Earnings: The Sting of the Strong DollarDavid Bogoslaw
Foreign currency exposure has gone from being a major tailwind to a major headwind for large U.S. companies. Along with deteriorating economic conditions around the world, the unexpected resurgence in the dollar's value against most foreign currencies since the fall has dealt a blow to the profitability of U.S. outfits. And the negative impact of the strong greenback on financial results is likely to worsen in 2009, many companies have been saying on conference calls.
As of Jan. 30, total earnings for the companies in the Standard & Poor's 500-stock index for the fourth quarter were down 35.2% from the prior-year period, according to the Thomson Reuters Proprietary Research Group. Earnings for the first quarter are expected to be 24.7% lower, while a 22% drop in earnings is projected for all of 2009 as of Jan. 30.
Earnings Reports Cite Exchange Losses
Reporting results for its second quarter of fiscal 2009, which ended Dec. 31, Procter & Gamble (PG) said that unfavorable foreign exchange reduced net sales by 5% as the U.S. dollar appreciated against the euro, British pound, and Canadian dollar. On its Jan. 30 earnings call, P&G said it continues to expect foreign exchange to lower sales by about 5% on the year, while the impact for the March quarter is projected in the high single digits.
Kraft Foods (KFT), whose per-share earnings took a 3¢ hit from currency exposure in the fourth quarter, recently slashed its 2009 earnings forecast under generally accepted accounting principles, or GAAP, to $1.88 from $2.00 to account for currency and higher pension costs, anticipating a 16¢ hit from currency.
Foreign exchange losses lowered Corn Products International's (CPO) fourth-quarter revenue by 10% and the negative impact of currencies is expected to worsen over the next few quarters, Chief Financial Officer Cheryl Beebe said on the company's Feb. 2 conference call. Corn Products expects to earn $2.10 to $2.60 a share for all of 2009, with a negative currency impact of more than 30¢ a share. Normally, the company would expect to be able to recoup any currency losses within three to six months, but without the ability to raise prices while global economic conditions remain weak, Corn Products said it now sees the recovery of those losses taking anywhere from 6 to 18 months.
Hedging with Currency Forwards
Prior to last September, a weaker dollar magnified the positive impact of having foreign sales, translating into more dollars when companies repatriated euros and other currencies from overseas. That's no longer the case. The U.S. dollar index, which measures the greenback's value against a basket of other currencies, has climbed 7.9% since Sept. 30. As foreign currencies weaken, local sales are likely falling when a U.S. company raises its prices to keep pace with that currency's decline in value. Companies can hedge these potential costs by buying or selling so-called currency forwards through commercial banks' foreign exchange trading desks. Forwards are similar to futures, except that futures adhere to set contract dates as well as to size and trade specifications on regulated exchanges, while forwards are traded over the counter on a per-deal basis for any desired amount on any date.
Unlike futures, which are tracked by governmental organizations, it's virtually impossible to collect marketwide information on OTC transactions. Credit Suisse's (CS) foreign exchange trading desk noted a pickup in corporate hedging activity in September and October but hasn't seen much of an increase lately, according to James Sweeney, a director in global strategy research at Credit Suisse.
Call it the downside of U.S. companies' global focus. "You could still argue that having overseas exposure is a long-term positive, but in the near term, having a lot of exposure to the U.K. or Germany is not a good thing," says Alec Young, equity strategist at Standard & Poor's Equity Research.
FAS Rule 133
More companies would probably use hedging programs to offset their risk if not for concerns that their hedges might be deemed ineligible for hedge accounting under Financial Accounting Standards Rule 133 (FAS 133), which was put in place to deter speculative hedges, says Jiro Okochi, chief executive at Reval.com, a provider of Web-based hedging strategies to help companies with risk management.
Okochi believes the stringent rules "probably prevented some of the FX [foreign exchange] hedging that certainly would have been favorable for true hedges before FAS 133." He's critical of companies that choose not to hedge just to avoid the extra paperwork for accounting and the potential challenge of having to explain volatility in profit-and-loss statements for business hedges to their shareholders.
"Shareholders will understand if you have a gain or loss on your hedge [positions] because you had significant exposure to overseas [markets], and if the dollar moved" you would have incurred a big foreign exchange loss, he says.
Successful Hedging at Google
Google (GOOG) is one of the few companies that's managed to buck the trend. With $2.86 billion, or 50% of its total revenue in the fourth quarter, coming from outside the U.S., adverse currency moves potentially could have had a devastating effect on the search engine company's results. Although currency continued to work against it in the final quarter of 2008, its cash-flow hedging program allowed Google to recognize an additional $129 million in revenue, the company said on a Jan. 22 earnings call. Before hedging, the stronger dollar relative to other currencies had a negative impact of $334 million on revenue.
"Q4 was an extraordinary quarter from a volatility standpoint," with the British pound dropping from above $1.80 to between $1.50 and $1.60 in a matter of weeks, Google Chief Financial Officer Patrick Pichette said on the conference call. "That's why we had the results we had. In some cases, we had a lot more benefit because of these hedges." Revenues from Britain totaled $685 million, or 12% of total revenue, in the latest quarter.
Google hedges only its profits rather than trying to exactly match revenue recouped for revenue lost through currency translation, as required under FAS 133, Pichette said.
How FiREapps Helped
Google's ability to dodge the currency bullet may have stemmed partly from its use of software as a service provided by FiREapps, which enables financial officers to see their company's total exposure to foreign exchange effects by pulling all data relevant to transactions involving foreign currencies out of a company's computerized ledger. By eliminating the need to compile that data manually, FiREapps has allowed Google to devote more time to managing its exposures, Google Treasurer Brent Callinicos said in a recent FiREapps press release.
One shortcoming of the internal Enterprise Resource Planning (ERP) systems that most companies use is that they look at transactions purely from an accounting perspective instead of an economic perspective, says Wolfgang Koester, FiREapps' chief executive. The accounting approach typically translates only the functional currency of a foreign subsidiary, such as the Brazilian real, into dollars, while ignoring the impact of a transaction the subsidiary may have done in a third currency like Chilean pesos, he says.
Other Ways to Offset Losses
Besides hedging programs, there are other ways in which companies are trying to offset foreign equity losses. Avon Products (AVP), whose fourth-quarter revenue took an 11% hit vs. the year-ago period due to foreign exchange, hopes to recoup some of that loss through its strategic sourcing program, by procuring more materials and components from fewer suppliers and sourcing on a more global basis, says Sharon Samuel, a company spokeswoman.
The fact that some currencies in the 66 markets Avon serves had been devalued 30% to 50% against the dollar in recent months will also provide room for higher prices in the future, Charles Cramb, Avon's chief financial officer, said on the Feb. 3 earnings call. "If these currency rates are structural and hold, then inflation is sure to follow in those markets," he said. That should create pricing opportunities for Avon, not necessarily as a price leader but on a lagging basis, he added.
Some companies, such as Kraft, choose to hedge only transactions done in non-U.S. currencies while leaving the translation of revenue in foreign currencies unhedged.
There's also a major misconception about hedging, says Binky Chadha, chief U.S. equity strategist and global head of FX research at Deutsche Bank (DB). It's impossible to completely hedge your foreign currency exposure over a long time horizon using rolling hedges that have to be renewed every six to nine months at the prevailing exchange rate, he says. Companies also don't know how much revenue they will earn overseas, which makes it hard to decide how much of any particular currency they need to sell forward at the current exchange rate to cover future translations back into dollars.
Sweeney at Credit Suisse believes it's often prudent for companies to manage their foreign exchange risk, but says larger pressures on company revenues from a correlated global economic downturn outweigh currency risk at this time.
But it's the short term the market focuses on, and right now, the ascendant greenback is one more irritant for U.S. firms facing a sea of economic troubles.