On Apr. 28 the second largest U.S. automaker surprised Wall Street by reporting a profit of $100 million for the first quarter of 2008, its first since the second quarter of 2007. The Street was expecting a loss, and the shock of a U.S. automaker posting a decent profit pushed up the stock to 8.21, from 7.50 the previous trading day. Heavier-than-anticipated cost-cutting, plus strong sales in South America and Europe that helped offset the weak performance in the U.S., enabled Ford to deliver the unexpected profits.

A month later, however, the upbeat mood in Dearborn, Mich., changed. Besieged by a drop in sales of trucks and SUVs caused by high fuel prices and the poor U.S. economy, the company conceded that it wouldn't be able to meet its goal of profitability in 2009 and at best would only manage to break even. It made new production cuts and proceeded to lay off more employees. Analysts quickly downgraded their ratings on the stock and cut their sales and earnings estimates. Predictably, the stock fell, and by May 30, it had dropped to 6.71.

That was when Kerkorian jumped in with an announcement that he would still honor his commitment to increase his stake, as planned, to buy 20 million more Ford shares at $8.50, a price he had agreed to when he had offered to buy more shares on May 8. He waived a condition in his tender offer that would have allowed him not to proceed with the purchase if the stock dropped 10% or more below the May 8 closing price of 8.20. Kerkorian, through his investment firm Tracinda said that he continues to believe in Ford's management and in its ability to turn the company around.

Beautiful Table Setting

Kerkorian has a colorful history of engagement with the auto industry. In the 1990s, he acquired a big stake in Chrysler, whose management he pressured to enhance shareholder value. His unrelenting efforts pushed Chrysler into a merger deal with Daimer-Benz (DAI). In 2005, his efforts to achieve the same goal at General Motors (GM) didn't quite succeed. He sought to effect a change in management and tried to push it toward restructuring the No. 1 automaker. Kerkorian gave up ultimately, but not before he had scored a decent profit on his 10% stake in GM.

And then he turned his attention and interest in Ford.

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A Mideast Valley of Peace

Itzhak Tshuva was born into a poor family of 11 who crammed into a single room after immigrating to Israel from Libya in the 1940s. He went on to build a global real estate empire that includes New York's Plaza Hotel, as well as a recently announced $8 billion luxury hotel, retail, residential, and casino complex on the Las Vegas Strip. Now the 60-year-old billionaire, one of the world's richest men, is spearheading an ambitious plan to bring another desert project to life.

This time Tshuva has set his sights on the Arava, an arid valley along the southern portion of the border between Israel and Jordan. If his vision comes to pass, the private sector will build a $3 billion canal that not only connects the Red Sea to the Dead Sea but also links Israelis, Jordanians, and Palestinians—possibly helping bring about peace through greater economic integration.

This so-called Valley of Peace is part of a 520-kilometer (323-mile) corridor being proposed by Israeli President Shimon Peres for regional economic development. About 420km of the corridor runs along the Jordanian border—with no fences, walls, or minefields—and another 100km touches on the Palestinian territories. Other projects envisioned by Peres involving the German, Japanese, and Turkish governments are meant to create up to a million new jobs in Israel and the West Bank. "People are sick and tired of peace conferences because they don't see the results," says Peres. "Here they can have jobs and make a living."

An Ambitious Vision

The 166km (103-mile) Red-Dead Sea canal is only the beginning. Both sides of the waterway would be developed to include convention and cultural centers, up to 200,000 beds of hotel space, restaurants, parks, artificial lakes and lagoons, waterfalls, and one of the largest botanical gardens in the world. Greenhouses would produce winter fruits and vegetables to be sold in the region and abroad. A high-speed train line and highway would run along the canal, transporting people and goods between the Dead and Red Seas within an hour. The area also could be made into a free-trade zone, attracting investment from around the world.

It's an audacious vision, to be sure, but the question is whether it will ever happen. Engineers have talked about building a canal from the Dead Sea to the Red Sea since as far back as 1858. Some 30 years ago when Menachem Begin was Prime Minister, plans were floated to link the Dead Sea to the Mediterranean, and in the 1990s, after Israel and Jordan signed a peace treaty, a Red-to-Dead Sea canal plan blossomed again. But progress has been excruciatingly slow.

The difference this time is the private sector is getting on board in a big way. Peres has long championed the project as a path to peace through regional economic cooperation. Now people like Tshuva—who owns the El-Ad Group real estate empire and a controlling interest in Delek (DELKG.TA), Israel's second-largest oil and gas company—and Carnival (CCL) cruise line heiress Shari Arison are throwing their support behind it.

Arab Support for the Project

Joining them are Nochi Dankner, chairman and chief executive of IDB Holding, which has interests in telecommunications, real estate, and insurance; Stef Wertheimer, founder of Iscar Metalworking, which sold 80% of its shares to Warren Buffett's Berkshire Hathaway (BRKA) in 2006 for $4 billion; and Israeli businessman Benny Steinmetz, who owns interests in diamonds, high tech, real estate, and African mines.

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