A Stronger Dollar Is a Double-Edged Sword

Advertisement

eurozoneA friend of mine who recently returned from a trip to Spain offered up some good news and some bad news with regard to the eurozone and more importantly strengthening of the dollar against the Euro.

The good news was his dollars had more purchasing power than at any time in his recent memory. The bad news was Spanish consumers were not buying as many American products because — guess what? — the cost of those products is higher.

Indeed, a stronger dollar — as of today, the dollar/euro value is $1.25 (compared to $1.47 last year) — is a double-edged sword:

  • A stronger dollar increases the purchasing power of U.S. consumers abroad for items like travel, leisure goods and products, while companies benefit if they decide to go shopping for foreign companies, since their purchasing power increases, too.
  • A stronger dollar reduces the competitiveness of U.S. goods sold abroad, as foreign trade partners pay more in their currency for imports, making American goods less attractively priced at the consumer and business level.

Generally speaking, a country’s currency strengthens as a result of an improving economic outlook. The U.S. dollar is the most actively traded currency in the world, and the valuation tends to presage or reflect the outlook for our economy.

However, what’s happening in large measure today is that the euro is losing ground on fears of weakness in several member countries’ economies — particularly those of Greece and Spain. In the worst-case scenario, the eurozone itself might dissolve.

In the global economy, the stakes are much higher than the cost of my friend’s paella, and the pluses and minuses of a strengthening dollar can wreak havoc on or bolster U.S. companies’ operating results. Included in those results can be some surprises for investors who aren’t plugged into the minutia of currency hedging or forward contract exposures.

Indeed, any U.S. firm doing business around the world — not just in Europe — engages in some level of strategy to offset market fluctuations in costs, one of which is currency fluctuations. And the position can, in some cases, be very material when it comes to surprises for unknowing investors.

Two U.S.-based multinationals — one in the auto industry, one in tech — provide real-world examples:

Ford

Drive through any Western European country and you will see the Ford (NYSE:F) badge all over the roads. Fords are wildly popular in Europe, and the company builds its products overseas specifically for that market, with cars that are generally smaller and more fuel-efficient than those same models offered in the U.S.

Ford’s European segment is its second-largest within the company, representing 30% of Ford’s overall auto revenues of $33.8 billion. Unfortunately, because of slower growth last year in Europe, the group lost $27 million — a huge drop-off from 2010’s $182 million in profit. Ford’s European operation incurred $427 million in unfavorable currency exchange-rate costs as part of the overall $529 million in European costs.

The bigger news in the Ford disclosure is that the company’s net value of forward currency contracts showed a liability of $236 million in 2011 against $35 million in 2010. The company acknowledged that a 10% adverse change against their position could increase the liability to $1.7 billion. Just so you know.

Cisco

In 2012, Cisco (NASDAQ:CSCO) reorganized its operations to include a European group, which now will report as a strategic entity. Servers and storage are just as critical to European company’s as those in the U.S., and Cisco is no stranger to the segment.

Cisco’s European operation has consistently represented around 20% of overall corporate sales, with $8 billion (of $40 billion) and $8.5 billion (of $43.2 billion) in sales respectively for 2011 and 2010. Cisco has a fairly benign hedging strategy in place, with virtually offsetting positions long and short in the market. Cisco also makes a point of disclosing it does not hedge monies for “trading purposes.”

With all that in mind, the company still suggests that sales can slow with a strengthening dollar, and Cisco’s outstanding notional amount of contracts outstanding stands at $2.5 billion — again, not an insignificant number.

Other Concerns

Researching outstanding currency hedging positions and obligations/exposure is a critical part of examining multinational stocks. Look through a company’s annual reports for disclosure and notes on the subject, and act accordingly.

In particular, pay attention to multinational giants like Monsanto (NYSE:MON), whose currency foreign exchange contracts put around $79 million at risk; DuPont (NYSE:DD), with 65% of its $38 billion in revenues attributable to Europe and where it operates 77 facilities; and Alcoa (NYSE:AA), which has operations in Italy, Ireland, Norway and Spain.

Marc Bastow is Assistant Editor of InvestorPlace. As of this writing, he did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2012/06/stronger-dollar-euro-double-edged-sword-csco-f-dd-aa-mon/.

©2024 InvestorPlace Media, LLC