Corporate Japan's profits are sinking fast, hit by a slump in demand and a strong yen, but the long-term outlook for Toyota and other top firms is arguably a lot brighter than their weak share prices suggest.
With more cash and less debt than Western rivals, Japanese firms are better placed to not only weather the crisis, but also make strategic investments that could help tip the competitive balance in their favour.
Japanese firms spent a record $67 billion (Dh246bn) buying overseas competitors last year, buoyed by a strong yen and funding from a banking sector stung, but not sidelined, by the credit crisis.
Investors want to see the same zeal for restructuring.
Sony Corp and other major firms are now cutting jobs and scaling back capacity, and further cuts will be needed as the crisis drags on.
"The most important factor now, because this is going to be a very long downturn, is balance sheet strength," said Hannah Cunliffe, a fund manager at Germany's Union Investment.
"But if Japanese companies fail to respond with more aggressive restructuring and cost-cutting, that balance sheet will melt like snow in the sunshine. And then it is a lost opportunity rather than an advantage."
The average debt-to-equity ratio of Japanese firms in the Topix index stood at 0.73 at the end of the previous financial year, lower than 0.93 for constituents of the US Standard & Poor's 500 and about 0.8 for large European shares.
They also hold a higher percentage of cash relative to their assets, data from Factset and Macquarie Research shows.
TORTOISE AND HARE
That debt-light capital structure made Japanese companies look stodgy when the global economy was booming and Western rivals were "leveraging" their balance sheets to make acquisitions or amplify shareholder returns. The crisis has turned that logic on its head.
"As financial engineering fades or dissipates and as private sectors deleverage in Europe, the US and elsewhere, then it's a bit like the tortoise and the hare," said Peter Eadon-Clarke, director of strategy at Macquarie Capital Securities in Tokyo.
"Their ability to deliver good products, market share gains and growth over time is still there. But its been obscured by the leverage on balance sheets among global competitors."
Japan has a relatively high number of firms that will emerge stronger from the crisis, Eadon-Clarke says, citing solid balance sheets, a commitment to restructure and, often, market leadership.
Companies that make the grade include Toyota, tyre maker Bridgestone, auto parts supplier Denso Corp, retailer Seven & I Holdings and Japan Tobacco, a cigarette maker majority owned by the state.
All these shares have been battered in the Topix's slide to its lowest in a quarter of a century. The cost of insuring against corporate failure in Japan, as measured by the benchmark credit default index, has soared to record highs.
"There are a lot of reasons to suggest this is an undervalued, oversold market. It is just that the uncertainties are so intense," Eadon-Clarke said.
BACK TO BASICS
The near-term earnings picture is bleak. The operating profit of 300 top Japanese companies will fall 17.5 per cent in the year to March 2010, following a 38 per cent drop in the current year, predicts Daiwa Institute of Research.
But, as investors peer beyond the crisis, they may find some traditional Japanese management practices revered during the country's economic bubble in the 1980s are relevant once more. Japanese executives tend to take a longer-term view in running their firms. Other pillars of the Japanese model include consensual decision-making, cradle-to-grave employment and seniority-based pay.
"The debate now is very much about getting back to the basics with a renewed focus on the Japanese principles of long-term management and caring for the employee," said Takashi Konda, Assistant Director of research at the Japan Management Association. "Management became too short-sighted, only focusing on one quarter at a time."
But investors may worry that Japanese companies could use the crisis as an excuse to backtrack on progress made over the past decade or so, such as boosting return on equity and raising dividends to run down excess cash.
Another traditional practice – holding large amounts of shares in their business partners to cement ties and ward off hostile takeovers – has triggered losses across the corporate sector amid the stock market slump.
"Japanese companies were going in the right direction in looking at capital efficiency as a valuable concept," said Andreas Schuster, head of research strategy at CLSA Japan.
- Nathan Layne is a Reuters analyst. The opinions expressed are his own