Surging US Dollar May Be Triple Whammy For Corporate Earnings

(Reuters) -- The suddenly unstoppable U.S. dollar is posing a triple threat to American companies’ profits by driving up the costs of doing business overseas, suppressing the value of non-U.S. sales and, perhaps most worryingly, signaling weak international demand.

The dollar has been on a tear, with an index tracking it against six other major currencies notching roughly an 8 percent gain since the end of June. Few analysts see its breakout performance stalling anytime soon because the U.S. economy stands on much firmer footing than most others around the world, Europe’s in particular.

For companies in the benchmark large-capitalization S&P 500, that’s a big headwind due to the fact so many are multinationals: As a group, they derive almost one-half of their revenue from international markets.

“You will get some companies that have failed to meet expectations based on the weakness we’re seeing overseas, so it is going to be a source of disappointment,” said Carmine Grigoli, chief investment strategist at Mizuho Securities in New York. Moreover, that weakness, especially in Europe, “is going to be critical here,” he said. “It’s an important component of [U.S.] earnings going forward.”

While analysts and investors have begun to figure in the negative effects of a fast-strengthening dollar with regard to the approaching third-quarter reporting period, the risk to the fourth quarter and 2015 remains largely unaccounted for.

For instance, third-quarter profit-growth expectations for S&P 500 companies have fallen back to 6.4 percent from about 11 percent two months ago, Thomson Reuters data showed. By contrast, the fourth-quarter growth forecast is down just slightly, to 11.1 percent now from 12.0 percent July 1. And profit-growth estimates for 2015 have actually increased in that time, to 12.4 percent from 11.5 percent.

“If you try and extrapolate out to the fourth quarter how much that currency effect is going to be, your guidance is probably going to come down for a good slug of the multinationals on the S&P,” said Art Hogan, chief market strategist at Wunderlich Securities in New York.

Ford Issues Warning

While the dollar’s strength is a sign of better economic prospects in the U.S. compared with the eurozone and other parts of the world, it makes U.S. goods and services more costly overseas.

Data this week showed German factory activity shrank for the first time in 15 months, while European Central Bank President Mario Draghi disappointed stock investors when he failed to provide a specific stimulus program for the eurozone’s flagging recovery. In China, data showed the country’s manufacturing sector is barely growing.

Mizuho’s Grigoli said third-quarter profit estimates for U.S. companies with the most overseas sales have fallen more than forecasts for the entire S&P 500 and more than projections for companies with almost no overseas sales. His firm’s data show a 1.5 percentage-point decline in estimates from July 31 to Sept. 29 for companies that derive 60 percent or more of their sales from overseas, compared with a 1.0 point decline in estimates for the S&P 500 and a 0.4 point decline for companies with almost no overseas sales exposure.

The Ford Motor Co.’s disappointing forecast this week may be a hint of what’s to come. The No. 2 U.S. automaker cut its forecasts for pretax profit this year, citing steeper losses in Russia and South America.

“Not to extrapolate too broadly from one company, but I think the negative sentiment ... has been pretty dramatic,” said Michael James, managing director of equity trading at Wedbush Securities in Los Angeles. Ford’s share price shed 10.7 percent last week.

The potential hit to earnings follows a nearly flat quarter for the market performance of the S&P 500. The index gained just 0.6 percent, although it remains near its record high.

Equity valuations are also tipped to the high side. From a forward 12-month perspective, the price-to-earnings ratio on the S&P 500 is 15, just above its historic average of 14.9, according to Thomson Reuters data.

Reporting Parade Set To Start

The onslaught of quarterly results begins soon, and the next two weeks bring reports from U.S. companies with some of the highest levels of overseas sales. Among them, fast-food restaurant operator Yum Brands Inc., with about 77 percent of its sales overseas, is scheduled to report Tuesday, while chipmaker Intel Corp., with about 83 percent of its sales overseas, is slated to report Oct. 14.

In the last 30 days, analysts have slashed Yum’s estimates, lowering the average earnings-per-share forecast by 5.4 percent, according to Thomson Reuters StarMine. At the same time, though, Intel’s estimates have been nudged up by 0.2 percent.

Among sectors, tech has the highest percentage of foreign sales, at 57 percent, and analysts say it may take the biggest hit from the dollar this earnings season, according to S&P Dow Jones Indices data.

Qualcomm Inc., whose shares fell 5.6 percent in the third quarter, derives 97 percent of its sales abroad, the data showed. There’s been little recent forecast revision activity for Qualcomm, which will not report earnings until early November.

Accenture PLC tops the list of companies with the most sales abroad within the mega-cap S&P 100, while Fabrinet leads the list of companies with the most sales abroad within the small-cap S&P 600. Twenty-one of the 23 analysts who have revised their Accenture forecasts in the last month have cut their outlooks, while no analysts have changed Fabrinet’s forecasts in the last 30 days.

Tech also has the highest number of profit warnings for the third quarter, although its ratio of negative-to-positive preannouncements, at 2.1-to-1, is lower than the S&P 500’s ratio of 3.3-to-1, Thomson Reuters data showed.

(Reporting by Caroline Valetkevitch. Additional reporting by Chuck Mikolajczak. Editing by Dan Burns and John Pickering)