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International market exposure has always been a competitive edge for companies, as these markets offer higher growth rates. However, companies with international market exposure have to face currency headwinds, as strengthening of the U.S. Dollar adversely impacts sales and earnings growths. In 2013, the U.S. Dollar strengthened by approximately 3% against 25 foreign currencies. I believe foreign exchange will remain a headwind in 2014, as the U.S. Dollar is likely to strengthen in the near term. The following table shows the strengthening of the U.S. Dollar against some major foreign currencies in 2013.

Currencies

Change in 2013 (YoY)

Venezuelan Bolivar

(31.5%)

South African Rand

(19%)

Japanese Yen

(18%)

Brazilian Real

(13%)

Indian Rupee

(11.5%)

Russian Ruble

(7.5%)

Canadian Dollar

(6.5%)

Source: googlefinance.com

As the Fed is likely to continue its asset purchase tapering in 2014 and Treasury Yields are rising, it will result in strengthening of the dollar, translating into lower sales and earnings for companies with international exposure. Consumer companies, including Avon Products (AVP), Mondelez International (MDLZ), Procter & Gamble (PG), Philip Morris (PM), Coca-Cola (KO), PepsiCo (PEP), Mead Johnson (MJN), Colgate-Palmolive (CL) and General Mills (GIS), have large international market exposures and foreign exchange changes are expected to adversely impact the sales and earnings growths of these companies.

As consumer companies with large international market exposure are expected to have higher earnings growth projections, in contrast to their peers with little to no international market exposure, they enjoy valuation premiums due to attractive growth profiles. The following table shows the percentage of international sales to total sales and the expected next five years growth rates for some of the consumer companies.

Companies

Percentage of International Revenue

Next Five Year growth rate est.

AVP

>75%

12.5%

CL

>75%

9.5%

PG

60%

8.5%

PM

100%

5%

MDLZ

76%

12.5%

GIS

30%

7.7%

PEP

~30

8%

KO

>30%

6%

Source: Yahoofinance.com and Calculations

Philip Morris, one of the leading tobacco companies of the world, recently announced that foreign currency movements would affect its sales and earnings more than what was expected in Q4 2013, and 2014. Mondelez derives more than three quarters of sales from international markets and approximately 45% of sales from fast growing emerging markets, which is likely to fuel its earnings growth; however, foreign currency is likely to remain a drag on its earnings in 2013 and 2014. The following table shows the foreign currency drag for companies from 2011 through 2014 (2014 numbers are based on estimates).

2011

2012

2013

2014*

AVP

2.6%

(5%)

(3.5%)

(3%)

CL

2.6%

(4%)

(2.5%)

(2%)

PG

2.5%

(2.5)

(1.5%)

(1%)

PM

3.5%

(5%)

(3.5%)

(3%)

MDLZ

3.5%

(4.5%)

(2%)

(1.5%)

GIS

1.4%

(1.25%)

(1%)

(0.5%)

PEP

1%

(1%)

(0.25%)

(0.25%)

KO

3%

(3.5%)

(3)

(2%)

Source: Companies Annual Reports and Estimates

Conclusion
Foreign exchange volatility has increased in recent times as countries are engaged in a currency war, depreciating their currencies to make their exports competitive and attractive. However, as the Fed is likely to continue with its asset tapering it is likely to strengthen the U.S. Dollar against major currencies of the world. The dollar's strengthening will adversely affect the sales and earnings growths of the companies, therefore, I recommend investors to stay cautious and keep an eye on any unexpected movement in foreign currencies, which could have a material impact on the abovementioned companies' financial performances going forward.

Source: The Case Of Foreign Exchange As A Headwind In 2014