Dr. P.V. Viswanath
Tested by the mighty euro
A STRONG currency may be a central banker's dream, but it can be a nightmare for companies. If they export to countries with weakening currencies, their goods become less competitive while imports into their home market become more so. Export sales fade while repatriated profits count for less.
So, given that the great majority of European blue-chip firms are big exporters and that the euro has risen by some 50% against the dollar since its low in July 2001, why are European businessmen not depressed? France's business-confidence index has been rising since last June. Germany's IFO confidence index rose for nine consecutive months until a small blip in February. Only the Italians are gloomy, owing to their financial scandals.
European businesses have been able to cope with a strengthening euro because of strong global growth and their use of foreign investments and hedging to protect against currency risk. Many big European companies have produced decent results for 2003, as the pick-up in global activity compensated for currency losses.
In addition to using financial derivatives for currency hedging, many firms have built “natural hedges” by moving some production abroad, at the expense of euro-zone output. DaimlerChrysler, for instance, produces all of its M-class Mercedes in Alabama, and so the weaker dollar has meant windfall profits on exports back to Europe. But, as the euro has risen, for most of its exported models Mercedes, like its rival BMW, has had to increase its prices in America.
There are other indirect effects. Passenger aircraft are priced in dollars (like oil, see next story), so Airbus has to grit its teeth and can take only slight consolation from the $4 billion of parts it buys from America each year. Airbus's boss, Noël Forgeard, says, somewhat bombastically, that he will rely on the high margins from Airbus's new super-jumbo, on sale from 2006, as his ultimate hedge against the weak dollar.
Louis Vuitton Moët Hennessy (LVMH), a French luxury-goods firm, announced a 9% rise in operating profits earlier this month. If the euro had remained at its 2002 levels, the rise would have been 20%, says Patrick Houel, the group's finance director. All LVMH's production costs are in euros, while revenue splits three ways between euros, dollars and other currencies.
For DSM, a Dutch specialty-chemicals group, a one percentage-point move in the dollar exchange-rate has a €7m-11m impact on profits. About four-fifths of its sales are in dollars, but two-thirds of production is in the euro zone. For the moment, says the chairman, Peter Elverding, DSM's only hedge is to borrow in cheap dollars. The company may also move more of its production outside the euro zone. In 2000 it bought Catalytica, an American pharmaceuticals firm, partly in order to reduce its currency risk.
Across the board, European firms lost between 8-10% in revenue growth because of the weakness of the dollar last year, says Walter Kemmsies of J.P. Morgan. Even so, European firms have been lucky—in particular, the recovery of the capital-expenditure cycle is soothing the euro pain, says Joachim Fels, an economist at Morgan Stanley. The euro's appreciation coincided with rising demand for European goods. German exports to China, for instance, increased by 30% last year says Mr Fels.
But how long can this surprisingly happy situation continue? The latest numbers from the European Central Bank and Eurostat show the volume of exports of capital goods from the euro zone falling at an annual rate of 10.5% in the fourth quarter of last year, even as trade inside the euro zone grew. Meanwhile imports from outside the zone grew by almost 4% last year. By the end of 2003 the euro zone's import prices had fallen by 12% from their peak in November 2000.
In theory, the many disadvantages to European firms of the strong euro come with one notable advantage: they now enjoy greater purchasing power in the merger and acquisition markets of countries with weakening currencies. Yet, curiously, they have bought hardly any American businesses in the past two years, whereas American takeovers in the euro zone have been rising, according to Jimmy Elliott, head of North American mergers and acquisitions at J.P. Morgan. This suggests that exchange-rate opportunism is probably not, in fact, a big driver of merger activity—and, perhaps, that the global ambition, risk-appetite and balance sheets of American firms have recovered from their recent battering more quickly than those of their European counterparts.
Overall, though, few American firms have gained much from the strong euro because few of them are big exporters—although those that are have done nicely.
Last week McDonald's reported its 10th consecutive monthly sales gain, a shift attributed partly to the weaker dollar. Its European sales were up by 27% in February, but by only 9% in “constant currency” terms. The same is true for drugs firms, such as Merck, Pfizer, Bristol-Myers Squibb and Eli Lilly; all have big overseas sales, but incur manufacturing costs in euros.
Chinese firms are reaping the currency bonanza too, with the weakness of the dollar-pegged yuan spurring growing exports of Chinese goods (clothes, toys and cheap knick-knacks) into Europe. Euro-China trade used to balance, but last year, according to Allan Jianjun Zhang, director of the China Business Centre at PricewaterhouseCoopers, China enjoyed a surplus of more than $16 billion.
In their budgeting for the coming year, now reaching its conclusion, most European firms are assuming that the dollar will stay around $1.20 to the euro. But BMW, for one, thinks that the euro is now overvalued, and has stopped hedging against further falls in the dollar. On the other hand, plenty of European businessmen fear that the dollar has further to fall. Still, at today's exchange rate, the euro is not much above the $1.17 at which it was launched in January 1999. Then nobody called the new-born currency too strong. In fact, many claimed it was too weak.