November 25, 2007
The dwindling dollar takes toll on Europe
Strong pounds and euros are great for shoppers, but at what cost? Dominic Rushe and James Ashton
AT the Dubai Air Show this month Airbus secured the largest single aircraft order in history. The 80-plane deal with the Emirates airline is worth about $20 billion (£10 billion) and adds to an estimated $82 billion backlog for the European manufacturer this year.
The order should have been the crowning achievement in a fantastic year. Airbus has been flying high in 2007 on orders for the A380, the biggest passenger plane in the world, and praise for the soon-to-be launched A350. Before Dubai the European giant had already won more than 1,000 orders and pulled ahead of its rival Boeing in the sales race.
But even as Airbus heads for a record-breaking year, its profits have gone into a tailspin, dragged down by the weakness of the US dollar. It’s a story that is worrying executives and investors on both sides of the Atlantic.
The weakness of the dollar may be great news for the European shoppers heading for New York but it is “life-threatening” for Airbus, its chief executive, Tom Enders, told employees in Germany. “The dollar exchange rate has gone beyond the pain barrier,” he said.
Most of Airbus’s expenses are in euros, but aircraft are sold in US dollars. For every 10 cents that the greenback falls against the euro, Airbus loses a billion euros in unfavourable foreign exchange. On Friday the euro was worth $1.48, up from $1.35 at the beginning of the year.
Analysts are predicting that it will head to $1.50-$1.60 in the coming months.
Not all Airbus problems are dollar denominated. Airbus’s parent company, EADS, is in the throes of a huge restructuring, including plans to slash 10,000 jobs and to shut down or spin off six factories.
It recorded a third-quarter loss this month of €776m (£559m) after incurring bigger-than-expected costs in developing its A400M military transport plane and running over budget and behind schedule on the A380, which was delivered nearly two years late.
But of all Airbus’s problems the weakness of the dollar is the greatest, according to Enders, and its record number of orders will be accompanied by “tremendous losses”, he said. Yet more severe cost-cutting measures will be taken.
Nick Nelson, European equities strategist at UBS, said the weakness of the dollar had started to take its toll in European company results. His research of third-quarter earnings found that in Europe there were fewer positive earnings surprises relative to expectations compared with the US. The trend was particularly noticeable in currency-sensitive sectors like capital goods, pharmaceuticals and IT hardware.
“We are starting to see some signs of stress in the more obvious places, such as automakers. Porsche and BMW have referred to it as an issue,” said Nelson.
Airbus’s woes were echoed by the Daimler chief Dieter Zetsche, who said that the company would struggle to reach its targets under present conditions.
The dollar is out of favour with investors and with countries such as China and Russia, which are increasingly looking for investments outside the US currency. Even celebrities have turned their backs on the once all-powerful dollar. Gisele Bünd-chen, one of the world’s highest-paid models, managed the unusual feat of combining capital markets and high fashion this month when it was revealed that she now won’t get out of bed for dollars ? preferring payment in euros. Mega-rich rapper Jay-Z captured the zeitgeist in his latest video by waving wads of euros.
The euro, the pound and other currencies have been climbing steadily against the dollar since August when the sub-prime mortgage crisis triggered a melt-down in the credit markets. On Friday speculation that Ben Bernanke, Federal Reserve chairman, would soon cut interest rates in an effort to boost the US economy led to further falls in the exchange rate.
In his last speech to Congress, Bernanke seemed more concerned with the slowing US economy than with inflation, a sign many read as pointing to further rate cuts.
For the past week the euro has been hitting new highs daily as investors transfer funds to countries where they can earn higher returns. As Airbus has shown, the shift in currency power is now at a level that has European businesses and governments worried.
In a television interview last week the German chancellor, Angela Merkel, said: “We are pleased that Europe has a strong currency, but this obviously also creates problems for exports.” Nelson said there were a number of methods companies had used to try to tackle the problem, but they had their weak-nesses. “Currency hedging in most cases is just postponing the problem rather than solving it,” he said. European companies had already begun to offset the dollar weakness over the past few years with increased outsourcing and offshoring ? but “there is only so much outsourcing you can do”.
For companies with the right business model, exposure to the dollar isn’t necessarily a bad thing, said Numis analyst Lorna Tilbian. She said that media firms Pearson, Reed and Thomson were among the most resilient in their sector, despite doing most of their business in dollars.
Pearson, the education and publishing company, generates about two-thirds of its sales in America and, according to its last trading statement, each five-cent change in the average pound/ dollar exchange rate for the full year would have an impact of about 1p on adjusted earnings per share.
Tilbian said the strength of the dollar was not her major concern with the company. She would be more concerned if the companies were heavily exposed to the debt markets or the UK consumer. “We can live with the dollar exposure. It’s a lesser of all evils,” she said.
That “evil” looks likely to continue for some time, said James Hughes, an analyst at CMC Markets. “It’s unbelievable,” he said.
For a long time the dollar seemed to have a support at $1.96 to the pound and rarely broke through that level, but now the brakes are off it is hard to see how low the dollar can go, Hughes said.
“The credit crunch is still really dragging on the market and I think it’s having a bigger effect than most people realise,” he added. On top of that, rate cuts expected from the Federal Reserve, the Bank of England and the European Central Bank are likely to put further downward pressure on the dollar.
“Predicting the bottom is very hard. I can’t see an end to it. It doesn’t look like there is anything holding it up,” Hughes said.
“I’m going to New York in the next couple of weeks so, as long as it continues until then, I’ll be all right.”
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