Strong dollar hurting U.S. bottom lines
SAN FRANCISCO (MarketWatch) -- Recent turmoil in the currency markets, especially in Europe, is crimping the bottom lines of U.S. companies with heavy overseas sales, making shareholders anxious to hear how they will mitigate the damage.
At the heart of the problem is a strong U.S. dollar, which has gained against other major currencies as a haven in the middle of a financial crisis in Europe and a sluggish global economy.
A strong dollar, while good for Americans traveling abroad, takes a heavy toll on corporate overseas operations, eroding the value of local sales when the money is converted back into U.S. dollars.
The U.S. dollar index (DXY) hit a 52-week high Monday against a basket of six major currencies. It is also outperforming the euro and yen for the year to date, keeping emerging currencies at bay for now.
"In some ways, I'm surprised the euro is not trading [at] parity with the U.S.," said Sam Stovall, chief equity strategist for S&P Equity Research, who predicts a continued weakening of the euro this year because of the region's unresolved debt issues.
J.P. Morgan conducted a survey, released July 6, of 108 company executives worldwide in which they predicted a euro rebound in 2013. According to the survey, U.S. executives participating in the survey said they expect the euro to average $1.28 next year. The euro was trading at $1.22 Wednesday, a two-year low.
Multinational corporations can hedge their exposure to big swings in exchange rates by buying currency futures and options -- which is exactly what many of them are doing.
U.S.-based companies increased current-year currency hedging to 69% of their estimated cash flow in June 2012, up from 61% a year ago, according to J.P. Morgan. At the same time, their year-ahead currency hedging jumped sharply to 43% from 31% in 2011.
Timing is possibly a factor, as the survey was taken before the latest European Union summit, which aimed to resolve the region's spreading debt crisis. The outcome failed to reassure skeptical currency traders, though.
"We had a strengthening of the euro, weakening of the dollar as a result of just those talks," Stovall commented. "The strength of the U.S. dollar has nothing to do with growth projections, but [is] simply a flight to safety."
Earnings down, not out
Even with hedging strategies in place, many companies have been forced to step up their efforts to cope with turbulent exchange rates while lowering their own earnings expectations.
"Companies have been very capable of adjusting expectations lower, so they can beat [earnings projections] by a penny or two," Stovall noted.
Demand for new vehicles has fallen in all 19 of Ford's European markets. The Dearborn, Mich.-based company said it expects to lose between $500 and $600 million in European profits in 2012, prompting the company to slash costs, staff and close plants to offset the losses.
Ultimately, for American investors dealing in locally denominated products, any rise in the dollar's value translates into potential declines in profit.
"Our revenues have also been negatively impacted by the appreciation of the U.S. dollar against a number of currencies," Chairman and Chief Executive Tom Linebarger said in a statement.
The Columbus, Ind.-based company's share price is down 25% over the past three months to $86.31. It plans to release its second-quarter results on July 31.
However, worry over ups and downs in the currency market also can force a company to diversify its product line to accommodate local conditions, which in turn can raise revenue.
For a company like
"Considering the ongoing pressures on consumers and our focus on maintaining and growing guest counts, we've stepped up our emphasis on branded affordability," McDonald's President Donald Thompson said in an earnings call with investors in April.
Product diversification helped the company retain market-share gains and profitability in the first quarter of 2012, despite the loss of purchasing power and price-cutting in Asian markets.
Stovall said Europe's problems may force blue chips to diversify more as "global currencies hedging may neutralize losses."
Still worth the risk
Companies listed on the Dow Jones Industrial Average (DJIA) have tailored their response to Europe's tough conditions. Andrew Wilkinson, chief economic strategist for Miller Tabak & Co., tested individual companies' European exposure levels.
"We wondered how stocks more exposed to the euro zone had performed relative to those most sheltered from it," Wilkinson wrote in a research note. The findings showed that companies whose overseas sales fall in a midrange percentile, such as Coca-Cola Co. (KO) , performed worst.
The beverage company gets about 44% of its revenue domestically, and in 2012, currency translation lowered profit by 2 cents a share compared with a year ago. Currency translations yielded $122 million in revenue for the company in the first quarter, down about 30% from $175 million generated a year prior.
"For much of the last 21% gain in the Dow average since October 2010, investors would have benefited by seeking the diversity of international earnings," said Wilkinson.
The Northfield, Ill.-based food maker managed a 4.5% net revenue increase in Europe. In 2011, Kraft Foods Europe accounted for $17.24 billion, or about 32%, of the company's overall revenue.
"Among the Dow industrial components, it pays to have an international presence," added Wilkinson.