The Currency Conversion Conundrum
Following some communication with GRIN,
some further explanation has been forthcoming
on the losses incurred by the company due to
currency conversion. There appear to be two main
forms of currency loss:
(1) The loss which happens when a weakening
currency is used, to buy product priced in a
stronger currency. For example, a US-priced product
available for CAN$1 at the beginning of 1998
cost about CAN$1.12 about nine months later. If
GRIN was selling the product for CAN$1.50 then
gross profit would decrease from 50% to about
33%. This loss was showing-up as a decreasing
gross profit through 1998 in the quarterly
earnings reports.
(2) If the product costs incurred in (1) were
paid-for by a CAN$ line-of-credit then no
further conversion loss would occur, apart from
a 12% reduction in final net earnings (continuing
the above example) when GRIN's earnings would be
stated in US$. Unfortunately, their line-of-credit
is a US$ account, so the balance of this account
was steadily inflating through 1998 in CAN$ terms
yet the ability to pay this was remaining constant
(they were receiving the same CAN$1.50 from customers
throughout the year). GRIN chose to realize this
loss at the end of 1998, so converting the apparent
net profit into a loss for the year. Had the line-of
-credit been in CAN$, I estimate the net profit
would have been around US60c (before the ARK
acquisition).
So GRIN's method of handling their currency
transactions appears to be a risky one. Why not
reduce the risk by having a CAN$ line-of-credit ?
I don't know the answer to that, but the valuation
on the company becomes clearer because of the
extreme earnings volatility caused by currency
variations - would you value a company with annual
earnings of 50c, 50c, 50c... the same as a company
earning $1, 0c, $1, 0c...? They both have the same
average annual earnings but I think the company with
the choppier earnings would trade at a discount. It's
interesting to consider what might happen this year
for a few different currency scenarios...
* CAN$ does the same as last year and steadily loses
another 12% through the year.
The result here would be another break-even
year (before any further acquisitions). This would
happen no matter how many millions of Furbys that
GRIN could sell. They could sell Hasbro's total
production and still make nothing.
* CAN$ remains fairly constant around US66c for
the rest of the year.
Assuming they do similar sales to the past
few years, then a net profit in the 50c - $1.00
range would result.
* CAN$ steadily recovers back to the old 'standard'
value of US72c.
Everything that had been working against
them in 1998 would now be working in their favor
and net profits would improve dramatically.
So an investment in GRIN has some similarity
to investing in CAN$ futures, though it would be wrong
to focus solely on this effect as changes such as the
the acquisition of US company ARK, can begin to reduce
the currency conversion dependence.
My 2c,
Frank (going/gone for Easter) |
