Dollar downgrades

The impact of the high Australian dollar is becoming a feature in broker forecasts and broker sentiment. Southern Cross, having blamed the Federal government for all Australia’s problems, now seems to believe that some of it is due to the high currency. Perhaps they have woken to the joys of reading MacroBusiness. A Southern Cross report today says that the $A has become a “genuine headwind” for a variety of reasons. It points out that few companies are hedged against the high currency, they simply have to struggle with the consequences.

What usually happens is listed management teams “hope” for a pick-up in trading conditions but at the end of 2/3rds of the financial period they realise their budgets and therefore guidance can’t be met. They then blame everyone but themselves for the downgrade. You can look forward to the high Aussie dollar, weak household sector, savings rates, the internet, interest rates, the Government, natural disasters, weather, inflation and commodity prices getting a lot of blame over the next few weeks for lowered industrial cyclical expectations. All factors we have mentioned in these notes over the last six months, but particularly in our lonely bearish stance on discretionary retailers which we maintain today (next leg down coming in disc retailers, just look at the awful HVN, MYR, DJS charts).

But it gets even trickier, because this isn’t only about industrial stocks struggling with the weak domestic economy. This is also about downgrades for foreign earning Australian industrial stocks. Again, very few companies would be using 108usc in their 2H FY11 budgets, particularly if they had listened to the consensus bank forecaster view of where the AUD was headed. While the AUD has averaged 102usc since Jan 1st, the point is at today’s prices the earnings conversion damage starts getting exponential. I would suspect many Australian companies would have simply used in their budgets the consensus AUD view for 2H FY11 which was around 95usc.

Deutsche Bank has started to factor the high $A into profit expectations. It has a sell recommendation on Incitec Pivot after reducing its earnings forecasts by 3-6% because of the currency (although it maintained its price target). It also has also downgraded its earnings forecast by 2-3% for Orica, although it has a buy on the stock.

Deutsche is not altering its expectations for Resmed, which has more of a global platform, with operations in Singapore. Plus Resmed is hedged.

The FX translation impact in Q3 should be negligible given the US/EUR was relatively flat on the pcp, but a hedge gain of US$2m+ is likely due to the recent strength on the A$.

Goldman Sachs is bullish on the supply demand balance for Australian equities, arguing that that the supply has been reduced because of an easing of equity raisings (placements and issues). They argue that the market is returning to “normal”. But what is happening with the currency is far from “normal” and is likely to skew the market even more towards mining and away from the weak half of the two speed economy. The damage to Australia’s industry base is likely to be generational.


Southern Cross

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  1. …at today’s prices the earnings conversion damage starts getting exponential.

    This parabolic run up in the AUD has broken the back of many an exporter. Mark my words, decisions were made over Easter to shut up shop, slash costs and cancel investments.

    The cheerleaders for the resources boom have won. They’ve finally succeeded in transforming Australia into a rocks-only economy.

    • Don’t worry Lorax, I really need someone to help clear rocks from my paddocks and to create a nifty series of weirs along the creek to help manage the precious floodwaters.

      I’ll pay you some homemade raspberry jam but make sure you bring your own dried cow pat to eat off of.

  2. “what is happening with the currency is far from “normal” and is likely to skew the market even more towards mining and away from the weak half of the two speed economy”

    Please explain how our ‘strong’ dollar is not negatively impacting the mining sector, which exports most of its product & competes with overseas operations, while it is ‘destroying’ other exporters like ‘The Lorax’?

    • JMD, I think you’ll find the answer is historically high commodity prices which have outpaced the growth of the AUD. I worked in a thermal coal mine in the early 2000’s and they were barely breaking even. Now with current coal prices, their only difficulty is getting all the money to the bank on Friday.

      • Commodity producers require commodities to produce their product, which they buy with AUD. If prices have “outpaced the growth of the AUD” you would expect profit margins to have contracted, yet you say now “their only difficulty is getting all the money to the bank on Friday.”?

        • I am pretty sure the answer to that little contradiction lies in China’s low-wage growth model. They take our over-priced resources, apply low-cost labour to them, and sell them back as cheap value-added goods. I’ll let the economists or more knowledgeable pundits correct me if I am wrong on that one.

          I believe your general thrust is correct though – it can’t go on forever and eventually commodity inflation will cause end-product inflation. The real question seems to be how long the Chinese model can contain the inflation within their economy.

          • “commodity inflation will cause end-product inflation”

            Sure, but as I’ve stated several times the ‘strong’ AUD is improving our terms of trade, at present at least input costs are relatively stable unlike our competitors who are seeing their input costs rise, thus squeezing profit margins.

            What you might gain in sales due to a depreciating dollar you lose immediately through higher costs.

            If the AUD does fall, then commodity prices will likely also fall which brings us right back to your coal mine in the early 2000’s.

            A weak dollar policy is the road to penury.

  3. I won’t hazard a guess at the dynamics of a low-dollar environment (definite economist territory). Needless to say though, marginal exporters will feel pinch as the AUD goes up.

    As for whether a strong AUD is a good or bad thing, I’ll let you and Lorax duke that one out. 🙂

    • Definite economist territory? God help us. It’s actually pretty simple – any ‘gains’ caused by $ devaluation are an illusion. Remember, these are the same $ you are expected to accumulate your savings in. How can you save when the value of those savings is being destroyed – your capital is being stolen from under your nose.

  4. Save? LMAO… can save but not in paper currency, i guess some people figured this out in the last 10-11 years while the majority borrowed there way to prosperity…this shit is gonna end real bad for alot of people I see breadlines everywere.