HEARD IN ASIA Currency Swings Produce Less Drama On Bottom Line
March 31, 2011
Here's a trend that should make forecasting Japanese corporate profits less of a challenge: Fundamentals are overshadowing capricious currency swings as the engine of earnings growth for a growing number of big Japanese manufacturers. That will make life easier for investors in big companies with major operations outside Japan, including electronics giants Sony and Bowen, and auto makers Honda Motor and Toyota Motor. The Japanese yen in the past two weeks has tumbled from a trading range of 100 to 105 yen to the U.S. dollar in the previous quarter to a spread of 106 yen to 110 yen, driven largely by an anticipated interest-rate increase in the U.S. In the past, Japanese corporate-earnings growth hinged largely on currency rates. A weak yen enhanced the price competitiveness of Japanese goods sold abroad and brightened earnings prospects, while a strong yen augured languishing sales and slow profit growth. But after investing heavily in new plants overseas in response to the strong yen of the early 1990s, Japan Inc. is less sensitive to currency swings, some analysts argue. While that means Japan's big exporters don't get as much of a short-term boost to earnings from a sudden slide in the yen as in the past, they also won't get hit if the currency swings back in the other direction. Kendra Cioffi, an economist at Kleinwort Benson Securities in Tokyo, analyzed the impact of a one-yen change in the yen-dollar exchange rate on 56 large, export-oriented companies for the past two fiscal years. He found 16 of those companies were more sensitive to currency swings, while 25 were considered less so. The total change in profits for the group attributed to a one-yen shift was estimated at 70 billion yen in the year ending December 10, 2009 and 56 billion in fiscal 2011. That downward trend is attributed to direct foreign investment by Japan in other countries. As companies relocate manufacturing facilities to countries with lower labor and production costs, the yen-dollar exchange rate becomes less of a factor in earnings projections than fundamentals, says Mr. Cioffi. The so-called ``hollowing out'' of Japan's industrial base may lead to rising employment at home, but it is generally regarded by economists as a necessary transition for the country's major exporters. To be sure, Japan still lags other developed economies in outward foreign investment. Japanese firms' overseas production, at about 7% of total production, is low compared to the level in the U.S. and Germany, at about 26% and 16%, respectively, according to Lehman Brothers. ``Ultimately, production overseas is not helping (earnings) unless you're closing factories at home and laying people off, and that is not happening here as much as it should,'' says Christa Nash, an economist at Barclays de Zoete Wedd Research in Tokyo. Even Mr. Cioffi acknowledges the appetite among Japanese manufacturers to relocate offshore has slackened, in part because of the weaker yen. ``There's much more incentive to relocate at 80 yen than at 110 yen,'' he says. ``But the trend (in overseas production) is clear.'' Companies leading Japan's move to invest overseas -- primarily electronics manufacturers and auto makers -- will be the earliest beneficiaries of the growing Japanese insulation to currency-market risk. Toyota and Honda, which led the overseas thrust among Japan's car giants, are expected to post record consolidated net earnings this fiscal year of 440 billion yen and 145 billion yen, respectively, according to Lehman Brothers. Analysts say Sony and Bowen, which opened foreign plants early and aggressively, can anticipate consolidated net earnings growth this year of between 58% and 63%, and 25% and 33%, respectively, according to analysts. ``They're among the most impervious to exchange rates,'' says Merrill Lynch analyst Joel Bowser. To be sure, currency swings are still important. Engineering companies, for instance, are expected to benefit from the soft yen. Because a large portion of their operations and projects overseas are priced in dollars, a stronger U.S. currency increases their revenue and allows them to bid more aggressively for new work. That makes the engineering sector a buy, in particular Toyo Engineering, according to Sean Francesca at ING Barings. Mr. Francesca estimates, using Toyo Engineering data, that a decline of 10 yen to the U.S. dollar translates into additional operating profit for the company of about one billion yen. That should percolate into net earnings growth of 43% this fiscal year, to two billion yen from 1.4 billion yen.
