Strong dollar tipped to hurt earnings

A STRONGER-than-expected Australian dollar will hit the earnings growth of some of the country's biggest companies in the next two years, a new report says.

By InvestSMART · 14 Feb 2012

By InvestSMART ·
14 Feb 2012

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A STRONGER-than-expected Australian dollar will hit the earnings growth of some of the country's biggest companies in the next two years, a new report says.

Goldman Sachs sharply revised its estimate for the dollar upwards, saying that as concerns diminish about the global economy, the currency will hover at US108? for the rest of the year. Goldman had previously predicted the local currency would be worth US103? by December.

It said if the dollar remained high, companies in the industrial sector would take a hit to earnings in the next few years.

Goldman Sachs analyst and author of the report, Chris Pidcock, said the stronger dollar would cause the earnings before interest and tax for industrials stocks to fall by between 1.2 per cent to 1.3 per cent, in both 2013 and 2014. That means net profit could fall by close to 1 per cent.

"The Australian dollar received a positive fillip from easing global tail risks, a less-worrying outlook for Chinese growth and slower-than-expected progress in the domestic [interest rate] easing cycle," the report said.

"Against this backdrop, our base case is for the dollar to track around US108? throughout 2012 ... we therefore expect ongoing negative earnings per share revisions to Australian companies."

Paper and packaging firms, healthcare, general insurance and chemicals firms are singled out as those most at risk. Developers and contractors are also at risk.

The report also found fears about the state of the global economy had had a greater influence on stock prices in the past four years than movements in the Australian dollar.

Looking at stocks with the strongest correlation to movements in the dollar, the "key driver" of share prices in recent years had been concerns about macro-economic conditions, the report said.

It found a high proportion of stocks with no exposure to currency movements, including companies such as CSL, Telstra, Coca-Cola Amatil, Westfield Group, ResMed, and Woolworths, had a negative correlation to rises and falls in the dollar compared to the greenback.

It singles out Woolworths as an example of a company that will be "sold down" when the dollar strengthens, as investors get rid of defensive stocks to buy riskier ones.

Conversely, the report found share prices for resource stocks had had a positive correlation with movements in the dollar, despite the negative impact a stronger dollar had on their earnings.

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Frequently Asked Questions about this Article…

How will a stronger Australian dollar impact company earnings?

Goldman Sachs warns a stronger-than-expected Australian dollar will hit earnings growth for some of the country’s biggest companies over the next two years. Their report forecasts industrials’ earnings before interest and tax (EBIT) could fall about 1.2–1.3% in both 2013 and 2014, with net profit potentially down close to 1%.

Which sectors are most at risk from a strong Australian dollar?

The report singles out industrials and several specific sectors as most at risk: paper and packaging, healthcare, general insurance, chemicals, and also property developers and contractors. These groups are more likely to see negative earnings revisions if the dollar stays high.

Which well-known ASX companies showed a strong negative correlation to moves in the Australian dollar?

Goldman Sachs found a number of companies with little exposure to currency movements that nevertheless have a negative correlation with the dollar, including CSL, Telstra, Coca-Cola Amatil, Westfield Group, ResMed and Woolworths.

Why might defensive stocks like Woolworths be sold down when the Australian dollar strengthens?

The report uses Woolworths as an example: when the dollar strengthens investors may rotate out of defensive stocks and buy riskier assets. That selling pressure can push down prices of traditionally defensive names even if they have little direct currency exposure.

How high does Goldman Sachs expect the Australian dollar to trade?

Goldman Sachs revised its view upward and said its base case is for the Australian dollar to track around US108 (about US$1.08) for the rest of the year, compared with an earlier forecast near US103 (about US$1.03) by December.

How do resource stocks respond to moves in the Australian dollar?

Interestingly, the report found resource stocks have shown a positive correlation with movements in the dollar: their share prices have tended to move with the currency even though a stronger dollar can still have a negative effect on their earnings.

Has the Australian dollar or global economic concerns been the bigger influence on Australian share prices recently?

Goldman Sachs found that over the past four years fears about the global economy had a greater influence on stock prices than movements in the Australian dollar. For stocks closely tied to the currency, macroeconomic concerns have been the key driver of share-price moves.

What practical steps should everyday investors take after this report on a stronger Australian dollar?

The report suggests investors should be aware of possible negative earnings-per-share revisions for exposed sectors (industrials, paper and packaging, healthcare, insurance, chemicals, developers/contractors). It also highlights that defensive names may be sold during a stronger-dollar phase while resource names may track the currency — so reviewing sector exposure and earnings sensitivity to the AUD could be a sensible first step.