Irish firms with dollar exposure perform well despite its falling value

Since the beginning of the year the daily financial news has been dominated by the continuing decline in the foreign exchange value of the US dollar.

In 2003 the dollar depreciated by 17 per cent against the resurgent euro and already in 2004 it has weakened by approximately a further 2 per cent.

Most experts are now predicting that the euro/dollar exchange rate will soon reach a rate of $1.35 and there are some forecasting a rate of $1.50. Considering that at the end of the first quarter 2002 a euro only bought 87 US cents it is apparent just how large the depreciation of the dollar has been over the past 18 months.

At today's exchange rate the euro will now buy $1.28 representing a cumulative euro appreciation of approximately 47 per cent from its low point. Of course, at its low point the euro did look extremely undervalued and a correction was fully justified. Nevertheless at current exchange rates the euro is now almost 10 per cent above the level at which it was launched against the dollar.

The initial phase of the euro's life was marked by persistent weakness in the value of the new currency in the foreign exchange market. The main explanation for this weakness was attributed to the slow pace of economic growth in the euro zone relative to the booming US economy.

However, the US economy continued to perform more strongly than Europe throughout the economic slowdown and has recovered sooner.

This year the US economy is forecast to grow by at least 4 per cent compared with an expected sub 2 per cent GDP growth rate in Europe. Therefore, the explanation for the current phase of dollar weakness must lie elsewhere.

The US trade and services deficit is now so large that it can only be funded with capital inflows of over $1.5 billion from foreigners each and every day. With US short-term interest rates at record lows of 1 per cent it has become increasingly difficult to attract in the necessary capital inflows and as a consequence the dollar has weakened.

From an Irish perspective the strengthening euro is undoubtedly putting pressure on Ireland's international competitiveness outside of the euro zone. However, an important offsetting influence has been the recent performance of the sterling exchange rate.

The UK still accounts for a very high proportion of Ireland's external trade and therefore the euro/pound exchange rate has an even larger impact on Ireland's international competitiveness than the euro/dollar rate.

In the past sterling has tended to behave as a halfway house between the dollar and euro, weakening when the dollar has been weak but at a slower pace. In recent months this link has been broken and in fact sterling has strengthened against the euro so far this year.

For many companies quoted on the Irish stock exchange movements in both sterling and the dollar have a significant translation impact on profits. For those companies with substantial UK operations the worst may now be over if sterling does remain firm on the foreign exchange markets.

Those companies with substantial dollar earnings are still at risk of further profit downgrades due to dollar weakness.

However, analysis of share price performance so far this year highlights that quoted Irish companies with substantial overseas businesses have in fact performed quite well.

For example AIB's share price has risen by over 4 per cent so far this year despite the fact that it owns 22.5 per cent of M&T Bank, a large regional US bank.

CRH is even more dependent on its US businesses but its share price has rise by over 3 per cent so far in 2004.

The most dollar-sensitive Irish stock is Waterford Wedgwood and yet its share price has now risen by approximately 18 per cent since the beginning of the year.

Part of the explanation for these share price gains is that investors are paying more heed to the positive impact on profitability caused by the strengthening US economy.

With the US economy predicted to continue to grow in 2004 profits generated by US businesses are likely to continue to expand at an above average pace.

Furthermore, at some point the decline in the US dollar will end and it may well be that the share prices of companies with large US operations already discount even further dollar weakness.

Indeed, if the current consensus view of the dollar proves to be too bearish then there could well be a sharp rally in the share prices of those Irish and European companies that generate a high proportion of profits in the US.