Managing the Dollar's Decline

The melting greenback isn't necessarily bad news, but finding the best way to adjust could be a CFO's toughest challenge this year.

February 2008
by Kate O'Sullivan/CFO Magazine

Ever since Carlo Ferro was promoted to CFO at STMicroelectronics, a $10 billion (€6.8 billion) Geneva-based chipmaker, two years ago, he's spent a lot of time pondering the plight of the dollar. The US-listed firm reports in dollars, and nearly all of its invoices are in dollars or Asian currencies linked to the dollar, while most of its operating expenses are in euros. As the dollar lost value against the euro — roughly 20% over the past two years — ST has taken a beating.

But Ferro hasn't sat idly by watching the dollar's tumble. Since becoming CFO, he has been "continuously evolving" how the company handles its currency exposure. This has meant readjusting the heavy euro weighting of costs of goods sold at ST, which has fallen from around 60% to 40%, while the dollar's share of costs increased from 40% to 50%. This was a critical move as the dollar slid to $1.47 against the euro last summer, the highest level since Europe's common currency began trading in January 1999. Ferro also introduced a programme to hedge around 50% of its dollar exposure which requires ST subsidiaries to book capital expenses in dollars rather than euros. (See "Accounting for the Dollar" at the end of the article.)

Managing a rapidly changing forex environment is critical at ST, asserts the CFO. The company aims to "absorb" medium-term changes to exchange rates through "organic growth, enhancing the quality of our product portfolio and progressing cost measures, while reducing the expense structure not only in Europe but also globally." That explains ST's decision to close facilities in Europe, North Africa and the US over the past year, moving work to sites in low-cost Asia, where most of the demand for its products comes from.

ST is certainly not alone. With the greenback at its weakest in decades, companies around the world are feeling the impact of its decline and scrambling to adjust. Consider Infosys Technologies in India. For every percentage point that the dollar slips against the rupee, the Bangalore-based outsourcing firm sees its profit margins shrink 50 basis points. And the dollar has fallen a long way over the past few years. Two years ago, one dollar bought 44 rupees. Today it buys 39.

The size of the earnings hit Infosys suffered is not all that surprising, considering how dependent the business is on dollar-denominated revenues. "About 98% of our revenue comes from overseas and about 63% comes from North America," says CFO V. Balakrishnan. Unlike his peers in industries such as manufacturing, however, Balakrishnan doesn't have significant US dollar costs to balance against the blow to revenues — as a service business, Infosys imports relatively little. "Indian companies like ours are very exposed," he says.

But other companies are happy to make adjustments. For example, for every cent the euro increases against the dollar, Connecticut-based United Technologies Corporation (UTC) records an additional $10m in earnings. The diversified manufacturer earns more than 60% of its revenues outside the US, and it received an earnings boost of about $100m last year as the dollar slid against the euro, according to vice president of accounting and finance, Greg Hayes.

Indeed, the change rippling through the global economic system affects different companies in very different ways. Indian outsourcers are suffering. US manufacturers selling into Europe are celebrating. In Europe, many are considering moving manufacturing operations not only to Asia, but also to an increasingly lower-cost America.

Every CFO, however, must eventually place a strategic bet on the dollar's future course, no matter what the relative economic advantage. If the dollar stays weak, what will be the net effect on diverse, global businesses? And what is the best response?

Now Or Forever?
This isn't the first time businesses have lived through a long stretch of a weak dollar — during the 1970s, for example, the dollar was in the doldrums, a situation which led, like today, to rocketing oil prices and economic malaise. But there are a couple of important differences between then and now.

For one thing, businesses are far more global and interconnected today, increasing the number of ways that currency values can influence financial performance. An American technology company, for example, is likely to have manufacturing operations in different parts of the world, some of which share the price benefits of a weak dollar, and others that are now more expensive. Each of those regional operations may import components from a range of countries with varying relative currency values. And the company's ability to pass on cost increases due to a falling dollar may not be the same everywhere.

The prospect of a prolonged decline in the dollar isn't as far-fetched as it might once have seemed. According to our most recent quarterly Global Business Outlook Survey, a stunning 50% of Europe's CFOs and 60% of Asia's believe the decline in the dollar represents a permanent or long-term devaluation. Only a third of their US counterparts agree.

"I think it's a fundamental adjustment," says Charles Kane, CFO of investment firm Global BPO Services and a lecturer on international finance at the MIT Sloan School of Management in Massachusetts. "There are a lot of factors driving the dollar down." And it could fall still further if, say, the oil-exporting countries decide to peg oil prices to another currency or to a basket of currencies.

"My concern is not that the dollar's decline is cyclical, but that it's a long cycle," adds Scott Goble, finance chief at Alliance Flooring, a Tennessee-based private company with more than $1 billion in annual sales. Although Alliance only does business domestically, the company has been affected by rising raw-materials costs. "We need to keep interest rates low to keep the housing situation from getting out of hand, but we need to maintain high enough rates to keep foreign investment coming in," Goble says. "I don't see a way to do that without a devalued currency."

Seizing The Day
The earnings benefit for US companies with overseas sales is undeniable. For Compact Power, a small manufacturer of landscaping and construction equipment based in South Carolina, the falling dollar has meant a rapid rise in the company's overseas sales. The $100m company began selling internationally only two years ago, has doubled its worldwide sales in the past year and plans to double them again in 2008. "We've absolutely accelerated our international growth because of the exchange rate," says CFO Norman Boling. "The falling dollar has made us competitive in markets where we're up against established existing competition."

Compact Power recently developed two diesel units that will be distributed in the UK this year, and has entered into a distribution agreement with an Italian manufacturer to sell that company's product — tractors — in America. To address currency fluctuations, the two companies agreed on a rate in their contract, a strategy Compact Power plans to continue with other partners. While the manufacturer does not do financial hedging, "by locking down the exchange rate at which we purchase, we can take out some of the risk," says Boling. Trade partners have been willing to agree on rates in their contracts because the practice removes uncertainty for them as well. "We might feel a pinch here if the dollar goes back the other way," says chief operating officer Michael Edwards. "We're developing sources out of Europe and other regions so that we can play the other side when that happens."

In Asia, meanwhile, many companies rely on dollar-denominated exports. But not every company in the East is bemoaning the weak dollar. Martin Cubbon, CFO of Swire Pacific, the HK$19 billion (€1.6 billion) Hong Kong-based owner of Cathay Pacific Airlines, is unperturbed by the dollar's slide. "Although we do have a lot of Hong Kong dollar revenue [the Hong Kong dollar is pegged to the US dollar], we also have a lot of renminbi, euro and yen," he says. "And we have a lot of dollar costs, namely fuel and capital costs. It's a good position to be in."

This article was excerpted from CFO Magazine. Read the full article here.

Kate O'Sullivan ia a senior writer at CFO. Additional reporting by Don Durfee, Tom Leander and Janet Kersnar.

© CFO Publishing Corporation 2008. All rights reserved.