April 29, 2007
British firms shrug off weak dollar
The American currency’s fall is likely to hit the earnings of the biggest British companies. But the picture is complex, writes Ben Laurance
IT seems like a lifetime ago – the Social Democratic Party (SDP) was born; Harrison Ford was drawing in the crowds in the film Raiders of the Lost Ark; and the Tweets made it to No1 in the British charts with The Birdie Song. And one pound sterling would buy more than two dollars. The year was 1981.
The SDP was to die a quiet death in 1988. Harrison Ford went on to make dozens more films – and will this year celebrate his 65th birthday. Mercifully, The Birdie Song, voted the worst record of all time in a BBC poll, is now rarely heard.
But in the past couple of weeks the pound has climbed back above $2 for the first time in more than a quarter of a century.
Sterling’s new bout of strength has prompted a string of newspaper stories about the joys of shopping in Manhattan; why pay nearly £170 for an iPod in London when the New York price, converted from feeble dollars, is less than £120?
But for corporate Britain, the decline of the dollar is rather more serious. Many big, quoted companies make their money in dollars, so if those dollar profits are worth less when translated back into pounds, then reported corporate earnings should, in theory, suffer. And for companies exporting from Britain, selling goods in overseas markets where their competitors’ costs are in dollars, any fall in the American currency makes it harder for British firms to achieve sales without sacrificing profit margins.
A weak dollar hurts – doesn’t it? In fact, the picture is more complicated. Ian McCafferty, the CBI’s chief economic adviser, said: “The rise in sterling is a two-edged sword, particularly if the strength continues.
“Metals, oil and many other commodities are priced in dollars and will become cheaper for British businesses. It will, however, put pressure on exporters, though businesses have lived with a strong pound for the past few years.”
Research by Citigroup shows that there have been nine years since 1980 when sterling appreciated by more than 5%. So earnings growth in those years should have been hit by the dollar’s weakness. But what actually happened? Average earnings growth in those nine years was 11.9% – significantly higher than the annual average of 8.1% between 1980 and 2006.
This seems curious, given that such a large slug of British business relies on American sales. Among the 350 largest UK-quoted companies, about 22% of their sales are reckoned to go to America. A further 11% of sales are accounted for by countries where the currency is closely tied to the American dollar – in South America, Asia and the Middle East.
Exposure to the United States varies enormously by sector. British electricity companies, general retailers and tobacco manufacturers have virtually no sales in America. At the other end of the spectrum, America accounts for nearly half the sales of pharmaceutical companies. For aero-space, the proportion is almost as high. For British-quoted media companies, America accounts for almost a third of sales.
Of course, this is a crude measure. For example, less than 10% of sales by quoted British mining companies are in America, yet most of their output is denominated in dollars. Similarly, the output of oil companies is sold in dollars, wherever in the world they operate.
Nevertheless, the exposure of some companies to the American market is striking. The oil and gas company Hunting gets more than 90% of its revenues from America. For companies as diverse as Tomkins, Ashstead, Wolseley, Bunzl, Regis, Shire, Signet, Amvescap and Pearson, the proportion is well over 60%.
So for these companies, does a weak dollar mean bad news? The calculation is not simple. Pearson chief executive Marjorie Scardino, speaking at the company’s annual meeting last Friday, pointed out the impact on her business.
“Each five-cent change in the average sterling-dollar exchange rate for the full year would have an impact of approximately 1p on adjusted earnings per share,” she said.
For most companies with big dollar exposure, there are complications. It is not just sales that are denominated in dollars; in many cases, costs are too. So although there may be a “loss” when dollar profits are converted into sterling, underlying profits are not necessarily hit by a fall in the greenback.
And many large companies hedge their currency exposure to protect themselves against the sort of upheavals seen recently. Eventually, of course, these hedges will expire. And if the dollar stays low then, eventually, the impact of a shift in the relative values of currencies will be felt. But at least the pain can be delayed.
For companies quoted in Britain, the most striking differences are between large companies and small. For FTSE 100 companies, excluding financials, only
30% of sales are in Britain. UBS calculates that for the FTSE 250, 66% of their sales are in Britain – only 13% of their revenues come from North America.
So for investors seeking to insulate themselves from the vagaries of the dollar, the message is pretty clear: keep away from the largest companies.
For investors in the FTSE 100, the relationship between the level of the dollar and reported earnings is complex but perceptible. Equity strategist Neil Cherry from UBS said in a recent report: “With about 45% of aggregate net earnings for FTSE 100 companies reported in the American currency – nearly all of the resources stocks report in dollars as well as other mega-caps such as HSBC and Astra Zeneca – broadly speaking, a four-cent rise in the cable rate [sterling to the dollar] takes about 1% off future aggregate earnings for the index.”
This month’s reemergence of a $2 pound marks an important point in a trend that has been under way for five years. In early 2002, it took less than $1.50 to buy £1. Then the dollar began its slide. In 2006 alone, it fell 14%.
And so far, there are no signs of distress in the British manufacturing sector. The Confederation of British Industry’s latest monthly report showed that order books are as strong as they have been for a decade.
The dollar’s weakness isn’t hurting too much – for now.
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