August 18, 2011
Forex Markets Are Moving Companies
With flagging growth and the sovereign debt crisis, European companies have no shortage of things to worry about right now. An extra headache: exchange rates. Dollar and euro weakness is hitting earnings at companies from big miners to Swiss watchmakers. That is provoking some to rethink where in the world they should operate.
The forex problem is large, but firms' responses vary. Miners Rio Tinto, Xstrata and Anglo American took a combined $2.1 billion hit to first-half earnings—equivalent to 16% of the total—thanks to the strength of currencies like the Australian dollar. Yet these companies don't bother to hedge their exchange rate exposure, because rising commodity prices usually offset the adverse impact of strong currencies in countries where minerals are extracted. They also fear that they will not be rewarded for hedging that works, but will be castigated if it goes wrong.
Other industries face a far more pressing problem. Take multinational Swiss companies, which earn much of their revenues in dollars or euros, but pay production costs in francs. Watchmaker Swatch fears the franc's strength this year could knock CHF1 billion ($1.26 billion) off its CHF7 billion revenue target. Confectioner Nestle saw its first-half earnings rise 5.2% year-on-year in local currencies, but fall 8.5% when those earnings were translated back to francs.
Finding the right strategy to combat sheer currency moves isn't easy. Companies can use derivatives to protect their earnings against future fluctuations. But knowing how much to hedge is tricky, especially in uncertain economic times when companies find their own profits hard to predict. Moreover, accounting rules that force companies to reflect changes in the market value of derivatives used for hedging in the profit and loss statements can add to earnings volatility.
Corporate treasurers are making greater use of currency options as a hedging tool; they accounted for 22% of average daily foreign exchange turnover in London by non-financial companies in the six months to April, according to Bank of England data, up from 11% in the previous six months. Still, that involves paying often-expensive upfront premiums to banks.
Moreover, companies' best hope of mitigating currency risk is making longer-term changes. Swiss companies, such as chemicals-makers Lonza Group and Clariant, are considering moving production facilities outside of Switzerland, so that their revenues and costs are better-matched. Aircraft-maker EADS says it is seeking acquisitions in the US to lessen the problem it has of selling products in dollars but paying manufacturing costs in euros. As the currency markets get tough, some in Europe are getting going.
http://online.wsj.com/article/
