The weak dollar will finally start showing up as a plus in company earnings in the fourth quarter.
It’s been one of the puzzles of recent quarters how a falling dollar could hurt earnings at U.S. companies with big overseas sales such as McDonald’s (MCD), PepsiCo (PEP), and Proctor & Gamble (PG). In the third quarter each of these companies has noted that “currency effects” had resulted in hits to reported revenue of five, six, seven, or more cents per share.
So what’s going on? A weaker U.S. dollar is supposed to help the reported revenue and earnings for companies like these. When sales in Euros or baht or yen are translated back into dollars, a weak dollar turns them into more dollars.
And the dollar has certainly been weak in 2009. The U.S. dollar has fallen against the Dollar Index of the euro, pound, yen, Swedish krona, Canadian dollar and Swiss franc by 6% this year.
So how is it possible that the dollar cut 22 cents off McDonald’s earnings in the first nine months of 2009?
Because, like earnings themselves, the gain or loss from currency effects is a year to year comparison. So the gain or loss in the dollar from the beginning of the year is irrelevant when it comes to reporting earnings. It’s the change in the dollar from the third quarter of 2008 to the third quarter of 2009, from the second quarter of 2008 to the second quarter of 2009, and so on that counts.
And on this comparative basis, because of when the dollar dropped and temporarily rallied in 2008 and 2009, the dollar has actually been stronger in this year’s third and second quarters than it was at the same time last year.
Those same comparisons that have hurt results at U.S. companies with a big percentage of sales overseas are about to reverse. In the fourth quarter of 2009 the dollar is likely to be weaker than it was in the fourth quarter of 2008. As of October 29, for example, the euro is 16% higher against the dollar than it was a year ago.
Companies are starting to include the positive effect from a weaker dollar in their guidance for fourth quarter earnings.
For example, when Procter & Gamble gave guidance on its fiscal second quarter (the one that ends in December) on October 29 the company said a weaker dollar was expected to add one to two percentage points to net sales growth in the period. That’s quite a change from the fiscal first quarter when the dollar was one reason the company showed a 5.6% drop in revenue from the fiscal first quarter of 2008.
The weak dollar comparisons aren’t likely to be a gold mine for these companies, however. Remember that they both sell their products and buy their raw materials in dollars. A falling dollar may translate into higher dollar revenue numbers but it also means that U.S. companies are paying more for many raw materials.
Thanks for the insight Jim. I had been wondering the same thing after MCD said currency was a negative last quarter. The accounting for currency and indeed for foreign operations is very complicated and well above my accounting pay grade but your explanation is sensible. At some point companies like MCD ARE going to outperform because of the declining dollar and, contrary to what robert1234 suggests, the investor who takes advantage of this will indeed benefit in a real way. The relative standard of living of the USA versus the rest of the world is in an long term decline that is really inevitable. If an investor wishes to mitigate that, he must invest in foreign companies or US companies that operate all over the world. He must also invest in the real asset classes that are produced outside the USA but denominated in US dollars. This is how you smile at the gas pump when you pay $5 a gallon!
That is what I have always thought, a weak dollar is really in the long run,,, of interest to nobody. It simply looks like higher earnings, but no real increase in purchasing power.
Any thoughts on DBV or ICI?