A robust dollar sounds like a good thing. But for U.S. companies that do a lot of business in foreign markets, it can turn seemingly strong overseas sales into much weaker ones.
As companies that make and sell goods abroad report their latest quarterly financial results, many are blaming lower profits on currency exchange rates. Both Burger King Corp., the nation's No. 2 hamburger chain, and cosmetics maker The Estee Lauder Cos. said last week their profits dropped as international sales translated into fewer dollars.
How serious a hit are U.S. companies taking from the strength of the dollar? And did they see this problem coming?
Here are some questions and answers about the how the dollar has affected company earnings.
Q: Why are so many companies saying the strong dollar hurt their earnings?
A: Most U.S. companies that sell goods overseas — whether it be food, makeup, equipment or clothing — translate their sales abroad from foreign currencies into dollars when they report their financial results. If the dollar is stronger than those currencies, the translation results in fewer dollars in revenue.
Here's an example: Let's say a dollar is worth the same as a euro. If an American company sells an item in Europe for a profit of 10 euros, the company can turn that profit into $10. Now let's assume that the dollar strengthens, so it only takes 80 cents to buy a euro; suddenly, that same 10-euro profit will only earn the company $8.
In this scenario, a U.S. company could maintain a constant level of earnings in a foreign country — or even increase its earnings in that country — but the number of U.S. dollars it takes in from there could go down.
A strengthening dollar also decreases the buying power of overseas consumers since their money is worth fewer dollars. That can affect companies' underlying sales and lead to declining profit.
Q: Did companies that sell products overseas see this coming? Don't they track currency movements?
A: Most do track exchange rates, but the sharp rise in the dollar caught even currency experts off guard. Before last fall, the dollar had been weakening for nearly six years due to wars abroad and low interest rates. (Wars are expensive and typically require the government to put more money into circulation, which can devalue currency. Lower interest rates lead to reduced demand for investments in U.S. government debt, and that translates into less demand for dollars — which means a weaker dollar.)
Most economists had expected the dollar to weaken even further as the economy fell deeper into a recession — the typical path for the dollar in bad economic times.
But no one could have predicted the bankruptcy of Lehman Brothers amid the fallout from the subprime mortgage crisis. The collapse of the investment bank roiled stock markets around the world and led many foreign investors to flock to the safest assets they could find: investments in U.S. government debt. As more people invested in Treasury bills, notes and bonds — all of which are made out in dollars — the demand for the dollar went up, increasing its value against other currencies.
"Lo and behold, we've seen the dollar attract capital from around the globe," said Andrew Wilkinson, senior market analyst at Interactive Brokers Group LLC. "That's really gone against the grain."
The economic crisis in the U.S. has made forecasting exchange rates even more difficult. Any bailout, rescue or stimulus plan that requires the government to pay for something will probably require putting more money into circulation. And that usually leads to a weaker dollar.
Since it's been hard to predict the final price tag of any stimulus legislation or whether banks and car makers will need more money to shore up their finances, forecasting the dollar's strength has become extremely challenging, Wilkinson said.
Q: Why were some businesses in the same industry affected in different ways?
A: Although the dollar has strengthened against most currencies, it has weakened against others, including the Chinese yuan. If a company does a large amount of business in one of those countries, it could actually see a boost to its profit and revenue.
McDonald's Corp., for example, did not take as much of a hit to its profits from exchange rates as Burger King because Mickey D's has locations in many countries, some of which may have seen their currencies strengthen against the dollar. Burger King, meanwhile, does a lot of business in Germany and Britain, where currencies have weakened against the greenback.
Q: What has the impact been on manufacturers?
A: For manufacturers, the high dollar has raised prices of exports and lowered prices of imports, resulting in a penalty of sorts on products made in the U.S. (and, in many cases, great deals for Americans buying foreign goods).
Q: What's the long-term effect for these companies seeing lower profits because of the dollar?
A: Most companies are now forecasting a stronger dollar for the remainder of the year and are warning investors that their profits may continue to be affected.
Manufacturers that may have forecast a 5 percent gain from currency last year, when the dollar was weaker, now expect a decline of about the same amount, according to Longbow Research analyst Eli Lustgarten.
Many retailers have also already chopped their forecasts so investors won't be disappointed if the dollar remains strong and profit continues to fall.
Q: What are the companies doing to mitigate the effect?
A: There's not much companies can do about currency rates. Trying to hedge the dollar's strength has its own drawbacks given the volatility in the global economy these days. A bad guess could be disastrous. After all, those airlines that hedged for oil when prices were far higher — locking in prices out of fear they'd get even higher — might not be looking so smart now that the price has dropped and they're still paying the higher rates.
Axel Merk, president and chief investment officer of Merk Mutual Funds, said the most successful companies when the dollar strengthens have local production facilities for local sales. In other words, goods sold in Britain are manufactured in Britain. That way, at least, companies are not forced to pay expenses in one currency and record sales in another.
Ordinarily, some companies would raise prices overseas to offset the unfavorable exchange rates. But the downturn in the global economy has made that a dubious proposition — consumers are already cutting back on spending, and higher prices could mean even fewer sales. And that, in turn, could make profits even lower.