Impact of the falling Australian dollar

05 Nov 2015

By Shadforth Financial Group

Over the past year the Australian dollar (AUD) has fallen almost 20 per cent from 88 cents to just under 73 cents against the US dollar (USD). The falling AUD not only affected the Australian economy, but also influences companies listed on the ASX from both a revenue and costs perspective. It also impacts the balance sheet and consequently the outlook for earnings.

The weakness in the AUD has been driven by multiple factors, such as 

  •  the weakness in both the Australian economy and its major trading partner (China)
  •  the differential outlook for interest rates between the US (raising rates) and Australia (falling rates) 
  •  lower commodity prices. 

 It should be kept in mind that whilst the AUD has weakened against many currencies, its weakness against the USD has been most pronounced.

Graph 

The Reserve Bank of Australia has previously been quite vocal in its view that the AUD was overvalued and that a lower AUD would help rebalance the economy from mining into housing, tourism, agricultural exports and educational services. This is now occurring, but at a slower than optimal pace. 

Currency movements can impact stock valuations in many ways and should not be looked at in isolation. Most stocks have multiple drivers and many moving parts, making the exact currency impact difficult to assess. 

Drivers of earnings 

 From an earnings perspective, both the income and cost line may be subject to the impact of a currency move. If a company sells goods priced in USD or exports into foreign markets, the company receives an uplift in earnings when translated back into AUD terms. This has a positive impact to top-line growth even if sales remain unchanged and thus an earnings per share (EPS) increase. Ansell (ANN), ResMed (RMD), James Hardie Industries (JHX) and Westfield (WFD) are all examples of stocks that receive direct USD income and may benefit from translation back to AUD. 

The second potential driver of earnings is the impact the currency has on the costs of goods sold (COGS). These costs include factors such as labour, raw materials and final product. If these goods are priced in USD (oil/raw materials), the currency has an immediate negative impact on costs (unless they are hedged). 

Discretionary retailers in Australia importing goods are directly impacted by higher COGS, with The Reject Shop (TRS), Pacific Brands (PBG) and Premier Investments (PMV) examples of stocks that see significant negative leverage to the higher cost of importing and therefore need to increase prices to recover these higher COGS. Companies like Coca-Cola Amatil (CCL) have a policy to hedge these COGS, thus minimising the impact of currency swings. 

The balance sheet is impacted by where assets are domiciled as well as the denomination of the liabilities. The knock on effect of not matching assets to liabilities could impact both an income statement and balance sheet. 

Outlook 

The AUD outlook remains weak and the effect of the currency will continue to influence valuations and the economy going forward. The currency has sold off, yet with slower global growth, a lacklustre Australian economy and differing outlook for interest rates, we are of the view that the AUD will remain weak.

Educational guides