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Stocks

Market Scramble: Auto stocks on collision course with yen

TOKYO -- The earnings season for automakers kicks off Wednesday, amid concern that the potentially weaker profit projections tied to a stronger yen may dim the otherwise brightening market outlook.

     The Nikkei Stock Average fell for a second straight session Tuesday, dropping 86 points to close at 17,353. Many investors took profits after last week's rally, as the market awaits earnings results as well as the outcome of the Bank of Japan's policy meeting starting Wednesday.

Lift or chill

The yen's appreciation has ceased of late, fueling optimism that all the bad news on automotive companies -- which are vulnerable to currency fluctuations -- will come out with their results, and the stocks will start to regain their footing. But if the automakers disappoint with weak profit outlooks based on a stronger yen, the market may experience an unexpected chill.

     Masahiro Suzuki, a senior quantitative analyst at Daiwa Securities, has observed that the market-projected pretax profit of companies on the Tokyo Stock Exchange's first section was upgraded for the first time this year on Friday, by 118.6 billion yen ($1.06 billion) from a week earlier. His tracking has shown downgrades since the start of the year due to the yen's rise against the greenback.

     "The recent halt in the yen's appreciation was the major factor" for the upgrade, he said.

     The Nikkei industry subindex for automotive stocks has fallen about 20% since the end of last year, sharper than the 9% decline by the Nikkei average. Traders of major securities companies are hopeful that the stocks will rebound as adverse factors are exhausted.

     But with automakers' forex assumptions seen reflecting a stronger yen than last fiscal year, such optimistic views may not stand.

Conservative assumptions

The exchange rate for fiscal 2015 was around 120 yen per dollar. For the current year started in April, many automotive companies likely will assume a rate of roughly 110 per dollar. One official of a major manufacturer cited 105 per dollar as a possible rate.

     The yen did soften slightly recently. But the yen-selling momentum seems certain to slow, with the U.S. Federal Reserve likely to skip an interest rate hike in April and the foreign bond and stock holdings of Japan's Government Pension Investment Fund near the self-imposed limit of about 40%. The GPIF had earlier helped weaken the Japanese currency by boosting investment in foreign securities. Managers of automakers thus appear to think they must set forex assumptions conservatively.

     Toyota Motor takes a 40 billion yen hit in annual operating profit when the yen strengthens by 1 against the dollar. Masataka Kunugimoto, an analyst at Nomura Securities, estimates a profit impact of 100 billion yen on Japan's automotive industry when that rate changes by 1 yen. Under this estimate, a forex assumption by manufacturers of 110 yen per dollar for fiscal 2016 means an erosion of profits by 1 trillion yen. If the assumed rate is 105 per dollar, the blow would be around 1.5 trillion yen.

     Analysts have factored in just 130 billion yen or so of related erosion of operating profit for seven major automakers combined.

     Automakers cannot afford to cut back on research and development spending, as noted by Mitsuru Takahashi, chief financial officer of Subaru maker Fuji Heavy Industries. Autonomous driving and fuel efficiency are among the technologies demanding investment. And unit sales are unlikely to grow much worldwide. Cost reduction -- one of the few profit-boosting factors -- is estimated at 600 billion to 700 billion yen on average. The negative impact of the yen appears to be considerably underestimated.

     Some investors are growing cautious. A British pension fund will unload Japanese automotive shares if the companies assume a yen stronger than 110 per dollar, an asset manager said.

     Mazda Motor will be the first to announce earnings Wednesday. Automotive stocks once drove the market rally supported by Prime Minister Shinzo Abe's economic policies. But as the market outlook brightens amid hopes for extra monetary easing, the industry could weigh down the market.

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