How Will the Dollar Impact Q2 Earnings?

Last updated 7/3/2009 10:45 AM ET (GMT -5) 7 Comments

Kathy Lien

Director of Currency Research, GFT

U.S. traders are off for the July 4 ^th holiday which means that we should have quiet trading in the forex markets. When they return on Monday, the focus will shift to earnings season as investors look for signs of improving profits to offset the pessimism following Thursday’s non-farm payrolls report. Therefore we take this opportunity to talk about the impact of currency fluctuations on second quarter profits. Many equity analysts believe that Q2 earnings will be stronger for the nonfinancial sectors because of cost cutting, the rally in equity markets, the improvement in consumer confidence, government stimulus programs and the slower pace of contraction in manufacturing indices. However, we believe that the weakness of the U.S. dollar has also played a large role in corporate profitability between April and June just as the dollar’s strength in the first 3 months of the year bit into earnings.

In the second quarter, the U.S. dollar weakened across the board. The most dramatic slide was against the Australian dollar while the least dramatic was against the Japanese Yen.

Companies that Were Hurt by USD Strength in Q1 Will Benefit from Weakness in Q2

To get a sense of which companies will benefit from dollar weakness, we should look at the companies that were hurt by the dollar’s strength in the first quarter. One of the most high profile companies that are also very sensitive to foreign exchange fluctuations is Google . Over the past few years, they have implemented hedges to protect themselves against volatility in the U.S. dollar, but they are still vulnerable. In the second quarter for example, they reported that the strength of the dollar against the Euro and British pound had an unfavorable impact on their international revenues. Had foreign exchange rates remained constant, their revenues would have been approximately $429 million or 7.8 percent higher. Their foreign exchange hedges only recognized gains of $154.1 million. Considering that the dollar only strengthened 5.16 percent against the euro and 1.85 percent against the British pound in the first 3 months of the year, we can imagine the positive impact that a 14 percent appreciation of the British pound and close to 6 percent appreciation of the euro will do to earnings. Some analysts estimate that Google, who makes more than 50 percent of their money abroad will see a 20 cent contribution to earnings purely because of FX flows. The same idea that international revenues will be translated into more dollars will apply not only to Google but many other firms with large foreign operations such as eBay and Amazon.

Beyond the technology sector, another good example is McDonald’s who said that the dollar’s strength shaved earnings by $0.08 a share in the first quarter. To explain this further, imagine that McDonald’s sell Big Macs in the U.K. for 2 British pounds at a GBP/USD exchange rate of 1.80. For U.S. based McDonald’s, that would mean revenue of $3.60 per Big Mac. Suppose that the British pound weakens 20 percent, bringing the GBP/USD exchange rate down to 1.44. The 2 British pounds that they charge for each Big Mac now equals revenue of only $2.88 instead of $3.60. Compound this by millions of Big Macs sold abroad and you understand how a strong dollar can hurt a company like McDonald’s. The dollar’s weakness in Q2 however should lead to higher rather than lower profits. In their Q1 results, they projected that currency translation would cut second and third quarter earnings by $0.11 per share and now there is a decent chance that it will contribute rather than take away from earnings.

The list goes on and on. Burger King reported that in Q1, currency exchange fluctuations negatively impacted earnings by $0.03 a share. Guess, the clothes retailer, announced that profits dropped severely by 32 percent, leaving the decline in international revenue partially to blame on the strong dollar. Constellation Brands showed a similar result, with sales falling 15 percent. Each company partially attributed their weaker profits to the dollar’s strength.

Types of Companies that will be Impacted by Dollar Weakness

Let us delve into this idea further as not all companies will be impacted by the dollar in the same way. Here is a breakdown of the companies that will be positive and negatively impacted by dollar weakness.

Who benefits from Dollar weakness?

1. Exporters who sell a lot of goods abroad because a weaker dollar allows them to record greater profits or reduce prices

2. Companies with foreign operations because sales revenue generated in a foreign currency will be translated into more dollars.

3. Companies with accounts receivable in foreign currencies because when the payments are made, they will be worth more dollars.

Who is hurt by Dollar weakness?

1. Companies that import a lot of things such as raw materials from abroad

2. Companies with accounts payable in foreign currencies because when the payments are made, it would require more dollars

In general, the industries with the greatest foreign sales exposure are energy, technology and consumer staples. Companies that produce commodities could also benefit as the weaker dollar drives commodity prices higher.

We have only looked at how the dollar behaved against the majors and even though a 16 percent rally in the Australian dollar is significant, it is also important to point out that in the third quarter, the South African Rand rose 23 percent while the Brazilian Real rose 19 percent. For companies in Australia, South Africa and Brazil, a strong currency could pressure earnings and stifle the recovery. If you only trade currencies, stronger earnings in the U.S. could lift equities, which would boost risk appetite. If you trade equities, you can watch currency fluctuations to gain an edge in forecasting earnings but it will be important to take into consideration the company’s business structure. Next week we start off with earnings from Alcoa, a Dow component followed by the financials and IBM the following week.

Comments (7)

Qin

July 03, 2009 at 11:53 AM ET

Hey, Kathy
Thanks for the information.
According to your article, is this mean that stock may rise by the earning report which will weaken US dollar?
Because weaker US dollar is good for most of the companies in US.
Many traders are talking that S&P will break 880 and go to reach 800 this year. Do you believe this prediction?

Best regards
Qin

klien

July 06, 2009 at 08:29 AM ET

In a nutshell, yes. When earnings are released and if they are good. It would most likely be bullish for stocks and bearish for the dollar

Qin

July 03, 2009 at 12:01 PM ET

Hey, Kathy
What do you think about bank sector? Will the earning reports be positive or negative?
Any kind of idea will be fully appreciate.

Best regards
Qin

jet

July 05, 2009 at 09:02 AM ET

i don't see any break out in the equities markets anytime in the near future - weekly stochs are overbought and turning down in the nasdaq, dj and the s&p - the dj and s&p have been rejected from their 200 day exponential moving averege and although the nasdaq did break through it appeareas to have done so with bearish divergence and appears to be turnning down as well. The 4 hour studies seem to confirm the equities markets are turning down as well Hourly studues have reached oversold territory so i woukd not rule out a bounce however I would expect selling into those rallies as all the equities are below the 200 hour ema's which is also turning down - I would expect more dollar strength in the days and weeks ahead. Anyway that's what i see i would love to hear what you think. Thank you.

klien

July 06, 2009 at 08:33 AM ET

Technically, the major marubozu candle that we have in the Dow and S&P is very bearish, but we have some very decent support at 8250 at 880 respectively. So you can be right ST and I can be right long term =)

jet

July 05, 2009 at 09:03 AM ET

i don't see any break out in the equities markets anytime in the near future - weekly stochs are overbought and turning down in the nasdaq, dj and the s&p - the dj and s&p have been rejected from their 200 day exponential moving averege and although the nasdaq did break through it appeareas to have done so with bearish divergence and appears to be turnning down as well. The 4 hour studies seem to confirm the equities markets are turning down as well Hourly studues have reached oversold territory so i woukd not rule out a bounce however I would expect selling into those rallies as all the equities are below the 200 hour ema's which is also turning down - I would expect more dollar strength in the days and weeks ahead. Anyway that's what i see i would love to hear what you think. Thank you.

jet

July 06, 2009 at 08:29 PM ET

;-) excellent point thank you!

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.