Fitch: Strong Dollar Remains Headwind for US Multinationals

Many U.S. multinational companies cited the strong dollar as a headwind to revenues during 1Q15 earnings calls; the dollar has climbed 9% this year against most major currencies. Companies with significant international sales and operating exposure are experiencing pressure not faced by peers with a domestic focused business, according to Fitch Ratings.

Despite efforts by management to defray the impact on the bottom line through hedging agreements or operational adjustments, the profitability of companies with significant international exposure remains vulnerable to currency swings. When accompanied by other operational or capital structure challenges, the impact on a company's credit profile may be great enough to influence ratings.

In early May, Fitch downgraded Avon Products Inc. to 'BB-' with a Negative Rating Outlook. Avon generates more than 80% of revenues internationally, with a strong orientation toward the emerging markets of Brazil and Russia. The value of the real and the ruble dropped by 9% and 21%, respectively, against the dollar in 2014, and the company absorbed $315 million of foreign exchange (FX) translation and transaction costs. In the first quarter of 2015, negative FX translation took 19% off the top line and dampened operating profits and EBITDA by $135 million.

Companies with a greater degree of financial flexibility and a stronger operating outlook are better able to withstand the pressure of FX headwinds on the credit profile. At Coca-Cola Enterprises (CCE), FX has pressured cash generation, but CCE's focus on improving working capital has offset some of the headwind. Cuts to capital expenditures could also be used as a safety valve if needed for CCE to meet free cash flow (FCF) guidance. Furthermore, both CCE and its competitor, PepsiCo Inc. (PEP), have a good deal of operating costs in international markets, which provides a natural hedge to the impact of FX on operating income.

Some other industries benefit from a similar natural hedge. Most auto manufacturers build where they sell, and although there are some transactional effects on imported parts, the rise of global suppliers means that many of the parts are built in the same locations as the cars. Of greater concern is the advantage that the strong dollar creates for international competitors that can cut prices due to a cheaper local currency. A significant increase in yen-driven price competition has yet to occur in the U.S. for auto makers, but there are circumstances where Japanese manufacturers may be adding content without raising prices. A significant number of the Japanese nameplate vehicles sold in the U.S. are also built in the U.S., lessening opportunity to be overly aggressive on price.

Aside from the price strategies used by international competitors to exploit the FX advantage, currency fluctuations will have an organic influence on customer demand in some industries. Lodging C-Corps will likely feel a negative impact, as Fitch expects currency translation losses caused by U.S. dollar strength to temper systemwide RevPAR growth by 100-200 bps (i.e. 4%-6% versus 5%-7% in constant currency). The strong dollar also is likely to lower inbound international visitation rates to the U.S. and prompt more Americans to travel abroad. Lodging REITs' predominantly domestic focus protects them from currency losses but not lower visitation rates. The global focus of most lodging C-Corps will balance the effect from lower net visitation to the U.S.

Dollar strength clearly makes it more affordable for Americans to travel abroad, which amplifies the hit to demand from currency movements. Fitch views gateway markets, such as New York, Los Angeles, San Francisco and Miami, as the most exposed. Few companies have reported weaker demand from international visitors to the U.S.; however, the effect will primarily be felt in the transient demand segment, which has shorter booking lead times and skews toward the summer months.

The strong dollar has created a headwind for airlines with large international networks. However, lower jet fuel is set to be a major benefit to the airlines this year. Companies like Delta have even said it believes the strong dollar might be a net positive and projected second-quarter operating margins of 16%-18%, with over $1.5 billion of FCF. Domestic-focused airlines like Southwest, Alaska, JetBlue and Spirit will not likely see much of a negative impact from a stronger dollar as they have less international business in comparison to other airlines.