Currency Conundrum

When Europe's first unified currency made its debut in January 1999, it was a cause for celebration and a coup for the region, which believed a common currency would help heal its fractured market. Yet, less than two years later, the euro has lost more than 20% of its value against the U.S. dollar and has become a conundrum for global automakers and suppliers.

Economists blame the euro's slide on European economies overshadowed by the red-hot pace set by the U.S.; the European Central Bank, which has yet to establish its credibility; and on euro-zone governments that are seemingly unable to implement more radical structural reforms and coordinate their fiscal policies. Others point out that the euro still is a "virtual money," without coins or notes until two years from now.

Regardless, many now are hopeful that a turning point has been reached as the euro's value begins to gain strength, fueled by the perception that the U.S. economy is slowing down. For the moment, multinational automotive companies find themselves in an odd juxtaposition, with a weak euro padding the bottom line of European-based firms but taking profit away from U.S. and Japanese-based companies.

Analysts maintain that the globalization of the industry in many ways has taken away the sting of currency fluctuations. "For any global company with costs and sales relatively balanced, the only effect comes when profits are consolidated," says automotive analyst Ludovic Fava at Credit Lyonnais in Paris.

In other words, firms that do all their business within Europe don't notice any difference. The only companies seriously affected are those that export heavily. Exporters to Europe have a 14% loss in income; exporters from Europe experience a gain.

"Most of our activities are done in the euro zone, so there's no significant effect on our business," says Isabelle Vayssie, a spokeswoman for Faurecia SA, a seating supplier. Faurecia is preparing for its first big seating contract in the U.S. for General Motors Corp.'s Delta platform.

For other suppliers, it's a bit more complicated. "I'm not too sure this (weak euro) has a major impact," says Philippe Anglaret, president of FCI Automotive, the second-largest supplier of connectors in Europe and fourth largest globally. "Trade between regions is small, and we are implanted everywhere. Our sales and costs are each about 50% in dollars."

Mats Odman, spokesman for safety restraints supplier Autoliv Inc., a U.S. company based in Sweden, agrees. Autoliv, he says, has hedged its operation by keeping costs and revenues in the same currencies: 60% of revenues are in euro currencies, as are 60% of costs.

"It's a virtual problem, rather than a real problem," Mr. Odman says. "The profits in France and Germany turn out to be somewhat smaller than you expected when you translate theminto the U.S. dollar. We get the same money in euros that we planned to get. It's only for the accountants that it becomes complicated."

Valeo SA, a French supplier of electrical and climate control systems, also hedges in dollars. "We do roughly one-third of our sales in dollars in North America and, to some extent, also in Asia, but we have our production costs in dollar-denominated countries," says David Newhouse, Valeo's investor relations officer. "A strong dollar mechanically increases our sales, but also our production costs in those countries. In the first quarter of 2000, we had a currency impact of about 5%."

For Japanese companies doing business in Europe, the burden has been far greater, compounded by the strength of the yen, which made an unanticipated surge over the past fiscal year, climbing 14% to an average of Yen112 against the U.S. dollar.

Unfortunately, Japanese automakers based early forecasts for last fiscal year on an exchange rate of Yen120/$1. The unexpected fluctuation came at a particularly inopportune time, as auto sales continued to suffer from a weak domestic market still influenced by the 1997 Asia/Pacific financial crash.

As a result, Japan's automakers have become reliant on strong profits from overseas markets to compensate - especially the booming North American automotive terrain. The end result: Though last fiscal year's sales were strong, profits fell far below targets. Some companies were hit harder than others; Mazda Motor Corp., which exports about two-thirds of its Japan-made vehicles, saw operating profits plunge 60%, largely due to unfavorable exchange rates.

The situation was particularly painful in Europe, where the yen's strength was no match for the euro. The euro has dropped about 26% on the yen compared to the U.S. dollar, which fell 5% on the yen. Honda Motor Co. Ltd. was one of many to show an operating loss for its European subsidiary last year, as the exchange rates ate away profits from sales on already low-margin, economical cars.

Honda doesn't see the currency conundrum letting up. The automaker forecasts a dismal 27% drop in group profits for the current fiscal year. The company bases its assumptions on a continued strengthening of the yen, with an exchange rate of Yen105/$1, as compared to a present rate of Yen108/$1; and Yen100/euro, compared with the present rate of Yen98/euro.

Solutions, these companies say, are not easy. Some Japanese automakers and suppliers are looking to lock in euro rates when they sign contracts to help lessen the damage if the euro continues to fall or the yen gains strength.

Japanese companies in the U.K. have an additional dilemma because the U.K. has not joined the euro and continues to use the inflated pound sterling. The euro has dropped about 13% against the pound in the last 18 months.

"Nissan and all of its U.K.-based component suppliers carry a heavy burden with the high value of sterling," says John Cushnaghan, managing director of Nissan Motor Mfg. (U.K.). Nissan has warned its suppliers that because the new Micra car will be jointly developed with the Renault SA Clio, the two companies will jointly source components. Mr. Cushnaghan has urged Nissan's 135 suppliers to respond positively to the challenge.

"The choices of component suppliers for the Renault-Nissan alliance are now much wider, resulting in exposure for Nissan's U.K. suppliers to unprecedented price competitiveness," he says. "This will mean that U.K.-based suppliers must overcome the additional burden of an overvalued pound."

Worse, because components sent from the U.K. to euro countries now are far less profitable, some companies are looking at moving production from the U.K. to central or southern Europe. Additionally, Toyota Motor Corp., Ford Motor Co., Honda, Nissan and PSA Peugeot Citroen have warned the U.K. government that jobs could be in jeopardy if the pound's strength continues. BMW AG acknowledged the pound played a big part in its decision to sell off its loss-making Rover division.

Economists say the over-valued pound's recent slip comes as great relief to manufacturers and could prove a blessing for the British economy, as well. Contrarians argue that a lot depends on how much further the currency falls, which, in turn, is influenced by market confidence.

Wary automakers and suppliers have asked the U.K. government to announce whether or not it eventually will join the euro. "I'd like to see some certainty on the exchange rate, and I believe entrance into the euro will give us some certainty," Nissan's Mr. Cushnaghan says in a recent BBC interview.

"The pound is at a totally uncompetitive level at the moment, and it needs to come down. We're on the edge of euro land, and right now we have the worst possible world - a weak euro and a strong pound."

That may not be the case much longer. Euro-zone political leaders and central bankers have finally begun speaking in one voice: the euro's weakness against the dollar has gone on long enough, they say. Central bank intervention in support of the euro is becoming a distinct possibility.

Additionally, European taxes are being cut, labor concessions are being won and excessive regulation is becoming less popular as the "new economy" gains ground. If the U.S. dollar, indeed, has peaked and the euro rebounds above the dollar by early next year, it's only a matter of time before Europe's fortunes begin to revive.

Meanwhile, European-based automotive companies that do much of their business in the dollar and yen are adding a last-minute boost to their bottom line. Says Paris analyst Mr. Fava: "Valeo and Michelin are happy. When they consolidate their results, the dollars get bigger." - with William Diem in Paris, Andrea Wielgat and Katherine Zachary in Detroit