27 June 2016 Asia Pacific/Japan Equity Research Automobile Manufacturers / Auto Parts & Equipment (Auto/Auto Parts/Tire) / MARKET WEIGHT/MARKET WEIGHT/MARKET WEIGHT Auto/Auto Parts Sector Research Analysts THEME Masahiro Akita 81 3 4550 7361 [email protected] Brexit’s impact Koji Takahashi 81 3 4550 7884 [email protected] ■ Summary: Britain's decision to leave the EU is being received as a negative surprise by global equity and currency markets. This report is our initial impression of how Brexit could affect Japanese automakers and auto-parts makers. ■ Direct impact limited, indirect fallout substantial: We conclude that Japanese automakers should see little near-term impact in view of the UK market’s modest contribution to sales volume and their generally low sales weightings for Europe overall. However with trade agreements between the UK and EU likely to be reworked, we think the Japanese Big Three (J3)— Toyota Motor (7203), Nissan Motor (7201), and Honda (7267), all of which have factories in the UK—could rethink their UK investment plans and overall European production. We also see a potential impact on auto parts and tire makers’ regional strategies. Brexit is meanwhile having a substantial indirect impact in the form of a sharply higher yen. We estimate that a 1% rise in the yen against all currencies would depress automakers’ OP by an average 2.5%, including −3.7% for Mitsubishi Motors (MMC, 7211), −3.6% for Mazda (7261), and −3% for Toyota Motor. The J3 all have exposure to the plummeting British pound, but their OP is less forex-sensitive than MMC’s and Mazda’s. Auto parts and tire makers have less forex sensitivity than automakers, but we think a 1% rise across all currencies could still lower profits by an average 0.8%. ■ Stock calls: In any case, the sector’s external environment has clearly become more uncertain. Against this backdrop, we remain focused on the investment strategy laid out in our 1 April report, Auto, Auto Parts Sector: Structural over cyclical. We recommend parts makers that present a favorable structural equity story based on: (1) comparatively low forex sensitivity, (2) growth exceeding that of global auto demand fueled by specific technologies and market trends, and (3) restructuring effects. Our specific picks here are Aisin Seiki (7259), Toyota Boshoku (3116), Ichikoh Industries (7244), and Topre (5975). Among automakers, we recommend those that could see growth in excess of the overall auto market driven by strong exposure to specific regions and superior model pipelines. This also supports investors’ preference for "local over global" and "niche over major" players. Our specific pick is Suzuki Motor (7269). DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. CREDIT SUISSE SECURITIES RESEARCH & ANALYTICS BEYOND INFORMATION® Client-Driven Solutions, Insights, and Access 27 June 2016 Brexit’s impact Direct impact limited, indirect fallout substantial Britain's decision to leave the EU is being received as a negative surprise by global equity and currency markets. This report is our initial impression of how Brexit could affect Japanese automakers and auto-parts makers. We conclude that Japanese automakers should see little near-term impact in view of the UK market’s modest contribution to sales volume and their generally low sales weightings for Europe overall. However with trade agreements between the UK and EU likely to be reworked, we think the Japanese Big Three (J3)—Toyota, Nissan, and Honda, all of which have factories in the UK—could rethink their UK investment plans and overall European production. We also see a potential impact on auto parts and tire makers’ regional strategies. Brexit is meanwhile having a substantial indirect impact in the form of a sharply higher yen. We estimate that a 1% rise in the yen against all currencies would depress automakers’ OP by an average 2.5%, including −3.7% for Mitsubishi (MMC), −3.6% for Mazda, and −3% for Toyota. The J3 all have exposure to the plummeting British pound, but their OP is less forex-sensitive than MMC’s and Mazda’s. Auto parts and tire makers have less forex sensitivity than automakers, but we think a 1% rise across all currencies could still lower profits by an average 0.8%. In any case, the sector’s external environment has clearly become more uncertain. Against this backdrop, we remain focused on the investment strategy laid out in our 1 April report, Auto, Auto Parts Sector: Structural over cyclical. We recommend parts makers that present a favorable structural equity story based on: (1) comparatively low forex sensitivity, (2) growth exceeding that of global auto demand fueled by specific technologies and market trends, and (3) restructuring effects. Our specific picks here are Aisin Seiki (7259), Toyota Boshoku (3116), Ichikoh Industries (7244), and Topre (5975). Among automakers, we recommend those that could see growth in excess of the overall auto market driven by strong exposure to specific regions and superior model pipelines. This also supports investors’ preference for "local over global" and "niche over major" players. Our specific pick is Suzuki Motor (7269). UK makes only modest contribution to sales volume While Brexit’s economic impact remains unclear, among institutions such as the IMF and OECD there is a widespread view that slower economic growth is inevitable in the countries involved—namely, the UK and European nations. As consumer sentiment is likely to cool also, it seems probable that auto demand will be affected. On the other hand, the UK makes a relatively small contribution to global sales volume at Japanese automakers. Although the UK sales weighting is somewhat higher at Nissan, MMC and Mazda, even at these companies the UK accounts for only about 3% of global sales. All three companies, however, have a comparatively high exposure to Europe as a whole, at 19.7% for MMC, where the Outlander PHEV is among models selling well, 16.8% for Mazda, where the suite of Skyactive models remains popular, and 13.9% at Nissan. Auto/Auto Parts Sector 2 27 June 2016 Figure 1: Percentage of vehicles sold in the UK per Figure 2: Percentage of vehicles sold in the EU per carmaker (2015) carmaker (2015) 3.5% 25.0% 3.1% 3.0% 3.0% 3.0% 20.0% 19.7% 2.5% 16.8% 15.0% 2.0% 13.9% 1.5% 1.5% 1.4% 9.6% 1.3% 10.0% 1.1% 7.2% 1.0% 5.0% 4.4% 4.0% 3.6% 0.5% 0.4% 2.8% <0.1% 0.0% 0.0% Nissan MMC Mazda Isuzu Toyota Suzuki Honda FHI Hino MMC Mazda Nissan Toyota Suzuki FHI Hino Honda Isuzu Source: Company data, Marklines, Credit Suisse Source: Company data, Marklines, Credit Suisse Focus on stance taken by J3, all of which have factories in UK Among Japanese automakers, only the J3 (Toyota, Nissan, and Honda) have production facilities in the UK. Nissan has the greatest capacity, as its Sunderland plant produces roughly 500,000 vehicles a year, mostly the Qashqai compact crossover. Of that output, about 80% is exported to continental Europe, and Nissan also had intended using the plant to export the new Infiniti Q30/QX30 to the US. Toyota manufactures some 190,000 vehicles annually in the UK, including the Avensis and Auris, and exports approximately 75% to Europe (excluding the UK). Similarly, Honda’s Swindon plant, which produces around 120,000 vehicles each year (mostly the Civic) is used as a base for exports to non- UK Europe. All three have quite a long history of manufacturing in the UK, however if Brexit leads to higher tariffs their export margins would deteriorate, likely limiting any benefit from persisting with local production. This could cause the J3 to rethink their UK investment plans and indeed their production strategies for Europe as a whole. Automakers’ actions likely to have knock-on effect on auto parts and tire makers In the event Japanese automakers rework their production strategies for Europe as a whole, this is likely to have an impact also on the regional strategies of suppliers—namely, auto parts and tire makers. Currently, a number of Toyota suppliers have factories in the UK, among them Aisin Seiki (7259), Denso (6902), Toyoda Gosei (7282), and Tokai Rika (6995). Aisin Seiki’s UK plant is largely used for manufacturing body parts, including door locks and door frames. Denso has four bases in the UK, used for the manufacture and sale of electronic and electrical systems, climate control systems, radiators, and so forth. The UK plants of Toyoda Gosei and Tokai Rika respectively supply automotive interiors and switches, predominantly for Toyota. Among Honda suppliers, Keihin (7251) has a factory in the UK, used mostly for the manufacture of throttle bodies, EGR (exhaust gas recirculation) systems, and die-cast parts. Nissan-affiliated suppliers Calsonic Kansei (7248) and Unipres (5949) both have multiple production facilities, primarily supplying parts to Nissan. Calsonic Kansei manufactures exhaust systems, radiators, condensers and such like, while Unipres produces automotive exteriors/structural components including panels and frame parts. Among other suppliers in our coverage, Bridgestone (5108), Exedy (7278), Koito Mfg (7276), Nifco (7988), Stanley