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Companies Brace for Profit Hit From Euro Rally

09/07/2020 | 06:25am

By Caitlin Ostroff

The euro's sharp rally this year is seen as a vote of confidence by investors on the prospects for Europe's economic recovery. But companies and their shareholders are bracing for pain.

The euro has climbed 5.6% against the dollar this year, its biggest advance since 2017. On Sept. 1, it surpassed $1.20 for the first time since May 2018. The currency is near an all-time high on what is known as a trade-weighted basis. That means the euro has also strengthened against the currencies of other major trading partners, including China and the U.K.

When the euro is strong, it makes exports such as machinery, cars and chemicals from the eurozone more expensive for foreign buyers. It also erodes the value of overseas sales for companies in the 19 member states, and can chip away at profit just as they emerge from the Covid-19 economic crunch.

"We're at the start of the pain threshold when I look at the trade-weighted index," said Viraj Patel, a foreign-exchange and global-rates strategist at research firm Arkera. "If it stays here, it's a small problem. If it goes higher, it's a big problem."

The gains in the euro mirror a weakening in the U.S. dollar. Investors have eased out of the greenback in recent months, after the Federal Reserve signaled it would keep interest rates low and allow inflation to climb. That has erased 3.7% from the dollar's value this year.

The strengthening euro hasn't weighed much on European stocks yet, though it is one of the reasons why equity benchmarks in the region have lagged behind the U.S. gauges, analysts said. The Euro Stoxx index, a benchmark tracking a broad swath of stocks in the euro area, is down about 10.6% this year, compared with the S&P 500's 6% advance.

The real impact from the currency's strengthening will start showing up on companies' bottom line, analysts said.

But it is hard to quantify how much it will eat into corporate earnings. Companies with more than $250 million in earnings typically deal in 40 currencies with more than 200 cross currencies, said Wolfgang Koester, senior strategist at Kyriba, a financial software company.

"There is a tendency to really balance this off what's happening between the U.S. versus Europe, but in reality it's much more complex than that, " Mr. Koester said.

Eurozone companies in general derive more of their income from abroad than large U.S. businesses, which rely more on the American consumer, said Lars Kreckel, global equity strategist at Legal & General Investment Management. For every 10% that the euro strengthens against the dollar, eurozone corporates stand to lose about 3% in profits, he estimated. For S&P 500 companies, a 10% appreciation in the dollar costs companies up to 2%.

European car makers are likely to see profits eroded by a stronger euro, said Gianluca Bertuzzo, an equity research analyst at Italian investment bank Intermonte Sim SpA. Italian-American Fiat Chrysler Automobiles NV and Italian racing-car manufacturer Ferrari see much of their sales outside the eurozone. Fiat Chrysler, for instance, draws an estimated 70% of its revenues from North America.

Ferrari famously only builds its cars in Italy, which means much of its costs are in euros while its sales are largely in other currencies. For every 1% that the euro strengthens against the dollar, Ferrari's earnings per share could fall about 1%, Mr. Bertuzzo estimated. The car maker's earnings for the third and fourth quarters, year-over-year, are likely to be eroded by the currency's depreciation: the euro was about $1.11 in the third quarter of last year, compared with $1.18 now.

Fiat Chrysler declined to comment. Ferrari didn't respond to requests for comment.

The euro's rise against the dollar has also made French tire manufacturer Michelin more cautious in offering guidance for the rest of the year, Chief Financial Officer Yves Chapot said July 27. About 40% to 50% of the company's gross sales are denominated with the dollar, he said. Michelin didn't respond to requests for comment.

Some investors have started betting in recent days that the European Central Bank will take steps to halt the euro's march upward, because a stronger currency would reduce the cost of imports and damp inflation. Comments last week by the ECB's chief economist, Philip Lane -- that the euro's strength would influence policy makers' forecast for economic growth and influence monetary policy decisions -- bolstered that view, and sent the euro sliding lower.

Speculative bets that the euro will climb further rose to a record high as of Aug. 25, before scaling back slightly in the week ending Sept. 1, according to RBC Capital Markets.

"There is a cost to the euro rising, and it's on earnings," said Mathieu Savary, a strategist at BCA Research. "If you're a European industrial company and you compete with Caterpillar, you're likely to see your profits being hurt when the euro is going up."

Write to Caitlin Ostroff at caitlin.ostroff@wsj.com


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