Sterling fall shakes Irish profits

Sterling’s recent weakness is proving devastating for large swathes of corporate Ireland, with Merrion Stockbrokers last week announcing it was slashing earnings forecasts for 25 of the top listed companies.

Sterling has weakened by 10 per cent since the year end, and almost 20 per cent since last September. It had traded for the past five years in a band of 66p-70p to the euro. Merrion, which is reducing its earnings forecasts by an average of 1.9 per cent for 2008 and 2.8 per cent in 2009, is assuming a forward sterling-euro rate of 80p.

The dollar has also fallen by 10 per cent against the euro since the start of the year. Merrion says this is part of an ongoing dollar weakness which started in 2002, whereas it is the speed and magnitude of sterling’s fall that is the new ingredient in the mix.

Few Irish companies are removed from this threat.

The impact on companies is twofold. Analysts distinguish between the translation effect, which is the adjustment made when non-euro overseas profits are converted into euros, and the transaction or trading effect when exports sales are booked in euros.

John Sheehan, analyst with NCB stockbrokers, says there is little most companies can do to ameliorate the translation effect. Moreover, he says the underlying cashflows of a UK subsidiary business are not affected by exchange rates.

Irish banks all have large UK exposure. Sterling weakness will be reflected in the slower growth of their loan books. In the case of Anglo Irish bank, this will probably be doubly apparent, as it feels the impact of sterling weakness and slower demand as the UK economy slows.

Irish builders with large UK operations are also affected by the translation effect. Merrion calculates that every 1p change in the exchange rate has a 0.7 per cent impact on Grafton’s earnings.

For Kingspan, maker of insulation panels, it is even greater, at 0.9 per cent.

Both companies have in recent weeks warned the markets that profits would be below forecasts but this is largely the impact of falling demand as the UK and Irish housing markets slow.

A trading or transaction impact for a company that exports a product made in Ireland into the UK is even harder to manage and it has a direct effect on margins.

If the value of a company’s exports in euro terms is falling, while its euro cost base remains unchanged, profit margins will be hit.

Take C&C, the Irish cider maker, which is relying on sales of its Magners brand in the UK for 43 per cent of group profits. It has some UK distribution and marketing outlays, but production costs are still in euros at its County Tipperary base.

It could in theory adjust sales prices to compensate, but this would put it at a competitive disadvantage to Scottish & Newcastle, its main rival, which has all its costs in sterling. C&C can seek to increase the amount of inputs it buys in the sterling area.

But as one analyst put it, there are only so many apples it can source in the orchards of Northern Ireland to maximise its sterling costs, while still claiming to be an Irish product.

Ryanair is another company with a large UK earnings exposure, with 35-40 per cent of its fares in sterling.

This has a direct effect on margins if costs are still largely in euros. Merrion is forecasting a 9.5 per cent reduction in earnings per share this year.

Irish Continental Group, the former Irish Ferries company, is hit by a double whammy. The bookings made by UK tourists coming to Ireland are worth less in euro terms. Also, it is not easy to raise prices as demand softens as the euro makes it more expensive for tourists to come to Ireland.

The traditional tool for companies to protect themselves against currency fluctuations was hedging.

Most companies will hedge to protect against a transaction impact. Only the banks will tend to have hedges in place for the translation effect. But Mr Sheehan at NCB says hedging is only really a timing device – it only delays the impact of currency movements.

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