Year Of Living Dangerously

Sydney Morning Herald

Wednesday May 7, 2008

By Martin Roth

Australian companies exposed to US markets are losing value.

Australia's Cochlear, the world leader in cochlear ear implants for severe hearing problems, is enjoying booming business, with strong demand in all regions and double-digit profit growth in the half year to December last year.

In February, the company forecast 15 to 20 per cent profit growth for this financial year, stating in a media release, "We remain excited by the strong fundamentals of the business and the ability to bring hearing to many thousands of people around the world in a way that delivers sustainable growth to our shareholders."

Yet from a high price of more than $79 in September, the shares have retreated sharply, trading at about the $55 mark in late April.

A primary reason is the company's big exposure to the United States - North and South America represented 40 per cent of sales revenue in the December 2007 half - and investor concerns about the US dollar and economic weakness.

Cochlear itself has said that adverse foreign exchange movements led to a $4.9 million loss in the December 2007 half, despite the company engaging in a substantial amount of currency hedging.

Cochlear is just one of a number of Australian companies suffering because of their success in penetrating the US market. There are dozens of others.

For example, blood products company CSL, which gets more than 80 per cent of its revenues from abroad, said its December 2007 half-year after-tax profit of $349 million - up 36 per cent from the December 2006 half - would have been $28 million higher but for the impact of adverse foreign currency movements.

It also said it expected the currency to reduce its June 2008 full-year profit by $65 million to $70 million.

Packaging giant Amcor makes about 70 per cent of its sales in overseas markets, principally America and Europe. Its December 2007 half-year after-tax profit of $185 million was flat on the December 2006 half, rather than up 9 per cent, following a $16 million currency hit.

Building product maker Boral has brick and roof tile operations in the US, exposing it to the American housing slump. In the six months to December last year, the company's American EBIT (earnings before interest and tax) plunged 87 per cent from the December 2006 half in Australian dollar terms, although continuing strength in the Australian non-residential construction market partially offset this.

Rubber products manufacturer Ansell manages its global business in US dollars, though, unlike some other Australian multinationals, it continues to report its financial results in Australian dollars.

In the six months to December last year its sales rose 16 per cent in US dollars, but just 2 per cent when translated into Australian dollars. For its after-tax profit, the figures were 46 per cent and 28 per cent respectively.

CSL's shares have stood up well, thanks to its continuing excellent business prospects, especially for its cervical cancer vaccine, Gardasil. But stock prices of many of the other companies with a big US exposure have come under pressure.

Prasad Patkar, portfolio manager with Platypus Asset Management, says: "I would think about the impact of a weakening US economy and US dollar on Australian companies in the following manner - firstly, there are companies that generate revenues in the US and could therefore experience pressure on their top line from a weakening American economy. This is what I would call the economic impact.

"Then there are companies that generate US-dollar-denominated revenues and could see an impact in their Australian-dollar-denominated results from a weaker US dollar - this is the translation impact," Patkar says. "The companies that fall into both categories would feel the greatest impact."

In the words of Hans Kunnen, head of investment markets research at Colonial First State, "It is almost a double whammy - an American slowdown combined with a stronger Aussie dollar. We do not know how much hedging there is in place. There will be some. But from an unhedged basis, it is a double whammy."

Nevertheless, Silvio Gasparet, head of equities and fund manager with Austock Asset Management, is reasonably positive about the longer-term outlook.

"Many of these stocks have already under-performed in a relatively weak market over the last 12 months," he says. "In many ways, stock prices are already reflecting these problems.

"So, for Australian companies with business in the US, the issue is, when does the US economy turn and what shape is the recovery?" Gasparet says.

"That is pretty much unknown at this stage. But if you think that, given the work of the Federal Reserve to cut rates, it will bounce in a V-shape, then you would be more positive. But if you think it is going to be a U-shape, then you would be a little bit more concerned.

"That is the first issue," he says. "The second issue is the currency. The US Federal Reserve has been dropping cash rates, while we have been increasing them. So the question is, when does that turn around? When do we start seeing the US economy strengthening? When do we start seeing the Federal Reserve increase short-term rates? And when does our Reserve Bank start thinking that they have beaten inflation, and rates start falling here?

"Right now, I think the question is, do these things start to happen at the beginning of 2009 or will it be at the beginning of 2010? That is probably where the debate lies at the moment."

If this prognosis is accurate, it suggests that, for the short term at least, Australian stocks with business in the US could remain volatile.

Kunnen adds: "You have got the weaker US economy which is not helping anybody. And no one knows what the currency will do. Anyone who says they do is pulling your leg.

"Then, we might change our interest rates, or we might not. The Americans might change theirs or they might not. You could have another unearthing of subprime and confidence suddenly strips away. If you are a company [with] American exposure, the next 12 months could be rough."

© 2008 Sydney Morning Herald

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