3 Ways To Win If The Dollar Falls
#-ad_banner-#As countless companies have noted on recent conference calls, the surging U.S. dollar is creating a strong challenge for U.S.-based multinationals. It has risen roughly 12% against the euro since the fourth quarter of 2013.
Companies with strong revenue overseas post lower sales when the foreign currencies they are holding are translated into dollars (i.e. it takes more of the currency to equal one dollar). Of the 11 companies in the Dow 30 that break out revenue from Europe, eight reported a year-over-year decline in fourth quarter sales, thanks to currency impact.
Adding insult, foreign rivals are having an easier time selling goods and services in the United States, thanks to their weaker currencies.
The bad news continues: among the 105 companies that warned the market of disappointing earnings ahead of the official Q1 release, 69 of them pointed to the stronger dollar as a key factor.
As this chart shows, a rising number of U.S. companies have deep exposure to foreign markets.
A simple way to gauge the dollar fallout: Companies that derived 90% of their revenue from within the United States saw shares jump by 13% (in the six months ended February 2015), according to research by fund company WisdomTree. On the other hand, firms that booked less than 60% revenue domestically saw their stocks rise less than 1%.
Yet even as investors have braced for the worst, we may soon be looking at a dollar reversal, which could greatly alter the profit picture at many firms.
The upside could be especially strong in one sector, in particular, along with a pair of globally-focused consumer stocks.
The Greenback Losing Some Green
The dollar has already come down off of its March high, and economic factors could push the dollar even lower over the rest of the year.
The reason behind a potential reversal is simple: The U.S. economy slowed in the first quarter, in part due to a 7% drop in exports. That shows the strong dollar is having an impact.
Meanwhile, in Europe, signs are emerging that the central bank’s massive $1 trillion monetary program may be working. The eurozone manufacturing purchasing managers’ index (PMI) for April came in at 52 (any reading above 50 signals expansion). The European Commission recently upgraded its forecast of economic growth to 1.8% for the year and to 2.1% for 2016.
Weak U.S. growth has put off fears of a Federal Reserve interest rate hike until later. And increasing bond yields in Europe and abroad has meant less demand for dollars from foreign investors. Continued weakness in the dollar could trigger unexpected profit gains when quarterly results are announced in July.
One Sector And Two Stocks To Win From A Weaker Dollar
Among the potential beneficiaries of a weaker dollar, the energy sector stands out as a clear favorite. This sector has been reeling since last summer, thanks to both a drop in oil prices and a reduction in foreign-sourced earnings (thanks to the weaker dollar).
As oil is a dollar-denominated commodity, it has moved in an inverse fashion to the dollar. That’s because foreign buyers have reduced purchasing power. A look at the performance of the Energy Select Sector SPDR ETF (NYSE: XLE) against the dollar index shows the extent of this correlation.
The price of a barrel of West Texas Intermediate, the U.S. oil benchmark, has jumped 27.5% from the first day of the second quarter against a 3% drop in the dollar index. This upside to oil prices could lead to surprisingly stronger Q2 sales and earnings, especially as companies in this sector rushed to cut expenses over the last two quarters.
Beyond energy, investors may want to look at other companies that have been hit hard by the dollar’s uptrend.
Colgate-Palmolive Co. (NYSE: CL) derives 82% of net sales outside of North America and 20% from Europe alone. The company reported a 6% negative impact from currency in the fourth quarter, partially offset by 3% volume growth and 2% pricing growth.
Organic growth of 5% beat average industry growth of 3%. The company could see a very strong quarter if a drop in the dollar actually adds to sales. Sales declined 10% in the first quarter on currency impacts, but grew 4% in currency-neutral terms. The street is expecting earnings of $0.70 per share, 4.1% lower compared to the year-ago quarter, on a 6.7% drop in sales.
The Priceline Group, Inc. (Nasdaq: PCLN) pre-announced weaker-than-expected Q1 results, thanks to the dollar. The online travel firm derives 90% of its business internationally.
Thanks to the tepid near-term view, shares of Priceline have fallen roughly 10% from their all-time high. Forward guidance was predicated on a still-strong dollar, but incipient dollar weakness could translate into better-than-expected second-quarter results. Not only will the company benefit from a weakening dollar, but stronger global economic growth would support sales.
Analysts expect second quarter earnings to drop around 3%, on a 6.4% sales increase, compared to the same period last year. Nineteen analysts have downgraded current quarter earnings expectations over the last 30 days. Yet a surprise beat on sales, due to a weaker dollar, could send the shares significantly higher when Priceline reports results in early August.
Risks To Consider: The massive central bank monetary programs in Europe and Japan will limit appreciation of the yen and euro. The dollar may experience brief increases in value on stronger economic data, but should weaken over the quarter.
Action To Take –> Position in solid companies that have been affected by the surge in the dollar for a surprise upside on second quarter earnings. Companies like Colgate-Palmolive and Priceline as well as those in the energy sector stand to profit from dollar weakness.
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