Proctor & Gamble Highlights Currency Exchange Impact With Rising Dollar

The economic conditions across the globe have driven the value of the US dollar to some of the highest levels we've seen in years as compared to virtually all other major currencies in Europe, Asia, and Latin America.  It's well known that this new-found strength in the dollar has a negative impact on US exports.  This week, however, Proctor & Gamble (NYSE: PG) provided an impromptu lesson on the full impact of foreign exchange on global corporations.  For anyone interested in the details, their Q4 2014 Earnings Call Transcript is a must-read. 

What is important to understand is that the exchange rate between the US and the Euro only impacts one aspect of a global business.  Right now, the impact on the bottom line is a negative one, for sure, since the translation back into US dollars is not favorable on the balance sheet, but across Europe as a whole, the problem gets significantly worse.

Goods or product components that are exported to Europe, for instance, are in turn exported to other countries on the continent that are not necessarily in the Eurozone.  This leads to yet another foreign exchange transaction that, depending on the value of that currency versus the Euro, may translate into another negative bottom line impact.  This is especially true if the destination is Russia, Ukraine, or one of the other Eastern European nations with similarly depressed currencies.

Using P&G as the example, they experienced a negative foreign exchange impact to the tune of $1.4 Billion after tax.  Six currencies contributed to 71% of that total, and they represent countries from around the globe: Venezuela, Russia, Japan, Ukraine, Argentina, and Switzerland.  It's common for global companies to import components - P&G used plastic bottles as their example - into a destination hub for subsequent packaging.  In the case of the bottles, you're looking at a Euro to Rubles conversion that is a bottom line negative impact, followed by a Euro to Dollar conversion on the balance sheet that is yet another bottom line negative impact.  The more components imported from around the globe, the greater the impact, especially when the final destination is a country with a very low-valued currency.

Between the actions taken by the ECB to introduce Quantitative Easing, the actions taken by the Swiss recently, and the impact of geopolitical tensions between Russia, Ukraine, and the west, global companies will face this FX headwind through 2015 and likely beyond.  While Proctor & Gamble did a fantastic job of detailing the impact in their conference call last week, the lesson they provided applies to all companies that have a global reach. 

There is no evidence that the US Dollar will weaken in 2015.  In fact, there's suggestion now that it may test its all-time strength against the Euro before the year is out.  We can expect this to put a significant amount of financial pressure on companies with a large exposure to Europe.  Be sure to factor this into your analysis of companies when planning a long-term trade or an investment.  It's a factor with which we have not had to deal throughout the run of this bull market.  Now that it's here, at least for the next year or so, we need to factor it into our thinking.