For a few dollars more
The weak dollar is doing real damage to drinks companies exporting to the US, says Helen Dunne. Only the most prestige brands can offset dollar weakness by raising prices
THE WEAK US dollar may prove a bonanza for European tourists stocking up on cheap Levi’s and Ray Ban sunglasses, but for international drinks companies it has been a headache that has lasted more than two years and shows no signs of easing.
Recently, for example, Allied Domecq forecast that currency movements would knock £35 million off profits this year, while Diageo’s forward hedging policy against the dollar’s weakness is expected to cost the group about £80m this year and next.
These are among the betterknown giants, generating about 40% of earnings in America, but many smaller drinks companies with production bases in Europe or South Africa are also suffering as they sell products into America.
Many have found it impossible to hike prices in America to take account of the currency’s weakness, leading to pressure on their margins as the cost of production increases while revenues remain relatively flat.
Important to note is that transactional impact (as you swap dollars for other currency) overshadows the translational impact (the impact that the dollar’s weakness has on deals).
This is not an economic loss per se, merely an accounting change, but it cannot be hedged against. Almost £15m of Allied Domecq’s currency related costs derive from translational costs. Joel Gosler, chief executive of Reformed Spirits Company in America, believes drink companies importing into America have seen margins decline by an average of 10%.
Analysts at investment bank Merrill Lynch believe that the proportion of dollarrelated earnings, before tax and interest, of major European drinks companies has fallen from 27% in 2003 to 21% today.
The 8% fall in the dollar since September means that profits, on current trend, are likely to come in about 2% below expectations, although Heineken could be 4% down.
Melissa Earlham, drinks analyst at investment bank UBS, also believes Heineken will be hardest hit. It exports into America but has no offsetting costs that are dollar denominated, making it hugely susceptible to the greenback’s weakness.
Demand for its product has also slowed, making it difficult to raise prices. "If you track Heineken’s share price, there is a huge correlation with the dollar/euro exchange rate," explains Earlham.
"But it has taken the long-term view and not pulled back on advertising or promotional spend." Heineken has suffered partly because it is not seen as a premium brand.
Moët Hennessy, for example, has been able to increase prices by single digits with little problem. Certain Scotch whiskies, such as single malts, are also viewed as premium, and enjoy strong demand, allowing them to partially offset dollar weakness by raising prices.
The dollar’s weakness has also impacted on many Asian markets, where the local currencies maintain informal links with the dollar. Rémy Cointreau, for example, has a significant presence in the US and Asian markets.
Merrill Lynch analysts believe Rémy’s exposure to the US dollar is about 47%, and estimate that each 10% fall in the US currency will knock 15% off the company’s earnings per share.
Spot of bother
Rémy is an active user of financial hedging to protect itself against the dollar’s movements. But the spot prices it has selected have not proved to be wise. It has confirmed that it has hedged about two-thirds of its projected earnings next year at about 1.27 dollars to the euro.
However, Merrill Lynch points out: "Unless the dollar rallies strongly over the next six to 12 months, at some point Rémy’s financial results will need to reflect the fact that the current euro/dollar exchange rate stands at around 1.33."
The bank’s analysts forecast that, if the current exchange rate stays constant, Rémy will face a 6% adverse movement on translation back to euros, and a 9% adverse movement on transaction costs.
Wine producers have also been affected. European and South African producers have struggled, particularly as the US market is now increasingly open to cheap South American wines, from Chile and Argentina, where there are no currency difficulties.
Reformed Spirit’s Joel Gosler admits margins are "not too great" in the wine sector, although producers take advantage of new vintages coming on stream to raise prices.
"But wine drinking is growing, and American customers want a variety, so they are looking much more at overseas producers," he adds. Gary Greenfield, managing director for Distell Europe, says the South African based wine producer launched a major drive into America, with wines like Tassenberg and Fleur du Cap, just as the dollar began its decline.
Distell has seen a "dramatic reduction in margins" as it absorbs currency related losses and maintains prices. "I would estimate that our margins have fallen by 30% on average since 2001 as the rand has strengthened against the dollar.
On the other side, some marketing expenditure is cheaper, because it is reimbursed in dollar terms, so the total loss is not 30%."
Distell has been trying to attain attractive price points at a time when logic states that it should be increasing them.
"The US market is so competitive," Greenfield adds. "We are trying to gain distribution in the US, and we cannot pass on any increase to the distributors. We will absorb the loss as long as possible to get the products established. It is short-term pain for long-term gain."
But the company has reevaluated its production methods and is now constantly looking for ways to save costs, for example by renegotiating long-term contracts with suppliers, finding cheaper packaging and reducing stock levels.
"The dollar’s weakness has actually forced us to be more and more competitive in the production process," admits Greenfield. John Wakely, former city analyst and now independent adviser to many major drinks companies, believes concern over the weak US dollar is somewhat overblown.
He explains, "If you ask any drinks company boss if they would rather a vibrant market and a weak currency or a stagnant market and a strong currency, they would always select the former.
They can still make progress in that environment. "If you look at Japan, the currency is certainly stronger but the economy has not recovered its former glory. The market is weak and drinks companies are struggling there."