Treasury Wine Estates, CSR, Incitec Pivot to benefit from low $A

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Seven weeks ago, the Australian dollar was sitting at US$1.03, in that lofty above-parity (to the US$) perch that it had occupied for 18 months.

Since then, the dollar has given up more than 10 cents, cramping the style of Australian tourists and online shoppers – the people whose perspective always seemed to dominate when the Aussie’s long period of ascendancy against the greenback was reported on the evening news.

But the falling A$ – and the prospect of even lower exchange rates, perhaps with an eight in front – has had brokers dusting off their models to examine the exchange-rate “sensitivity” of company earnings: where for every US cent that the $A falls, some company’s earnings rise by X%.

While currency movements are rarely a one-way street, and the exchange rate should not be looked at in isolation, there are definitely companies that benefit more than others from a falling A$.

Reporting in USD

The companies most enjoying the lower A$ are those that actually report their financial results in US$, including BHP Billiton, Rio Tinto, Fortescue Metals Group, CSL, Woodside Petroleum, News Corporation, QBE Insurance, Oil Search, Brambles, Computershare, James Hardie and ResMed. The weaker A$ helps boost their earnings.

For example, investment bank UBS says a drop of US5c in the value of the A$ could translate to a rise of 11% in the profit of Fortescue Metals, and a 5% jump in earnings a share for more diversified miners BHP Billiton and Rio Tinto. But for the resources companies, commodity prices are more important than the exchange rate: because Fortescue Metals only mines iron ore, a favourable exchange rate does not mean much if a Chinese slowdown were to send iron ore plummeting below US$100 a tonne.

Offshore revenue

Also benefiting from the A$’s slide are companies with significant percentages of their revenue coming from overseas, such as Amcor, CSR, Cochlear, Treasury Wine Estates, ‘New’ News Corporation, 21st Century Fox (still trading as News Corporation), Sims Metal Management, Mayne Pharma, Westfield Group, Sonic Healthcare, Henderson Group, Ansell, Adelaide Brighton, GWA, SDI, Navitas, Bega Cheese, Macquarie Atlas Roads, Incitec Pivot and Orica.

It’s important to distinguish between companies where A$ fluctuations have a translation effect on earnings (meaning it affects the amount of foreign earnings when repatriated to Australia and reported in A$ terms) and companies where the A$ has a conversion effect, meaning that changes in the A$ actually have a direct effect on cash flow.

A good example of a translation effect is Amcor, which repatriates more in A$ terms when the A$ is weak, but its overseas businesses do not get any more competitive.

Similarly, CSL suffers a translation effect, because 90% of its revenues come from outside Australia. Just as most of its earnings come from the US, so does its cost base and raw material (blood) supply. The level of the A$ does not affect CSL’s ability to sell its product relative to its arch-rival Baxter: nor does it damage CSL’s markets or strategies or business model.

But when it comes time to report profit, CSL says foreign exchange “headwinds” stripped a potential US$108 million from what became a $US1 billion profit in 2012. The US$/Swiss franc exchange rate is more important to the business’ bottom line than the A$/US$ exchange rate: CSL shareholders first need to see the greenback strengthen against the Swiss franc for CSL’s earnings to grow.

This is why currency can’t be viewed in isolation. Take Computershare, whose 2011 merger of its US operations with Bank of New York-Mellon’s Shareowner Services business created by far the most dominant share register operator in the world’s largest share market. Computershare also reports in US$, so a weakening A$ boosts earnings. But investors should focus on the actual business: a far bigger boost to Computershare’s profits will come from resurgent mergers and acquisitions (M&A) and initial public offering (IPO) activity in the northern hemisphere markets, which is waiting on renewed corporate confidence.

Companies that compete against imports – for example Arrium and ARB Corporation – should gain some respite from a weaker $A, as should those retailers that compete against products bought online from overseas, which is suddenly a less-attractive transaction.

Harvey Norman, JB Hi-Fi, David Jones, Myer and Premier Investments are all in this boat, but again, a lower A$ is not a panacea for them, because it both increases the costs of the goods they have made for them overseas, and makes it easier for the Zaras and the Top Shops of the world to expand into the Australian market.

How to play

The best way to play the currency changes is to concentrate on the companies with some level of business in US$, that will benefit from depreciation in the Australian dollar.

For example, Credit Suisse analysts have been working on the assumption that the A$ will slide as low as 85 US cents over the next 12 months. The investment bank says industrial stocks with US$ exposure will benefit most – but again, investors should not look solely at currency. Credit Suisse looks first at whether a company can be classed as defensive (less exposed to economic growth rate changes) or cyclical (more exposed to economic growth rate changes).

Assuming that the $A reaches 85 cents and stays roughly at that level, Credit Suisse says its best defensive currency-related pick, Treasury Wine Estates, would see its earnings per share rise by 13% in FY14 and by 18% in FY15. Even better, the stock’s discounted cash flow valuation would jump by 18.6% in A$ terms.

Other defensive beneficiaries would be Amcor, Brambles, Cochlear, ResMed, Sonic Healthcare and Westfield Group.

If investors are prepared to take US-economic-cycle risk, Credit Suisse reckons CSR, Incitec Pivot and James Hardie look best.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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