The Dollar’s Gain Could Be Tech’s Loss…
Why Accenture And IBM Should Worry About The Euro
The Smart Profits Report #552
by Paul Moore, Technology Specialist, Smart Profits Report
Mediocre at best.
That’s how you can sum up the growth rate for the S&P 500 index over the past six-and-a-half years.
In fact, since the end of the first quarter of 2002, the index has risen by a total of 12.8%. That’s just 1.87% on an annualized basis, as the following chart shows…
Even if you add in the 2% dividend yield, you get a whopping 3.87% return per year.
That might be bad news for companies that do the bulk of their business in the U.S. But multi-national companies have enjoyed some serious benefits during this six-and-a-half year period, as the performance of the euro has pummeled that of the S&P, soaring 73%.
This strengthening euro has dramatically increased the buying power of European technology customers, who pay American companies in euros. And in turn, it’s created a great tailwind that may be unwinding…
A Rough 2009 For These Tech Multi-Nationals?
As the broader U.S. economy plods along sluggishly and the dollar has sunk, American multi-national companies like IBM (NYSE: IBM) and Accenture (NYSE: ACN) have seen international markets drive their growth.
However, as the combination of weakening European economies and the strengthening dollar eliminate this growth source, companies will have a difficult time meeting analysts estimates for 2009. For example…
Accenture: Revenues from the EMEA region (Europe, Middle East and Africa) increased 23% in U.S. dollars, but only 11% in constant currency. So even without constraints on demand, the revenue growth would be cut in half.
IBM: The company has also benefited from the weakening dollar and stronger euro. Its European business grew at 17.9% in dollar terms, but only 6% in constant currency.
Both Accenture and IBM will see the growth contribution from these regions more than cut in half in the coming quarters at a time where the domestic business is continuing to languish.
In short, 2009 has the potential to be a tough year for multinationals. If the Euro/Dollar exchange rate holds constant at 1.545 (shown in the chart below), the year-over-year growth of the euro drops to 3.2% in the first quarter of 2009.
So as you can see on the chart below, what had provided a strong tailwind of between 13% and 15% over the first three quarters of 2008 disappears towards the end of the year - the historically weakest period for technology companies and the time that management gives guidance for the forthcoming year.
And this could be the best-case scenario…
Breaking Down The Bottom-Line Damage
What if the exchange rate doesn’t stabilize in this area? It’s very possible that the dollar could continue to appreciate. Considering that the European Central Bank just announced its first quarter of GDP growth contraction and the strengthening dollar has reduced the impact of inflation, we believe there’s a real chance of seeing European interest rates decline, while domestic rates remain stable.
How much damage could there be?
~ In Accenture’s case, EMEA represents 50% of revenue, but since the domestic business is growing more slowly, it’s more than 50% of the growth.
~ IBM is in somewhat better shape, with 37% of revenue coming from EMEA, but this is still a sizeable portion of both revenue and growth.
The flip side of the strengthening dollar is the benefit to operating expenses. When a company is in business-building mode (and European operations have a lower margin than domestic), this can have a positive impact on profit, despite the negative impact on revenue.
Since companies are not required to break out operating expenses by currency and some engage in hedging programs to reduce the impact of foreign exchange fluctuations, the impact on profit will vary on a case-by-case basis.
So when will this happen?
Tech Trouble Towards The End Of This Year As Guidance Goes Awry
The timing for this issue to be incorporated into financial expectations will be either during the third quarter reporting season, or as the end of the year approaches.
Companies typically don’t offer guidance for 2009 until the end of 2008, but this trend is large enough that it will be addressed sooner than later.
For example, in its conference call where it issued financial guidance for the coming quarter, Hewlett-Packard (NYSE: HPQ) mentioned that its projections are based on exchange rates as of the end of July and that currency fluctuations could cause revenue to be below guidance.
Management also addressed the profit issue and said that even in the case of a strengthening dollar, the company would meet earnings-per-share projections. This may yet prove to be accurate, but it would come at the expense of potential earnings upside.
Since the end of July, the dollar has appreciated 4.6% versus the euro and considering the market’s current volatility, investors should remain more cautious than dismissive of the impact of this trend.
Paul Moore
P.S. Speaking of Europe and European growth, Investment Director Karim Rahemtulla just shot me an e-mail about his upcoming “Grand Essential Tour” to two of the region’s biggest economic players: France and Italy.
Cities like Paris, Rome, Venice, and Florence are all on the agenda - and guiding you through them with Karim will be acclaimed author and founder of Agora Inc, Bill Bonner, and Colin Wells, a recognized authority on Roman history and archaeology. Between the three of them you’re promised the kind of lively, diverse banter that you simply won’t find on any other tour!
You’ll gain knowledge about these cities’ legendary status in Europe - the history, culture, geography, art, and architecture, and the inventions that make them the forces they are today. But you’ll also learn about the countless innovations, disciplines, and practices that are commonplace today. For example, the world’s first public issue of company stock … the world’s first multi-national currency … the foundations of our Senate … the story behind the Capitol building… and more.
And of course, today’s best investment opportunities. It’s an exclusive tour, full of history, art, culture, roots, ideas, camaraderie, luxury, and taste. Click here for more information and to reserve your seat now as the tour is filling up quickly.
Today’s Smart Profits Notes
- Chordiant Software, Inc. and IBM announced an extended partnership they believe will profit global brands that interact with their clientele on a larger scale. This has already proved a profitable alliance as seen in their mutual products used by German health insurance provider DAK and Poland’s ING Bank Slaski. According to the contract, their next plans include Asian and Eastern European businesses.
- The iPhone might be big news in the U.S., but you have to pay people to take interest in it in Poland. Literally. In order to beef up sales, Orange, the country’s largest mobile operator is paying dozens of actors to stand in lines in the hopes that they’ll start a trend. While the July launch was profitable back in the U.S., Polish consumers might be more difficult to win over due to the hefty additional monthly charges tacked on to full usage.
P.S. We also have a couple of fun optional excursions planned in and around Nicaragua & Panama (including Rancho Santana), so be sure to get all the details.
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[...] key part of the guidance reductions were due to the strengthening dollar - as I wrote about here on August 25. That, along with the confluence of the financial bankruptcies, credit crunch, and the beginning of [...]
[...] period profits. A key part of the guidance reductions were due to the strengthening dollar - as I wrote about here on August 25. That, along with the confluence of the financial bankruptcies, credit crunch, and the beginning of [...]