Exchange-rate volatility and big business

Earlier this month, The Economist published an interesting profile of Toyota Motor Corporation. The magazine notes that, in the fiscal year that ended March 2009, Toyota recorded its first net loss since 1950, even as it assumed the position of the world’s biggest automobile manufacturer. The Economist claims that the company has lost “its seemingly unstoppable market-share momentum” and chalks up the malaise to its slowness to market cars in emerging markets, failure to manage the geographical nuances of its business, and a lack of focus on its traditional strengths of quality and reliability.

These criticisms seem to be more or less on target, but there was an interesting nugget of information near the front of the article that was not dwelled upon at length, but probably deserved to be – the effect of foreign-exchange rates on company profitability. The magazine reports:

“In the most recent quarter Toyota made a surprise net profit of ¥58 billion. It also raised its sales forecast for the year from 6.6m units to 7m. Much, however, depends on the yen-dollar exchange rate. The yen has been climbing, and a rise of ¥1 can subtract ¥30 billion from Toyota’s bottom line.”

While the article makes a good case for the longer-term causes of Toyota’s recent slide, the quarter-to-quarter volatility of exchange rates can do a lot to mask – for good or ill – the underlying trends of a global business. According to McKinsey’s What Matters website, we should expect this volatility to increase in the near to intermediate term. Authors Richard Dobbs and David Skilling cite a recent McKinsey Quarterly survey as evidence “that both the level of exchange rates and exchange rate volatility have a large, and growing, negative effect on company profits and investment decision making.”

Another interesting point in the McKinsey piece is how the “yen-dollar exchange” talked about in The Economist is only part of the puzzle in figuring out corporate profitability, particularly for companies based in Asia. Take, for example, this interesting comparison between Japanese and Korean manufacturers vis-à-vis the yen-won exchange:

“And the competitive position of Japanese companies such as Toyota Motor and Sony, relative to South Korean rivals such as Hyundai and Samsung Electronics, has deteriorated as the Korean won has depreciated (as a result of capital outflows) and the Japanese yen has strengthened (because of its safe haven status). The yen is now 60 percent stronger in won terms than its pre-crisis level, currently trading at around 13 won, compared to below 8 in 2007. Observers attribute to this shift, the fact that Samsung Electronics’ third quarter 2009 operating profits were more than twice the combined operating profits of nine of Japan’s largest consumer electronic companies.”

For the investor, the impact of currency exchange puts an added layer of complexity on top of what is already a complex task. I have long treated currency exchange as mere white noise; it has never figured substantially into my investment decisions (not least of all because I scarcely understand it), but if we are entering a period of heightened volatility, it might benefit all investors to think about how to profit from it.

To this end, check out McKinsey’s What Matters website. They published earlier this month some interesting articles on currency, particularly the role of the U.S. dollar in the global economy.