European groups buffeted by emerging market currency volatility

Unilever’s warning that “significant currency weakening” in emerging markets would cause quarterly sales growth to slow reminded investors this week that currency effects will weigh on European third-quarter corporate results.

Over the past two years fast-growing sales in emerging markets have provided a much-needed cushion for large European multinationals, offsetting stagnation or decline in their core home markets.

But big currency fluctuations in emerging markets such as India, Brazil, Turkey and Indonesia this summer demonstrated that this cushion is still subject to a strong element of risk.

“The world is ever more strongly interconnected. When [Federal Reserve chairman Ben] Bernanke makes remarks, it has an impact on the rupee, on the Turkish lira and on the South African Rand,” says Norbert Reithofer, BMW chief executive.

Mr Bernanke’s recent comments hinting that US bond buying will not be phased out as quickly as some had feared has sparked a brief rally in emerging market currencies.

Nevertheless, since late May, when the Fed first outlined plans to withdraw the stimulus, the Indian rupee has lost more than 15 per cent of its value against the euro, the Brazilian real has dropped more than 12 per cent and the Mexican peso more than 10 per cent against the single currency.

Currency headwinds are therefore set to be a feature of many third-quarter earnings reports, particularly in sectors such as motors, consumer and luxury goods where emerging markets account for a significant portion of sales.

Some companies are already feeling the heat as the value of their local emerging market sales decline in euro terms and as goods exported from the eurozone to emerging markets become less competitive as the euro strengthens.

“The emerging market slowdown has accelerated as a result of significant currency weakening,” Unilever, the Anglo-Dutch consumer goods group said on Monday, cautioning that third-quarter sales growth would, therefore, slow compared with the previous quarter. Emerging markets represent roughly half of Unilever’s sales. The stock fell about 3.5 per cent on Tuesday, dragging sector peers such as Nestlé lower.

Adidas, the sports apparel company, also said last month that the weakening of currencies such as Russian rouble, yen, Brazilian real and Argentine peso in August and September would affect its third-quarter results.

European luxury goods companies – that are headquartered in Europe but have as much as half of their sales in Asia – have been most exposed to currency fluctuations.

Louis Vuitton, Salvatore Ferragamo and Chanel are among houses that have raised prices on their products sold in Europe as much as 8 per cent to 10 per cent over the past year to try to shrink the price differences with Asia and the US.

But Luca Solca, head of luxury goods research at Exane BNP Paribas, says that the price increases are not sufficient in most cases.

“FX is likely going to be a headwind in the second half of 2013, as you have already started to see in the case of companies such as Adidas,” Mr Solca says.

US companies are also set to be affected. According to an analysis by FiREapps, a foreign exchange risk-management company, US multinationals lost at least $4bn because of currency swings in the second quarter. US executives blamed swings in the yen, the euro, Australian dollar, Brazilian real and Venezuelan bolívar, it says.

FiREapps added that “we fully expect to be talking about companies impacted by the Brazilian real, Indian rupee and Russian rouble” in the third quarter.

In motors, Renault is facing currency headwinds because of its significant footprint in Russia and South America. The French carmaker reported a €242m currency hit in its first-half results, partly because of movements in the Argentine Peso.

Commerzbank said in a recent note on Renault that “FX is developing unfavourably,” contributing to a decision to lower its price target on the stock.

German premium automakers are somewhat less affected because a large part of their recent emerging market growth has come in China, which does not have a free-floating exchange rate. Audi sold more than 400,000 vehicles in China last year but only 9,000 in India, for example.

“If there are further currency effects in India, this won’t have an enormous impact because of the low volume we are talking about,” says Rupert Stadler, Audi’s chief executive.

Nevertheless, Max Warburton at Bernstein Research told clients “we are getting worried that the big moves in emerging market exchange rates in 2013 – and the Japanese yen – are going to affect the German automakers’ earnings”.

“While China, Germany and the US remain much more important for profitability, the [emerging market] exposures are relevant,” he says, estimating that BMW and Daimler could respectively see a 10 per cent and 12 per cent earnings per share headwind in 2014 because of currency moves, including the yen.

Mr Warburton believes the impact on Germany’s Volkswagen will be smaller because it produces a higher proportion of vehicles locally in emerging markets, which provides a natural hedge against currency swings.

VW-owned Audi last month said it planned to start producing cars at a new plant in Brazil from 2015. Audi already assembles cars in Aurangabad, India and increasingly it sources parts there too.

“India is also a purchasing market for us as lot of suppliers have now reached a good standard. [A weaker currency] is an opportunity to purchase more cheaply,” says Ulrich Hackenberg, Audi board member for technical development.

European multinationals tend to hedge most (though not all) of their foreign currency exposures, meaning the short-term impact of this volatility should be manageable.

Moreover, the recent improvement in many struggling European economies should help offset emerging market currency issues, according to Robert Parkes, equity strategist at HSBC.

“Currency is clearly a headwind – there’s no denying that – but our view is that the European economic backdrop is becoming more supportive and should help in the second half,” he says.

HSBC estimates that emerging markets account for about 15 per cent of European corporate earnings. Factoring in a roughly 10 per cent decline in a basket of emerging market currencies against the euro over the past year, that could bring down European earnings by about 1.5 per cent in the third quarter

“In terms of the overall picture, we don’t see it as having a huge impact,” Mr Parkes, says. “Nevertheless, currency clearly becomes more of an issue at a sector or company-specific level.”

Additional reporting by Delphine Strauss.

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