Surging dollar poses threat to offshore earners

Companies with big offshore operations are expected to feel the heat.

Companies with big offshore operations are expected to feel the heat. Photographer: Dhiraj Singh/Bloomberg

A surging exchange rate is set to be a significant headwind in the February reporting season as companies with big offshore operations expected to feel the heat.

The Australian dollar rose 2 per cent this week, topping US75c for the first time in 2½ years.

Since the end of June, the Aussie has climbed almost 10 per cent on a heady cocktail of:

• an improvement in the global risk appetite and the US dollar falling amid encouraging coronavirus vaccine trial results;

• diminishing US political risk and expectations of more US monetary and fiscal stimulus; and

• commodity prices surging with the iron ore price almost doubling to a 7½- year high of $US158.25 a tonne amid Brazilian supply issues and strong Chinese demand.

After falling 22 per cent from a December 31 peak of US70.32c to a 17-year low of US55.10c on March 19 amid the initial turmoil with the coronavirus pandemic, the exchange rate has surged as much as 37 per cent amid unprecedented central bank liquidity and fiscal stimulus.

On Friday the Aussie dollar reached US75.72c, its highest since June 2018.

This week the currency claimed a scalp as shares in Appen — a former market darling of the technology space — dived 15 per cent after warning that its calendar 2020 earnings will be about 16 below its August guidance.

Most of Appen’s profit warning related to the higher dollar.

Bloomberg’s consensus estimate is for the Australian dollar to rise to US77c by the end of 2021, but some economists including AMP Capital’s Shane Oliver predict a rise to US80c over the next 12 months, helped by rising commodity prices and a cyclical decline in the US dollar.

UBS analyst Pieter Stoltz has reviewed his lists of offshore income earners and retailers in the ASX 200 according to the sensitivity of their earnings and share prices to the Australian dollar.

The 10 stocks in the index with the most to lose from the dollar’s rise are Cochlear, Ramsay, Macquarie, Orora, Clover Corp, Domino’s, Ansell, Brambles and Treasury Wine.

Amid exchange rate sensitive stocks, CSL fell 3.2 per cent, Cochlear and Brambles both declined 3.8 per cent and ResMed lost 3.1 per cent on Friday. The S&P/ASX 200 index fell 0.6 per cent to 6642.6 after hitting a 9-month high of 6745.3 this week.

Cochlear and CSL are two stocks that have significant negative sensitivity to an appreciation in the dollar. In contrast, retailers could benefit but with a lag due to forex hedges.

“Offshore earners could experience earnings headwinds due to recent Australian dollar strength,” Stoltz said. “The retailers that stand to benefit the most from dollar appreciation are those that sell private label products such as Premier Investments, Adairs, Wesfarmers and Super Retail Group. As importers of auto parts, GUD and Bapcor also stand to benefit.”

He noted that while positive sensitivities weren’t so clear for retailers, Harvey Norman stood out as having positive share price sensitivity to an appreciation in the exchange rate.

UBS predicts the exchange rate will rise to US78c at the end of 2021 and US82c at end-2022.

Credit Suisse macro strategist Damien Boey said the strength of the dollar was “very much justified”. “Traditional drivers include the terms of trade or commodity prices, real interest rate differentials and relative scarcity.

“With commodity prices rising strongly — notably iron ore prices — the equilibrium level of the currency is up to around US82c, and this despite the best efforts of the Reserve Bank to lower Australian real yields relative to US real yields.”

But while still seeing “clear valuation upside” for the dollar, he noted that Australian financial institutions were currently experiencing greater difficulties in accessing US dollar funding.

“Recently, we observed that Australian-US cross-currency basis swap spreads have turned negative for the first time since the 2008 financial crisis,” he said.

“There are a number of explanations for this phenomenon, ranging from attempts by US banks to lower global systemically important bank scores for regulatory purposes, to the trade dispute Australia is having with China.

“Regardless, the issue is that Australia is experiencing a moderate US shortage despite clear valuation support for the currency. In the circumstances, two-way risk should be on the rise.”

Boey noted the dollar’s strength was one of several factors now contributing to tighter financial conditions which now suggest growth may slow in late 2021.

“Driving the fading in our financial conditions index are the slowing public sector credit impulse, lack of growth in the trade surplus — even before the Australia-China trade dispute manifests in the data — falling real wages and a diminishing discount on the currency (relative to equilibrium).”

For stocks, currency strength supports smaller-cap and resource companies over non-resource earners of US dollars like CSL, Cochlear and Brambles.

“Among these are the usual suspects in healthcare, logistics, construction and packaging,” Boey said.

On the flip side, resources exposures could outperform to the extent that the stronger currency reflects better world growth driving commodity price inflation.