Is Higher Oil Fully Reflected in Japanese Utility Stock Prices?
In recent weeks the yen has rebounded nicely against the dollar, moving from a high of ¥124 this past summer to the recent low of ¥107. Some observers say the yen carry trade has almost unwound and the yen has peaked. Others predict that, with continuing mortgage woes in the US, the yen is slated to move under ¥100.
The strong yen is bad news for the many Japanese companies that rely heavily on exports (Sony, Toyota, Honda, and Nintendo, to name just a few). But Japan is also a net importer in certain sectors, most notably energy, food, and wood. In particular, Japan imports most of its oil from abroad, thus margins at electric utilities are strongly affected both by the crude oil price and currency exchange rate. Electric utility company stocks had rebounded late in 2007, before the sharp decline at the beginning of 2008 with the rest of the Japanese market.
Currently the average forward PER of Japan's utility companies is 23.4. Do their stock prices reflect both the effect of rising energy costs and a stronger yen? We think that recent surge in oil prices to around $100 has not been incorporated in many of the March 2008 earnings estimates that were announced a few months ago. Thus when third- quarter results are released in late January they should include some "surprises" -- which really shouldn't be surprises at all if you do some rough calculations to adjust the previously announced estimates.
For example, Chubu Electric's (9502) most recent forecasts for the March 2008 year is ¥145 million for ordinary income and ¥89 million for net income. These estimates assume a crude oil price of $68.10 per barrel for the fiscal first half and $70 for the second half (October 2007 to March 2008).
However, the actual average oil price for the second half is more likely to be around $85 or even $90. Chubu's disclosures tell us that every $1 rise in crude oil prices adds ¥7.6 million to its costs. So if the average oil price for the year is $85 instead of $70, the gross impact on costs would be ¥121.6 million. That amount would be somewhat offset by the benefits of a rising yen: if the average exchange rate is ¥115/$ instead of ¥120/$ that their current estimates incorporate, the gross positive impact on the margin would be ¥26 million. However, considering that ordinary income is pegged at only ¥145 million, the overall impact from higher oil prices would still be substantial.
Of course, utility companies use various hedging contracts for commodities and exchange rates (for which we could not find detailed disclosures). There are other factors as well -- such as the percentage of electricity generated from nuclear -- so the back-of-the-envelope calculation offered above is not the whole picture. But it's helpful to remember that Chubu's forward PER of 24 is based on estimates released two months ago – whose assumptions are now very different from current reality.
In recent weeks the yen has rebounded nicely against the dollar, moving from a high of ¥124 this past summer to the recent low of ¥107. Some observers say the yen carry trade has almost unwound and the yen has peaked. Others predict that, with continuing mortgage woes in the US, the yen is slated to move under ¥100.
The strong yen is bad news for the many Japanese companies that rely heavily on exports (Sony, Toyota, Honda, and Nintendo, to name just a few). But Japan is also a net importer in certain sectors, most notably energy, food, and wood. In particular, Japan imports most of its oil from abroad, thus margins at electric utilities are strongly affected both by the crude oil price and currency exchange rate. Electric utility company stocks had rebounded late in 2007, before the sharp decline at the beginning of 2008 with the rest of the Japanese market.
Currently the average forward PER of Japan's utility companies is 23.4. Do their stock prices reflect both the effect of rising energy costs and a stronger yen? We think that recent surge in oil prices to around $100 has not been incorporated in many of the March 2008 earnings estimates that were announced a few months ago. Thus when third- quarter results are released in late January they should include some "surprises" -- which really shouldn't be surprises at all if you do some rough calculations to adjust the previously announced estimates.
For example, Chubu Electric's (9502) most recent forecasts for the March 2008 year is ¥145 million for ordinary income and ¥89 million for net income. These estimates assume a crude oil price of $68.10 per barrel for the fiscal first half and $70 for the second half (October 2007 to March 2008).
However, the actual average oil price for the second half is more likely to be around $85 or even $90. Chubu's disclosures tell us that every $1 rise in crude oil prices adds ¥7.6 million to its costs. So if the average oil price for the year is $85 instead of $70, the gross impact on costs would be ¥121.6 million. That amount would be somewhat offset by the benefits of a rising yen: if the average exchange rate is ¥115/$ instead of ¥120/$ that their current estimates incorporate, the gross positive impact on the margin would be ¥26 million. However, considering that ordinary income is pegged at only ¥145 million, the overall impact from higher oil prices would still be substantial.
Of course, utility companies use various hedging contracts for commodities and exchange rates (for which we could not find detailed disclosures). There are other factors as well -- such as the percentage of electricity generated from nuclear -- so the back-of-the-envelope calculation offered above is not the whole picture. But it's helpful to remember that Chubu's forward PER of 24 is based on estimates released two months ago – whose assumptions are now very different from current reality.
posted by Bob at 4:37 PM
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