Different hedging strategies subaru might adopt

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Reference no: EM132689197

Subaru's Sales Boom Thanks to the Weaker Yen For the Japanese carmaker Subaru, a sharp fall in the value of yen against the U.S. dollar has turned a problem-the lack of U.S. production-into an unexpected sales boom. Subaru, which is a niche player in the global auto industry, has long bucked the trend among its Japanese rivals of establishing significant manufacturing facilities in the North American market. Instead, the company has chosen to concentrate most of its manufacturing in Japan in order to achieve economies of scale at its home plants, exporting its production to the United States. Subaru still makes 80 percent of its vehicles at home, compared with 21 percent for Honda. Back in 2012, this strategy was viewed as something of a liability. In those days, one U.S. dollar bought only 80 Japanese yen. The strong yen meant that Subaru cars were being priced out of the U.S. market. Japanese companies like Honda and Toyota, which had substantial production in the United States, gained business at Subaru's expense. But from 2012 onward, with Japan mired in recession and consumer prices falling, the country's central bank repeatedly cut interest rates in an attempt to stimulate the economy. As interest rates fell in Japan, investors moved money out of the country, selling yen and buying the U.S. dollar. They used those dollars to invest in U.S. stocks and bonds where they anticipated a greater return. As a consequence, the price of yen in terms of dollars fell. By December 2015, one dollar bought 120 yen, representing a 50 percent fall in the value of the yen against the U.S. dollar since 2012. For Subaru, the depreciation in the value of the yen has given it a pricing advantage and driven a sales boom. Demand for Subaru cars in the United States has been so strong that the automaker has been struggling to keep up. The profits of Subaru's parent company, Fuji Heavy Industries, have surged. In February 2015, Fuji announced that it would earn record operating profits of around ¥410 billion ($3.5 billion) for the financial year ending March 2015. Subaru's profit margin has increased to 14.4 percent, compared with 5.6 percent for Honda, a company that is heavily dependent on U.S. production. The good times continued in 2015, with Subaru posting record profits in the quarter ending December 31, 2015. Despite its current pricing advantage, Subaru is moving to increase its U.S. production. It plans to expand its sole plant in the United States, in Indiana, by March 2017, with a goal of making 310,000 a year, up from 200,000 currently. When asked why it is doing this, Subaru's management notes that the yen will not stay weak against the dollar forever, and it is wise to expand local production as a hedge against future increases in the value of the yen. Indeed, when the Bank of Japan decided to set a key interest rate below zero in early February 2016, the yen started to appreciate against the U.S. dollar, presumably on expectations that negative interest rates would finally help stimulate Japan's sluggish economy. By late March 2016, the yen had appreciated against the dollar and was trading at $1=112 yen.

Sources: Chang-Ran Kim, "Subaru-Maker, Fuji Heavy Lifts Profit View on Rosy US Sales, Weak Yen," Reuters, February 3, 2015; Yoko Kubota, "Why Subaru's Profit Is Surging," The Wall Street Journal, November 14, 2014; Doron Levin, "Subaru Profit Soaring on Weaker Yen," Market Watch, November 15, 2014; Y. Kubato, "Weaker Yen Drives Subaru Maker's Profit Higher," The Wall Street Journal, February 4, 2016. Page 294 Case

Questions

Why do you think that historically, Subaru chose to export production from Japan, rather than set up manufacturing facilities in the United States like its Japanese rivals?

What are the currency risks associated with Subaru's export strategy?

What are the potential benefits? Why did Subaru's sales and profits surge in 2014 and 2015? Is Subaru wise to expand its U.S. production capacity?

What other strategies could the company use to hedge against adverse changes in exchange rates? What are the pros and cons of the different hedging strategies Subaru might adopt?

Reference no: EM132689197

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