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Economy

Corporate Japan tames forex risk, reaps record profits

Overseas production -- and some help from robots -- ease the sting of volatility

Honda Motor Executive Vice President Seiji Kuraishi announces the company's financial results on April 28 in Tokyo. (Photo by Masayuki Kozono)

TOKYO -- Even with the yen gaining significant muscle, combined net profit at Japan's major listed companies is set to soar to a record level for the year ended March 2017.

Driving the growth are manufacturers, which have cushioned much of the impact of the Japanese currency's 12-yen appreciation against the dollar between fiscal 2015 and 2016 and helped offset the decline in exports by expanding overseas production. Companies that depend mainly on domestic demand, most of which are nonmanufacturers, also enjoyed a robust performance.

Since the 2008 global financial crisis, Japan's bigger manufacturers have been building earnings structures that are resistant to exchange rate fluctuations.

No need for sleep

In that group is motor manufacturer Nidec, which is expected to log its fourth-straight record profit for fiscal 2016.

Referring to the company's overseas plants, Nidec President Shigenobu Nagamori said that even he was surprised at how quickly operations are changing there. But he welcomes it, saying the company's ability to quickly adapt is the key to its profitability.

At one of its foreign plants, robotic arms and other automated devices are the main "workers," operating around the clock. This is part of the company's "smart factory" program, under which robots and machines are replacing human workers.

The plan is to halve its overseas manufacturing workforce to 40,000 people in the five years through fiscal 2020.

By boosting its cost-competitiveness through automation, Nidec will further protect its profit structure against exchange rate volatility.

Tadaaki Naito, president of shipping powerhouse Nippon Yusen, better known as NYK Line, described the business conditions last fiscal year as a "perfect storm." The negative impact of cheap resources continued to be felt strongly through the first half, leading to a fall in demand for shipping services and construction machinery.

The yen's sharp appreciation against the dollar has also dealt a blow to many Japanese companies. Four years of an Abenomics-fueled weak yen came to a screeching halt in fiscal 2016, when the average exchange rate rose to 108 yen per dollar, compared with 120 yen in fiscal 2015.

The currency's 12-yen appreciation against the greenback is the largest since the 14-yen rise seen in the year ended March 2009, during which the financial crisis occurred.

So how did Japanese companies turn this headwind into a record profit?

Foreign focus

The biggest reason is that major manufacturers focusing on foreign demand are increasing their tolerance to exchange rate fluctuations.

This is evident in a graph that Chisato Haganuma, chief strategist at Mitsubishi UFJ Morgan Stanley Securities, said looks like "an alligator opening its mouth."

The graph shows the change in the nominal value of exports from Japan and combined sales at manufacturers' overseas units. In the past, the two factors used to move up and down in tandem. But that has changed with the strong yen trend, which has progressed since the financial crisis.

To mitigate the effects of the exchange rate, Japanese manufacturers have increasingly turned to overseas production, targeting their output at local consumers.

The graph shows that the value of Japanese exports and sales at overseas units move in the opposite direction, with exports heading downward and sales upward. As a result, there is also a change in the break-even point at exporters.

According to a Cabinet Office survey, the profitability ceiling for exporters in fiscal 2016 was an exchange rate of 100.5 yen to the dollar, compared with 103.2 yen in fiscal 2015. This means these companies became 2.7 yen more resistant to a stronger yen over the year.

"Japan's shipbuilders must aim to establish a structure that can generate profits even at an exchange rate of 100 yen to the dollar," said Kawasaki Heavy industries Chairman Shigeru Murayama.

Honda Motor is a prime example of a Japanese company that has reduced the impact of the exchange rate through local production. Its overseas production ratio reached 84% at the end of March 2017, up 21 percentage points from 10 years earlier.

In fact, the ratio of cars sold in the U.S. that Honda produces locally is higher than that of General Motors.

As a result of Honda's heightened overseas focus, every 1-yen change in the Japanese currency against the dollar now reduces or boosts its profit by 12 billion yen ($107 million), down from 18 billion yen 10 years ago.

Sony is an example of an exporter that has turned the stronger yen to its benefit. Every 1-yen appreciation in the Japanese currency against the dollar adds 3.5 billion yen to its operating profit.

It made this possible by procuring most of its smartphone parts locally and paying in dollars. This enables it to save on procurement costs when the yen strengthens.

It was not always like this. Fifteen years ago, Sony exported large quantities of digital cameras and TVs. Every time the Japanese currency strengthened by 1 yen, the company's profit shrank by 8 billion yen.

When the yen became stronger in the wake of the financial crisis, Sony began procuring more parts locally and consolidating its domestic and overseas plants to shield its profits from the impact of exchange rate fluctuations.

No place like home

Also contributing to corporate Japan's banner year for profits are companies that focus primarily on domestic demand. Exporters may be growing more resistant to changes in the exchange rate, but they cannot fully escape the impact. So if domestic-oriented players, which are less affected by rate swings, ramp up their earnings, it has the effect of boosting corporate Japan's overall resistance to forex fluctuations.

Nonmanufacturers, the bulk of which cater to Japanese demand, accounted for 47% of combined net profit for fiscal 2016, up 7 percentage points on the year.

Leading that group were construction companies, which enjoyed booming demand at home.

Taisei and other three construction majors all earned record profits in the previous fiscal year. This is attributable to brisk construction demand ahead of the 2020 Tokyo Olympics and a more profit-focused approach to accepting orders, which has helped push the price per project up to the level seen in the early 1990s.

Companies may have largely overcome the hurdle of a strong yen, but by no means can they afford to be complacent. Political and geopolitical risks abroad have created a cloud of uncertainty over the global economy, and while that has worked in the favor of corporate Japan, it also makes for potential instability.

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