If there's a silver lining to the whole U.S. subprime mortgage mess, this could be it: In recent weeks, the market convulsions have given Japan's long-beleaguered currency a big boost. At its current rate of 115 yen to the dollar, the yen is 7% stronger than it was in June, when it was languishing at near five-year lows. By the end of the year Mizuho Bank reckons the yen could appreciate even further to 106 to the dollar, which would mark its highest level in two years.
That spells trouble for many Japanese exporters, which have seen soaring profits in recent years in part due to the yen's weakness. But it's an unexpected gift for a diverse group of U.S. companies, from insurer Aflac (AFL) to jewelry retailer Tiffany (TIF).
California Tech in Japan
Never mind all the buzz about China and India. For many blue chip U.S. companies, Japan is still the make-or-break market in Asia. The world's second-largest economy accounts for a whopping 70% of Georgia insurer Aflac's $14.6 billion in annual revenues. Coach (COH) and Tiffany have well-heeled Japanese to thank for about a fifth of their overall sales, roughly $2.6 billion a year.
Tech companies also do brisk business in Japan. Qualcomm (QCOM), the San Diego-based wireless-solutions company, saw the country account for 21% of its $7.5 billion in revenues last fiscal year, while Texas Instruments' (TXN) Japan-only sales made up 16% of an overall $14.3 billion last year. Altera (ALTR), a San Jose-based maker of components used in digital circuits called programmable logic devices, banked 23% of its $1.29 billion in sales from Japan last year. There are many more U.S. companies that rely on Japan for a good chunk of their revenues, but relatively few break out earnings by country.
The yen's recent rally could be a financial blessing for these businesses—especially coming after a rough patch in Japan. Last year, as the yen was one of the few currencies worldwide to lose ground against the greenback—earnings of U.S. affiliates in Japan fell by 6.4%, reckons Joseph Quinlan, chief market strategist at Bank of America's (BAC) global wealth and investment management group. That's compared to an 18% increase in global earnings for the overseas operations of U.S. companies last year.
Doing Business in Yen
The first quarter of 2007 was even worse, with Japan earnings falling 18% in the first quarter, calculates Quinlan. "The key point to remember is that Japan represents one of the largest markets in the world for U.S. companies," says Quinlan.
Not every company will be affected in the same way, and many do what they can to minimize the currency's impact on global operations. Aflac, for instance, says yen fluctuations "can significantly affect our [financial] results as reported in dollars." But since Aflac's costs are also largely denominated in yen—it has hundreds of offices dotting the country—its underlying profitability is unlikely to change much.
On the other hand, Coach's Japan affiliate pays dollars for the goods it imports to stock store shelves, and a stronger yen offers a chance for better profitability in Japan. The company, which buys derivatives and swaps contracts to limit currency exposure, says the impact of big currency shifts is "slight." But analysts say that's not always the case. "Even with a hedge, a significant move in the yen would have a discernible effect on net earnings," says Quinlan.
Carried Away by the Carry Trade
What's behind the yen's sudden show of strength? Turmoil stemming from the U.S. mortgage market triggered the initial yen-buying binge. But a big push came from a massive sell-off by investors in what's known as the carry trade, say economists and currency traders. Participants in the carry trade target the gap between Japan's ultra-low interest rates (the benchmark now stands at 0.5%) and the higher rates that prevail elsewhere (5.25% in the U.S. and 4% in Europe, for instance).
By borrowing in yen and investing in higher yielding assets denominated in other currencies, there was money to be made. As the yen strengthened in July and August, investors in Tokyo bailed out of tens of billions of dollars' worth of carry trades, according to JPMorgan (JPM).
In the coming months, analysts think the yen could be poised for another surge, especially if the Federal Reserve lowers rates soon, as expected, narrowing the difference between U.S. and Japanese rates, or if jittery investors move once again to close out risky bets on the yen. U.S. companies with sizable stakes in Japan might be rooting for just that.