FX swings knock company earnings
Companies’ financial results have revealed the impact of unprecedented currency volatility on revenues and is a running theme this year, say analysts, emphasizing the need for a flexible hedging policy.
The surprise outright Conservative win in the UK election has boosted the pound against the dollar – meaning that some UK companies’ earnings are worth less due to their exposure to the exchange rate and might be used as a reason to talk down earnings ahead of their results.
We typically find they are more likely to blame FX on the way down than thank it on the way up
This week budget airline easyJet published its half yearly report for the six months to the end of March 2015, reporting revenues of £1.8 billion and a profit of £7 million. The impact of foreign-exchange volatility is notable – the airline reported an £18 million gain from exchange-rate movements alone.
The figures show that a weakening euro resulted in a £35 million loss on revenues generated in euros, but this was more than offset by a gain of £50 million on costs incurred in euros and a £6 million gain on the purchase of fuel.
Easyjet says the effective US dollar rate had “slightly weakened” from the prior half year from $1.58 to $1.60, generating the £6 million gain.
However, the story is different for US companies, who have had to contend with a strengthening dollar and warn it will impact their earnings figures.
“Retail companies are usually most vocal about currency costs,” says Howard Silverblatt, senior index analyst at S&P Dow Jones Indices. “It impacts them almost immediately.”
Luxury jeweller Tiffany and US fast-food chain McDonald’s, among others, have complained of the dampening effect of a stronger dollar, citing weaker sales and the impact of currency translation, when converting revenues in foreign currencies back into the dollar.
“Larger companies do hedge their costs somewhat,” says Silverblatt. “[But smaller companies] that don’t have global operations make extra dollars when the currency goes with them; when it goes against them they have to absorb it.”
A surprise currency gain can easily reverse – easyJet estimates that currency movements will have an “adverse impact” for the full year – highlighting the need for a hedging policy.
Some companies can take advantage of heightened volatility in the currency market by using a flexible hedging policy. Jaguar Land Rover is one such company that has the flexibility with its five-year hedging programme to make tactical trades, where appropriate, when rates have moved favourably, according to its treasurer.
The big story now is cable (GBP/USD), says Sebastian Jory, strategy and stock selection analyst at investment bank Liberum.
The UK pound has steadily strengthened against the dollar from a low of 1.46 in April to around 1.57 today, in light of an outright Tory win in the general election, which removed the threat of a hung parliament.
The Tory win, favourable production numbers and a slight shift from the implied date of the first UK rate rise from early December to late January 2016 all helped cable break out of the 1.45 to 1.55 range.
It is important to figure out which stocks carry downgrades, says Jory. Analysts periodically review their estimates once a quarter and update the spot rate, so if it has moved from the previous quarter, it tells them which stocks have hidden upgrades or downgrades.
Companies that export to the States will have dollar earnings, which are now worth less in pounds.
“This is amplified in, for example, mid-cap technology companies which have costs in pounds but revenues in dollars,” says Jory.
“This may not be reflected in the pricing yet, especially in small to mid-sized companies where we tend to find a longer lag between the FX move and ensuing changes to estimates.”
Liberum published research earlier this week to identify FTSE companies vulnerable to the sterling rally, by screening for USD earners and estimating their implied sales downgrade after the 5.2% rally in cable seen since mid-March.
Stocks that are at risk of an FX downgrade include FTSE 100 names such as Ashtead, Pearson, Bunzl, Wolseley and Compass. These companies should have seen a larger downward revision, if based purely on FX, according to the Liberum research, as should a number of FTSE 250 and FTSE Small Cap companies.
Affected industries include technology, capital goods, industrial, chemicals and some media conglomerates, says Jory.
“Another thing to watch out for is companies using the GBP strengthening as a reason to talk down their earnings in the run up to results season,” he says. “We typically find they are more likely to blame FX on the way down than thank it on the way up.”