Rudi's View | Jul 26 2007
This story was first published two days ago in the form of an email sent to registered FNArena readers.
By Rudi Filapek-Vandyck,
Editor FNArena
For the first time in years the major earnings reporting season in Australia is preceded by a clear negative trend in securities analysts’ expectations. The main culprit is, of course, the rising Australian dollar, or more accurately: the weakening US dollar.
The US dollar has again come under downward pressure recently as more negative media headlines about the US housing market, sub-prime mortgage loans and Collaterised Debt Obligations (CDOs) have spooked international investors. In addition, the US Federal Reserve is believed to be on hold, which is a further negative as central banks in Europe, Japan, China and Australia are likely to increase interest rates further.
To make matters worse for the greenback, the long mooted asset diversification by central banks in Asia is believed to have started with governments of China and Singapore this week agreeing to invest billions in UK based investment bank Barclays. As major oil producers are believed to already invest most of their US dollar profits in alternative assets throughout Asia and the Middle East it would seem there is but a clear case for further US dollar weakness in the year ahead.
How high will the Aussie dollar go? Forex experts believe the currency appears ripe for a downward correction in the short term after running above US88c in the past week. But beyond this (potential) short-term pull back US90c is widely regarded as a genuine possibility. Several experts see the Aussie move higher still. US95c might be possible, they believe. Even reaching parity with the US dollar, depending on how the US housing crisis will pan out, no longer seems as fanciful as it used to be.
Such developments will have a significant impact for investors in the Australian share market with most large corporations also operating outside the country. These companies all bear currency risks, though not all in the same manner and not all to the same degree. Most banks and locally operating retailers should be net beneficiaries as they either carry no currency risks (or very small risks) or as their margins stand to benefit through cheaper product purchasing costs.
Nevertheless, if the Australian dollar moves into the US$0.90s as experts believe it will, and with most securities analysts still working off a currency estimate of US81-82c, the matter is bound to gain centre stage during the upcoming results season, and most likely for a long time beyond it.
Assuming the Aussie remains above US90c in the months ahead, the impact on company profits is estimated at circa 5% for those that are relatively insulated to up to 30% and more for others. Amongst the worst hit will be paper manufacturer PaperlinX (PPX) with an estimated bottom line impact of 4-5% for every cent the Australian dollar appreciates against the US dollar.
Oil and gas producers Woodside Petroleum (WPL), Oil Search (OSH) and Santos (STO) will also noticeably feel the brunt of a stronger Aussie, as well as oil refiner Caltex (CTX). Many resources companies will be among the hardest hit as well. Mineral sands miner Iluka (ILU) often resides at the top of stockbroker’s “to avoid” list with an estimated earnings impact of some 12% for every cent of extra strength for the Aussie against the US dollar.
Iluka is in the unenviable position of paying most of its costs in Australian dollars while nearly all of its revenues are in US dollars. This causes a double-whammy effect.
Other miners with a large currency exposure include Zinifex (ZFX), Alumina (AWC) and Portman (PMM) while industry heavyweights BHP Billiton (BHP) and Rio Tinto (RIO) won’t be unaffected either. (A cynic might argue that if iron ore prices only go up by 10% next year and the Aussie does move beyond US90c the bottom line gain for both giants will be effectively zero. If costs move up further the net effect might even be negative).
While it is true that most resources companies operate with a natural hedge in that a weaker US dollar tends to go hand in hand with higher prices for spot market commodities such as copper, nickel and lead (as well as for oil and wheat and others), investors better not overlook the potential impact from rising costs.
Arguably, the local stock market has already responded to the rising Aussie dollar through further weakness in share prices of companies such as James Hardie (JHX) and ResMed (RMD). Some strategists have already argued these companies have been treated too harshly (especially since the currency impact for James Hardie is seen as negligible).
Investors looking for opportunities among such victims of a currency-led underperformance better ask themselves two questions:
1.Are there any other reasons that may be co-responsible for the share price weakness?
2.Is the Aussie likely to rise further (and therefore cause a greater negative impact)?
In the case of James Hardie there’s still the possibility of more negative developments in the US housing market while ResMed shares seem to suffer from uncertainty about the precise impact from increased price competition in the company’s US market.
A full share price recovery for stocks hit by currency angst would seem rather unlikely as long as the market believes there’s still a genuine chance the Australian dollar might strengthen further in the foreseeable future.
Amongst the winners from a further strengthening Aussie dollar are transport companies, such as airlines, as their costs become relatively cheaper. Goodman Fielder (GFF) is regarded a noticeable beneficiary (through cheaper input costs). Coca-Cola Amatil (CCL) is regarded a net-beneficiary as well, but to a minimal extent only.