Hedging Against the Loonie

 |  Includes: FXC, UDN, UUP
by: The Operations Room

By Gad Allon

The Wall Street Journal had an interesting article on the impact of the rise of the Canadian Dollar on the manufacturing sector there and what firms do to fight it (“Loonie Hinders Canadian Firms“).

According to the article, Canada’s rising dollar has started impacting the country’s manufacturing sector, which is trying to stay competitive:

The Loonie, nicknamed for the waterfowl on the one-dollar coin here, hit a post-World War II high in 2007, the peak of a long flight higher that triggered a frenzy of cost-cutting among manufacturers—from moving production out of Canada to sourcing raw materials and other input costs in cheaper U.S. dollars. Executives started taking currency hedging more seriously.

The article then mentions the different strategies firms use to mitigate this risk: Christie Digital System for example, sources its raw material in US dollars and hedges against currency fluctuations by forward buying currency. Both of these are financial hedges, which are usually fairly costly. The firm also increased its automation to cut costs. Other firms engage in what one may consider a natural hedge:

Linda Hasenfratz, chief executive of auto-parts maker Linamar Corp., said about 80% of its production in Canada still goes to the U.S. But mitigating that, as much as 70% of its input costs are now priced in U.S. dollars, depending on the product, she said.

The article points out that in dealing with such risks, there is always need for good old manufacturing techniques that focus on productivity and continuous improvement:

Bombardier Inc., the world’s third-largest aircraft framer behind Boeing Co. and Airbus, actively hedges its currency exposure, but it has also taken measures to improve its productivity, including a complete overhaul of its Toronto plant, where it builds the Q400 turboprops and the Global family of business jets. The Montreal-based company introduced lean-manufacturing techniques in 2007 that improved on-time aircraft delivery and lowered the labor count per unit.

While currency will continue to fluctuate, the impact of these improvements and the ability to instill these processes will surely add value in the long run, unlike most financial hedges. It’s not that the latter are not important. They clearly play an important role. Yet, one has to combine them with operational hedges and improvements.