European Aerospace Earnings Seen at Risk From Dollar Weakness

European aerospace and defense companies from Rolls-Royce Holdings Plc to Finmeccanica SpA face an increased risk to earnings as the dollar weakens against the euro and pound, according to industry analysts.

Dollar weakness “has probably created the biggest single macro risk to our positive stance on the European commercial aerospace stocks,” Ben Fidler, a London-based analysts at Deutsche Bank AG said in a note today. “Share prices could be vulnerable if current U.S. dollar weakness were to be sustained or worsen further.”

European commercial aerospace companies are exposed to dollar swings with most of their revenue generated in the greenback while costs are accrued in local currency. The dollar slid to a two-year low against the euro last week amid concern that U.S. growth was hampered by a government shutdown earlier this month. Companies such as Airbus-parent European Aeronautic, Defence & Space Co. and Zodiac Aerospace SA use hedging contracts to protect against exchange-rate volatility.

“The level of unhedged open exposure is the highest for Zodiac,” Fidler said. “Safran and Rolls-Royce due to their high hedging levels have the least short-term earnings sensitivity” to exchange rate changes.

Defense companies, which generate a large portion of sales from the Pentagon, also face pressure as they repatriate profits. Finmeccanica has the largest impact linked to its U.S.- based DRS Technologies Inc. unit, UBS analyst Charles Armitage said in a note today.

Hedged Positions

Sustained dollar weakness may also affect companies with large hedging positions, such as EADS and Rolls-Royce, Armitage said. “In the long term, Rolls-Royce has the largest fundamental impact, with 1 cent moving the fair value by about 8 pence per share,” he said.

EADS, Safran SA, and MTU Aero Engines Holding AG are at risk from a strong euro as dollar hedging positions unwind, Armitage said.

EADS’s hedge portfolio stood at $82.1 billion at mid-year with an average hedge rate of $1.36 per euro for the last six months, according to the company.

The dollar gained 0.1 percent to $1.3768 per euro at 1:30 p.m. in London after falling to $1.3832 on Oct. 25, the lowest since November 2011.

Rolls-Royce, which sees a 10 million pound ($16 million) impact on profit from a 1 cent movement in the dollar against the pound, had a hedge book of $26.7 billion at an average rate of $1.59 as of June 30.

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