Our Top Play for a Depreciating Yen

Since reclaiming the prime minister’s office in late December, Japanese leader Shinzo Abe has been on a campaign of psychological warfare aimed at driving down the value of the yen.

While Abe has backed off some of the more extreme rhetoric he was using on the campaign trail, it is clear that he has lost patience with the Bank of Japan (BoJ) and intends to curtail a great deal of its independence. Given the stagnant nature of Japan’s economy of the past two decades and its heavy reliance on imports, the BoJ has always been leery of introducing too much inflation into the company’s economy.

But inflation and a fairly significant depreciation of the yen is exactly what Abe wants and he has opened his battle on all fronts, fiscal and monetary.

On the fiscal side of the equation, Abe has successfully pushed through a stimulus package worth JPY10.3 trillion (USD117 billion). JPY3.8 trillion will be allocated to redevelopment efforts in the region devastated by the tsunami and earthquake in 2011, while a further JPY3 trillion will go towards programs to enhance the competitiveness of Japanese industry. Yet another JPY3 trillion will go towards funding health care and educational programs.

On the monetary front, Abe has made it clear that he is pressuring the BoJ to accept a 2 percent inflation target and is pushing it to embark on a massive program of Japanese government bond purchases.

So far, his campaign has worked, driving a sudden depreciation of the yen, which has fallen from about JPY80/USD1 to its current level of JPY91/USD1. We suspect he is trying to get the exchange rate to JPY100/USD1 and probably won’t back off until he achieves that goal.

Abe is coming under sharp international criticism for his efforts. Some analysts fear that his policies might spark a currency war, especially with China, and ultimately push his country into bankruptcy.

However, Abe’s campaign of yen depreciation will yield real benefits for his country’s export-dependent companies. Not only will the weakened yen make their products much more attractive, it will be a boon for their domestic sales if the economy is subsequently pulled out of recession.

Our favorite yen depreciation play is KEYENCE Corp (Tokyo: 6861, OTC: KYCCF).

The company manufactures a wide variety of automatic controlling, measuring, data gathering and other electronic equipment primarily used in industrial automation.

We look for automation to be a major emerging markets investment theme in 2013 for a variety of reasons.

For one thing, China has reached a point where fewer rural dwellers are migrating to the cities in search of work. As a result, the bottom of what seemed to be the endless pool of cheap Chinese labor is finally being plumbed, contributing to growing labor costs in the country. That will push more Chinese manufacturing concerns, particularly those producing higher value added goods, into implementing greater automation measures, to meet current production needs and to lower labor costs and enhance profitability.

Strong corporate balance sheets in the rest of the world will also help fuel greater industrial automation. At this point many manufacturers, especially those in the US, have the cash to fund large capital expenditure plans to pursue sophisticated automation processes.

These trends put KEYENCE in a sweet spot to grow sales around the world. The company has substantial production capacity in Japan while the bulk of its revenues are now sourced internationally. What’s more, these revenues benefit from a weaker yen.

Even at the current exchange rate, KEYENCE’s stock is a pricy proposition for some American investors—it currently trades at around USD275. A less expensive alternative is Mitsubishi Electric Corp (Tokyo: 6503), which offers similar exposure but produces less sophisticated equipment.