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What Companies Benefit (Or Not) From A Weaker Yen?

Monday - 4/8/2013, 5:11pm  ET

The yen has been a strong currency for the past four decades, quadrupling in value against the dollar. Despite the fact that Japan has had a bad economy since the early 1990s, low inflation, a savings surplus, and competitive industries have sustained the yen's strength.

However, the situation is now changing for three reasons.

Reason number one: a deteriorating corporate sector

Japan's nominal GDP in 2012 was 9% lower than in 2007 and 2.5% lower than in 1992. The impact of deflation on business confidence is making Japan lose competitiveness in many industries it used to dominate. The auto industry –the pillar of Japan's economy- is still profitable, but is now losing out to Germany, South Korea, and the U.S. As for the electronics sector that once ruled the world, it is now in serious financial difficulty. Former giants such as Sony, Sharp, and Panasonic are even on the verge of bankruptcy. Devaluation is the only way out. It will restore Japan's competitiveness and lay the foundation for its industrial recovery.

Reason number two: the fiscal situation

The country's fiscal situation is at a dead end. As long as the economy remains in deflation there is no way the government could pay back its astronomical debt. Even though the ten-year Japanese government bonds yields at only 0.53% (the lowest worldwide), the interest expense represents 25% of the total budget. If the bond yield rises to 2%, the interest expense would surpass the total expected tax revenue of the government. 

Reason number three: the territorial dispute with China

Japan's savings rate has been declining with an aging population. Its trade deficit is growing for the first time. The military dispute with China only makes things worse. As China is the largest market for Japanese companies, the Japanese trade deficit could mushroom even more in 2013 if things get ugly and retaliatory commercial measures are adopted between both countries.

Who wins with a Yen devaluation?

Toyota

Auto, steel, and electronics firms are major exporters. A one percent decline in the value of the yen typically boosts corporate Japan's profits by about one percent. Auto-makers, such as Toyota, welcome the weak yen because it contributes to greater operating profits from exports. According to a Toyota 2012 press release, every one yen drop against the US dollar will mean 35 billion yen more in annual operating profits! In my opinion this isn´t corporate wishful thinking: ever since the yen´s depreciation began last October, Toyota's foreign sales have increased and the stock price has jumped over 40% from around $74 to $106. The upward trend will continue as the yen still has some more room to fall.

Intel

Japanese suppliers produce much of the silicon and other materials used in chip making by Intel. However, the company earns almost all of its total global sales in U.S. dollars. A weaker yen over a long period of time would therefore give Intel a boost by lowering its rising costs of goods sold, a major problem at the company in the past two years. Looking at the numbers, Intel´s costs of sales rose to 37.9% of its total revenue in 2012 from 34.7% in 2010. If the company decides to invest in distressed Japanese electronics companies that turn profitable with a yen devaluation, it will add a low-cost element into its own supply chain and that would improve its profit margins.

... and who loses?

The three American companies that draw the highest percentage of their sales from the Japanese market will be the most seriously affected by a depreciating yen. These are health insurer AFLAC and luxury brands Coach and Tiffany & Co.

AFLAC is Japan major foreign insurer and makes 75% of its total revenue from Japanese sales. Its 4Q 2012 return on equity and profit margins have deteriorated, casting doubts over the future of the stock price. The company's Free Cash Flow plummeted from $4.2 Billion in October 2012 to a negative $11.458 Billion today! Rarely a very good sign...

As for Coach and Tiffany, the Japanese market respectively represents 21% and 19% of their total sales. Coach stock price has taken a nosedive since April 2012, losing 40% of its value. Its P/E has dropped from over 24x earnings in March 2012 to below 14x earnings YoY. As for Tiffany's, management has done a good job managing international capitalization structure, but in light of a yen depreciation and soaring inputs costs like gold and silver, its revenues have also underperformed throughout 2012. However the valuation metrics have only gotten more expensive: the P/E ratio rose from 18.3x in October 2012 to 21.3x today. Since early 2013, the stock has been up over 23%.This is quite surprising because it means that despite a weaker yen and all the uncertainty regarding the future of the Japanese economy (Tiffany´s greatest foreign market), the share price still hasn´t factored in these negative prospects. In my view Tiffany is headed for a 10-15% correction in the months to come, especially if gold prices continue to increase -which they should as long as the Fed is headed by people who believe that money printing is the answer to all the world´s problems.

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