Published Febraury 13th, 2017 by Nick McCullum
The recent strength of the U.S. dollar has been widely-publicized. Here are just a few headlines I have witnessed discussing this macroeconomic trend:
- “The dollar’s strength is a problem for the world economy”
- “U.S. Dollar Strength Continues as Consumer Confidence Jumps”
- “U.S Dollar Strength Pushes to 13-Year High”
- “Dollar Slumps After Trump Says Currency Strength ‘Killing Us’”
Anyone who has done any international travel recently will have seen this trend first-hand. It has become more affordable to travel to international destinations. A dollar buys more in other countries today than it has for a long, long time.
For companies with international operations, foreign exchange swings can have a meaningful effect on their top and bottom lines. Just ask any company from the U.K. who witnessed the dramatic fluctuations in the Great British Pound post-Brexit. As the value of the pound dropped, it became very expensive for UK businesses to purchase goods and services from international suppliers.
In this article, data is presented to validate the current strength of the U.S. dollar and analyze four companies who will benefit when the dollar returns to a more normalized level.
A Historical Basis for the Current Greenback
Measuring the strength of the U.S. dollar might seem tricky on the surface.
After all, the United Nations recognizes 180 global currencies. If an investor wanted to get really analytical, they could assess today’s exchange rate for the currency-currency pair for the U.S. dollar and each of the other 179 currencies.
For obvious reasons, this is impractical. It would require too much data analysis to answer such a seemingly simple question.
The individual running the analysis would also need to somehow take into account the volume of each of the other global currencies. After all, a large, economically-important currency like the Yen should hold more weight than a smaller, less-widely traded currencies like the Vietnamese Dong.
To solve this problem, the U.S. Dollar Index (DXY) was created. It measures the strength of the U.S. Dollar relative to six currencies used by the United States’ most significant trading partners.
- The Euro
- The Japanese Yen
- The Canadian Dollar
- The British Pound
- The Swedish Krona
- The Swiss Franc
The Euro holds the most weight in the index, followed by the Yen. This is in accordance with the amount of trade that the United States performed with the users of these currencies at the time that the index was formed.
The index was created in 1973 with a base of 100, which allows for easy calculations of the dollar’s total appreciation since then. The recent strength of the U.S. dollar versus these six currencies can be seen in the following diagram.
Source: Yahoo! Finance
In 2016, the dollar traded at levels higher than any seen throughout the past decade. The greenback has not meaningfully decreased in value since then.
With the dollar trading at such a high level right now, it is natural to wonder when it will return to a more typical level – or revert to the mean, if you will. Multinational companies with a substantial international revenue base are poised to benefit when this happens, as their non-U.S.-dollar earnings will become more valuable when reported in USD.
In particular, four dividend-paying companies will benefit. These are:
- Johnson & Johnson (JNJ)
- The Coca-Cola Company (KO)
- 3M (MMM)
- Procter & Gamble (PG)
Each of these companies is analyzed in detail below.
Johnson & Johnson
Johnson & Johnson (JNJ) is a massive company that manufactures and sells health care products. The company has more than 260 subsidiary companies and operates the world’s sixth-largest consumer health company, the sixth-largest biologics, and the fifth-largest pharmaceutical company.
Johnson & Johnson is also one of the most stable, consistent businesses around, which is evidenced in their noticeably low stock price volatility. This trend is also seen in the company’s financial performance. When they reported fiscal 2016 earnings, Johnson & Johnson announced their 33rd consecutive year of positive earnings growth. This is the longest record I have seen.
Johnson & Johnson has translated this business success to their shareholders in the form of dividend increases. The company has increased dividends for 54 consecutive years.
This means that Johnson & Johnson is qualified to be a Dividend King, a group of elite companies with 50+ years of consecutive dividend increases.
A large part of Johnson & Johnson’s competitive advantage comes from their worldwide operating scope. The company generates a large proportion of their revenues from outside the United States, as outlined in the following slide.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 6
In fiscal 2016, Johnson & Johnson generated $37.8 billion of sales in the United States and $34.1 billion in international markets. 47.4% of the company’s sales were originated outside the United States.
The value of these international sales declines as the value of the U.S. dollar increases. In their 4Q2016 earnings presentation, Johnson & Johnson did not explicitly comment on the impact of currency on fiscal 2016’s results.
Instead, the company forecasted the effect that they expect currency will have on 2017’s results. The following slide displays how Johnson & Johnson expects currency headwinds to create a 1.0% drag on 2017’s sales.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 33
These currency effects trickle down to Johnson & Johnson’s bottom line. The company predicts a 1.8% negative impact on its bottom line during fiscal 2017 because of foreign exchange fluctuations.
Source: Johnson & Johnson Fourth Quarter Earnings Presentation, slide 33
As a very globalized company, Johnson & Johnson will benefit when the U.S. dollar eventually returns to a more normalized level.
The Coca-Cola Company
The Coca-Cola Company (KO) is the gold standard in the beverage industry and member of the blue chip stocks list. Coca-Cola has been delivering outsized returns to investors for decades thanks to their strong brand image, consumer loyalty, and diverse product portfolio.
The company has also been a darling for dividend investors. With 54 consecutive years of dividend growth, Coca-Cola is a Dividend King. Further, Coca-Cola is the most popular dividend growth stock among dividend growth bloggers.
They have the largest market share in their industry by far. With 20 brands that deliver $1 billion in annual sales and a worldwide sales presence, much of Coca-Cola’s revenues are generated in currencies other than the U.S. dollar.
Source: Coca-Cola Fourth Quarter Earnings Presentation, slide 7
This considerable geographic diversification means that the current strength of the U.S. dollar makes Coca-Cola’s international sales less valuable when reported in domestic currency.
This was evident in the company’s recent announcement of their fourth quarter financial results. Coca-Cola’s net revenues declined 6% for the quarter and 5% for the full year. We can assess the impact of currency on these numbers by looking at the “combined unfavorable impact from foreign currency and structural changes of 12% and 9%” for the quarter and full year, respectively.
While not all of these substantial 12% and 9% changes are necessarily being caused by currency (with the remainder being structural changes), it is reasonable to assume that the strength of the greenback has had a significant effect on Coca-Cola’s financial performance.
This trend is expected to continue. For fiscal 2017, Coca-Cola has estimated a 3% to 4% negative impact on earnings per share from currency effects alone.
Source: Coca-Cola 4Q2016 Investor Presentation, slide 12
When domestic currency returns to a level that is more in-line with historical norms, Coca-Cola will benefit as its international earnings suddenly become more valuable.
3M (MMM) is a diversified conglomerate in the industrial manufacturing industry. In many ways, the company is the poster child for its industry, manufacturing 60,000 products that are sold in 200 countries.
Based on the company’s geographically diversified business mix, it is no surprise that 3M’s financial performance is profoundly impacted by foreign exchange fluctuations.
In the fourth quarter of the company’s fiscal 2016, foreign exchange translation provided a 0.8% headwind for 3M’s sales. Other selected details surrounding the company’s financial performance can be seen in the following slide.
Source: 3M Fourth Quarter Earnings Presentation, slide 4
In the upcoming fiscal year, 3M’s management team expects foreign currency translation to have an even larger effect on the company’s top line. 3M has forecasted a currency headwind of 1%-2% for fiscal 2017.
Source: 3M Fourth Quarter Earnings Presentation, slide 15
Although the globalized industrial manufacturing industry continues to face a growth barrier in the form of domestic currency strength, this will change when the greenback returns to a level more consistent with its long-term historical value.
Procter & Gamble
Procter & Gamble (PG) is a massive company in the consumer staples business. They have been in business for 179 years, sell products in more than 180 countries across 10 product categories, and generate ~$65 billion in annual sales.
Procter & Gamble is a popular dividend growth stock. This is partially due to their tremendous dividend growth streak of 60 years, qualifying Procter & Gamble to be a Dividend Aristocrat and a Dividend King.
The company’s worldwide operations have led them to be impacted by the recent strength of the U.S. dollar. In fiscal 2016, Procter & Gamble generated 56% of its net sales from geographic regions outside of North America.
Source: Procter & Gamble 2016 Annual Report, page 2
These international revenues are worth less as reported in U.S. dollars when the greenback strengthens. Unlike some other companies in this article, Procter & Gamble does not appear to explicitly report the percentage effects of currency on their bottom line.
However, we can deduce this effect by comparing the company’s core earnings-per-share growth versus its constant-currency core earnings-per-share growth, both reported in investor documents.
The following slide outlines Procter & Gamble’s core earnings-per-share growth during the past three fiscal years.
The next slide presents Procter & Gamble’s constant currency core earnings-per-share growth. Note that constant currency earnings-per-share growth has been higher in each of the three years under consideration.
Comparing the two diagrams, we note that:
- Fiscal 2014 core earnings-per-share growth of 5% represents a 9% difference from the constant-currency growth of 14%
- Fiscal 2015 core earnings-per-share growth of -2% represented a 13% difference from the constant-currency growth of 11%
- Fiscal 2016 core earnings-per-share growth of -2% represents a 9% difference from the constant-currency growth of 7%
Over the past three years, the average difference between Procter & Gamble’s core earnings-per-share growth and its constant-currency earnings-per-share growth is ~10.3%. Clearly, the strength of the U.S. dollar has had a profound impact on this company’s financial performance.
However, it appears that the company is expecting it effect to slow down in the near future. In fiscal 2017, Procter & Gamble is forecasting that currency & minor brand divestitures will only have a 1% impact on the company’s sales.
Eventually, the U.S. dollar can be expected to return to a more normalized level. This should provide a tailwind for Procter & Gamble’s shareholders, although timing this is practically impossible.
The U.S. dollar is trading at a very elevated level compared to recent times. This has had a large effect on the four companies discussed in this article.
I believe that investors can expect that the U.S. dollar will eventually return to a more normalized level versus a basket of other currencies. Multinational companies that generate a significant proportion of their revenues from abroad will benefit when this happens.
For investors interested in reading more about the effect of foreign exchange fluctuations on their stock holdings, the following articles may be a worthwhile read: