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Japan-Update

Japan contractors turn builders' market into record profit

Investors betting fiscal 2017 forecasts are too cautious

Contractors' labor costs rose less than expected in fiscal 2016.

TOKYO -- A building boom handed four leading Japanese general contractors record net profits in the year ended March despite a deepening labor shortage -- or perhaps because rising labor costs gave companies the upper hand in negotiations.

Obayashi, Kajima, Taisei and Shimizu together booked 558.7 billion yen ($4.93 billion) in operating profit, beating the sum of their initial projections by 49%. A spate of redevelopment projects and infrastructure demand, primarily in the Tokyo area, bolstered their leverage in price talks, fattening profit margins on construction.

Labor expenses, which account for around 40% of construction costs, did not rise as much as anticipated. The unit price for construction starts rose 20% from fiscal 2011 to fiscal 2016, according to the Ministry of Land, Infrastructure, Transport and Tourism. But a measure of labor costs for public-works projects climbed just 10% over the same period.

Labor-saving efforts account for part of this gap. "New construction techniques have caught on, and we still have more than enough manpower for formwork and reinforcement tasks, for example," Shozo Harada, executive vice president at Obayashi, said while presenting fiscal 2016 earnings. The company holds long-term arrangements with many of its subcontractors, and locks down a certain amount of labor in advance, buffering rapid cost shifts. Moreover, contractors "could face hurdles if clients think we're making too much," according to one industry insider, leading companies to play up the cost of labor in price talks.

Better than expected

Labor will be a key factor in fiscal 2017 as well. Kajima, Taisei and Shimizu have kept their forecasts conservative, projecting double-digit declines in operating profit. Kajima expects the gross profit margin on building construction to narrow 3.1 percentage points to 10.3%, due largely to rising labor expenses. "As construction for the 2020 Tokyo Olympics kicks into full gear, the labor shortage will grow more intense," director Hironobu Takano said.

Obayashi is taking a bolder outlook, anticipating that its labor costs will remain roughly level. The builder sees net profit growing 0.5% to a record 95 billion yen.

Many investors are similarly skeptical of projected labor cost increases in light of the contractors' record profits last fiscal year. "While construction is concentrated in the Tokyo area, the number of projects is still low compared to fiscal 2013," when clients aimed to get work done before a hike in Japan's consumption tax, "and the labor shortage less intense," said Kentaro Maekawa of Nomura Securities. "Labor costs' climb will be fairly gradual," he predicted.

All four contractors' shares gained Friday, defying an overall market decline. Taisei, which has forecast a 4% net profit drop in fiscal 2017, climbed 3% at one point to a year-to-date high of 910 yen.

Changes in plans during construction have historically boosted contractors' earnings above projected levels. That gap has been particularly large over the past few years, and the market is betting on a repeat this time around. 

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