Saturday, April 19, 2008

Dollar’s plunge enables corporate earnings

The recent round of earnings reports from large companies with international operations on the surface appear to be solid. Coca-Cola, IBM, Caterpillar, eBay, and others all hit the ball out of the park. A more detailed look reveals the weakness; the strong earnings were built on the back of the falling greenback. International sales did not explosively rise, they simply look much better in dollar terms as the greenback continues to steeply slide.

Understandably growth outside the U.S is stronger than domestic increases, with the economy on the brink of recession. The outsized 1st quarter earnings from international sources are more reflective of the greenback’s slide than improvements in non-U.S. sales. In actuality, it is possible to make a case that overall international sales are deteriorating as consumers become more cautious world-wide.

While the profits are reported in dollars on quarterly balance sheets, most of the currency remains offshore and is not converted into greenbacks. In many ways, this serves as paper tiger that helps the quarterly report look solid, while no real benefit is accrued to the company. If the effect of currency rate of conversion was backed out of the earnings, in some cases the international profits would look just as bleak as the domestic situation.

Additionally, most of these overseas profits are difficult to repatriate to the U.S. and put to work. This means that the cash will be put to work internationally or simply sit in offshore accounts; neither scenario helps drive growth or increase jobs domestically.

At some point the trend in the dollar will reverse; at this point many of these firms that excelled in previous earnings will have to mark their offshore cash hordes to market. If not properly hedged in the forex markets, these companies are likely to announce future write-downs in their cash and equivalents.

Dollar's plunge becoming lynchpin in 1Q earnings discusses this situation in more detail.