How Currency Risk Impacts Business Earnings

To see how significant currency risk can be, consider how some U.K. companies have been impacted by the deteriorating value of the pound sterling (GBP) they use to make key purchases. For example, the airline EasyJet reported before-tax earnings of £495 million in 2016, a decrease of £191 million from 2015 – but that figure reflected £88 million in “unfavourable movement from foreign exchange.”¹

Negative Currency Risk Impact: Widespread and Significant

While currency risk impacts aren’t always this large, they are often significant. According to currency risk analytics software provider FiREapps, in the fourth quarter of 2016 245 out of 850 U.S.-based companies surveyed reported negative currency impacts, averaging $0.04 per share. FiREapps notes that many enterprises have set a “best-practice” goal of limiting currency risk impact to just $0.01 per share, so four cents is quite meaningful. It can make the difference between meeting or missing analysts’ targets.

According to Seeking Alpha’s analyst earnings call transcripts, companies reporting currency risk headwinds during the first half of 2017 include:

• Alphabet (Google’s parent company), which reported “a negative currency impact on our revenues year over year of $304 million” but said its currency risk hedging program had cut those losses to $87 million;³
• Beauty product manufacturer Estee Lauder, which projects that currency translation will “depress reported sales for the full fiscal year by nearly 2 percentage points”;⁴
• Technology company Hewlett Packard Enterprise, which recently reported that “currency remained unfavorable and was an 80-basis point year-over-year headwind to revenue.”⁵ (A basis point is 1/100th of a percentage point, or 0.01 percent. Hence, an 80 basis point headwind means that the company’s profit margin was 0.8 percent lower due to currency shifts.)
• Apparel manufacturer VF Corporation, which reported that its first quarter results were down 50 basis points instead of 10 “primarily as a result of the negative impact of changes in foreign currency.”⁶ In other words, these factors reduced profit margins by 0.4 percent.

Currency Cycles: Getting Shorter

For enterprise finance teams, managing currency risk is made more difficult by the increasing speed of exchange rate shifts. Currencies are more likely to reverse direction faster, demanding greater agility from managers who must quickly move from planning for rising to falling currency values (or vice versa). As FiREapps puts it, “currency cycles are now measured in quarters, not years.”⁷

The most volatile currencies can also change rapidly. In 4Q16, the most volatile G20 currencies were the South Korean won, the euro, the Turkish lira, the Indonesian rupiah, and the Australian dollar; in 3Q16 they were sterling, the Russian ruble, Argentine peso, Brazilian real, and Indonesian rupiah. Only Indonesia’s currency appeared on both lists.

Sometimes, the shifts happen even faster. As Global Finance Magazine notes, volatility in global currency markets was actually “at unusually low levels” during the second quarter of 2016, until the markets were surprised by the U.K. vote to leave the EU. The pound’s value dropped precipitously less than a week before the quarter ended – “catching many multinationals off guard.”⁸

Visibility: Sometimes Inadequate

Small and medium enterprises (SMEs) finding it challenging to understand the impact of currency risk on their businesses may take comfort in knowing they are not alone. FiREapps believes even more large companies are struggling with currency shifts than report the problem publicly. Those “that did not disclose headwinds in Q4 2016 most likely did not report because they are not confident in their data… when faced with the risk of reporting materially incorrect numbers they chose not to report at all… [since reporting] requirements are lax in this area.”⁹

Other recent executive surveys may lend support to this hypothesis. For example, a 2016 Deloitte survey found that “lack of visibility into FX exposures… is a challenge for nearly 60 percent of [executive] respondents. This challenge is pervasive… Without accurate measurement… value erosion from negative currency rate movements cannot be minimized.”¹⁰ A 2017 Treasury Strategies survey found that FX and financial risk management issues trailed only cash management amongst corporate treasurers’ top priorities and benchmarking concerns.¹¹

There is Positive Currency Risk Impact, Too

It’s also the case that some companies benefit from currency “tailwinds” that increase their profits. In late 2016 and early 2017, companies reporting this pleasant event include:

• German automaker Daimler, which recently projected currency tailwinds significantly above 500 million euros for the current year;¹²
• British American Tobacco, which recently said “First half EPS is expected to benefit from a significant currency translation tailwind of around 14 percent”;¹³
• GlaxoSmithKline, which said the pound’s devaluation against the dollar would give it a 9 percent forex tailwind, given that it books one-third of its sales in the U.S.;¹⁴
• The British-based global advertising firm WPP – which also serves many U.S. clients – said its billings soared by 16 percent in 2016 – and fully 2/3 of that growth reflected currency shifts.¹⁵

Currency Risk Winds Can Also Mix

Small, medium, or large enterprises that do business globally can experience mixtures of currency tailwinds and headwinds. For example, News Corporation – the global media firm with roots in Australia and the U.K. that owns Dow Jones & Company – says risk from shifting currency reduced its revenues by $21 million in the most recent quarter, “with modest year-over-year improvement in the Australian dollar” more than canceled out by the pound’s weakness. Despite its overall currency losses, NewsCorp actually earned $6M from favorable foreign currency fluctuations associated with its Australian real estate advertising business, and similar shifts boosted its cable network programming business.¹⁶

So, too, a company’s exposure to currency risk may change dramatically in the wake of major events such as acquisitions or divestments. For example, Treasury & Risk reports that when eBay spun off PayPal in 2015, it lost many natural hedges that existed when these very different businesses were unified. Mitigating euro-dollar exposures now requires a “highly complex” corporate finance project encompassing a wide array of business functions and stakeholders.¹⁷